INTERNATIONAL BUSINESS ENVIRONMENT & MANAGEMENT

Unit-I
International Business : An overview-types of international business; the external
environment; the economic and political environment, the human cultural
environment; influence on trade and investment patterns; recent world trade and
foreign investment-trends, country risk.

Qu1. Define International Business? What are the types of International

business?
Ans : business is increasingly becoming international or global in its competitive
environment, orientation, content and strategic intent. This is manifested or
necessitated or facilitated by following :
(a)
The competition can be in a firm local, national or foreign-now encounters, in
many cases, is global, i.e. besides the competition from the domestic it has to
competitive with products manufactured in India by foreign firms and imports.
(b)
Because of liberalization, a firm has the challen
ging opportunity to
improve its competitiveness and scope of business by global sourcing of technology,
material, finance, human resources etc.
(c)
Globalisation is facilitating globalization of operations management to
optimize operations and to improve competitiveness. Global value chain
management is indeed a key factor of success.
(d)
The universal liberalization and the resultant global market opportunities are
taken advantage of by the firms to consolidate and expand of business. Growing
competition at home pushing many companies overseas.
(e)
The global orientation of an increasing number of companies I evident from
their mission statements and corporate strategies.
Types :

International business is divided into following :

(a)
Trading :
Import and exports of goods and services have been very fast.
In countries like Japan, there are international trading houses, which transact
enormous volume of business. The export house, trading house, stare trading
houses and superstar trading houses are merchant exporters they buy and resell
goods. They are comparatively small in size from giant trading house of Japan.

(b)
Manufacturing and Marketing : The manufacturing exports are those who
export goods manufactured by them. Many MNCs and other firms both small and
large do manufacturing and marketing
(c)
Sourcing and Marketing : There are many MNCs and firms which outsource
their products which they market at home and abroad.
(d)
Global Sourcing for Production : There are many firms that outsource globally
their raw material, intermediates etc required for their manufacturing.
(e)
Services :
Services is an enormous and fast growing sector of international
businesses. There is a large variety of services rendered internationally. The broad
segment includes tourism and transportations, IT, banking, insurance, consultancies
etc.
(f)
Investments :
International portfolio investment has been growing
fast, as a result of globalization. FDI are associates with establishment of
manufacturing or marketing facilities abroad.
So, in short we can say that every business in todays world is growing
internationally and world is coming closer and with this there are greater chances of
revenue generation.

Qu. 2 What is economic environment? Explain different kinds of economic

system and their influence on international business.

Ans. Apart from the political and legal environment, the economic environment
also influences international business decision. This is because the decision to
trade or locate manufacturing operations varies from one host country to other,
depending upon the form of economic system existing there and various economic
parameters prevailing there, for example, level of income and inflation, health of
industrial, financial and external sector and many others.
Types :

There are three types of economic system :

(a)
Centrally Planned Economy :
It is an economy where production and
distribution system is owned by the Government. The Govt designs the
investments and coordinates the activities of different economic sectors.

Ownership of the means of production and the whole process of production lies in
the hands of Govt. the former USSR and other Eastern countries were examples of
these types of economic system. In international trade, normally the state trading
corporation participates that highly influences the consumers and business.
(b)
Market Based Economy : It is an economy where the decision to produce and
distribute goods is taken by individual firm based on the forces of demand and
supply. They take such decision for the purpose of maximising profit or wealth.
Consumers are free to decide what they want to buy. The United States of America
and Western European countries are example of market based economy. In market
based economy, trade is handled by individual firms that affect the international
business.
(c)
Mixed Economy : It is a compromise between CPE and market based
economy where private and public sectors exist side by side. There is no country
that represents any of the two systems in its purest form. Indian economy system
represents mixed economic system. Economic activities that are fraught with social
considerations are owned and regulated by the Govt. The others are owned and
performed by private sectors.

Qu. 3 Write note on Political environnent.

Ans. The political environment is an important factor that influences the
international business, especially when it is different between the home and host
country. Political setup vary widely between the two extremes :
(a)
Democracy : A democratic political system involves citizens directly or
indirectly, in the policy formulation of a country.
(b)
Totalitarianism : It is a political system , where political power lies in few
hands with virtually no opposition. Constitutional guarantees are denied to the
citizens.
Germany under the rule of Hitlor and Stalin;s Soviet Union were historical examples
of totalitarianism regime. Myanmar is the example of totalitarianism Government.
Political Risk :
Political risk is unexpected changes in political set up in the host
country leading to unexpected discontinuities that bring about changes in very
business environment. For example, if a rightist party wins election in the country
and the policy towards the foreign investment turns liberal, it would create
appositive impact on the operation of MNCs. On the other hand, if a left party
comes in power in the host country, it will have a negative impact on the operation
of MNCs.
Types of Political Risk : Stephen Kobrin classifies political risk as :

(1)
Macro Risk : It is also called country specific risk that affects all foreign firms
in the country.
(a)
Expropriation : It means seizure of private property by the Govt. it involves
payment of compensation. The reason behind expropriation has mainly been
political turmoil. In the post war period, foreign and domestic firms were
nationalized in China in 1960. The Swedish Govt nationalized the ship building
industry at a time when this industry was hit by world wide recession. an estimate
revels that around 12 % of all foreign investment made in 1967 was nationalised
within less than a decade.
(b)
Currency Inconvertibility : Sometimes the host Govt enacts law prohibiting
foreign companies from taking their money out of the country or exchanging the
host country currency for any other currency. The reason is both economic and
political. The Govt of Nigeria imposed such restrictions a couple of decades back in
order to serve its economic and political objectives.
(c)
Credit Risk : Credit risk is refusal to honour a financial contract with a foreign
company or foreign debts. For example when Khomeini came into power in Iran,
the Iranian Govt refuse to pay its debts on grounds that loans were taken during
Shahs regime.
(d)
Ethnic, Religious or Civil Strife : Macro political risk arises on account of war
and violence and racial, ethnic, religious and civil strife within a country. Recent
example of these risks is slaughter in Bosnia and Herzegovina, breakdown of local
authority in Somalia and Rwanda, the upsurge of Islamic fundamentalism in Algeria
and Egypt. Such risks become major political risks for MNCs operating in these
countries.
(2)
Micro Risk : The micro or firm specific risk affecting a particular industry or
firm. The micro risks are :
(a)
Conflict of interest :
The host Govt desires to have a sustainable growth
rate, price stability, comfortable balance of payment, and so on, but the policy of
MNCs operating there is to maximize corporate wealth. For example, transfer of
funds by MNCs may influence the money supply and may cause inflation or
deflation. MNCS may adopt transfer pricing techniques that may cause loss of tax
revenue. It is not simply economic issues that cause conflicts but also noneconomic issues like national security. The US Govt did not permit the Japanese
purchase of Fairchild Industries on the grounds of national security.
(b)
Corruption : It is endemic in many countries, as a result MNCs have to face
serious problems. Foreign firms in Kenya had to sell a part of equity to powerful
politician. Transparency International has surveyed 85 countries and has brought
about the corruption perception index. Many countries rank high in the index. In

1999 34 countries, including OECD members and five other signed a convention to
ban bribery of foreign public officials in international business transaction.
Evaluation of Political risk : Assessment of political risk is first step before a firm
moves to abroad. It is because if such risks are very high, the firm would no like to
operate in that country. If the risk is moderate or low, the firm will operate in that
country but with a suitable political risk management. There are two ways of risk
assessment:
(a)
Qualitative Approach :
It involves inter-personal contacts. Person may
come from within the enterprise or may come from out side the firm. Those persons
are often well acquainted with the political structure of a particular country or
region. Kraar has cited the example of Gulf Oil, which hired person in Govt since
and from universities to find out whether investment in Angola would be safe.
Sometimes company sends a team of experts for on-the spot study of the
political situation of a particular country. This step is only taken after a preparatory
study yields favorable features. This method always gives a more reliable picture
subject to availability of correct information from the local people.
This approach also involves the examination and interpretation of diverse
secondary facts and figures. For this purpose, companies maintain an exclusive risk
analysis division.
(b)
Quantitative Approach ; Quantitative tools are also used to estimate political
risk. American Can uses a computer programme known as primary risk investment
screening matrix involving about 200 variables and reducing them to two numbers.
It represents an index economic variability as also an index of political stability. The
variables includes, in general, frequency of change of Govt, level of violence in the
country, number of armed insurgencies, conflicts with other nations and economic
factors such as inflation rate, external balance deficit, growth rate of economy and
so on.
Management of political Risk :
The political risk management strategy
depends upon the types of the risk and the degree of risk the investment carries. It
also depends upon the timing of the steps taken. There are two types of strategies :
(a)

Management Prior to Investment : there are five ways to manage it :

(i)
included in
increased.

Capital budgeting: in this method

, the factor of political risk is
the very process of capital budgeting and the discount rate is

(ii)
By Reducing the Investment Flow : The risk can be reduced by
reducing
the investment flow from the parent to the subsidiary and filling the
gap through local borrowing in the host country. In this strategy, it is possible that
the firm may
not get the cheapest fund, but the risk will be reduced.

(iii)
Agreement :The political risk can also be reduced by negotiating
agreements with the host Govt. prior to making any investment.
(iv)
Planned Divestment : It is yet another method of reducing risk. If the
company plans to orderly shifting of ownership and control of business to the
local shareholders and it implements the plan, the risk of expropriation will be
minimal.
(v)
Insurance of Risk : The investing firm can be insured against political
risk. Insurance can be purchased from governmental agencies, private financial
service
organisation or from private property-centred insurers.
(b)
Risk Management during the Life Time of the Project :
Management of
risk during pre-investment phase reduces the intensity of risk, but does not
eliminate it. There are four ways to handle the risk in this phase :
(i)
Joint Venture and Concession Agreement :
In a joint venture
agreement, the participants are local shareholders who have political power to
pressurize the
govt to take a decision in their favour or in favour of enterprise.
The govt is interested in earning from the venture and so it does not cancel the
agreement
(ii)
Political Support : Risk can be managed with political support.
International
companies act sometimes as a medium through which the host
govt fulfills its
political needs.

(iii)

Structured Operating Environment : Political risk can be reduced by

creating a linkage of dependency between the operation of the firm in high
risk country and the operations of other units of the same firms in other
countries.
(iv)
Anticipatory Planning: It is also a useful tool in risk management. The
company should take necessary precautions quite in advance. For example,
during Marcos regime in Philippines, the foreign countries begin to foresee
the fall
of Marco regime and they took necessary measures well in advance.
Risk Management following Nationalisation : Despite care taken by international
companies for minimizing the impact of political risk, there are occasions when
nationalisation takes place. There are many ways to minimise this effect :
(a)
Negotiation :The investing company negotiates with the host govt on various
issues and shows its willingness to support the policy and programmes.
(b)
Political and Economic Pressure :
On failure of negotiations with the
host govt, the investing company tries to put political and economic pressure.

(c)
Arbitration : If nationalisation is not reversed through negotiations and
politico-economic pressure, the firm goes for arbitration. It involves the help of a
neutral third party who mediates and asks for payment of compensation.
(d)
Court of Law : when arbitration fails, the only way out is to approach the
court of law. The international law suggests that the company has, first of all, to
seek justice in the host country itself. If it is not satisfied with the judgment of the
court, the company can go to international courts of justice for fixation of adequate
compensation. However, there are occasions when the host govt failed to honour
the verdict of court. For example, the Cuban Government failed to pay
compensation to US companies expropriated during 1959-1961.

Qu. 4 Write note on recent world trade and foreign investment trends.

Ans. World Trade :

For quite a long time, global trade has grown faster than
word output and the trend is likely to continue in future. Exports of developing
countries have been growing faster than those of the developed. The growing
faster means growing proportion of the national output is traded internationally.
For more than two and half decade until the oil stock of the early 1970s there
was a tremendous of world trade propelled by the progressive trade liberalization
and high growth rates of output. There after there has been a substantial growth of
non-tariff barriers and a fall in the growth rates of the developed economies causing
a slow down of the pace of trade growth. However, the growth of the world trade
has been significantly higher than that of the world output.
A trade growth continued to exceed output growth, the ratio of the world
trade in goods and services to world GDP reached 29% in 2000. Since, 1990, this
ratio has been increased 10% points, more than in two preceding decades
combined.
The first rank in terms of the value of exports had been occupied by US, with
Germany and Japan in second and third position respectively, followed by France,
UK and Italy in that order. An important aspect of global trade is the large intraregional trade. Indias share in global exports was 0.4% in 1980. Since around the
mid 1980s there has been a slightly improvement.
Export of developing countries, as a group, has been growing faster than
those of the developed countries. As a result their share in the global exports
increased very significantly so that their share in world trade exports today is
merely 30% while their share in global GNP is about 20%. Many countries have
been marginalized by global trading system. The share of the 50 least developed

countries (LDC) in the global trade is very dismal about 0.5%. A major part of this is
the contribution of a small number among them.
In short, developing countries present a mixed picture of trade performance.
On the one side there is a picture of spectacular performance of some countries and
on the other there is a dismal presented by many. One is therefore tempted to draw
a hypothesis that trade performance has something to do with the domestic
economic factors, including the development and trade strategies.
Foreign Investment :

Foreign investment takes two forms :

(1)
Foreign Portfolio Investment : It is an investment in the share and debt
securities of companies abroad in the secondary market nearly for sake of returns
and not in the interest of the management of the company. It does not involve the
production and distribution of goods and services. It simply gives the investors, a
non-controlling interest in the company. Investment in the securities on the stock
exchange of foreign country or under the global depository receipt mechanism is an
example.
(2)
Foreign Direct Investment : It is very much concerned with the operations
and ownership of the host country. It is an investment in the equity capital of a
company abroad for the sake of the management of the company or investment
abroad through opening of branches. It is found inform of :
(a)
Green-field Investment : It takes place either through opening of branches in
foreign countries or through foreign financial collaboration. If the firm buys entire
equity shares of a foreign company, the later is known as wholly-owned subsidiary
of the buying firm. In case of purchase of more than 50% shares, the later is known
as subsidiary of the buying firm. In case of less than 50%, the later is known as
equity alliances. General Motors of USA has 20% shares in the equity of the Italian
firm Fiat and Fiat maintains 5% shares in equity of General Motors.
(b)
Merger and Acquisition : M &A are either out right purchase of running
company abroad or an amalgamation with a running foreign company. There are
three forms of M & A :
(i)
Based on corporate structure : Acquisition, where one firm acquire or
purchase another firm. Amalgamation, in this two merging firms lose their
identity
into a new firm that comes into exist representing the interest of
the two.
(ii)
Based on Financial Relationship: It can be vertical, horizontal and
conglomerate. In horizontal, two or more firms are engaged in similar lines of
activities join hands. Horizontal m & A helps to create economies of scales in
occurs among firms involved in different stages of production of a single final
product. If oil exploration and refinery firms merge, it will be called a vertical

integration. Conglomerate merger involves two or more firms in unrelated

activities. There are financial conglomerates where a company manages the
financial function of other companies in the group. Similarly, there are
managerial conglomerates combining the management of several companies
under one roof.
(iii)
Based on techniques :
M & A are either Hostile or Friendly. In the
hostile takeovers, the time devoted to negotiations is minimized as much as
possible because it is just the discreet purchase of shares of the target
company.
In friendly takeovers, there are a lot of negotiations. The takeover deal
is not disclosed until it is finalised. To this end, the acquiring company signs the
confidentiality letter whereby it promises not to disclose the fact to third
party.
Finally, after the announcement is made to the press, a contract is
signed.
Motivation of Merger & Acquision : There are following motives behind M & A :
(a)
M & A provides synergistic advantages. For example, when the fixed costs in
firm A does not cross the relevant range even after it acquires firm B, the
combination will lead to saving of fixed costs that firm B was previously incurring.
(b)
It enables the overnight growth of firm. At the same time very risk of
competition reduces after merger.
(c)
It reduces financial risks through greater amount of diversitification. More
particularly in case of conglomerates, assets of completely differently risk classes
are acquired and there are possibilities of negative correlation between the rates of
return.
(d)
It leads to diversification, which raises the debt capacity of the firm. It helps
the cost of capital to move downward and raises the value of corporate wealth.
(e)

The tax savings sometimes leads firms to combine.

In international business, M & A are very common now a day because of

above said reasons. However, international M & A sometimes becomes an essential
step when the domestic market is saturated and firm is desirous of further
expansion for reaping gains from external economies.

Unit II

Balance of payment accounts and macro economic management; theories

and institutions; trade and investment ; govt. influence on trade and
investment.

Qu. 5. Define Balance of Payments?

Ans Balance of payments is a statement showing a countrys commercial

transaction with rest of the world. It shows outflow and inflow of foreign exchange.
The system recordings are based on the concept of double entry book keeping,
where the credit side shows the receipt of foreign exchange from abroad and debit
side shows payment in foreign exchange to foreign resident.
Types : There are three types of payments :
(a)
Current account Transaction :
Current account is a part of BOP
statement showing flow of real income or foreign exchange transactions on account
of trade of goods and invisibles. The current account records the receipt and
payments of foreign exchange in the following way :
Current Account receipt
(i)
Export of goods :
into the country.
(ii)

The export of goods effect the inflow of foreign exchange

Invisibles such as services, unilateral transfers and investment income.

(iii)
Non-monetary movement of gold : This is for industrial purpose and shown
in current account, either separately from, or along with, trade in merchandise.
Current account Payments
(i)
Import of Goods import of goods cause outflow of foreign exchange from the
country.
(ii)

Invisibles such as services, unilateral transfers and investment income.

(iii)
Non-monetary movement of gold : This is for industrial purpose and shown in
current account, either separately from, or along with, trade in merchandise.
The debit and credit side of two account are balanced. If the credit side is
greater than the debit side, the difference shows the current account surplus. On
the contrary, the excess of debit side over the credit indicates current account
deficit.
(b)
Capital account Transactions : Capital account is a part of BOP statement
showing flow of foreign loans / investment and banking funds. Capital account
transactions takes place in following ways :
Capital account Receipt :

(i)

Long term inflow of funds

(ii)

Short term inflow of funds

Capital account Payments ;

(i)

Long term Outflow of funds

(ii)

Short term outflow of funds

Errors and Omission : It is also termed as statistical discrepancy. It is an

important item on BOP statement, and is taken into account for arriving at overall
balance. Following are some reasons:
(a)
It arises because of difficulties involved in collecting balance of payment
data. There are different sources of data, which sometimes differs in approach.
(b)
Movement of funds may lead or leg transaction that funds are supposed to
finance. For example goods are shipped in march, but the payments are received in
April. In this case figures complied on 31 March, will record the shipment that has
been sent, but the payment would be recorded in the following year.
(c)
Certain figures are derived on the basis of estimates. For example, figures for
earning on travel and tourism accounts are estimated on the basis of sample cases.
If the sample is defective, there is every possibility of error and omission.
(d)
Errors and omission are explained by unrecorded illegal transaction that may
be either on the debit side, or on credit side, or on both sides. Only the net amount
is written on the balance of payments. When the country is politically or
economically stable, credit balance is normally found because unrecorded inflows of
funds occur. The experience reveled that when Iraq invaded Kuwait, the US balance
of payments witnessed such flows on credit side.
Accommodating Capital Inflows :
After the errors and omission is located, the
overall balance of payments is arrived at. If the overall balance of payment is
surplus, the surplus amount is used for repaying the borrowings from IMF and then
the rest is transferred to the official reserve account. On the contrary, if the balance
is found in deficit, the monastery authorities arrange for capital inflows to cover up
the deficit. Accommodating of capital flow is the inflow of foreign exchange to meet
the balance of payments deficit, normally from the IMF.
Autonomous capital flow : It refers to flow of loans / investments in normal course
of a business. A foreigner paying back the loan or the inflow of foreign direct
investment is an apposite example of such inflow. These account goes above-theline while accommodating capital account inflow goes below-the-line.
(c)
Official Reserve Account : Official reserve are held by the monetary
authorities of a country. They comprise of monetary gold, SDR allocations by the

IMF and foreign currency assets. Foreign currency assets are normally held in the
form of balance with foreign central banks and investment in foreign government
securities. The surplus of balance is transferred to this account. But if the overall
balance of payment is in deficit, and if accommodating capital is not available, the
official reserve account is debited by the amount of deficit.
EQUILIBRIUM, DISEQUILIBRIUM AND ADJUSTMENT
Equlibrium : since the BOP is constructed on the basis of double entry book
keeping, credit is always equal to debit. If debit on the current account is greater
than the credit side, funds flow into the country, which are recorded on the credit
side of capital account.
The excess of debit is wiped out. Thus the concept of BOP is based on the concept
of accounting equilibrium, that is :
Current account + capital account +0
The accounting balance is ex post concept that describes what has happened over a
specific past period.
Disequilibrium : In economic terms, BOP equilibrium occurs when surplus or deficit
is eliminated from the balance of payments. In real such equilibrium is not found,
rather disequilibrium in the BOP which is a normal phenomenon. There are external
economical variables influencing the BOP and giving rise to disequilibrium. Some
important variables are :
(i)
National Output and Spending : If the national income exceeds spending, the
excess amount will be invested abroad, resulting in capital account deficit. Excess
of spending over income causes borrowings from abroad, pushing the capital
account into surplus zone.
(ii)
Money Supply : Increase in money supply rises the price level and export
turn uncompetitive. Fall in export earnings leads to deficit in current account. The
higher price of domestic goods makes the price of imported commodities
competitive and import rise, leading to enlargement in the current account.
(iii)
Exchange Rate : If the currency of a country depreciates, export becomes
competitive. Export earnings improve. On the other hand import becomes costlier.
If as a result import is restricted, the trade account balance will improve. But if
imports are not restrained, deficit will appear in the trade account. The net effect
depends upon how far the demand for export and import is price elastic.
(iv)
Interest Rate : The increase in domestic interest rate causes capital inflow in
lure of higher returns. Capital account runs surplus. The reverse is the case when
the interest rate falls.

Adjustments : Disequilibrium becomes a cause of concerns when it is associated

with the current account. This is because current account represents shift in real
income and at the same time any adjustments in this account is not very easy. If
balance of trade is in surplus, its correction is not difficult. The surplus amount is
used in meeting the deficit on invisible account or it may be invested abroad. But if
the balance of trade is in deficit and the deficit is large, so as not to be covered by
invisibles trade surplus, current account deficit will occur. If the deficit on the
current account continues to persist, official reserve will be eroded. If a country
borrows large amount to meet the deficit, it may fall to a vicious debt trap. This is
why adjustment measures are primarily aid at correcting disequilibrium in the trade
account.

Qu. 6 Explain theory of Trade and Investment.

Ans. There have been a number of theoretical explanations on international trade

and investment.
TRADE THEORY :
Following are the trade theories:
Classical theory : there are two classical theories :
(i)
Theory of Absolute Cost Advantage : Adam Smith compounded this theory
of international trade in 1976. He was of the opinion that productive efficiency
differed among different countries because of diversity in natural and acquired
resources possessed by them. The theory explains that a country having absolute
cost advantage in the production of a product on the account of greater efficiency
should specialize in its production and export. For example, suppose country A
produces 1 kg of rice with 10 units of labour or it produces 1 kg of wheat with 20
units of labour. Country B produces the same amount of rice with 20 units of
labour and same amount of wheat with 10 units of labour. Each of countries has
100 units of labour. Equal amount of labour is used for the production of two goods
in the absence of trade between them. But when the trade is possible between two
countries, A will produce only rice and exchange a part of rice output with wheat
from country B. Similarly country B will do. The total output of both the countries
will rise because of trade.
(ii)
Theory of Comparative Cost Advantage : This theory is compounded by
David Ricardo. The theory explains that a country should specialize in the
production and export of a commodity in which it possesses greatest relative
advantage. For example, Bangladesh and India, each of the two has 100 units of
labour. In Bangladesh, 10 units of labour are required to produce to produce either

one kg of rice or one kg of wheat. On the contrary, in India, 5 units are required to
produce one kg of wheat and 8 units are required to produce one kg of rice. From
the viewpoint of absolute cost advantage, there will be no trade as India possesses
absolute cost advantage in the production of both the commodities. But Ricardo is
of the view that from the viewpoint of comparative cost advantage, there will be
trade, because India possesses comparative cost advantage in the production of
wheat. This is because the ratio of cost between Bangladesh and India is 2:1 in
case of wheat, while it is 1.25: 1 in case of rice. Because of this comparative cost
advantage, India will produce 20 kg of wheat with 100 units of labour and export
apart of wheat to Bangladesh. On the other hand, Bangladesh will produce 10 kg of
rice with 100 units of labour and export apart of rice to India. The total output of
foodgrain in the two rises because of trade.
Limitations : Despite of being simple, the classical theory of international business
suffers of following limitations :
(i)
It takes into consideration only one factor of production that is labour. But in
real world, there are other factors that play a decisive role in production.
(ii)
The theory assumes the existence of full employment, but in practical, full
employment is not possible.
(iii)
Theory stress too much on specialization that is expected to improve
efficiency. But it is not always the case in real life.
(iv)
Classical economist feel that resources are mobile domestically and immobile
internationally. But neither of the two assumptions is correct
Summary : The Classical theory holds good even today insofar as it suggest how a
nation could achieve the consumption level beyond what it would in absence of
trade.
Factor Proportions Theory or Heckschar and Ohlin Model
The theory was compounded by two Swedish economists, Eli Heckscher and
Bertil Ohlin. The theory explains that a country should produce and export a
commodity that primarily involves a factor of production abundantly available in the
country. For example, country A has large population and large labour resources.
Thus it will be able to produce the goods at a lower cost using a labour intensive
mode of production. Country B has abundance of capital but is short of labour
resources and will specialize in goods that involve a capital intensive mode of
production. After the trade, both the countries will have two types of goods at the
lest cost. Mr. Samuelson went a few steps ahead saying that in this way the prices
of factors of production tend to equalize among different countries. Leontief found
in his empirical study that the USA being the capital abundant economy, exported
labour intensive goods. But he was of this view that such possibilities could not be

ruled out because the USA was able to produce labour intensive goods in a capital
intensive fashion.
Neo-Factor proportion Theory
Extending Leontiefs view, some of the economist emphasis on the point that
it is not only the abundance of a particular factor, but also the quality of that factor
of production that influences the pattern of international trade. The quality is so
important in their view that they analysis the trade theory in a three-factor
framework :
(a)
Human capital : It is the result of better education and training. Human
capital should be treated as a factor input like physical labour and capital. A
country with human capital maintains an edge over other countries with regards to
the export of commodities produces with the help of improved human capital.
(b)
Skill Intensity : The skill intensity hypothesis is similar to human capital
hypothesis as both of them explain the capital embodied in human beings. It is only
empirical specification that differs.
(c)
Economies of Scale : It explains that with rising output, unit cost decreases.
The producers achieve internal economies of scales. A country with large production
possesses an edge over other countries with regards to export. However, a small
country can reap such advantages if it produces exportable in large quantities.
National Competitive Advantage
The theory is compounded by Porter. This theory explains that countries seek
to improve their national competitiveness by developing successful industries. The
success of targeted industries depends upon a host of factors that are termed the
diamond of national advantage. The factors are :
(a)
Factor Conditions : It show how far the factors of production in a country can
be utilised successfully in a particular industry. This concept goes beyond the factor
proportion theory and explains that an availability of the factor of production per se
is not important, rather their contribution to the creation and upgradation of
products is crucial for competitive advantages.
(b)
Demand Condition : The demand for the product must be present in the
domestic market from the very beginning of production. Porter is of view that it is
not merely size of the market that is important, but it is intensity and sophistication
of demand that is significant for competitive advantage.
(c)
Related and Supported Industries : The firm operating along with its
competitors as well as its complementary firms gathers benefit through a close
working relationship in form of competition or backward and forward linkage.

(d)
Firm Strategy, Structure and Rivalry : The firms own strategy helps in
augmenting export. There is no fixed rule regarding the adoption of a particular
strategy. It depends on the numbers of factors present in the home country or the
importing country.
Limitations : There are various criticism put forth against Porters theory :
(a)
There are cases when absence of any factors embodied in Porters diamond
does not affect the competitive advantage. For example, when a firm is exporting
its entire output, the intensity of demand at home does not matter.
(b)
If the domestic supplier of input is not available, the backward linkage will be
meaningless.
(c)
Porters theory is based on empirical findings covering 10 countries and four
industries. A majority of countries in the sample have different economic
background and dont necessarily support the findings.
(d)
Availability of natural resources, according to Porter are not the only
conditions for attaining competitive advantage. And there must be other factors too
for it. But in 1985, some Canadian industries emerged on the global map only on
the basis of natural resources.
(e)
Porter feels that sizable domestic demand must be present for attaining
competitive advantage. But there are industries that have flourished because of
demand from foreign sales.
Summary: Nevertheless these limitations do not undermine the significance of
Porters theory.
INVESTMENT THEORY
There are a number of investment theories. Except for MacDougall hypothesis,
investment theories are primarily based on imperfect market conditions. A few of
them are based on imperfect capital market.
MacDougall-Kemp Hypothesis: Assuming a two-country model- one being the
investing and other being the host country and the price of capital being equal, the
investment flows from abundant economy to a capital scare economy until the
marginal productivity of capital in both the countries are equal or till the returns
from investment is greater than the loss of output in home country.
Industrial Organisation Theory : The theory is based on oligopolistic or imperfect
market in which the investing firm operates. Market imperfection arises in many
cases, such as product differentiation, market skills, proprietary technology,
managerial skills, better access to capital, economies of scales, government
imposed market distortion and so on. Such advantages confer MNCs an edge over

their competitors in foreign locations and thus helps in compensate the additional
cost of operating in an unfamiliar environment. It refers to technological and similar
other advantages possessed by a firm that enable it to produce new and
differentiated products.
Location Specific Theory : This theory is compounded by hood and Young. It refers
to advantages like cheap labour, abundantly available raw material, and so on for
the production of a commodity to be established in a particular location or country.
Since real wage cost varies among countries, firms with low cost technology move
to low wage country.
Product Cycle Theory : Raymond Vernon feels that most product follow a life cycle
that is divided into three stages :
(a)
Innovation Stage: It is a stage in the product cycle when the product is in
demand because of its new and improved quality, irrespective of its price. The
product is manufactured in the home country primarily to meet the domestic
demand but a portion of the output is exported to the other developed countries.
(b)
Maturing Product Stage : At this stage, the demand for the new product
grows and it turns price elastic. Rival firms in the host country begin to supply
similar product at a lower price owing to lower distribution cost, whereas the
product of innovator is costlier as it involves transportation cost and tariff that is
imposed by the importing government. Thus to compete with the rival firms,
innovator decides to set up a production unit in host country itself which would lead
to internationalization of product.
(c)
Standardised Product ;
It is the stage in the product cycle when technology
does not remain the exclusive possession of innovator and competition turns stiffer.
At this stage price competitiveness becomes even more important and the
innovator shifts the production to a low cost location, preferably a developing
country where labour is cheap.
(d)
Denaturing Stage : It is the stage when development in technology or in
consumers preference breaks down product standradisation. Cheap labour does
not matter at this stage as sophisticated model involves a capital intensive mode of
production.
Internalization Approach : Buckley and Casson too assumes market imperfection,
but imperfection in their view, is related to transaction cost that is involved in intrafirm transfer of intermediate product such as knowledge or expertise. It is
internalization benefit is cost free intra-firm flow of technology development by the
parent unit.
Currency Based Approaches : It is compounded by Aliber. Such theories are
normally based on imperfect foreign exchange and capital market. The theory

postulates that internationalization of firms can best be explained in terms of the

relative strength of different currencies. Firms from strong currency country moves
to a weak currency country. In a weak currency country, income stream is fraught
with greater exchange risk. As a result the income of strong currency country firm
is capitalized at a higher rate.
Politico-Economic Theories : These theories concentrate on political risk. Political
stability in the host country leads to foreign investments. Similarly, political
instability in the home country encourages investment in foreign countries.
Modified theories for Third World Firms : Developing country MNCs posses firm
specific advantages in form of modified technology. They move abroad also to reap
advantages of cheap labour and abundance of natural resources. These firms have
long been importing technology from industrialized countries. But since imported
technology is mainly designed to cope with a large market, firm export a part of
their output after meeting their domestic demand.

Unit- III

World financial environment-tariff and non-tariff barriers, forex market

mechanism, exchange rate determination, euro-currency market;
international institutions (IMF, IBRD, IFC,IDA, MIGA) NBFCs and stock
markets.

Qu. 7 Explain various types of tariff and non-tariff barriers. What are the
objectives of these barriers?
Ans. International trade is affected by a number of factors including government
policies. The government endeavor to promote export and import in many
countries are hit by protectionism and trade barriers.
Types : There are two types of barriers :
(a) Tariff Barriers : Tariff in international trade refers to the duties or taxes imposed
on the import traded goods when they cross the national borders. After Second
World War, there has been a reduction in the average level of Tariffs in the
advanced countries. Tariff rates are generally high in developing countries. With
the recent economic liberalization across the world, many developing countries
have reduced the tariff as a part of their trade liberalization. in most economies and
organisation like WTO prefers tariff to non-tariff barriers because tariff are

transparent and less regressive than non-tariff barriers. The developed countries
tariff continues to be very strenuously loaded against the developing ones.
Characteristic:

Tariff applied on to consumer goods are often higher than on the cheaper
goods of luxury version.

There is also tariff escalation, when tariff increases with degree of processing
involved in the product.

(b)
Non-Tariff Barriers : Non-tariff barriers are new protectionism measures
that have grown considerably, particularly since around the beginning of 1980s.
The export growth of many developing countries has been seriously affected by
non-tariff barriers.
Categories of NTBs :
(i)
Those which are generally adopted by developing countries to prevent
foreign outflow or result from their chosen strategy of economic development.
These are mostly traditional NTBs like import licensing, import quotas, foreign
exchange regulations and canalization imports.
(ii)
Those which are mostly used by developed countries to protect domestic
industries which have lost international competitiveness or which are politically
sensitive for government.
For example Import Prohibition, Quantitative
Restrictions, Variable Levis, Multi-Fiber Arrangements, Voluntary Export
Restraint and Non-Automatic Licensing. Example of NTBs excluded from the
group includes technical barriers (including health and safety restriction and
standards), Minimum Pricing Regulations and Use of Price Investigation and
Pricing Surveillance.

Qu. 8 Explain the theories of exchange rate determinants .

Ans The theories of exchange rate are divided into following categories :
DETERMINANTS OF EXCHANGE RATE IN SPOT MARKET There are
following two theories under this category :
(a)
Process of determination : It is the interplay of demand and supply that
determines the exchange rate between two countries in a floating rate-regime.
For example, the exchange rate of Indian rupee and the US dollar depends upon
the demand for the US dollar and supply of dollar in Indian foreign exchange
market. The demand for foreign currency comes from individuals and firms who
have to make payments to foreigners in foreign currency, mostly on account of
import exchange result, services and purchase of securities. The supply of

foreign exchange results from the receipt of foreign currency, normally on

account of export or sale of financial securities to the foreigners.
In the following figure, the demand curve slopes downwards to the right
because the higher the value of US dollar, the costlier the imports and the
importers curtails the demand for higher value of the US dollar makes export
cheaper and thereby, stimulates the demand for export. The supply of US dollar
increases in the form of export earnings. This why, the supply curve of US dollar
moves downwards to the right with a rise in its value. The equilibrium exchange
rate arrives where the supply curve intersects the demand curve at Q1. This
rate, as shown in the figure, is Rs 40/US $.
S
Rs/US$
S1
42
40
D1
D
Q1

Q2

Q3

Demand for and supply of US$

If the demand for import rises owing to some factors at home, the demand
for the US dollar will rise to D1 and intersect the supply curve at Q2. The exchange
rate will be Rs 42/US$. But if the export rises as a result to decline in value of rupee
and supply of the dollar increase to S1, the exchange rate will again be Rs 40/US$.
So the frequent shifts in demand and supply condition cause the exchange rate to
adjust to a new equilibrium.
(b)
Purchasing Power Parity Theory (PPP) : This theory was compounded by
Cassel in 1921. There are two version of this theory :
(i)
Absolute Version ; The theory suggest that at any point of time, the rate of
exchange between two currencies is determined by their purchasing power. If e is
the exchange rate and Pa and Pb are the purchasing power of the currencies in the
two countries, A and B, the equation can be written as :

e = Pa / Pb

This theory is based on the theory of one price in which the domestic price of
any commodity equals its foreign quoted in the same currency. For example, if the
exchange rate is Rs 2/US$, the price of a particular commodity must be US $ 50 in
the USA if it is Rs 100 in India.
US$ price of commodity x price of US$ = Rupee price of the commodity
The exchange rate adjustment resulting from inflation may be explained further. If
the Indian commodity turns costlier, its export will fall. At the same time, its import
from the USA will expand as the import gets cheaper. Higher import will raise the
demand for the US dollar raising, in turn its value vis--vis.
Limitation : however this theory holds good if the same commodity are included in
the same proportion in the domestic market and world market. Since it is normally
not so, the theory faces a serious limitation as it does not cover non-traded goods
and services, where the transaction costs are significant.
(ii)
Relative version : To overcome the limitation of absolute version, this theory
has evolved. This version of PPP theory states that the exchange rate between the
currencies of two countries should be constant multiple of the general price indices
prevailing in the two countries. In other words, the percentage change in the
exchange rates should equal the percentage change in the ratio of price indices in
the two countries. For example, if India has inflation rate of 5% and the USA has a
3% rate of inflation and if the initial exchange rate is Rs 40/US$, the value of the
rupee in two years period will be

e2 = 40[1.05/1.03]2 or Rs 41.75/US$

The theory suggests that a country with a high rate of inflation should devalue its
currency relative to the currency of the countries with lower rate of inflation.
Assumption : The theory holds good if :

Changes in the economy originate from the monetary sector.

The relative price structure remains stable in different sectors in view of the
fact that change in the relative price of various goods and services may lead
differently constructed indices to deviate from each other.

There is no structural change in the economy, such as change in tariff, in

technology and in autonomous capital flow.

Limitation of PPP : A number of studies have empirically tested the two version of
the PPP theory. There are three factors why this theory does not hold good in real
life :

The assumptions of this theory do not necessarily hold well in real life.

There are other factors such as interest rate, governmental interference and
so on that influences the exchange rate. In 1990, some of the European
Countries experienced a higher inflation rate than in the USA, but their
currency did not depreciate against dollar in view of high interest rate
attracting capital from the USA.

When no domestic substitute is available for import, goods are imported even
after their prices rise in the exporting countries.

DETERMINANTS OF EXCHANGE RATE IN FORWARD MARKET

Forward exchange rates are normally not equal to the spot rate. There are
two theories :
(i)
Interest Rate Parity Theory (IRP): The determination of exchange rate in a
forward market finds an important in the theory of Interest Rate Parity (IRP). The
IRP theory states that equilibrium is achieved when the forward rate differential is
approximately equal to the interest rate differential. In other word, the forward rate
differs from the spot rate by an amount that represents the interest rate differential.
In this process, the currency of a country with lower interest rate should be at
forward premium in relation to the currency of a country with higher rate of interest
rate. On the basis of IRP theory, the forward exchange rate can easily be
determined. One has simply to find out the value of the forward rate (F) in the
equation. The equation should be :

F = S/A [1 +rA/1+rB -1] +S

For example, suppose interest rate in India and the USA is, respectively, 10% and
7%. The spot rate is Rs 40/US$. The 90-days forward rate can be calculated as
follows :

F = 40/4[1.10/1.07-1]+40

= Rs 40.28/US$

it means a higher interest rate in India will push down the forward value of the
rupee from 40 a dollar to 40.28 a dollar.

(ii)
Covered Interest Arbitrage : This theory states that if interest rate
differential is more than forward rate differential, covered interest arbitrage
manifests in borrowing in a country with low interest rate and investing in a country
with high interest rate so as to reduce the interest rate differential. For example,
suppose the spot rate is Rs 40/US$ and three month forward rate is Rs 40.28/US$
involving a forward differential of 2.8%. Interest rate is 18% in India and 12% in the
USA, involving an interest rate differential of 5.37%. Since the two differentials are
not equal, covered interest arbitrage will begin. So long as the inequality continues
between the forward rate differential and the interest rate differential, arbitrageurs
will reap profit and the process of arbitrage will go on. However, with this process,
the differential will be wiped out because:

Borrowings in USA will raise the interest rate there.

Investing in India shall increase the invested funds and thereby lower the
interest rate there.

Buying rupees at spot rate will increase the spot rate of rupee

Selling rupee in forward will depress the forward rate of rupee.

Limitation : The study of Martson shows that the theory held good with greater
accuracy in the Euro-currency in view of the fact that there exist ed complete
freedom from controls and restrictions. But there are some limitations that as
follows:

Since different rates prevails in bank deposits, loans, treasury bills, and so on,
the short term interest rate can not be specific and chosen rate can hardly be
the definite rate of formula.

Marginal rate of interest applicable to borrowers and lenders differs from the
average rate of interest in view of the fact that interest rate changes with
successive amount of borrowing.

The investment in foreign assets is more risky than that of domestic assets.

There are cases when interest rate parity is disturbed owing to the play of
extraordinary forces which leads to speculation. It is basically the market
expectation of future spot that influences the spot rate that influences the
forward the forward rate.

The proponents of modern theory feel that it is not only the role of
arbitrageurs but of all participants in foreign exchange market, such as
traders, hedgers and speculators that influences the forward rate.

Qu. 9 Write short note on Euro-currency, IMF, IDA and IBRD.

Ans. Euro-currency : The growth of Euro-currency market, also known as

Eurodollar market, is one of the significant development in the international
economic shape after world war-II. Its phenomenon development, though poses
problem for the national monetary authorities and international monetary stability,
has helped the growth of international trade, transnational corporation and
economies of certain countries.
Scope : The scope of Euro-currency is as follows :
(a)
These are financial assets and liabilities denominated in US dollar but traded
in Europe. US dollar still predominates the market and most of transactions in the
money market of Europe, especially London. But today the scope of market
stretches far beyond the Europe and the dollar in the sense that the Euro-dollar
transactions are also held also in money markets other than European and
currencies other than the US dollar. Interpreted in a currency deposited outside the
country of issue. Thus any currency internationally supplied and demanded and in
which a foreign bank is willing to accept liabilities and loan assets is eligible to
become Euro-currency. It is interpreted this way that dollar deposited with banks in
Montreal, Toronto, Singapore, Beirut, etc are also Euro-dollar, so are the deposits
denominated in European currencies in the money markets of USA and the above
centers.
(b)
Euro-currency market would be the appropriate term to describe this
expanding market. The term Euro-dollar came to be used because the market had
its origin and earlier developments with dollar transactions in the European money
markets. Despite the emergence of other currencies and the expansion of market
to other area, Europe and the dollar still hold the key to the market. Today this term
is in popular use.

(c)
The Euro-currency market, the commercial banks accept interest bearing
deposited denominated in a currency other than the currency of the country in
which they operate and re-land these funds either in the same currency of a third
country. The acquisition of dollars by banks located out side the USA, mostly
through the taking of deposit, but also to some extent by swapping other currencies
into dollar, and the re-landing of these dollars, often after redepositing with other
banks, to non-bank borrows any where in the world.
(d)
The currencies involved in Eurodollar market are not in any way different from
the currencies deposited with banks in the respective home countries. But the
Euro-dollar is out side the orbit of this monetary policy whereas the currency
deposited with banks in the respective home country is enveloped by the national
monetary policy.
INTERNATIONAL MONETARY FUND (IMF)
It was created in 1945 to help and promote the health of world economy. It has its
Headquarters in Washington DC. It is governed by and accountable to the
governments of 184 countries. It was conceived at a United Nations conference in
Bretton Woods, New Hampshire, US in July 1944. the 45 countries govt represented
at that conference and sought to build a framework for economic cooperation that
would avoid a repetition of the disastrous economic policies that had contributed to
great depression in 1930s.
About IMF :

Current membership :

Staff : approximately 2680 from 139 countries.

Total Quotas :

Loans Outstanding:$71 billion to 82 countries, of which $10 billion to 59 on

concessional terms.

Technical Assistance provided:

Surveillance consultations concluded: 129 countries during FY-2005, of which

118 voluntarily published information on their consultation.

184 countries

$321 Billion (as of 31/8/2005)

381 person year during FY 2005

Responsibilities of IMF : The main responsibilities of IMF as per article 1 of Article

of Agreement
are as follows :

To promote international monetary cooperation.

Facilitating the expansion and balanced growth of international trade

To promote exchange stability.

Assisting in the establishment of multilateral system of payments.

T make its resources available to members experiencing balance of payments

difficulties.

IMF Activities :
(a)
Promote Global Growth And Economic Stability : The IMF works to promote
global growth and economic stability and thereby prevent economic crisis by
encouraging countries to adopt sound economic policies.
(b)
Help In Recovery : Whenever member countries experience difficulty to
finance their balance of payments, the IMF is the fund that can be tapped to help in
recovery.
(c)
Reduce Poverty : The IMF is also working actively to reduce poverty in
countries around the globe, independently and in collaboration with World Bank and
other organisations.
(d)
Poverty Reduction strategy Papers : In most low-income countries, these
papers are prepared by country authorities in consultation with civil society and
external development partners to describe comprehensive economic, structural and
social policy framework that is being implemented to promote growth and reduce
poverty in the country.
IMF Governance and Organisation : The IMF is accountable to the governments of
its member countries. At apex of its organizational structure is its Board of
Governors that consists of one Governor from each of the IMFs 184 countries. All
Governors meet once each year at IMF-World Bank Annual Meeting, 24 of Governors
sit on The International Monetary and Finance Committee (IMFC) and meet twice
each year. The day-to-day work of the IMF is conducted at Washington DC
headquarters by its 24-members Executive Board. This work is guided by the IMFC
and supported by the IMFs professional staff. The Managing Director is Head of IMF
staff and Chairman of Executive Board and assisted by three Deputy Managing
Directors.
INTERNATIONAL DEVELOPMENT ASSOCIATION (IDA)
It is an affiliate of IBRD. It was established in 1960 to provide assistance for the
same purpose as the IBRD, but primarily in the poorer developing countries and on
terms that would bear less heavily on their balance of payments than IBRD loans.
IDAs assistance is therefore concentrated on the very poor countries.
The funds used by IDA, called credits to distinguish them from IBRD loans,
come mostly in the form of subscriptions, general replenishment from IDA is more

industrialized and developed members and transfers from the net earnings of the
IBRD.
The term of IDA credits that are made to governments only, are ten years
grace period, fifth year maturities and no interests. The IDA provides soft loans to
member countries. Its object is to provide loan to member countries on liberal
terms in so far as these relate to the rate of interest and the period of repayment.
Another attraction of Ida loans is that they can be repaid in currency of member
countries.
Developing countries can avail themselves of IDA loans on very liberal terms
for projects which are not eligible for assistance from the World Bank either because
loans for such projects do not carry the guarantee of the government of the
borrowing country or because such projects do not contribute directly and
immediately to the productive capacity of the borrowing country.
IDA Credit Approval : In approving an IDA credit following criteria are observed :
(a)
Poverty Test : IDAs assistance is limited to poorest countries and which
continue to face such severe handicap as excessive dependence on volatile primary
product market, heavy debt servicing burdens and often rate of population growth
that outweighs the gains of production.
(b)
Performance Test : Within the range of difficulties of establishing objectives
standards of performance, these factors serve as the yardstick for an adequate
performance test. Satisfactory overall economic policies and past success in project
execution.
(C)
Project Test : The purpose of IDA is to advance soft loans , not finance soft
projects. IDA projects are appraised according to the same standard as that applied
to bank projects. The test essentially requires that the proposed projects yield
financial and economic returns, which are adequate to justify the use of scare
capital.
IBRD OR WORLD BANK
The international Bank for Reconstruction and Development (IBRD) or the World
Bank, one of the Bretton Woods Twin, was established in 1945. The IBRD has two
affiliates the International Development Association (IDA) and International Finance
Corporation (IFC).
The IBRD whose capital is subscribed by its member countries, finance its lending
operation primarily from its own borrowings in the world capital market. A
substantial contribution to the banks resources also comes from its retained
earnings and the flow of repayments on its loan. IBRD loans generally have a grace
period of five years and are repayable over twenty years, or less. They are directed
towards developing countries at more advanced stages of economic and social

growth. The interest rate that IBRD charges on its loan is calculated in accordance
with a guideline to its cost borrowing.
Purpose : The purpose of banks as laid down in its articles of agreement, are as
under :

To assist in reconstruction and development of the territories of the member

countries by facilitating the investment of capital for productive purpose.

The restoration of economies destroyed by war, the reconversion of

productive facilities to peace time needs and the encouragement of the
development of productive facilities and resources in less developed
countries.

To promote private foreign investment by means of guarantee or participation

in loans and other investments made by private investors.

When private capital is not available on reasonable terms, to supplement

private investment by providing on suitable conditions.

Finance for productive purposes out of its own capital funds raised by it and
other resources.

To promote the long range balanced growth of international trade and the
maintenance of equilibrium in the balance of payment, by encouraging
international investment of the productive resources of members, thereby
assisting in raising productivity, the standard of living and conditions of
labour in the territories.

Policy : The bank is guided by certain policies which have been formulated on the
basis of the article of Agreement :
(a)
The bank should properly assess the repayment prospects of the loans. For
this purpose it should consider the availability of natural resources and existing
productive plant capacity to exploit the resources and operate the countries past
debt record.
(b)
The bank should lend only for specific projects, that are economically and
technically sound and of a high priority nature. As a matter of general policy, it
should concentrate on lending for projects which are designed to contribute directly
to productive capacity, normally does not finance projects that are primarily of
social character such as education, housing etc.
(c)
The bank lends only to enable a country to meet the foreign exchange
content of any project cost, it normally expects the borrowing country to moblise its
domestic resources.

(d)
The bank does not expect the borrowing country to spend the loan in a
particular country, in fact it encourages the borrowers to procure machinery and
goods for bank finance in the cheapest possible market consistent with satisfactory
performance.
(e)
It is the banks policy to maintain continuing relations with borrowers with a
view to check the progress of projects and keep in touch with financial and
economic developments in borrowing countries. This also helps in the solution of
any problem that might arise in the technical and administrative fields.
(f)
The bank indirectly attaches special importance to the promotion of local
private enterprises.

Unit-IV

Regional blocks and trading agreements; global competitiveness; global

competition, HRD development, social responsibility; world economic
growth and physical environment.
Qu.10 What do you mean by regional blocks? Explain trading agreements
between different countries.
Ans. There has been a proliferation of regional economic integration
schemes or trade blocks, designed to achieve economic, social and
political purposes. The term economic integration is commonly used to
refer to the type of the arrangements that removes artificial trade
barriers, like tariffs and quantitative restrictions, between the integrating
economies. More than one third of world trade already takes place within
the existing RIAs. There are also a number of other international
cooperation schemes.
Benefit :

The expected benefits from RIA includes :

(a)
Efficiency improvements due to economies of scales arising out of
enlarged market.
(b)
Enhanced bargaining strength of members in multilateral trade
negotiations.
(c)

Promotion of regional infant industries.

(d)
Prevention of further damage to trading strength due to further
trade diversion from third countries.

(e)
Ensure increased security of market access for smaller countries by
forming regional trading blocks with larger countries.
(f)
To peruse non-economic objectives such as strengthening political
ties and managing migration flows.
Types : It is used to refer the types of arrangements that removes
artificial trade barriers, like tariffs and quantitative restrictions between
integrating economies. Following are the few types of integration :
(a)

Free trade Area : in this free trade is carried out among members.

(b)
Custom Union : Beside free trade among members, common
external commercial activities are also occurs in this type.
(c)
Common Market : Free trade, common external commercial
activities and free mobility within the market.
(d)
Economic Union : Free trade, common external commercial
activities, free mobility within the market and harmonized economic
policy.
(e)
Economic Integration : Free trade, common external commercial
activities, free mobility within the market, harmonized economic policy
and supranational organizational structure.
Examples : Industrial and Developing economies such as European Union
(EU), The North American Free Trade and Agreement (NAFTA) and Asia
Pacific Cooperation (APEC). Latin American and Caribbean.

Qu. 11 What is global competitiveness? What factors determines the

competitiveness of a country?

Ans. Global competitiveness is defined as the ability of a national

economy to achieve sustained high rates of economic growth on the basis
of suitable policies, industrial and other economic characteristics.
Factors Determining Competitiveness : Following are some factors that
determines the global competitiveness of a country :
(a)
Openness : This factor measures openness to foreign trade and
investments, foreign direct investment and financial flows, exchange rates
policy and ease of exporting (b)
Government : This factor measure the
role of the state in the economy. This includes the overall burden of govt

expenditure, fiscal deficit, rates public saving, marginal tax rates and the
overall competence of the civil service.
(c)
Finance : Finance measures how efficiently the financial
intermediaries channels savings into productive investments, the level of
competition in financial market, the perceived stability and solvency of
key institutions, level of national saving and investment and credit ratings
given by outside observers.
(d)
Infrastructure : It measures the quality of roads, railways, ports,
telecommunications, cost of air transportation and overall infrastructure
investments.
(e)
Technology : This factor measures computer uses, the spread of new
technology, the ability of the economy to absorb new technologies and
the level and quality of research and developments.
(f)
Management : Management measures overall management quality,
marketing, staff training and motivation practice, efficiency of
compensation schemes and the quality of internal financial control
system.
(g)
Labour : This factor measures the efficiency and competitiveness of
the domestic labour market. It combination of the level of countrys
labour costs relative to international norms, together with measures of
labour market efficiency, the level of basic education and skills and the
extent of distortionary labour taxes.
(h)
Institutions : This factor measures the extent of business
competition, quality of legal institution and practice, the extent of
competition and vulnerability to organised crime.