Master of Business Administration – MBA Semester 4-SMU

MB0037 – International Business Management

Assignment Set- 1 & Set- 2
3 Credits (60 Marks)

Submitted by : L.V.R.SASTRY
Reg No : 510910051
Master of Business Administration – MBA Semester 4
MB0037 – International Business Management
Assignment Set- 1
Note: Each question carries 10 Marks. Answer all the questions.
Q.1 a. How has liberalizing trade helped international business? (6 marks)
Sol.
The Benefits of Trade Liberalization
Policies that make an economy open to trade and investment with the rest of the world are
needed for sustained economic growth. The evidence on this is clear. No country in recent
decades has achieved economic success, in terms of substantial increases in living standards for
its people, without being open to the rest of the world. In contrast, trade opening (along with
opening to foreign direct investment) has been an important element in the economic success of
East Asia, where the average import tariff has fallen from 30 percent to 10 percent over the past
20 years.
Opening up their economies to the global economy has been essential in enabling many
developing countries to develop competitive advantages in the manufacture of certain products.
In these countries, defined by the World Bank as the "new globalizers," the number of people in
absolute poverty declined by over 120 million (14 percent) between 1993 and 1998.
There is considerable evidence that more outward-oriented countries tend consistently to grow
faster than ones that are inward-looking. Indeed, one finding is that the benefits of trade
liberalization can exceed the costs by more than a factor of 10. Countries that have opened their
economies in recent years, including India, Vietnam, and Uganda, have experienced faster
growth and more poverty reduction. On average, those developing countries that lowered tariffs
sharply in the 1980s grew more quickly in the 1990s than those that did not.
Freeing trade frequently benefits the poor especially. Developing countries can ill-afford the
large implicit subsidies, often channeled to narrow privileged interests that trade protection
provides. Moreover, the increased growth that results from free trade itself tends to increase the
incomes of the poor in roughly the same proportion as those of the population as a whole. New
jobs are created for unskilled workers, raising them into the middle class. Overall, inequality
among countries has been on the decline since 1990, reflecting more rapid economic growth in
developing countries, in part the result of trade liberalization.
The potential gains from eliminating remaining trade barriers are considerable. Estimate of the
gains from eliminating all barriers to merchandise trade range from US$250 billion to US$680
billion per year. About two-thirds of these gains would accrue to industrial countries. But the
amount accruing to developing countries would still be more than twice the level of aid they
currently receive. Moreover, developing countries would gain more from global trade
liberalization as a percentage of their GDP than industrial countries, because their economies are
more highly protected and because they face higher barriers.
Although there are benefits from improved access to other countries’ markets, countries benefit
most from liberalizing their own markets. The main benefits for industrial countries would come
from the liberalization of their agricultural markets. Developing countries would gain about
equally from liberalization of manufacturing and agriculture. The group of low-income
countries, however, would gain most from agricultural liberalization in industrial countries
because of the greater relative importance of agriculture in their economies.
b. What are the merits and demerits of international trade? (4 marks)
Sol.
Advantages and Disadvantages of International Trade
Advantages to consider:
• Enhance your domestic competitiveness
• Increase sales and profits
• Gain your global market share
• Reduce dependence on existing markets
• Exploit international trade technology
• Extend sales potential of existing products
• Stabilize seasonal market fluctuations
• Enhance potential for expansion of your business
• Sell excess production capacity
• Maintain cost competitiveness in your domestic market

Disadvantages to keep in mind:

• You may need to wait for long-term gains
• Hire staff to launch international trading
• Modify your product or packaging
• Develop new promotional material
• Incur added administrative costs
• Dedicate personnel for traveling
• Wait long for payments
• Apply for additional financing
• Deal with special licenses and regulations
Q. 2 Discuss the impact of culture on International Business. (10 marks)
Sol.
The following can be looked as the various aspects of the cultural dichotomies.

Table 2.1: Cultural Dichotomies

In this new millennium, few executives can afford to turn a blind eye to global business
opportunities. Japanese auto-executives monitor carefully what their European and Korean
competitors are up to in getting a bigger slice of the Chinese auto-market. Executives of
Hollywood movie studios need to weigh the appeal of an expensive movie in Europe and Asia as
much as in the US before a firm commitment. The globalizing wind has broadened the mindsets
of executives, extended the geographical reach of firms, and nudged international business (IB)
research into some new trajectories. One such new trajectory is the concern with national culture.
Whereas traditional IB research has been concerned with economic/ legal issues and
organizational forms and structures, the importance of national culture – broadly defined as
values, beliefs, norms, and behavioural patterns of a national group – has become increasingly
important in the last two decades, largely as a result of the classic work of Hofstede (1980).
National culture has been shown to impact on major business activities, from capital structure
(Chui et al., 2002) to group performance (Gibson, 1999). For reviews, see’ Boyacigiller and
Adler’ (1991) and ‘Earley and Gibson’ (2002).
The purpose of this Unit is to provide a state-of-the-art review of several recent advances in
culture and IB research, with an eye toward productive avenues for future research. It is not our
purpose to be comprehensive; our goal is to spotlight a few highly promising areas for
leapfrogging the field in an increasingly boundary-less business world. We first review the issues
surrounding cultural convergence and divergence, and the processes underlying cultural changes.
We then examine novel constructs for characterizing cultures, and how to enhance the precision
of cultural models by pinpointing when the effects of culture are important. Finally, we examine
the usefulness of experimental methods, which are rarely employed in the field of culture and IB.
A schematic summary of our coverage is given in Table 2.1, which suggests that the topics
reviewed are loosely related, and that their juxtaposition in the present paper represents our
attempt to highlight their importance rather than their coherence as elements of an integrative
framework.

1 Cultural change, convergence and divergence in an era of partial globalization

An issue of considerable theoretical significance is concerned with cultural changes and
transformations taking place in different parts of the world. In fact, since the landmark study of
Haire et al. (1966) and the publication of Industrialism and Industrial Man by Kerr et al. (1960),
researchers have continued to search for similarities in culture-specific beliefs and attitudes in
various aspects of work related attitudes and behaviours, consumption patterns, and the like. If
cultures of the various locales of the world are indeed converging (e.g., Heuer et al., 1999), IB-
related practices would indeed become increasingly similar. Standard, culture-free business
practices would eventually emerge, and inefficiencies and complexities associated with divergent
beliefs and practices in the past era would disappear. In the following section, we review the
evidence on the issue and conclude that such an outlook pertaining to the convergence of various
IB practices is overly optimistic.

2 Evolution of partial globalization

Globalization refers to a ‘growing economic interdependence among countries, as reflected in
the increased cross-border flow of three types of entities: goods and services, capital, and know-
how’ (Govindarajan and Gupta, 2001, 4). Few spoke of ‘world economy’ 25 years ago, and the
prevalent term was ‘international trade’ (Drucker, 1995). However today, international trade has
culminated in the emergence of a global economy, consisting of flows of information,
technology, money, and people, and is conducted via government international organizations
such as the North American Free Trade Agreement (NAFTA) and the European Community;
global organizations such as the International Organization for Standardization (ISO);
multinational companies (MNCs); and cross – border alliances in the form of joint ventures,
international mergers, and acquisitions. These inter – relationships have enhanced participation
in the world economy, and have become a key to domestic economic growth and prosperity
(Drucker, 1995, 153).
Yet, globalization is not without its misgivings and discontents (Sassan, 1998). A vivid image
associated with the G8 summits is the fervent protests against globalization in many parts of the
world, as shown in television and reported in the popular media. Strong opposition to
globalization usually originates from developing countries that have been hurt by the
destabilizing effects of globalization, but in recent times we have also seen heated debates in
Western economies triggered by significant loss of professional jobs as a result of off shoring to
low – wage countries. Indeed, workers in manufacturing and farming in advanced economies are
becoming increasingly wary of globalization, as their income continues to decline significantly.
In parallel to the angry protests against globalization, the flow of goods, services, and
investments across national borders has continued to fall after the rapid gains of the 1990s.
Furthermore, the creation of regional trade blocs, such as NAFTA, the European Union, and the
Association of Southeast Asian Nations, have stimulated discussions about creating other trade
zones involving countries in South Asia, Africa, and other parts of the world. Although it is often
assumed that countries belonging to the World Trade Organization (WTO) have embraced
globalization, the fact is that the world is only partially globalized, at best (Schaeffer, 2003).
Many parts of Central Asia and Eastern Europe, including the former republics of the Soviet
Union, parts of Latin America, Africa, and parts of South Asia, have been sceptical of
globalization (Greider, 1997). In fact, less than 10% of the world’s population is fully globalized
(i.e., being active participants in the consumption of global products and services) (Schaeffer,
2003). Therefore, it is imperative that we analyze the issues of cultural convergence and
divergence in this partially globalized world.
‘Universal culture’ often refers to the assumptions, values, and practices of people in the West
and some elites in non-Western cultures. Huntington (1996) suggested that it originates from the
intellectual elites from a selected group of countries who meet annually in the World Economic
Forum in Davos, Switzerland. These individuals are highly educated, work with symbols and
numbers, are fluent in English, are extensively involved with international commitments, and
travel frequently outside their country. They share the cultural value of individualism, and
believe strongly in market economics and political democracy. Although those belonging to the
Davos group control virtually all of the world’s important international institutions, many of the
world’s governments, and a great majority of the world’s economic and military capabilities, the
cultural values of the Davos group are probably embraced by only a small fraction of the six
billion people of the world.
Popular culture, again mostly Western European and American in origin, also contributes to a
convergence of consumption patterns and leisure activities around the world. However, the
convergence may be superficial, and have only a small influence on fundamental issues such as
beliefs, norms, and ideas about how individuals, groups, institutions, and other important social
agencies ought to function. In fact, Huntington (1996, 58) noted that ‘The essence of Western
civilization is the Magna Carta, not the Magna Mac. The fact that non-Westerners may bite into
the latter has no implications for their accepting the former’. This argument is obvious if we
reverse the typical situation and put Western Europeans and Americans in the shoes of recipients
of cultural influence. For instance, while Chinese Kung Fu dominates fight scenes in Hollywood
movies such as Matrix Reloaded, and Chinese restaurants abound in the West, it seems
implausible that Americans and Europeans have espoused more Chinese values because of their
fondness of Chinese Kung Fu and food. A major argument against cultural convergence is that
traditionalism and modernity may be unrelated (Smith and Bond, 1998). Strong traditional
values, such as group solidarity, interpersonal harmony, paternalism, and feminism, can co-exist
with modern values of individual achievement and competition. A case in point is the findings
that Chinese in Singapore and China indeed endorsed both traditional and modern values (Chang
et al., 2003; Zhang et al., 2003). It is also conceivable that, just as we talk about Westernization
of cultural values around the world, we may also talk about Easternization of values in response
to forces of modernity and consumption values imposed by globalization (Marsella and Choi,
1993).
Although the argument that the world is becoming one culture seems untenable, there are some
areas that do show signs of convergence. We explore in the following the roles of several factors
that simultaneously cause cultures of the world to either converge or diverge, in an attempt to
identify several productive avenues for future research.

3 Role of multiculturalism and cultural identity

The broad ideological framework of a country, corporation, or situation is the most important
determinant of the cultural identity that people develop in a given locale (Triandis, 1994). The
‘melting pot’ ideology suggests that each cultural group loses some of its dominant
characteristics in order to become the mainstream: this is assimilation, or what Triandis (1994)
calls subtractive multiculturalism.
In contrast, when people from a cultural group add appropriate skills and characteristics of other
groups, it may be called integration, or additive multiculturalism. Both of these processes are
essential for cultural convergence to proceed. However, if there is a significant history of conflict
between the cultural groups, it is hard to initiate these processes, as in the case of Israelis and
Palestinians. In general, although there has been some research on the typology of animosity
against other nations (e.g., Jung et al., 2002), we do not know much about how emotional
antagonism against other cultural groups affects trade patterns and intercultural cooperation in a
business context. The issues of cultural identity and emotional reactions to other cultural groups
in an IB context constitute a significant gap in our research effort in this area.
4 Implications of convergence and divergence issues
One message is clear: while convergence in some domains of IB activity is easily noticeable,
especially in consumer values and lifestyles, significant divergence of cultures persists. In fact,
Hofstede (2001) asserts that mental programs of people around the world do not change rapidly,
but remain rather consistent over time. His findings indicate that cultural shifts are relative as
opposed to absolute. Although clusters of some countries in given geographical locales (e.g.,
Argentina, Brazil, Chile) might indicate significant culture shifts towards embracing Anglo
values, the changes do not diminish the absolute differences between such countries and those of
the Anglo countries (i.e., US, Canada, UK). Huntington, in his ‘The Clash of Civilizations’
(1996), presents the view that there is indeed a resurgence of non-Western cultures around the
world, which could result in the redistribution of national power in the conduct of international
affairs. The attempt by the Davos group to bring about uniform practices in various aspects of IB
and work culture, thereby sustaining the forces of globalization, is certainly worthwhile.
However, our analysis suggests that there is no guarantee that such convergence will come about
easily, or without long periods of resistance.
IB scholars need to understand that although some countries might exhibit strong tendencies
toward cultural convergence, as is found in Western countries, there are countries that will reject
globalization, not only because of its adverse economic impacts (Greider, 1997) but also because
globalization tends to introduce distortions (in their view) in profound cultural syndromes that
characterize their national character.
Furthermore, reactions to globalization may take other forms. Bhagat et al. (2003) have recently
argued that adaptation is another approach that could characterize the tendencies of some
cultures in the face of mounting pressures to globalize. Other approaches are rejection, creative
synthesis, and innovation (Bhagat et al., 2003). These different approaches highlight once again
the complex dynamics that underlie cultural convergence and divergence in a partially globalized
world. Also, in discussing issues of convergence and divergence, it is necessary to recognize that
the shift in values is not always from Western society to others, but can result in the change of
Western cultural values as well. For example, the emphasis on quality and teamwork in the West
is partly a result of the popularity of Japanese management two decades ago.
Scholars of IB should recognize that the issue of convergence and divergence in this era of
partial globalization will remain as a persistent and complex issue whose direction might only be
assessed on a region-by-region basis. It is also wise to adopt an interdisciplinary perspective in
understanding the forces that create both convergence and divergence of cultures in different
parts of the world. For instance, in Understanding Globalization, Schaeffer (2003) has provided
an insightful discussion of the social consequences of political, economic and other changes,
which have significant implications for IB. The cause-effect relationships of globalization and its
various outcomes, especially the cultural outcomes, are not only characterized by bi-directional
arrows, but are embedded in a complex web of relationships. How these complex relationships
and processes play out on the stage of IB remains to be uncovered by IB researchers.

5 Processes of cultural changes

In the previous section, we make the point that, through the process of globalization, cultures
influence each other and change, but whether or not these changes will bring about cultural
convergence is yet to be seen. In this section, we delineate a general model that describes and
explains the complex processes underlying cultural changes. As explained before, IB is both an
agent and a recipient of cultural change, and for international business to flourish it is important
to understand its complex, reciprocal relationships with cultural change.
In line with the view of Hofstede (2001) that culture changes very slowly, culture has been
treated as a relatively stable characteristic, reflecting a shared knowledge structure that attenuates
variability in values, behavioral norms, and patterns of behaviours (Erez and Earley, 1993).
Cultural stability helps to reduce ambiguity, and leads to more control over expected behavioural
outcomes (Weick and Quinn, 1999; Leana and Barry, 2000). For instance, most existing models
of culture and work behaviour assume cultural stability and emphasize the fit between a given
culture and certain managerial and motivational practices (Erez and Earley, 1993). High fit
means high adaptation of managerial practices to a given culture and, therefore, high
effectiveness. The assumption of cultural stability is valid as long as there are no environmental
changes that precipitate adaptation and cultural change. Yet, the end of the 20 th century and the
beginning of the new millennium have been characterized by turbulent political and economical
changes, which instigate cultural changes. In line with this argument, Lewin and Kim (2004), in
their comprehensive chapter on adaptation and selection in strategy and change, distinguished
between theories driven by the underlying assumption that adaptation is the mechanism to cope
with change, and theories driven by the underlying assumption of selection and the survival of
the fittest, suggesting that ineffective forms of organization disappear, and new forms emerge.
However, although organizational changes as a reaction to environmental changes have been
subjected to considerable conceptual analyses, the issue of cultural change at the national level
has rarely been addressed.
There are relatively few theories of culture that pertain to the dynamic aspect of culture. One
exception is the eco-cultural model by Berry et al. (2002), which views culture as evolving
adaptations to ecological and socio-political influences, and views individual psychological
characteristics in a population as adaptive to their cultural context, as well as to the broader
ecological and socio-political influences. Similarly, Kitayama (2002) proposes a system view to
understanding the dynamic nature of culture, as opposed to the entity view that sees culture as a
static entity. This system view suggests that each person’s psychological processes are organized
through the active effort to coordinate one’s behaviours with the pertinent cultural systems of
practices and public meanings. Yet, concurrently, many aspects of the psychological systems
develop rather flexibly as they are attuned to the surrounding socio-cultural environment, and are
likely to be configured in different ways across different socio-cultural groups.
These adaptive views of culture are supported by empirical evidence. For example, Van de Vliert
et al. (1999) identified curvilinear relationships between temperature, masculinity and domestic
political violence across 53 countries. Their findings showed that masculinity and domestic
violence are higher in moderately warm countries than in countries with extreme temperatures.
Inglehart and Baker (2000) examined cultural change as reflected by changes in basic values in
three waves of the World Values Surveys, which included 65 societies and 75% of the world’s
population. Their analysis showed that economic development was associated with shifts away
from traditional norms and values toward values that are increasingly rational, tolerant, trusting,
and participatory. However, the data also showed that the broad cultural heritage of a society,
whether it is Protestant, Roman Catholic, Orthodox, Confucian, or Communist, leaves an
enduring imprint on traditional values despite the forces of modernization.
The process of globalization described before has introduced the most significant change in IB,
with its effects filtering down to the national, organizational, group and individual levels.
Reciprocally, changes at micro-levels of culture, when shared by the members of the society,
culminate into macro level phenomena and change the macro-levels of culture. In the absence of
research models that can shed light on this complex process of cultural change, Erez and Gati
(2004) proposed that the general model of multi-level analysis (Klein and Kozlowski, 2000)
could be adopted for understanding the dynamics of culture and cultural change.
6 The dynamics of culture as a multi-level, multi-layer construct
The proposed model consists of two building blocks. One is a multi-level approach, viewing
culture as a multi-level construct that consists of various levels nested within each other from the
most macro-level of a global culture, through national cultures, organizational cultures, group
cultures, and cultural values that are represented in the self at the individual level, as portrayed in
Figure 2.1. The second is based on Schein’s (1992) model viewing culture as a multi – layer
construct consisting of the most external layer of observed artefacts and behaviours, the deeper
level of values, which is testable by social consensus, and the deepest level of basic assumption,
which is invisible and taken for granted. The present model proposes that culture as a multi –
layer construct exists at all levels – from the global to the individual – and that at each level
change first occurs at the most external layer of behaviour, and then, when shared by individuals
who belong to the same cultural context, it becomes a shared value that characterizes the
aggregated unit (group, organizations, or nations).
In the model, the most macro-level is that of a global culture being created by global networks
and global institutions that cross national and cultural borders. As exemplified by the effort of
the Davos group discussed earlier, global organizational structures need to adopt common rules
and procedures in order to have a common ‘language’ for communicating across cultural borders
(Kostova, 1999; Kostova and Roth, 2003; Gupta and Govindarajan, 2000).

Figure 2.1: The dynamic of top-down–bottom-up processes across

levels of culture.
Given the dominance of Western MNCs, the values that dominate the global context are often
based on a free market economy, democracy, acceptance and tolerance of diversity, respect of
freedom of choice, individual rights, and openness to change (Gupta and Govindarajan, 2000).
Below the global level are nested organizations and networks at the national level with their local
cultures varying from one nation or network to another. Further down are local organizations,
and although all of them share some common values of their national culture, they vary in their
local organizational cultures, which are also shaped by the type of industry that they represent,
the type of ownership, the values of the founders, etc. Within each organization are sub-units and
groups that share the common national and organizational culture, but that differ from each other
in their unit culture on the basis of the differences in their functions (e.g., R&D vs
manufacturing), their leaders’ values, and the professional and educational level of their
members. At the bottom of this structure are individuals who through the process of socialization
acquire the cultural values transmitted to them from higher levels of culture. Individuals who
belong to the same group share the same values that differentiate them from other groups and
create a group – level culture through a bottom-up process of aggregation of shared values. For
example, employees of an R&D unit are selected into the unit because of their creative cognitive
style and professional expertise. Their leader also typically facilitates the display of these
personal characteristics because they are crucial for developing innovative products. Thus, all
members of this unit share similar core values, which differentiate them from other
organizational units. Groups that share similar values create the organizational culture through a
process of aggregation, and local organizations that share similar values create the national
culture that is different from other national cultures.
Both top-down and bottom-up processes reflect the dynamic nature of culture, and explain how
culture at different levels is being shaped and reshaped by changes that occur at other levels,
either above it through top-down processes or below it through bottom-up processes. Similarly,
changes at each level affect lower levels through a top-down process, and upper levels through a
bottom-up process of aggregation. The changes in national cultures observed by Inglehart and
Baker (2000) could serve as an example for top-down effects of economic growth, enhanced by
globalization, on a cultural shift from traditional values to modernization. However, in line with
Schein (1992), the deep basic assumptions still reflect the traditional values shaped by the broad
cultural heritage of a society.
Global organizations and networks are being formed by having local-level organizations join the
global arena. That means that there is a continuous reciprocal process of shaping and reshaping
organizations at both levels. For example, multinational companies that operate in the global
market develop common rules and cultural values that enable them to create a synergy between
the various regions, and different parts of the multinational company. These global rules and
values filter down to the local organizations that constitute the global company, and, over time,
they shape the local organizations. Reciprocally, having local organizations join a global
company may introduce changes into the global company because of its need to function
effectively across different cultural boarders. A study by Erez-Rein et al. (2004) demonstrated
how a multinational company that acquired an Israeli company that develops and produces
medical instruments changed the organizational culture of the acquired company. The study
identified a cultural gap between the two companies, with the Israeli company being higher on
the cultural dimension of innovation and lower on the cultural dimension of attention to detail
and conformity to rules and standards as compared with the acquiring company. The latter
insisted on sending the Israeli managers to intensive courses in Six – Sigma, which is an
advanced method of quality improvement, and a managerial philosophy that encompasses all
organizational functions. Upon returning to their company, these managers introduced quality
improvement work methods and procedures to the local company, and caused behavioural
changes, followed by the internalization of quality – oriented values. Thus, a top-down process
of training and education led to changes in work behaviour and work values. Sharing common
behaviours and values by all employees of the local company then shaped the organizational
culture through bottom–up processes. The case of cultural change via international acquisitions
demonstrated the two building blocks of our dynamic model of culture: the multi-level structure
explains how a lower-level culture is being shaped by top-down effects, and that the cultural
layer that changes first is the most external layer of behaviour. In the long run, bottom – up
processes of shared behaviours and norms shape the local organizational culture.
7 Factors that facilitate cultural change
Culture itself influences the level of resistance or acceptance of change. Harzing and Hofstede
(1996) proposed that certain cultural values facilitate change, whereas others hinder it. The
values of low power distance, low uncertainty avoidance, and individualism facilitate change.
Change threatens stability, and introduces uncertainty, and resistance to change will therefore be
higher in cultures of high rather than low uncertainty avoidance (Steensma et al., 2000). Change
also threatens the power structure, and therefore will be avoided in high power distance cultures.
Finally, change breaks the existing harmony, which is highly valued in collectivistic cultures,
and therefore will not be easily accepted by collectivists (Levine and Norenzayan, 1999).
A recent study by Erez and Gati (2004) examined the effects of three factors on the change
process and its outcomes:
· the cultural value of individualism – collectivism;
· the reward structure and its congruence with the underlying cultural values; and
· the degree of ambiguity in the reward structure.
The change process examined was a shift from choosing to work alone to a behavioural choice of
working as part of a team, and vice versa. Working alone is more prevalent in individualistic
cultures, whereas working in teams dominates the collectivistic ones.

8 Understanding when culture matters: increasing the precision of cultural models

Beyond exploring new cultural constructs and the dynamic nature of culture, we also argue for
the importance of examining contingency factors that enhance or mitigate the effect of national
culture. Consider the following scenario. A senior human resource manager in a multinational
firm is charged with implementing an integrative training program in several of the firm’s
subsidiaries around the globe. Over the term of her career, the manager has been educated about
differences in national culture and is sensitive to intercultural opportunities and challenges. At
the same time, she understands the strategic need to create a unified global program that serves
to further integrate the firm’s basic processes, creating efficiencies and synergies across the
remote sites. She approaches the implementation with trepidation. A key challenge is to
determine whether the program should be implemented in the same manner in each subsidiary or
modified according to the local culture at each site. Put another way, in this complex
circumstance, does culture matter?
Q.3. a. Explain the brief structure of WTO. (5 marks)
Sol.
Structure of World Trade Organization (WTO)
The WTO’s overriding objective is to help trade flow smoothly, freely, fairly and predictably.
It does this by:
· Administering trade agreements
· Acting as a forum for trade negotiations
· Settling trade disputes
· Reviewing national trade policies
· Assisting developing countries in trade policy issues, through technical assistance and training
programs
· Cooperating with other international organizations

Structure
The WTO has nearly 150 members, accounting for over 97% of world trade. Around 30 others
are negotiating membership.
Decisions are made by the entire membership. This is typically by consensus. A majority vote is
also possible but it has never been used in the WTO, and was extremely rare under the WTO’s
predecessor, GATT. The WTO’s agreements have been ratified in all members’ parliaments.
The WTO’s top level decision-making body is the Ministerial Conference which meets at least
once every two years.
Below this is the General Council (normally ambassadors and heads of delegation in Geneva,
but sometimes officials sent from members’ capitals) which meets several times a year in the
Geneva headquarters. The General Council also meets as the Trade Policy Review Body and the
Dispute Settlement Body.
At the next level, the Goods Council, Services Council and Intellectual Property (TRIPS)
Council report to the General Council.
Numerous specialized committees, working groups and working parties deal with the
individual agreements and other areas such as the environment, development, membership
applications and regional trade agreements.
Secretariat
The WTO Secretariat, based in Geneva, has around 600 staff and is headed by a director-general.
Its annual budget is roughly 160 million Swiss francs. It does not have branch offices outside
Geneva. Since decisions are taken by the members themselves, the Secretariat does not have the
decision-making role that other international bureaucracies are given with. The Secretariat’s
main duties are to supply technical support for the various councils and committees and the
ministerial conferences, to provide technical assistance for developing countries, to analyze
world trade, and to explain WTO affairs to the public and media.
The Secretariat also provides some forms of legal assistance in the dispute settlement process
and advises governments wishing to become members of the WTO.
Figure 5.1: Structure of WTO
The WTO is ‘member-driven’, with decisions taken by consensus among all member
governments.
The WTO is run by its member governments. All major decisions are made by the membership
as a whole, either by ministers (who meet at least once every two years) or by their ambassadors
or delegates (who meet regularly in Geneva). Decisions are normally taken by consensus.
In this respect, the WTO is different from some other international organizations such as the
World Bank and International Monetary Fund. In the WTO, power is not delegated to a board of
directors or the organization’s head.
When WTO rules impose disciplines on countries’ policies, that is the outcome of negotiations
among WTO members, the rules are enforced by the members themselves under agreed
procedures that they negotiated, including the possibility of trade sanctions. But those sanctions
are imposed by member countries, and authorized by the membership as a whole. This is quite
different from other agencies whose bureaucracies can, for example, influence a country’s policy
by threatening to withhold credit.
Reaching decisions by consensus among some 150 members can be difficult. Its main advantage
is that decisions made this way are more acceptable to all members. And despite the difficulty,
some remarkable agreements have been reached. Nevertheless, proposals for the creation of a
smaller executive body – perhaps like a board of directors each representing different groups of
countries – are heard periodically. But for now, the WTO is a member-driven, consensus-based
organization.
Highest authority: the Ministerial Conference
So, the WTO belongs to its members. The countries make their decisions through various
councils and committees, whose membership consists of all WTO members. Topmost is the
ministerial conference which has to meet at least once every two years. The Ministerial
Conference can take decisions on all matters under any of the multilateral trade agreements.
Second level: General Council in three guises
Day-to-day work in between the ministerial conferences is handled by three bodies:
· The General Council
· The Dispute Settlement Body
· The Trade Policy Review Body
All three are in fact the same – the Agreement Establishing the WTO states they are all the
General Council, although they meet under different terms of reference. Again, all three consist
of all WTO members. They report to the Ministerial Conference.
The General Council acts on behalf of the Ministerial Conference on all WTO affairs. It meets as
the Dispute Settlement Body and the Trade Policy Review Body to oversee procedures for
settling disputes between members and to analyze members’ trade policies.
Third level: councils for each broad area of trade, and more back to top
Three more councils, each handling a different broad area of trade, report to the General Council:
· The Council for Trade in Goods (Goods Council)
· The Council for Trade in Services (Services Council)
· The Council for Trade – Related Aspects of Intellectual Property Rights (TRIPS Council)
As their names indicate, the three are responsible for the workings of the WTO agreements
dealing with their respective areas of trade. Again they consist of all WTO members. These three
also have the subsidiary bodies.
Six other bodies report to the General Council. The scope of their coverage is smaller, so they
are “committees”. But they still consist of all WTO members. They cover issues such as trade
and development, the environment, regional trading arrangements, and administrative issues. The
Singapore Ministerial Conference in December 1996 decided to create new working groups to
look at investment and competition policy, transparency in government procurement, and trade
facilitation.
Two more subsidiary bodies dealing with the plural-lateral agreements (which are not signed by
all WTO members) keep the General Council informed of their activities regularly.
Fourth level: down to the nitty-gritty
Each of the higher level councils has subsidiary bodies. The Goods Council has 11 committees
dealing with specific subjects (such as agriculture, market access, subsidies, anti-dumping
measures and so on). Again, these consist of all member countries. Also reporting to the Goods
Council is the Textiles Monitoring Body, which consists of a chairman and 10 members acting in
their personal capacities, and groups dealing with notifications (governments informing the
WTO about current and new policies or measures) and state trading enterprises.
The Services Council’s subsidiary bodies deal with financial services, domestic regulations,
GATS rules and specific commitments.
At the General Council level, the Dispute Settlement Body also has two subsidiaries: the
dispute settlement “panels” of experts appointed to adjudicate on unresolved disputes, and the
Appellate Body that deals with appeals.
Heads of Delegations and other boards: the need for informality
Important breakthroughs are rarely made in formal meetings of these bodies, least of all in the
higher level councils. Since decisions are made by consensus, without voting, informal
consultations within the WTO play a vital role in bringing a vastly diverse membership round to
an agreement.
One step away from the formal meetings is informal meetings that still include the full
membership, such as those of the Heads of Delegations (HOD). More difficult issues have to be
thrashed out in smaller groups. A common recent practice is for the chairperson of a negotiating
group to attempt to forge a compromise by holding consultations with delegations individually,
in twos or threes, or in groups of 20 – 30 of the most interested delegations.
These smaller meetings have to be handled sensitively. The key is to ensure that everyone is kept
informed about what is going on (the process must be “transparent”) even if they are not in a
particular consultation or meeting, and that they have an opportunity to participate or provide
input (it must be “inclusive”).
One term has become controversial, but more among some outside observers than among
delegations. The “Green Room” is a phrase taken from the informal name of the director-
general’s conference room. It is used to refer to meetings of 20 – 40 delegations, usually at the
level of heads of delegations. These meetings can take place elsewhere, such as at Ministerial
Conferences, and can be called by the minister chairing the conference as well as the director-
general. Similar smaller group consultations can be organized by the chairs of committees
negotiating individual subjects, although the term Green Room is not usually used for these.
In the past delegations have sometimes felt that Green Room meetings could lead to
compromises being struck behind their backs. So, extra efforts are made to ensure that the
process is handled correctly, with regular reports back to the full membership.
The way countries now negotiate has helped somewhat. In order to increase their bargaining
power, countries have formed coalitions. In some subjects such as agriculture virtually all
countries are members of at least one coalition – and in many cases, several coalitions. This
means that all countries can be represented in the process if the coordinators and other key
players are present. The coordinators also take responsibility for both “transparency” and
“inclusiveness” by keeping their coalitions informed and by taking the positions negotiated
within their alliances.
In the end, decisions have to be taken by all members and by consensus. The membership as a
whole would resist attempts to impose the will of a small group. No one has been able to find an
alternative way of achieving consensus on difficult issues, because it is virtually impossible for
members to change their positions voluntarily in meetings of the full membership.
Market access negotiations also involve small groups, but for a completely different reason. The
final outcome is a multilateral package of individual countries’ commitments, but those
commitments are the result of numerous bilateral, informal bargaining sessions, which depend on
individual countries’ interests. (Examples include the traditional tariff negotiations, and market
access talks in services.)
So, informal consultations in various forms play a vital role in allowing consensus to be reached,
but they do not appear in organization charts, precisely because they are informal.
They are not separate from the formal meetings, however. They are necessary for making formal
decisions in the councils and committees. Nor are the formal meetings unimportant. They are the
forums for exchanging views, putting countries’ positions on the record, and ultimately for
confirming decisions. The art of achieving agreement among all WTO members is to strike an
appropriate balance, so that a breakthrough achieved among only a few countries can be
acceptable to the rest of the membership.

b. Highlight the drawbacks of GATT. (5 marks)

Sol.
Given its provisional nature and limited field of action, the success of GATT in promoting and
securing the liberalization of much of world trade over 47 years is incontestable. Continual
reductions in tariffs alone helped spur very high rates of world trade growth – around 8 per cent a
year on average during the 1950s and 1960s. And the momentum of trade liberalization helped
ensure that trade growth consistently out-paced production growth throughout the GATT era.
The rush of new members during the Uruguay Round demonstrated that the multilateral trading
system, as then represented by GATT, was recognized as an anchor for development and an
instrument of economic and trade reform.
The limited achievement of the Tokyo Round, outside the tariff reduction results, was a sign of
difficult times to come. GATT’s success in reducing tariffs to such a low level, combined with a
series of economic recessions in the 1970s and early 1980s, drove governments to devise other
forms of protection for sectors facing increased overseas competition. High rates of
unemployment and constant factory closures led governments in Europe and North America to
seek bilateral market-sharing arrangements with competitors and to embark on a subsidies race
to maintain their holds on agricultural trade. Both these changes undermined the credibility and
effectiveness of GATT.
Apart from the deterioration in the trade policy environment, it also became apparent by the early
1980s that the General Agreement was no longer as relevant to the realities of world trade as it
had been in the 1940s. For a start, world trade had become far more complex and important than
40 years before: the globalization of the world economy was underway, international investment
was exploding and trade in services – not covered by the rules of GATT – was of major interest
to more and more countries and, at the same time, closely tied to further increases in world
merchandise trade. In other respects, the GATT had been found wanting: for instance, with
respect to agriculture where loopholes in the multilateral system were heavily exploited – and
efforts at liberalizing agricultural trade met with little success – and in the textiles and clothing
sector where an exception to the normal disciplines of GATT was negotiated in the form of the
Multi-fibre Arrangement. Even the institutional structure of GATT and its dispute settlement
system were giving cause for concern.
Together, these and other factors convinced GATT members that a new effort to reinforce and
extend the multilateral system should be attempted. That effort resulted in the Uruguay Round.
Q.4. a. Give a short note on the regional economic integration. (5 marks)
Sol.
Regional Economic Integration
Regional integration can take many forms, and nowhere is this more evident than in the vastly
different integration processes taking place in the regions of Europe and East Asia. The subject
of this paper is regional integration as it has developed in East Asia with a focus on the drivers of
that integration. While the paper is not intended as a direct comparison of integration in East
Asia and Europe, it will include some comparisons between the two regions.
Integration in East Asia has progressed very slowly and is still in an early stage despite that the
process has continued for decades. In fact, it could be said that the process began centuries ago –
even as far back as the 15th century. By comparison, European integration has progressed
steadily and has gradually deepened over the last 50 years to reach an advanced stage today with
a common currency and well-developed regional institutions. Thus, the speed of progression and
the level of integration attained in the two regions are quite dissimilar.
In addition to these differences, the drivers behind the integration process in each region are
different. In Europe, the origins of integration have been institutional in nature, and the
development of institutions has been prominent throughout the process. Thus, regional
institutions have been the driving force behind integration in Europe. In East Asia, the
development of regional institutions has also occurred; however, progress in this area has been
slow and the few existing institutions are fairly weak and ineffective. Nevertheless, regional
integration is taking place in East Asia, but the driving force is the market rather than policy or
institutions. Corporations and the production networks they have established are driving
integration in East Asia.

b. Mention the benefits of WTO. (5 marks)

Sol.
Ten Benefits of WTO
1. The system helps to keep the peace
2. The system allows disputes to be handled constructively
3. A system based on rules rather than power makes life easier for all
4. Freer trade cuts the cost of living
5. It gives consumers more choice and a broader range of qualities to choose from
6. Trade raises incomes
7. Trade stimulates economic growth and that can be good news for employment
8. The basic principles make the system economically more efficient, and they cut costs
9. The system shields governments from narrow interests
10. The system encourages good government
Q. 5 a. Explain five-element product wave model. (7 marks)
Sol.
The Five-Element Product Wave
As illustrated in Figure 4.5, the wave model employs design engineering, process engineering,
product marketing, production, and end-of-life activities as elements. The first wave is associated
with the "A" version of a product or service, and survives through the traditional PLC
introduction and growth phases. A second wave begins with the "B" version, the markedly
improved second model. It starts just before the traditional life cycle maturity stage and lives
until sales decline to a point at which an EOL decision must be made.
Note that design engineering has a peak of activity level at each upgrade. Process engineering
activity shadows that of design engineering, as system changes will be contemplated and made to
facilitate the changes made in the product or service. Product marketing also has activity level
spikes that closely match engineering design activity, lagged somewhat for product introduction.
Production has one activity peak that results from demand management and production planning
through master production scheduling.
Finally, the EOL curve peaks at each redesign. The last wave begins shortly before original
production ceases and ends when the product is no longer manufactured or supported by the
EOL Company or division. The EOL element requires that a decision be made about the
preceding version at each major redesign: continue production, make a short-term run of spares,
keep blueprints active so that parts can be made as ordered, enter into a manufacturing and
support agreement with another entity, or discontinue production.
For the sake of parsimony, Figure 4.5 shows only a two-product model ("A" and "B" versions).
In reality, there may be hundreds of significant redesigns. The wave effect comes from the fact
that the process repeats for the successful firm, forming swells in design engineering, process
engineering, product marketing, and manufacturing curves before the final crest at EOL activity.
The five-element product wave, or FPW, uses trigger points, rather than time, as the horizon over
which the element curves vary. Changes in magnitude, represented by the vertical axis, result
from differing activity levels within the five elements. Simple changes in levels of dollar or unit
product sales, in and of themselves, do not necessarily determine the trigger points. Rather, the
varying activity levels are a direct result of product introductions and redesigns that, from the
outset, must take into account company strategy, core capabilities, and the state of the
competitive environment. For example, a product with strong sales may be redesigned in a
preemptive strike against competitors, further distancing that product from the competition, such
as with Caterpillar’s innovative high-drive bulldozers.
That the five-element wave is grounded in reality becomes apparent when considering the recent
research that suggests product introduction cycles are being compressed. Bayus (1994) claims
that knowledge is being applied faster, resulting in increasing levels of new product
introductions. Yet since product removals are not keeping pace with introductions, there are an
increasing number of product variations on the market. Slater (1993) observes that product life
cycles are growing shorter and shorter. Vesey (1992) reports that the strategy for the 1990s is
speed to market and discusses the pressures the market is exerting to shorten product
introduction lead times.
Regardless of whether life cycles are actually being compressed or knowledge is simply being
applied faster, it is apparent that firms are increasing the speed with which they bring their
products to market. The effect of this is a compression of the design engineering, process
engineering, production, and product marketing elements of the wave model. (The EOL curve
may remain unchanged because accelerated introductions do not necessarily affect EOL efforts.)
The five-element wave clearly shows the inefficiency of traditional "over-the-wall" systems as
speed to market increases. As the elements compress, more and more information is thrown over
the wall. Recipients find themselves with less and less time to take action. Taken to the extreme,
in-baskets, phone lines, conference rooms, desks, and floors are soon gridlocked and littered with
unanswered correspondence and things to do. Forget quality; production itself grinds to a halt.
The solution is to maximize the advantage of the relationships within the five-element wave and
work in concurrent teams, as illustrated in Figure 6. That way, responsibility is shared
throughout the system. Members from each discipline optimize the system. The method tears
down barriers between departments and speeds the introduction process, thus decreasing costs.
The focal point becomes the customer, rather than the task. The system is totally interactive and
bound together. Each element is connected to all of the others and is focused on the customer.
(Note that the authors have taken a great deal of artistic license here! No meaning should be
attached to the actual measure of overlap area in Figure 4.6.)
What is the recent experience with teams? There is evidence that using concurrent design teams
speeds the product to market and provides substantial savings. Boeing expects that concurrent
design will save some $4 billion in the development of its 777 airliner. Westinghouse recently
suggested that concurrent engineering would eliminate 200 duplicate processes in a project that
consisted of 600 using traditional over-the-wall approaches. Ford’s Team Taurus was able to cut
a full year out of model turnaround. In addition, design changes required after initial production
began were reduced by some 76 percent.
The strength of the five-element product wave is the fact that it illuminates critical decision
points in the life of a product or service. The interrelationships of the elements clearly illustrate
the benefit of working product introductions, design changes, and end-of-life decisions in teams.
This is particularly true in today’s rapidly compressing environment of speeding products to
market. Furthermore, the model is flexible and may be expanded or contracted to include those
functional areas relevant to the production team. Thus, whether a given firm’s product is a
service or a manufactured good, the five-element wave is a powerful tool that can be deployed to
accelerate effective decision making in markets demanding ever-increasing levels of speed and
agility.

b. What do you mean by globalization? (3 marks)

Sol.
Economic "globalization" is a historical process, the result of human innovation and
technological progress. It refers to the increasing integration of economies around the world,
particularly through trade and financial flows. The term sometimes also refers to the movement
of people (labor) and knowledge (technology) across international borders. There are also
broader cultural, political and environmental dimensions of globalization that are not covered
here.
At its most basic, there is nothing mysterious about globalization. The term has come into
common usage since the 1980s, reflecting technological advances that have made it easier and
quicker to complete international transactions – both trade and financial flows. It refers to an
extension beyond national borders of the same market forces that have operated for centuries at
all levels of human economic activity – village markets, urban industries, or financial centers.
Markets promote efficiency through competition and the division of labor – the specialization
that allows people and economies to focus on what they do best. Global markets offer greater
opportunity for people to tap into more and larger markets around the world. It means that they
can have access to more capital flows, technology, cheaper imports, and larger export markets.
But markets do not necessarily ensure that the benefits of increased efficiency are shared by all.
Countries must be prepared to embrace the policies needed, and in the case of the poorest
countries may need the support of the international community as they do so.
Q. 6. Give some examples of companies doing international business and discuss how they
have they have managed their business in the international markets. (10 marks) Fall 2010
Sol.
A PERSPECTIVE OF THE NORTHEN ISLAND SOFTWARE COMPANIES, RAPD M–
UP
Within six months of announcing it would invest $4.5 million to establish its new software
development center in Northern Ireland, IMR was up and running with more than one-third its
target staff.
"The fast start-up of the Belfast facility reaffirms our confidence to locate in Northern Ireland,"
said Sanan. "The success to date in building a quality work force has surpassed our expectations
and opens up new ambitions for our interests in Northern Ireland."
According to Arthur "Bro" McFerran, president of IMR (NI) Ltd., the company is hiring 12 to 18
programmers a month in Northern Ireland and is well on its way to meeting its staffing goal of
300 by 1999. McFerran credited Northern Ireland’s Training & Employment Agency (T&EA)
with helping place the company’s staffing on the fast track.
"The T&EA not only has helped us to identify and recruit qualified software graduates from
Northern Ireland’s universities, it is also assisting us with a unique initiative to bring additional
sources of high quality talent to the company," McFerran said.
Innovation In Training
Impressed by the number and quality of information technology graduates from the region’s
universities, IMR recognized an untapped resource in the well-educated, versatile graduates of
other fields in Northern Ireland. Working with the T&EA, IMR developed "IMR Academy," an
intensive
20-week training program at the Belfast Institute of Further and Higher Education, to expand the
skills of qualified applicants who are not computer software graduates, but who are equally well-
educated in other
Disciplines and who have demonstrated aptitude for learning computer software programming.
Tom Scott of the T&EA said IMR applicants are assessed throughout the program and those who
successfully complete the course are awarded a National Computing Certificate and full-time
employment with IMR. Approximately 40 trainees have already participated in the program.
"IMR is extremely pleased with the T&EAs ability to design and deliver a training program
customized to our needs, and one that is delivering us an impressive pool of incremental
programming talent," McFerran said.
Smart And Available
"The recent software investments by IMR and other companies provide a new opportunity for
Northern Ireland’s computer graduates," McFerrin said. Recruitment research by IMR indicates
that traditionally, nearly half of the region’s computer graduates have been forced to seek jobs
outside Northern Ireland due to the lack of available information technology positions.
Now IT graduates have the chance to find good jobs in Northern Ireland, and graduates from
other fields can take advantage of the IMR Academy training program to get a head start on a
career in the growing software sector.
McFerrin said. Recruitment research by IMR indicates that traditionally, nearly half of the
region’s computer graduates have been forced to seek jobs outside Northern Ireland due to the
lack of available information technology positions.
Competitive Advantage
Northern Ireland recently has attracted information technology – based investments from other
multinational companies such as BT, Fujitsu, Liberty Mutual Group, Seagate Technology, STB
Systems and UniComp. These companies cite Northern Ireland’s work force and favorable cost
base in their decisions to locate in the region.
"The availability of high-quality graduates combined with the region’s competitive operating
costs and attractive incentives made Northern Ireland the best possible location for STB," said
Richard W. Cooke, STB’s director of engineering operations.
With salaries and fringe costs for well trained software engineers in Northern Ireland
approximately 50 percent lower than costs for US engineers, and low employee turnover and
favorable rates for office space, the overall annual per capita operational costs to develop high
quality software can be significantly less compared with these same costs in the United States.
Typical starting salaries for IT graduates in Northern Ireland are $22,000 to $25,000 annually. At
less than three percent annually, Northern Ireland’s employee turnover rate is a fraction of the
rates typically experienced in other parts of Europe and the United States. Annual costs per
square foot for office space, exclusive of property taxes and service charges, range from as low
as $5 per square foot in some development areas, to approximately $14 in Belfast. These costs
can be as much as 50 percent lower than office space costs in other European cities.
Master Of Business Administration-MBA Semester 4
MB0037 – International Business Management
Assignment Set-2
Note: Each question carries 10 Marks. Answer all the questions.
Q.1 Evaluate the monetary system and currency markets in international business
management. (10 marks)
Sol.
The IMF is an international organization of 185 member countries. It was established to promote
international monetary cooperation, exchange stability, and orderly exchange arrangements; to
foster economic growth and high levels of employment; and to provide temporary financial
assistance to countries to help ease balance of payments adjustment.
The International Monetary Fund (IMF) is the intergovernmental organization that oversees
the global financial system by following the macroeconomic policies of its member countries, in
particular those with an impact on exchange rate and the balance of payments. It is an
organization formed with a stated objective of stabilizing international exchange rates and
facilitating development through the enforcement of liberalising economic policies[1][2] on other
countries as a condition for loans, restructuring or aid.[3] It also offers highly leveraged loans,
mainly to poorer countries. Its headquarters is in Washington, D.C., United States.

Organization and purpose

IMF "Headquarters 1" in Washington, D.C.
The International Monetary Fund was created in July 1945, originally with 45 members, [4] with a
goal to stabilize exchange rates and assist the reconstruction of the world's international payment
system. Countries contributed to a pool which could be borrowed from, on a temporary basis, by
countries with payment imbalances (Condon, 2007). The IMF was important when it was first
created because it helped the world stabilize the economic system. The IMF works to improve
the economies of its member countries.[5]
The IMF describes itself as "an organization of 187 countries (as of July 2010), [6][7] working to
foster global monetary cooperation, secure financial stability, facilitate international trade,
promote high employment and sustainable economic growth, and reduce poverty". With the
exception of Cuba (left in 1964),[8] Taiwan (expelled in 1980),[9] North Korea, Andorra, Monaco,
Liechtenstein, Tuvalu and Nauru, all UN member states participate directly in the IMF. Member
states are represented on a 24-member Executive Board (five Executive Directors are appointed
by the five members with the largest quotas, nineteen Executive Directors are elected by the
remaining members), and all members appoint a Governor to the IMF's Board of Governors.[1

Data dissemination systems

In 1995, the International Monetary Fund began work on data dissemination standards with the
view of guiding IMF member countries to disseminate their economic and financial data to the
public. The International Monetary and Financial Committee (IMFC) endorsed the guidelines for
the dissemination standards and they were split into two tiers: The GDDS and the SDDS.
The International Monetary Fund executive board approved the SDDS and GDDS in 1996 and
1997 respectively and subsequent amendments were published in a revised "Guide to the General
Data Dissemination System". The system is aimed primarily at statisticians and aims to improve
many aspects of statistical systems in a country. It is also part of the World Bank Millennium
Development Goals and Poverty Reduction Strategic Papers.
The IMF established a system and standard to guide members in the dissemination to the public
of their economic and financial data. Currently there are two such systems: General Data
Dissemination System (GDDS) and its superset Special Data Dissemination System (SDDS), for
those member countries having or seeking access to international capital markets.
The primary objective of the GDDS is to encourage IMF member countries to build a framework
to improve data quality and increase statistical capacity building. This will involve the
preparation of meta data describing current statistical collection practices and setting
improvement plans. Upon building a framework, a country can evaluate statistical needs, set
priorities in improving the timeliness, transparency, reliability and accessibility of financial and
economic data.
Q.2 a. Mention the different entry strategies to enter international markets. (4 marks)
Sol.
Entry Strategies
Methods of entry
With rare exceptions, products just don’t emerge in foreign markets overnight – a firm has to
build up a market over time. Several strategies, which differ in aggressiveness, risk, and the
amount of control that the firm is able to maintain, are available:
· Exporting is a relatively low risk strategy in which few investments are made in the new
country. A drawback is that, because the firm makes few if any marketing investments in the
new country, market share may be below potential. Further, the firm, by not operating in the
country, learns less about the market (What do consumers really want? Which kinds of
advertising campaigns are most successful? What are the most effective methods of
distribution?) If an importer is willing to do a good job of marketing, this arrangement may
represent a "win-win" situation, but it may be more difficult for the firm to enter on its own later
if it decides that larger profits can be made within the country.
· Licensing and franchising are also low exposure methods of entry – you allow someone else to
use your trademarks and accumulated expertise. Your partner puts up the money and assumes the
risk. Problems here involve the fact that you are training a potential competitor and that you have
little control over how the business is operated. For example, American fast food restaurants
have found that foreign franchisees often fail to maintain American standards of cleanliness.
Similarly, a foreign manufacturer may use lower quality ingredients in manufacturing a brand
based on premium contents in the home country.
· Contract manufacturing involves having someone else manufacture products while you take on
some of the marketing efforts yourself. This saves investment, but again you may be training a
competitor.
· Direct entry strategies, where the firm either acquires a firm or builds operations "from scratch"
involve the highest exposure, but also the greatest opportunities for profits. The firm gains more
knowledge about the local market and maintains greater control, but now has a huge investment.
In some countries, the government may expropriate assets without compensation, so direct
investment entails an additional risk. A variation involves a joint venture, where a local firm puts
up some of the money and knowledge about the local market.

b. How has E-commerce helped in international marketing? (6 marks)

Sol.
Electronic Commerce
1 Prospects for electronic commerce
Electronic commerce – usually in the form of sales, promotion, or support through the Internet –
is a hot topic at the moment, evidenced by the high market capitalization of firms involved in this
kind of business. Growth rates have been considerable over the last two years and are expected
to persist, at least to some extent, for at least the next several years. Yet, it should be recognized
that so far, sales over the Internet account for only a small portion of sales – especially outside
the U.S.
2 Obstacles to diffusion
Obstacles to the diffusion of Internet trade come both from enduring sources and temporary
roadblocks which may be overcome as consumer attitudes change and technology is improved.
Currently, Internet connections are slower than desired so that downloading pictures and other
information may take longer than consumers are willing to wait. "Glitches" in online ordering
systems may also frustrate consumers, who are unable to place their orders at a given time or
have difficulty navigating through a malfunctioning site. The lack of non-English language sites
in some areas may also be off-putting to consumers, and registering domain names in some
countries is difficult. Further, shipping small packages across countries may be inefficient due to
high local postage rates and inefficiencies in customs processing. Most of these obstacles may be
overcome within next few years.
Other obstacles may, however, have considerably greater staying power. First, there are legal
problems, as several different countries may seek to impose their jurisdiction on advertising and
laws of product assortment and business practices. Further, the maintenance of databases, which
are essential to delivering on the promises of e-commerce, may conflict with the privacy rules of
some countries – this is currently a hot issue of contention between the United States and the
European Union. Finally, there are issues of taxation and collection. While the Clinton
Administration has sought to get the WTO to go along with a three year tax "moratorium" on
Internet purchases much like the one observed in the U.S., strong opposition is expected. A great
attraction of e-commerce in Europe is that people may order from other countries and thus evade
local sales taxes, which can be prohibitive (e.g., 25% in Denmark and 16% in Germany). Some
firms will ship to customers in neighbouring countries without collecting sales taxes or duties,
with the responsibility of paying falling on the consumer. Although most consumers who order
and do not arrange to pay for these taxes get away with it, fines for those caught through random
checks can be severe.
3 Locus of the site
Some firms have chosen to maintain a global site, with reference only to local sales or support
offices; others, in contrast, have unique sites for each country. In some cases, global sites will
hyperlink surfers to a country or region relevant to the site. Note that some confusion exists since
many sites outside the U.S. maintain the ".com" designation rather than their countries’
respective suffix (e.g., ".de" for Germany, ".se" for Sweden, and ".au" for Australia). Some firms
have experienced problems getting their banks to accept credit card charges in more than one
currency, and thus it may be difficult to indicate precise prices in more than one denomination
(one site based in Britain offered its American customers to be as accurate as possible, based on
current exchange rates, although the charge could be off "by a few pennies.")
4 Lifecycle stages across the World
It has been suggested that Europe runs some five years behind the U.S. in electronic commerce,
but some sources dispute this, suggesting that lack of success among American retailers may
have other origins, such as inadequate adaptation (for example, some British users are put off by
American English). There are, however, some factors which cause most countries run behind.
Even in Europe, Internet access penetration rates are lower than they are in the U.S., and the
slower speed associated with downloading Asian characters is discouraging. In some countries,
credit card penetration is lower, and even in European countries with high penetration rates,
consumers are reluctant to use them. Further, the fact that consumers in most countries have to
pay a per minute phone charge discourages the essential casual and relaxed browsing common in
the U.S. so long as unlimited cable or hardwired access is not offered.
Q.3 a. Explain Bill of Lading and Letters of credit. (8 marks)
Sol.
A bill of lading (sometimes referred to as a BOL,or B/L) is a document issued by a carrier to a
shipper, acknowledging that specified goods have been received on board as cargo for
conveyance to a named place for delivery to the consignee who is usually identified. A thorough
bill of lading involves the use of at least two different modes of transport from road, rail, air, and
sea. The term derives from the verb "to lade" which means to load a cargo onto a ship or other
form of transportation.
A bill of lading can be used as a traded object. The standard short form bill of lading is evidence
of the contract of carriage of goods and it serves a number of purposes:
• It is evidence that a valid contract of carriage, or a chartering contract, exists, and it may
incorporate the full terms of the contract between the consignor and the carrier by
reference (i.e. the short form simply refers to the main contract as an existing document,
whereas the long form of a bill of lading (connaissement intégral) issued by the carrier
sets out all the terms of the contract of carriage);
• It is a receipt signed by the carrier confirming whether goods matching the contract
description have been received in good condition (a bill will be described as clean if the
goods have been received on board in apparent good condition and stowed ready for
transport); and
• It is also a document of transfer, being freely transferable but not a negotiable instrument
in the legal sense, i.e. it governs all the legal aspects of physical carriage, and, like a
cheque or other negotiable instrument, it may be endorsed affecting ownership of the
goods actually being carried. This matches everyday experience in that the contract a
person might make with a commercial carrier like FedEx for mostly airway parcels, is
separate from any contract for the sale of the goods to be carried; however, it binds the
carrier to its terms, irrespectively of who the actual holder of the B/L, and owner of the
goods, may be at a specific moment.
• A standard, commercial letter of credit is a document issued mostly by a financial
institution, used primarily in trade finance, which usually provides an irrevocable
payment undertaking.
• The letter of credit can also be source of payment for a transaction, meaning that
redeeming the letter of credit will pay an exporter. Letters of credit are used primarily in
international trade transactions of significant value, for deals between a supplier in one
country and a customer in another. They are also used in the land development process to
ensure that approved public facilities (streets, sidewalks, storm water ponds, etc.) will be
built. The parties to a letter of credit are usually a beneficiary who is to receive the
money, the issuing bank of whom the applicant is a client, and the advising bank of
whom the beneficiary is a client. Almost all letters of credit are irrevocable, i.e., cannot
be amended or canceled without prior agreement of the beneficiary, the issuing bank and
the confirming bank, if any. In executing a transaction, letters of credit incorporate
functions common to giros and Traveler's cheques. Typically, the documents a
beneficiary has to present in order to receive payment include a commercial invoice, bill
of lading, and documents proving the shipment was insured against loss or damage in
transit. However, the list and form of documents is open to imagination and negotiation
 and might contain requirements to present documents issued by a neutral third party
evidencing the quality of the goods shipped, or their place of origin.

b. What is UNCITRAL and what it does? (2 marks)

Sol.
The United Nations Commission on International Trade Law (UNCITRAL) was established
by the United Nations General Assembly by its Resolution 2205 (XXI) of 17 December 1966 "to
promote the progressive harmonization and unification of international trade law.
When world trade began to expand dramatically in the 1960s, national governments began to
realize the need for a global set of standards and rules to harmonize national and regional
regulations, which until then governed
Q.4. Explain the importance of STP in international markets. (10 marks)
Sol.
The importance of STP
Segmentation is the cornerstone of marketing – almost all marketing efforts in some way relate
to decisions on who to serve or how to implement positioning through the different parts of the
marketing mix. For example, one’s distribution strategy should consider where one’s target
market is most likely to buy the product, and a promotional strategy should consider the target’s
media habits and which kinds of messages will be most persuasive. Although it is often
tempting, when observing large markets, to try to be "all things to all people," this is a dangerous
strategy because the firm may lose its distinctive appeal to its chosen segments.
In terms of the "big picture," members of a segment should generally be as similar as possible to
each other on a relevant dimension (e.g., preference for quality vs. low price) and as different as
possible from members of other segments. That is, members should respond in similar ways to
various treatments (such as discounts or high service) so that common campaigns can be aimed
at segment members, but in order to justify a different treatment of other segments, their
members should have their own unique response behaviour.
Q. 5 a. Write a short note on branding and trademarks. (6 marks)
Sol.
Branding and trademarks
As mentioned in chapter four, it is difficult to protect a trademark or brand, unless all countries
are members of a convention. Brand "piracy" is widespread in many developing countries.
Other aspects of branding include the promotional aspects. A family brand of products under the
Zeneca (ex ICI) label or Sterling Health are likely to be recognised worldwide, and hence
enhance the "subjective" product characteristics.
Warranty
Many large value agricultural products like machinery require warranties. Unfortunately not
everyone upholds them. It is common practice in Africa that if the original equipment has not
been bought through an authorized dealer in the country, that dealer refuses to honour the
warranty. This is unfortunate, because not only may the equipment have been legitimately
bought overseas; it also actually builds up consumer resistance to the dealer. When the consumer
is eventually offered with a choice, the reticent dealer will suffer, for example, with the new
dealers coming up.
Cotton Production/Marketing Interface
Spinners
Machines are highly flexible, that is they can usually switch to a variety of yarn requirements.
The machines are geared to high production, are automated and are of a precision for constant
quality provision. There are strict process controls and built – in quality control. Poor raw
material, especially when contaminated with metal particles, damages opening mills, grid knives,
fans and card clothing. Previous devices employed to remove these (magnets) are becoming less
effective. The consequences are damage in the blow room and carding and danger of fire.
Quality is therefore defined as properties of the end use (clothing etc.), efficiency of weaving and
knitting and the efficient running of the spinning plant. Spinners require raw cotton which is free
of trash; dust, sugar and honey dew contamination, seed coats, bark and foreign fibres and, will
not nep the cloth. Further requirements are a certain length (could be short, medium or long),
uniformity of length, strength, fineness, maturity and a certain elongation and colour.
Suppliers
In order to meet these high quality demands, the growers have to ensure that the production,
picking and ginning is of a very high standard.
Cotton grading
The Liverpool Cotton exchange, for one, relied on the skills of its experts to manually classify
raw fibre purchases for its clients. It still holds the "standards" for length, colour and trash
content. As well as the demands of modem machinery, the lack of standardised measuring and
cotton classification procedures has resulted in commercial conflict and legal disputes about the
true nature of traded cotton. Now, computer based high volume instrument listing systems of raw
cotton (HVI systems) are available. The system can handle large numbers of bales, reduce
variation in classification and the need for highly trained bate classifiers.
For cotton exporters the system offers the following advantages:
· enhanced objectivity in classification
· improve communication if similar systems are used by sellers or buyers
· reduced conflict and need for arbitration
· enhanced competitiveness against synthetic fibres
· improved integration with modern spinning machines
· reduced costs on training of experts and in measuring time.
The system can process 2000 bales per day and give a printout on the seven parameters of
grading. These include length and length uniformity, strength and elongation, micronaire or
fineness, leaf and colour. Manufacturers include SPINLAR INC. of Knoxville, USA.
Service
In agricultural machinery, processing equipment and other items which are of substantial value
and technology, service is a prerequisite. In selling to many developing countries, manufacturers
have found their negotiations at stake due to the poor back-up service. Often, this is no fault of
the agent, distributor or dealer in the foreign country, but due to exchange regulations, which
make obtaining spare parts difficult. Many organisations attempt to get around this by insisting
that a Third World buyer purchases a percentage of parts on order with the original items. Allied
to this problem is the poor quality of service due to insufficient training. Good original
equipment manufacturers will insist on training and updating as part of the agency agreement. In
order to illustrate the above points, cotton can be used as an example. Cotton is a major foreign
exchange earner for Zimbabwe. In 1990/91, 52,000 tons were sold overseas at a value of Zim $
238 million. As the spinners, particularly those in the export market are in a highly competitive
industry, it is essential that the raw material is as clean as possible. Also today’s spinning
equipment is highly technical and the spinner wishes to avoid costly breakdowns by all means.
Product strategies
There are five major product strategies in international marketing.
Product communications extension
This strategy is very low cost and merely takes the same product and communication strategy
into other markets. However it can be risky if misjudgements are made. For example, CPC
International believed the US consumer would take to dry soups, which dominate the European
market. It did not work.
Extended product – communications adaptation
If the product basically fits the different needs or segments of a market it may need an
adjustment in marketing communications only. Again this is a low cost strategy, but different
product functions have to be identified and a suitable communications mix developed.
Product adaptation – communications extension
The product is adapted to fit usage conditions but the communication stays the same. The
assumption is that the product will serve the same function in foreign markets under different
usage conditions.
Product adaptation – communications adaptation
Both product and communication strategies need attention to fit the peculiar need of the market.
Product invention
This needs a totally new idea to fit the exclusive conditions of the market. This is very much a
strategy which could be ideal in a Third World situation. The development costs may be high,
but the advantages are also very high.
Table 9.2 summarizes the strategic alternatives with examples.
The choice of strategy will depend on the most appropriate product/market analysis and is a
function of the product itself defined in terms of the function or need it serves, the market
defined in terms of the conditions under which the product is used, the preferences of the
potential customers and the ability to buy the product in question, and the costs of adaptation and
manufacture to the company considering these product – communications approaches.
Table 9.2 International strategic alternatives
Product Communications Product/ Conditions Examples
strategy strategy functions of product
Met use
1. Extension Extension Same Same Pepsi
2. Extension Adaptation Different Same Soups
3. Adaptation Extension Same Different Agriculture
chemicals
4. Adaptation Adaptation Different Different Farm
implements
5. Invention New Same – Tyson turbine
water pump
Thailand tuna

b. What are the features of exchange and currency markets? (4 marks)

Sol.
The exchange rate regimes adopted by countries in today’s international monetary and financial
system, and the system itself, are profoundly different from those envisaged at the 1944 meeting
at Bretton Woods establishing the IMF and the World Bank. In the Bretton Woods system:
· exchange rates were fixed but adjustable. This system aimed both to avoid the undue volatility
thought to characterize floating exchange rates and to prevent competitive depreciations, while
permitting enough flexibility to adjust to fundamental disequilibrium under international
supervision;
· private capital flows were expected to play only a limited role in financing payments
imbalances, and widespread use of controls would prevent instability in such flows;
· temporary official financing of payments imbalances, mainly through the IMF, would smooth
the adjustment process and avoid unduly sharp correction of current account imbalances, with
their repercussions on trade flows, output, and employment.
In the current system, exchange rates among the major currencies (principally the U.S. dollar, the
euro, and Japanese yen) fluctuate in response to market forces, with short-run volatility and
occasional large medium-run swings (Figure 1). Some medium-sized industrial countries also
have market – determined floating rate regimes, while others have adopted harder pegs,
including some European countries outside the euro area. Developing and transition economies
have a wide variety of exchange rate arrangements, with a tendency for many but by no means
all countries to move toward increased exchange rate flexibility (Figure 2).
This variety of exchange rate regimes exists in an environment with the following
characteristics:
· partly for efficiency reasons, and also because of the limited effectiveness of capital controls,
industrial countries have generally abandoned such controls and emerging market economies
have gradually moved away from them. The growth of international capital flows and
globalization of financial markets has also been spurred by the revolution in telecommunications
and information technology, which has dramatically lowered transaction costs in financial
markets and further promoted the liberalization and deregulation of international financial
transactions;
· international private capital flows finance substantial current account imbalances, but the
changes in these flows appear also sometimes to be a cause of macroeconomic disturbances or an
important channel through which they are transmitted to the international system;
· developing and transition countries have been increasingly drawn into the integrating world
economy, in terms of both their trade in goods and services and of financial transactions.
Lessons from the recent crises in emerging markets are that for such countries with important
linkages to global capital markets, the requirements for sustaining pegged exchange rate regimes
have become more demanding as a result of the increased mobility of capital. Therefore, regimes
that allow substantial exchange rate flexibility are probably desirable unless the exchange rate is
firmly fixed through a currency board, unification with another currency, or the adoption of
another currency as the domestic currency (dollarization).
Flexible exchange rates among the major industrial country currencies seem likely to remain a
key feature of the system. The launch of the euro in January 1999 marked a new phase in the
evolution of the system, but the European Central Bank has a clear mandate to focus monetary
policy on the domestic objective of price stability rather than on the exchange rate. Many
medium-sized industrial countries, and developing and transition economies, in an environment
of increasing capital market integration, may also continue to maintain market-determined
floating rates, although more countries could may adopt harder pegs over the longer term. Thus,
prospects are that:
· exchange rates among the euro, the yen, and the dollar are likely to continue to exhibit
volatility, and schemes to reduce volatility are neither likely to be adopted, nor to be desirable as
they prevent monetary policy from being devoted consistently to domestic stabilization
objectives;
· several of the transition countries of central and eastern Europe, especially those preparing for
membership in the European Union, are likely to seek to establish over time the policy
disciplines and institutional structures required to make possible the eventual adoption of the
euro.
The approach taken by the IMF continues to be to advise member countries on the implications
of adopting different exchange rate regimes, to consider the choice of regime to be a matter for
each country to decide and to provide policy advice that is consistent with the maintenance of the
chosen regime (Box 3).
Q. 6 Discuss the various International product and pricing decisions. (10 marks)
Sol.
Production decisions
In decisions on producing or providing products and services in the international market it is
essential that the production of the product or service is well planned and coordinated, both
within and with other functional area of the firm, particularly marketing. For example, in
horticulture, it is essential that any supplier or any of his "out grower" (sub-contractor) can
supply what he says he can. This is especially vital when contracts for supply are finalized, as
failure to supply could incur large penalties. The main elements to consider are the production
process itself, specifications, culture, the physical product, packaging, labelling, branding,
warranty and service.
International Pricing In New Open-Economy Models
Recent developments in open-economy macroeconomics have progressed under the paradigm of
nominal price rigidities, where monetary disturbances are the main source of fluctuations.
Following developments in closed-economy models, new open-economy models have combined
price rigidities and market imperfections in a fully micro founded inter-temporal general
equilibrium setup. This framework has been used extensively to study the properties of the
international transmission of shocks, as well as the welfare implications of alternative monetary
and exchange rate policies.
Imperfect competition is a key feature of the new open-economy framework. Because agents
have some degree of monopoly power instead of being price takers, this framework allows the
explicit analysis of pricing decisions. The two polar cases for pricing decisions are producer-
currency pricing and local-currency pricing. The first case is the traditional approach, which
assumes that prices are preset in the currency of the seller. In this case, prices of imported goods
change proportionally with unexpected changes in the nominal exchange rate, and the law of one
price always holds.’ In contrast, under the assumption of local-currency pricing, prices are preset
in the buyer’s currency. Here, unexpected movements in the nominal exchange rate do not affect
the price of imported goods and lead to short-run deviations from the law of one price.
Empirical evidence using disaggregated data suggests that international markets for tradable
goods remain highly segmented and that deviations in the law of one price are large, persistent,
and highly correlated with movements in the nominal exchange rate, even for highly tradable
goods. Moreover, there is strong evidence that the large and persistent movements that
characterize the behaviour of real exchange rates at the aggregate level are largely accounted for
by deviations in the law of one price for tradable goods.
In this article I make use of a simplified version of a two-country model where the two markets
are segmented, allowing firms to price discriminate across countries, and where prices are preset
in the consumer’s currency. This model generates movements in the real exchange rate in
response to unexpected monetary shocks, which are a result of the failure of the law of one price
for tradable goods. I then compare this model to a version in which prices are preset in the
producer’s currency and examine the implications of these two alternative price-setting regimes
for several key issues.
The price-setting regime determines the currency of denomination of imported goods and the
extent to which changes in exchange rates affect the relative price of imported to domestic goods
and the international allocation of goods in the short run. That is, different pricing regimes imply
different roles for the exchange rate in the international transmission of monetary disturbances.
As we shall see, this assumption has very striking implications for several important questions,
namely real exchange rate variability, the linkage between macroeconomic volatility and
international trade, and the welfare effects of alternative exchange rate regimes, among others.
While generating deviations from the law of one price that are absent from models assuming
producer-currency pricing, the assumption of local-currency pricing still leaves important
features of the data unexplained. The key role of this assumption in the properties of open-
economy models suggests that it is necessary to keep exploring the implications of alternative
pricing structures in open-economy models.
In Section 1, I review the empirical evidence on the behaviour of real exchange rates and on
international market segmentation and pricing. In Section 2, I present the model with local-
currency pricing and explore the main implications of this pricing assumption. The final section
concludes.
1 Some Evidence on Real Exchange Rates
I first review some empirical evidence on the behaviour of real exchange rates using aggregate
data. I then turn to a review of the evidence on the sources of movements in real exchange rates.
The real exchange rate between two countries represents the relative cost of a common reference
basket of goods. For two countries, say the United States and Japan, the real exchange rate is
given by
where P^sub US^ and P^sub JP^ represent the American and Japanese price levels (measured in
terms of dollars and yen, respectively) and where e denotes the nominal exchange rate (defined
as the dollar price of one yen).
The theory of purchasing power parity (PPP) predicts that real exchange rates should equal one,
or at least show a strong tendency to quickly return to one when they differ from this value. The
fundamental building block of PPP is the law of one price: due to arbitrage in goods markets, and
absent barriers to trade, similar products should sell in different countries for the same price
(when converted in the same currency). Large international price differentials would be only
temporary, as profit-maximizing traders would quickly drive international goods prices back in
line. Therefore, if arbitrage in goods markets ensures that the law of one price holds for a
sufficiently broad range of individual goods, then aggregate price levels (when expressed in a
common currency) should be highly correlated across countries.
Because aggregate prices are reported as indices rather than levels, most empirical work has
tested the weaker hypothesis of relative PPP, which requires only that the real exchange rate be
stable over time. Figure 1 show the log changes in the CPI-based dollar-yen real and nominal
exchange rates and the relative price level. In this figure, which is typical for countries with
floating exchange rates and moderate inflation, it clearly stands out that short-run deviations
from PPP are large and volatile.(Delete) In the short run, movements in the real exchange rate
mimic those in the nominal exchange rate, with no offsetting movements in the relative price
level. Not surprisingly, early empirical work based on simple tests of short-run PPP produced
strong rejections of this hypothesis for moderate inflation countries. However; these studies did
not allow for any dynamics of adjustment to PPP and therefore did not address the validity of
PPP as a medium- or long-run proposition.
The conventional explanation for the failure of short-run PPP is the presence of nominal price
rigidities. If the short-term volatility of nominal exchange rates were due mostly to monetary and
financial disturbances, then nominal price stickiness would translate these disturbances into
short-run fluctuations in the real exchange rate. If this were true, however, we should observe a
substantial convergence to PPP in one to two years, as the adjustment of prices and wages takes
place. Purchasing power parity, therefore, would be re-established in the medium to long run.
An extensive body of empirical literature has tested the hypothesis of long run PPP by looking at
the mean-reverting properties of real exchange rates. As is well known, it has proved rather
difficult to find evidence supporting convergence of real exchange rates to PPP even in the long
run.
Earlier empirical studies, which used only post-Bretton Woods data, found it difficult to reject
the hypothesis that bilateral real exchange rates for industrialized countries follow a random
walk under floating exchange rates. But if PPP deviations are very persistent, then it may be
difficult to distinguish empirically between a random walk model and a slow mean-reversion
model for the real exchange rate, especially when this variable is highly volatile. As shown in
Frankel (1986), the post-Bretton Woods period may simply be too short to reliably reject the
random walk hypothesis. To overcome this problem of low power in tests of the random walk
hypothesis, Frankel used an extended data set (annual data for the dollar-pound exchange rates
from 1869 to 1984) and rejected the random walk model in favour of a mean-reverting model for
the real exchange rate. His point estimate for the rate of decay of real exchange rate deviations
was 14 percent per year, which implies a half-life of PPP deviations of 4.6 years. Other studies
that test convergence to PPP using long-horizon data sets tend to find values for the half-life of
PPP deviations between three to five years.
An alternative way to increase the power of unit root tests is to expand the number of countries
in the sample and to perform panel tests of convergence to PPP. Frankel and Rose (1996), for
example, use a panel set of annual data from 1948 to 1992 for 150 countries. They estimate half-
lives for PPP deviations of about four years. Other studies using panel data sets report similar
estimates. Interestingly, these estimates are also similar to those obtained using long-time series
data sets.
In brief, studies using aggregate data provide strong evidence that deviations from PPP are
highly volatile and persistent. Consensus estimates suggest that the speed of convergence to PPP
is roughly 15 percent per year, implying a half-life of PPP deviations of about four years. As we
shall see next, a look at disaggregated data will provide us with a much richer analysis of the
sources of PPP deviations.
The Law of One Price: Market Segmentation and International Pricing
As I pointed out earlier, the idea underlying PPP is that the law of one price holds for a wide
range of individual goods. It has long been recognized, however, that even for highly tradable
goods and at different levels of aggregation, deviations in the law of one price are large,
persistent, and highly correlated with movements in the nominal exchange rate.
One possible explanation for the failure of the law of one price is that international markets are
segmented by physical distance, like different markets within a country. Engel and Rogers
(1996), however, show that both the distance and the physical border between countries are
significant in explaining the variation in prices of similar goods across different U.S. and
Canadian cities. They find that price dispersion is much higher for two cities located in different
countries than for two equidistant cities in the same country. In fact, the effect of the border is
estimated to be equivalent to a distance of 1780 miles between cities within one country. Engel
and Rogers also show that nominal price stickiness accounts for a large portion of the border
effect, suggesting that prices are sticky in the local currency and that changes in the exchange
rate lead to deviations in the law of one price.
Not only are failures of the law of one priced significant but, as recent evidence suggests, they
also play a dominant role in explaining the behaviour of real exchange rates. Engel (1999)
measures the proportion of U.S. real exchange rate movements that can be accounted for by
movements in the relative prices of non-traded goods. Engel decomposes the CPI real exchange
rate into two components: a weighted difference of the relative price of non-traded to traded-
goods prices in each country, and the relative price of traded goods between the countries. If
tradable, as a category, closely followed the law of one price, then all variability in the real
exchange rate would be explained by movements in the first component. However, Engel finds
that movements in the relative price of non-traded goods appear to account for almost none of
the movement in U.S. real exchange rates, even at long time horizons. Instead, nearly all the
variability can be attributed to movements in the relative price of tradable. This finding strongly
suggests that consumer markets for tradable goods are highly segmented internationally and that
movements in the international relative price of consumer tradable are very persistent. Moreover,
given the high volatility of nominal exchange rates, these findings indicate that consumer prices
of most goods (either imported or domestically produced) seem to be sticky in domestic currency
terms.
An alternative approach to studying the relationship between exchange rates and goods prices is
examining how firms in an industry (or country) pass through changes in exchange rates to
export prices. Knetter (1989, 1993) measures the degree of price discrimination across export
destinations that is associated with exchange rate changes for U.S., U.K., German, and Japanese
industry-level data. He finds that the amount of exchange rate pass-through differs considerably
depending on the country and industry. Goldberg and Knetter (1997) provide an extensive survey
of the literature and find that local currency prices of foreign products do not respond fully to
exchange rate changes. While the response varies by industry, on average exchange rate pass-
through to U.S. import prices is only about 50 percent after one year, mainly reflecting changes
in destination-specific markups on exports.
In brief, there is strong evidence that international markets for tradable goods remain highly
segmented and that deviations from PPP are largely accounted for by movements in the relative
price of tradable goods across countries. At the consumer level, exchange rate pass-through to
import prices is virtually zero (suggesting that consumer prices are sticky in domestic currency).
At the producer level, however, exchange rate pass-through is generally positive, but
substantially below one.
Transaction Costs and the Adjustment of PPP and Law of One Price Deviations
Some recent empirical tests of long-run PPP and the law of one price have abandoned the
conventional framework, which assumes a linear autoregressive process for the price differential.
Instead, these studies have started to look into nonlinear models of price adjustment, where the
speed at which price differentials die out depends on the size of the deviation itself.
This alternative framework for the empirical analysis of price differentials is motivated by the
observation that commodity trade is not costless. Persistent deviations from the law of one price
are implied as an equilibrium feature of models with transaction costs, for deviations will be left
uncorrected as long as they are sufficiently small relative to the shipping cost.
The simplest econometric model that implements the notion of a nonlinear adjustment for price
differentials assumes that the process is well described by a random walk for small deviations
(that is, when deviations are within a "band of inaction") and an autoregressive process for large
deviations (that is, when deviations are outside the band). Taylor (2001) shows that the improper
use of linear models when the true model is nonlinear may produce a large bias towards finding a
low speed of convergence. Intuitively, a linear model will fail to support convergence to PPP if
the true model is nonlinear and the process spends most of the time in the random-walk band.
Using both monthly data from the 1920s and annual data spanning two centuries, Michael,
Nobay, and Peel (1997) reject the linear adjustment model in favour of a nonlinear model and
provide strong evidence of mean-reverting behaviour for PPP deviations for every exchange rate
considered.

2 International Pricing in New Open-Economy Macroeconomic Models

The common starting point for most of the recent research in open-economy models with price
rigidities is the model developed in Obstfeld and Rogoff (1995). This model explores the
international monetary transmission mechanism in a general equilibrium setup characterized by
nominal price rigidities, imperfect competition, and incomplete asset markets.
Obstfeld and Rogoff’s model does not generate deviations from the CPI– based purchasing
power parity. This feature reflects the fact that preferences are identical across countries and that
all goods are freely tradable, with prices set in the seller’s currency. In this model, there is
complete pass-through of exchange rate changes to import prices, implying that the law of one
price always holds for all goods and that the real exchange rate is constant.
Motivated by the empirical evidence on the sources of real exchange rate fluctuations, several
recent papers have extended Obstfeld and Rogoff’s framework in order to allow for pricing-to-
market and deviations from the law of one price. This class of models assumes that home and
foreign markets are segmented, which allows imperfectly competitive firms to price discriminate
between home and foreign consumers. Consumers’ inability to arbitrage price differentials
between countries is exogenous, possibly reflecting arbitrarily high transportation costs at the
consumer level. In addition to market segmentation, this class of models also assumes that prices
are sticky in each country’s local currency. That is, firms set prices in advance in the buyer’s
currency, as opposed to the standard assumption that prices are set in the seller’s currency.
I, next outline a basic model in which firms set prices in advance in the local currency of the
buyer (or pricing-to-market). The model is then used to explore the main implications of pricing-
to-market.