INTERNATIONAL ECONOMIC INTEGRATION AND INSTITUTION

I.HISTORY

Machlup (1977) was unable to find a single instance of its use prior to 1942. Since then
the term has been used at various times to refer to practically any area of international
economic relations. By 1950, however, the term had been given a specific definition by
economists specializing in international trade to denote a state of affairs or a process which
involves the amalgamation of separate economies into larger regions, and it is in this more
limited sense that the term is used today. More specifically, international economic integration
is concerned with the discriminatory removal of all trade impediments between the
participating nations and with the establishment of certain elements of cooperation and
coordination between them. The latter depends entirely on the actual form that integration
takes. Different forms of international integration can be envisaged and some have actually
been implemented:
(i)
free trade areas, where the member nations remove all trade impediments among themselves
but retain their freedom with regard to the determination of their policies vis-à-vis the outside
world (the non-participants) — for example, the European Free Trade Association (EFTA) and
the demised Latin American Free Trade Area (LAFTA)

II. CONTEMPORARY EXCHANGE RATE SYSTEMS

Exchange rates are determined by demand and supply. But governments can influence those
exchange rates in various ways. The extent and nature of government involvement in currency
markets define alternative systems of exchange rates. In this section we will examine some
common systems and explore some of their macroeconomic implications.

Free-Floating Systems

In a free-floating exchange rate system, governments and central banks do not participate in the
market for foreign exchange. The relationship between governments and central banks on the
one hand and currency markets on the other is much the same as the typical relationship between
these institutions and stock markets. Governments may regulate stock markets to prevent fraud,
but stock values themselves are left to float in the market. The U.S. government, for example,
does not intervene in the stock market to influence stock prices.

Managed Float Systems

Governments and central banks often seek to increase or decrease their exchange rates by buying
or selling their own currencies. Exchange rates are still free to float, but governments try to
influence their values. Government or central bank participation in a floating exchange rate
system is called a managed float.

Fixed Exchange Rates

In a fixed exchange rate system, the exchange rate between two currencies is set by government
policy. There are several mechanisms through which fixed exchange rates may be maintained.
Whatever the system for maintaining these rates, however, all fixed exchange rate systems share
some important features.

Commodity Standard

In a commodity standard system, countries fix the value of their respective currencies relative to
a certain commodity or group of commodities. With each currency’s value fixed in terms of the
commodity, currencies are fixed relative to one another.

III. DETERMINANTS OF FOREIGN EXCHANGE RATE

1. Differentials in Inflation
Typically, a country with a consistently lower inflation rate exhibits a rising currency value, as
its purchasing power increases relative to other currencies. During the last half of the 20th
century, the countries with low inflation included Japan, Germany and Switzerland, while the
U.S. and Canada achieved low inflation only later. Those countries with higher inflation
typically see depreciationin their currency in relation to the currencies of their trading partners.
This is also usually accompanied by higher interest rates.
2. Differentials in Interest Rates
Interest rates, inflation and exchange rates are all highly correlated. By manipulating interest
rates, central banks exert influence over both inflation and exchange rates, and changing interest
rates impact inflation and currency values. Higher interest rates offer lenders in an economy a
higher return relative to other countries. Therefore, higher interest rates attract foreign capital
and cause the exchange rate to rise. The impact of higher interest rates is mitigated, however, if
inflation in the country is much higher than in others, or if additional factors serve to drive the
currency down. The opposite relationship exists for decreasing interest rates – that is, lower
interest rates tend to decrease exchange rates.

3. Current Account Deficits

The current account is the balance of trade between a country and its trading partners, reflecting
all payments between countries for goods, services, interest and dividends. A deficit in the
current account shows the country is spending more on foreign trade than it is earning, and that it
is borrowing capital from foreign sources to make up the deficit. In other words, the country
requires more foreign currency than it receives through sales of exports, and it supplies more of
its own currency than foreigners demand for its products. The excess demand for foreign
currency lowers the country's exchange rate until domestic goods and services are cheap enough
for foreigners, and foreign assets are too expensive to generate sales for domestic interests.

4. Public Debt
Countries will engage in large-scale deficit financing to pay for public sector projects and
governmental funding. While such activity stimulates the domestic economy, nations with large
public deficits and debts are less attractive to foreign investors. The reason? A large debt
encourages inflation, and if inflation is high, the debt will be serviced and ultimately paid off
with cheaper real dollars in the future.

5. Terms of Trade
A ratio comparing export prices to import prices, the terms of trade is related to current accounts
and the balance of payments. If the price of a country's exports rises by a greater rate than that of
its imports, its terms of trade have favorably improved. Increasing terms of trade shows greater
demand for the country's exports.
6. Political Stability and Economic Performance
Foreign investors inevitably seek out stable countries with strong economic performance in
which to invest their capital. A country with such positive attributes will draw investment
funds away from other countries perceived to have more political and economic risk. Political
turmoil, for example, can cause a loss of confidence in a currency and a movement of capital to
the currencies of more stable countries.

IV.BALANCE OF PAYMENT

Balance of payments is the record of all international trade and financial transactions made by a
country's residents.

A country's balance of payments tells you whether it saves enough to pay for its imports. It
also reveals whether the country produces enough economic output to pay for its growth. The
BOP is reported for a quarter or a year. In the long-term, the country becomes a net consumer,
not a producer, of the world's economic output. It will have to go into debt to pay for
consumption instead of investing in future growth. If the deficit continues long enough, the
country may have to sell off its assets to pay its creditors. These assets include natural resources,
land, and commodities.

3 COMPONENTS OF BALANCE OF PAYMENT

CURRENT ACCOUNT - a country's trade balance plus net income and direct payments. The
trade balance is a country's imports and exports of goods and services. The current account also
measures international transfers of capital.

FINANCIAL ACCOUNT- is a measurement of increases or decreases in international ownership

of assets. The owners can be individuals, businesses, the government, or its central bank. The
assets include direct investments, securities like stocks and bonds, and commodities such as gold
and hard currency.

CAPITAL ACCOUNT- is part of a country's balance of payments. It measures financial

transactions that affect a country's future income, production, or savings. An example is a
foreigner's purchase of a U.S. copyright to a song, book, or film. Its value is based on what it will
produce in the future.
 V. International Foreign Exchange Market
The foreign exchange market (Forex, FX, or currency market) is a
global decentralized or over-the-counter (OTC) market for the trading of currencies. This market
determines the foreign exchange rate. It includes all aspects of buying, selling and exchanging
currencies at current or determined prices. In terms of trading volume, it is by far the largest
market in the world, followed by the Credit market.

The foreign exchange market is the market in which participants are able to buy, sell, exchange
and speculate on currencies. Foreign exchange markets are made up of banks, commercial
companies, central banks, investment management firms, hedge funds, and retail forex brokers
and investors.

The foreign exchange market – also called forex, FX, or currency market – trades currencies. It
is considered to be the largest financial market in the world. Aside from providing a floor for the
buying, selling, exchanging and speculation of currencies, the forex market also enables currency
conversion for international trade and investments.

VI. INTERNATIONAL CAPITAL MARKET

CAPITAL MARKET - is basically a system in which people, companies, and governments with
an excess of funds transfer those funds to people, companies, and governments that have a
shortage of funds. This transfer mechanism provides an efficient way for those who wish to
borrow or invest money to do so. For example, every time someone takes out a loan to buy a car
or a house, they are accessing the capital markets. Capital markets carry out the desirable
economic function of directing capital to productive uses.

Two main ways to accesses the capital markets:

Debt is money that’s borrowed and must be repaid.

Equity is money that is invested in return for a percentage of ownership but is not guaranteed in
terms of repayment.

International capital markets are the same mechanism but in the global sphere, in which
governments, companies, and people borrow and invest across national boundaries. In addition
to the benefits and purposes of a domestic capital market, international capital markets provide
the following benefits:

1. Higher returns and cheaper borrowing costs. These allow companies and governments
to tap into foreign markets and access new sources of funds. Many domestic markets are
too small or too costly for companies to borrow in. By using the international capital
markets, companies, governments, and even individuals can borrow or invest in other
countries for either higher rates of return or lower borrowing costs.
2. Diversifying risk. The international capital markets allow individuals, companies, and
governments to access more opportunities in different countries to borrow or invest,
which in turn reduces risk. The theory is that not all markets will experience contractions
at the same time.

TWO COMPONENTS OF CAPITAL MARKET

Primary market is where new securities (stocks and bonds are the most common) are issued. If a
corporation or government agency needs funds, it issues (sells) securities to purchasers in the
primary market.

Secondary market includes stock exchanges (the New York Stock Exchange, the London Stock
Exchange, and the Tokyo Nikkei), bond markets, and futures and options markets, among others.
All these secondary markets deal in the trade of securities. The term securities includes a wide
range of financial instruments. You’re probably most familiar with stocks and bonds.

International Entry Strategies

Target Market Selection

Target market represents a group of individuals who have similar needs, perceptions and
interests. They show inclination towards similar brands and respond equally to market
fluctuations.
Individuals who think on the same lines and have similar preferences form the target audience.
Target market includes individuals who have almost similar expectations from the organizations
or marketers.

Obese individuals all across the globe look forward to cutting down their calorie intake.
Marketers understood their need and came up with Kellogg’s K Special which promises to
reduce weight in just two weeks. The target market for Kellogg’s K Special diet would include
obese individuals.

Entry Strategies: Timing

The timing of entry is critical. Just as many companies have overestimated market potential
abroad and underestimated the time and effort needed to create a real market presence, so have
they justified their overseas’ expansion on the grounds of an urgent need to participate in the
market early. Arguing that there existed a limited window of opportunity in which to act, which
would reward only those players bold enough to move early, many companies made sizable
commitments to foreign markets even though their own financial projections showed they would
not be profitable for years to come. This dogmatic belief in the concept of a first-mover
advantage (sometimes referred to as “pioneer advantage”) became one of the most widely
established theories of business. It holds that the first entrant in a new market enjoys a unique
advantage that later competitors cannot overcome (i.e., that the competitive advantage so
obtained is structural and therefore sustainable).

Some companies have found this to be true. Procter & Gamble (P&G), for example, has always
trailed rivals such as Unilever in certain large markets, including India and some Latin American
countries, and the most obvious explanation is that its European rivals were participating in these
countries long before P&G entered. Given that history, it is understandable that P&G erred on
the side of urgency in reacting to the opening of large markets such as Russia and China. For
many other companies, however, the concept of pioneer advantage was little more than an article
of faith and was applied indiscriminately and with disastrous results to country-market entry, to
product-market entry, and, in particular, to the “new economy” opportunities created by the
Internet.

The “get in early” philosophy of pioneer advantage remains popular. And while there are clear
examples of its successful application—the advantages gained by European companies from
being early in “colonial” markets provide some evidence of pioneer advantage—first-mover
advantage is overrated as a strategic principle. In fact, in many instances, there are disadvantages
to being first. First, if there is no real first-mover advantage, being first often results in poor
business performance, as the large number of companies that rushed into Russia and China
attests to. Second, pioneers may not always be able to recoup their investment in marketing
required to “kick start” the new market. When that happens, a “fast follower” can benefit from
the market development funded by the pioneer and leapfrog into earlier profitability.For a more
detailed discussion, see Tellis, Golder, and Christensen (2001).

This ability of later entrants to free-ride on the pioneer’s market development investment is the
most common source of first-mover disadvantage and suggests two critical conditions necessary
for real first-mover advantage to exist. First, there must be a scarce resource in the market that
the first entrant can acquire. Second, the first mover must be able to lock up that scarce resource
in such a way that it creates a barrier to entry for potential competitors. A good example is
provided by markets in which it is necessary for foreign firms to obtain a government permit or
license to sell their products. In such cases, the license, and perhaps government approval, more
generally, may be a scarce resource that will not be granted to all comers. The second condition
is also necessary for first-mover advantage to develop. Many companies believed that brand
preference created by being first constituted a valid source of first-mover advantage, only to find
that, in most cases, consumers consider the alternatives available at the time of their first
purchase, not which came first.

Entry Strategies: Modes of Entry

What is the best way to enter a new market? Should a company first establish an export base or
license its products to gain experience in a newly targeted country or region? Or does the
potential associated with first-mover status justify a bolder move such as entering an alliance,
making an acquisition, or even starting a new subsidiary? Many companies move from exporting
to licensing to a higher investment strategy, in effect treating these choices as a learning curve.
Each has distinct advantages and disadvantages.

Exporting is the marketing and direct sale of domestically produced goods in another country.
Exporting is a traditional and well-established method of reaching foreign markets. Since it does
not require that the goods be produced in the target country, no investment in foreign production
facilities is required. Most of the costs associated with exporting take the form of marketing
expenses.

Licensing essentially permits a company in the target country to use the property of the licensor.
Such property is usually intangible, such as trademarks, patents, and production techniques. The
licensee pays a fee in exchange for the rights to use the intangible property and possibly for
technical assistance as well.

Strategic alliances and joint ventures have become increasingly popular in recent years. They
allow companies to share the risks and resources required to enter international markets. And
although returns also may have to be shared, they give a company a degree of flexibility not
afforded by going it alone through direct investment.