Block 2

MS-97
International Business
Indira Gandhi
National Open University
School of Management Studies
Block
2
INTERNATIONAL BUSINESS ENVIRONMENT
UNIT 4
PESTEL 5
UNIT 5
WTO Agreement and its Implications 26
UNIT 6
Regional Trade Blocks 41
UNIT 7
Risk Analysis 53
COURSE DESIGN AND PREPARATION TEAM
Prof. M. L. Bhatia Prof. N. V. Narasimham
(Course Editor) SOMS, IGNOU
Vasantkunj New Delhi
New Delhi
Prof. Srilatha
Dr. S. R. Mahnot Director
Centre for Industrial and Economic SOMS, IGNOU
Research, New Delhi New Delhi
Dr. Pinaki Dasgupta Prof. G. Subbayamma
Indian Institute of Foreign Trade (Course Coordinator)
New Delhi SOMS, IGNOU
New Delhi
Dr. Rajiv Ranjan Thakur
Jaipuria Institute of Management Dr. Neeti Agarwal
Noida SOMS, IGNOU
New Delhi
Prof. Prafulla Agnihotri
IIM, Tiruchirappalli Dr. Leena Singh
Tamil Nadu SOMS, IGNOU
New Delhi
Prof. Justin Paul
University of Puerto Rico
USA
Print Production
Mr. K.G. Sasi Kumar
Assistant Registrar (Publication)
SOMS, IGNOU, New Delhi
November, 2015
 Indira Gandhi National Open University, 2015
ISBN-978-93-85911-23-1
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BLOCK 2 INTERNATIONAL BUSINESS
ENVIRONMENT
This block deals with International Business Environment and has four units.
Unit 4: PESTEL Analysis

This unit discusses the political, economic, social, technological and environmental
(PESTEL) factors which plays an important role in international business. It also deals
with macro-economic indicators that affect global business environment. Further it
discusses the transition of certain countries to a market economy and its effects on
international firms and managers.
Unit 5: WTO Agreements and its Implications

This unit refers to multilateral trade agreements and multilateral trade organizations
like General Agreement on Trade and Tariffs (GATT) and World Trade Organization
(WTO). WTO is a successor of GATT. This unit discusses the trade negotiations that
took place under GATT and WTO. It also mentions the key functions of WTO and
India’s stand on WTO.
Unit 6: Regional Trade Blocks

The unit begins with types of Regional Trading Blocks within a specified geographic
region. It also identifies the major trade blocks formed in recent past. The unit examines
the static gains from regional integration and discusses trade creation and trade diversion.
It also describes European Union which is the world largest trade block.
Unit 7: Risk Analysis

This unit deals with risk assessment, risk management and risk communication. The
unit then describes the various factors which makes an economy attractive. It deals
with risk analysis, market prospects and competitive context which are an integral part
of assessing country attractiveness while, market opportunity measures the potential
demand in the country. It discusses industry opportunity analysis which is measured in
terms of competitive structure. In nut shell the unit analyses the various types of risks
involved in operating business in a foreign country.
Thus the block highlights the importance of international business environment, the
multilateral trade organizations, international trade blocks and risk analysis.
Environment
4
Pestel
UNIT 4 PESTEL
Objectives
After reading this Unit, you should be able to:

• analyze the political, economic, social technological and legal environment;
• distinguish between world’s major economic systems and the division of countries
into various economic categories;
• identify the key economic issues that influence international business;
• understand the transition of certain countries to a market economy and the effects
of the latter on international firms and their managers; and
• appreciate the dynamics of political, social, technological and legal environments
and their influence on business.
Structure
4.1 Introduction
4.2 Political Environment
4.3 Economic Environment
4.4 Social and Cultural Environment
4.5 Technological Environnent
4.6 Environmental Factors/Issues
4.7 Legal Environment
4.8 Summary
4.9 Key Words
4.10 Self-Assessment Questions
4.11 Further Readings
4.1 INTRODUCTION
PESTEL analysis essentially deals with the political, economic, social, technological,
environmental and legal environment that business faces today. Its understanding is
important for managers dealing with International Business. Political environment relates
to basic political ideologies, the various forms of government and impact of political
system on management decisions. Economic environment discusses the economic
classification of countries based on income, economic system and region specific issues
along with the transition to market economy. Social and cultural aspects deal with the
identification of various cultures, social stratification of systems, the relationship
preferences which affect work behaviour from country to country. It also deals with the
strategies for dealing with cultural differences. Technological environment revolves
around the speed of communication and the reduction in the cost of technology. Legal
environment relates to the various kinds of legal system prevailing in various countries.
This includes methods for consumer safeguards, legal issues in international business
and laws and ethical dilemmas faced day to day. An understanding of PESTEL analysis
helps in determining the major issues that influence international business. In this unit
we shall discuss the various aspects of the PESTEL i.e. Political, Economic, Social,
Technological Environmental and Legal aspects.
5
Environment 4.2 POLITICAL ENVIRONMENT
The political environment within a country impacts business and operation of firms.
Many organizations working in countries like U.S. are used to peaceful working
environment, however this may not exist in other countries. A country’s political
environment influences the operation of business both domestically and internationally
as politics and economics are interlinked.
Political Ideologies
Political ideologies are the ideas, theories and aims and how these ideas, theories can
be executed to fulfill the aims. Many different political ideologies can co- exist in a
single country (for example India). Each political ideology will have its own pressure
group, as a result a political system has to remain stable among varying and sometimes
conflicting ideologies.
There are three kinds of alternative ideologies. These are:

1) Pluralism (Political philosophy)
2) Totalitarianism (totalitarian rule)
3) Democracy (Mix of pluralism and totalitarian rule)
Impact of difference in political ideologies on Country’s Boundaries

Differences in political ideologies are due to differing history, culture, language, religion,
geography and polity which defend the boundaries of two nations. Bigger nations or
regions split into smaller states when political system collapses (e.g. USSR).
To understand the political environment better let us now discuss the various forms of
government. These are as follows:
Democracy
Multi National Corporations like to work in democratic countries. Democracy usually
provides freedom especially economic freedom and legal rights which safeguards
individuals and institutions. Political system having democracy demonstrate the
following six features:
i) freedom of speech, expression, press and freedom to organize;

ii) elections in which voters elect their representatives;
iii) officials are elected for a limited term
iv) an independent judiciary which safeguards individual rights and property;
v) bureaucracy which is non political and defence infrastructure;
vi) access to decision-making process.
Civil liberties and Political rights: Civil liberties include equality before law for all
individuals, freedom of press and personal freedom of movement, practice any
profession, etc.
Political rights include fair elections and people’s representatives exercise immense
power.
Stable democracies: Citizens of democratic countries feel that democracy is the best
form of government. However, all democratic countries do not have stable governments
due to interference of feudal and dictatorial tendencies, existence of weak political
parties and corruption.
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Will democracy survive? Pestel
A million dollar question is being raised globally about stability of government in

democratic countries. Lately many countries have adopted democratic form of
government. Only future will show whether democracy will survive in such countries
or not. Democratic form of government need not be stable always. The newer
democracies of the 1990’s, especially those that are part of disintegrated USSR are still
showing signs of instability. Countries like China and Singapore in Asia are
experimenting with alternatives to democracy.
Influence of Political System on Management Decision Making

A) Any business experiences various types of political risk because of being a part of
political system. Political risk occurs when the political climate within a country is
not favourable for the international companies to operate.
1) Causes and types of political risk: There are various types of political risk
which can create obstacles in the operation of a company e.g. government
takeover of property, frequent strikes and lockouts which hamper company’s
performance and operating restrictions. Such problems can arise due to radical
changes in opinion of country’s leadership, civil disorder and breakdown of
relationship between the home country and host country government.
2) Macro and Micro political risks: When political actions are aimed at
particular foreign investment company they are regarded as micro political
risks. On the contrary, if they are aimed at large section of foreign investors
they are considered as macro political risks.
B) Extent of Government Intervention in the Economy

Government’s intervention in the economy varies from “individualistic intervention”
i.e. minimum interference to “communitarian intervention” i.e. maximum
interference in economy. Usually companies prefer centralized bureaucracy with a
stable political party. If a U.S firm moves from its home country (individualistic)
to host country like Germany, Japan, or South Korea (communitarian) it will have
to develop new strategies for its stakeholders namely government, customers,
suppliers and competitors.
Designing and Implementing Political Strategies

There are certain steps which a company needs to follow to establish its business
operations within the prevailing political climate of a country.
The steps include the following:
i) Shortlist the specific issues confronted by the company like trade restrictions, rights
of workers.
ii) Identify the political aspect of the issue especially that aspect which can be dealt
from outside political intervention.
iii) Examine the likely political actions of competing companies.
iv) Assess the role played by important individuals and institutions.
v) Evaluate the impact of implementing strategies on firm’s image.
vi) Determine the appropriate strategy and execute it.
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Environment 4.3 ECONOMIC ENVIRONMENT
According to World Bank Data, there are 214 countries in the world with population of
more than 30,000. A prominent question that a Multi National Corporation (MNC)
faces is that in which of these countries it should expand? Two important considerations
that would guide an MNC are the ease of access to factors of production (e.g., raw
material, labour, etc) and demand conditions (size of market, market growth rate, and
so on). To understand the economic environment, it is important to understand how the
countries of the world are classified.
The countries of the world can be classified based on different aspects namely income,
region, economic system, etc. Figure 4.1. shows the classification.
Based on Income Region Economic System

* Low income * East Asia & Pacific * Free
* Lower middle income * Europe & Central Asia * Mostly free
* Upper middle income * Latin America & the Caribbean * Mostly unfree
* High income * Middle East & North Africa * Moderately free
* South Asia * Repressed
* Sub-Saharan Africa
Figure 4.1: Economic Environment
A) Classification based on Income

Based on income countries are usually classified by their GNP or GDP per capita.
GNP stands for Gross National Product and GDP for Gross Domestic Product.
GNP is the total value of all final goods and services produced within a nation in a
particular year, plus income earned by its citizens (including income of those located
abroad). It excludes income of non-residents located in a particular country. GDP
includes the total value of the economic activity within a country’s borders regardless
of whether that activity is a result of foreign or domestic investment. Gross National
Income (GNI) per capita is the amount of economic activity per citizen of a country
per year. The World Bank Report 2011, classifies economies into the categories
shown in Table 4.1 on the basis of GNI per capita.
Table 4.1 : GNI per capita, 2011
Low income $1025 or less

Lower Middle income $ 1026-$4,035
Upper Middle income $4,036 - $ 12,475
High income $12,476 or more
Source: data.worldbank.org/about/country-classifications (retrieved on June 2013)
It may be noted here that the World Bank February, 2013 income classification is
updated on July 1st every year, therefore despite the changes in the GNI of the
countries, the data remains the same till June 30 every year.
B) Classification based on Region

The major regions are: East Asia and Pacific, Europe and Central Asia, Latin
America and Caribbean, Middle East and North Africa, South Asia, and Sub-Saharan
8
Africa. These classifications are important to Multinational Corporations, which Pestel
organize their operations along geographic lines. Usually this classification reflects
the low-income and middle –income economies only, which are commonly referred
to as developing economies. The classification based on geographic region normally
reflects the development status of such economies.
C) Classification based on Economic System

Economic system is the system of production, distribution and consumption which
can be placed on a continuum from “free” to “repressed.” The current breakdown
is detailed in Table 4.2.
Table 4.2: Countries classified on the basis of Economic System
Categories Number of Examples of countries

countries
Free (80 & above) 69 Hong Kong, Singapore, Switzerland,
Mostly Free (70-79.9) 57 Jordan, Malaysia, South Africa, China
Moderately free (60-69.9) 33 Brazil, India
Mostly not free (50-59.9) 14 Sudan, Zimbabwe, Bangladesh
Repressed (under 50) 07 Maldives, North Korea and Iran
Source: Compiled from Heritage foundation calculations from 2103 Index of Economic Freedom.
D) Classification based on types of economies

There are basically four types of economies viz – a-viz.
- Market Economy
- Command Economy
- Traditional Economy
- Mixed Economy
Market Economy - is the type of economy where economic resources are owned and
controlled by the private sector. They are owned by private bodies and not by Government
or public sector for eg. U.S.A., U.K.
Command Economy - Here the economic resources are owned and controlled by the
government or public sector. The central government on the basis of central plan
determines the production and processing of product for e.g. China, and USSR before
disintegration into Russia, and other countries.
Traditional Economy –In this case the economic decisions are based on the age old
customs and beliefs followed by generations, e.g. most of the African Countries.
Mixed Economy – Most of the countries of the world follow a combination of above
three types of economies. Such countries have characteristics of both private and public
sector ownership and control, e.g. France and India.
Key Macro - Economic Issues

In a macro economy there are various undesirable situations which used to exist due to
lack of fulfillment of one or more macro-economic goals. Key macro economic issues
which are when the goals of the macro economy are not attained satisfactorily are as
follows: Unemployment, Inflation, Business cycle, Stagnant growth (www.anosweb.
com) accessed on 5-10-12.
9
International Business Unemployment: This is one of the major macro economic issues which is becoming
Environment
quite prominent throughout the globe. This arises due to the following two factors:
a) The output produced is less than the input because of which the economy is not
able to solve the problem of scarcity.
b) The income received by the owners of unemployed resources is less because of
which they have lower living standards.
Inflation: Inflation arises due to the continuous and persistent increase in the average
price level but to be precise, inflation is too much money purchasing too few goods/
price. Due to inflation, the economy is unable to attain the goal of stability.
Business Cycle: Unemployment and inflation lead to instability in the business cycle.
Both these macro economic issues affect the business cycle in one way or another. The
contraction and expansion phases of the business cycle are affected leading to unstable
conditions.
Stagnant growth : In a common parlance stagnant growth means that the growth has
slowed down at a particular point of the business cycle. This issue arises when the
supply of aggregate production does not increase at a desired pace. In certain cases it
tends to decline as well.
Due to various macro-economic issues, major financial crises around the globe took
place. These are discussed below in the chronological order:
South-East Asian Financial Crisis – 1997

This crisis began when Thailand national currency baht was devalued by its Central
Bank. The International help came in the form of IMF bail out package. Many other
countries of the South East Asian Region tried to minimize damage to their economies.
The crisis led to drop in the value of currencies of Malaysia, Indonesia and South
Korea. Most of these countries sought IMF bailout package and also introduced relevant
reforms. The impact of this crisis was experienced in stock markets of Asia, Europe
and to some extent United States. Much of the downturn was attributed to too much
government interference and mismanagement by private sector.
Latin American Crisis – 1999

The Brazilian currency collapsed resulting in decline in export revenues. For consequent
three years, economic growth was negative. Durability of the currency peg became
uncertain. Financial system could no longer pay back dollar liabilities which were backed
by Peso assets and government debt. This resulted in deposit withdrawals from the
banking system. As a result, Argentinean government resorted to suspending payments
on its external debt in 2001 and also curbed deposit withdrawals. Interest rate rose and
there was 356% of depreciation against US dollar. The economy witnessed decline in
output and rise in inflation.
The Global Financial Crisis – 2008

The global financial crisis started in 2008. It was started by the collapse of the US
sub-prime mortgage market which led to a boom in housing construction and easy
access to consumer spending based on debt financing. This was followed by the reversal
of the housing boom in other industrialized countries. There was decline in credit
availability which damaged the confidence of investors and had an impact on global
stock markets. Governments and Central Banks responded with IMF bailouts, expansion
of monetary policy and fiscal stimulus. The crisis ended by mid 2009.
10
The Euro Zone Crisis – 2011 Pestel
The European Sovereign debt crisis is an on going financial crisis. Europe has been
struggling to pay the debts which it had accumulated in recent decades. The principal
countries of Europe namely Italy, Greece, Portugal, Ireland and Spain have failed to
mobilize funds through economic growth to pay back bondholders the guarantee that
they had promised. These countries were identified as countries likely to default
immediately.
The consequences were far reaching and could impact both import and export to countries
like U.S.A and China and the world as a whole. The Euro zone is a monetary union
(with one currency) without fiscal union which further added to the crisis. The whole
Europe felt the impact of Euro zone crisis severely.
Transition to Market Economy

There are countries which have moved or are moving from a state – planned economy
to market economies. Such countries are known as transition economies. The countries
which fall under this purview are Former Soviet Union (FSU) and the Eastern and
European countries associates with Soviet union. More recently many countries in Asia
and Africa are also undergoing this change. The most prominent in the Asian subcontinent
are China, Mongolia and Vietnam. These countries range from middle to low income
group and come under the Europe and Central Asia (ECA) region of World Bank.
In this regard we are going to discuss the transition of Russia, Eastern Europe and
China to market economy.
Russia
Russia was initially part of United Sovereign and Socialist Republic (USSR). Both its
economic and political system underwent transition. There was disintegration of USSR
into smaller sovereign republics of which Russia was also a part. It was roughly estimated
that Russian economy in 1996 was reduced to half of its size in 1986. The transition in
Russia was sudden than phased resulting in the sudden fall of Russian economy. This
transition has posed certain challenges to Russia and till date it is trying to cope with
these challenges.
Eastern Europe
The fall of communism in 1989 and 1990 brought the economic growth in Eastern
Europe to a standstill. From 1990 to 1992, GNP in countries like Poland, Hungary and
Czechoslovakia fell to a great extent. There was competition among countries embracing
free market principles readily and those embracing gradually. The former seemed to
out perform the latter in recent years.
China
China’s transition was significantly different from that of Russia and Central Europe.
Chinese government preferred totalitarian political control as compared to political
reform. But even then China introduced privatization, liberalized its economy and
allowed private investment, without compromising with the complete economic control.
Growth Prospects of Transition Economies

As per the global economic outlook 2013 by UN, the world economy is still trying to
recover after the global crisis four years back. The global economic growth weakened
further in 2012. Many developed economies throughout the globe have undergone a
double dip recession. Apart from this, the growth in the transition economies have also
11
International Business gone down resulting in external as well as domestic challenges. Most of the European
Environment
economies are already undergoing a phase of recession. The productivity in Germany
has decreased and the economy of France is almost stagnating. The downfall in the
economies of developed nations has impacted the economic status of the developing
countries as well as transition economies resulting in weaker demand for exports and
high volatility in capital flows and commodity prices. Economies like that of China and
India have seen fast growth in the last decade but now have started facing structural
bottlenecks and financial constraints. Despite the global downfall, the economies of
the Commonwealth of Independent States (CIS), which termed to be transition economies
have registered considerable growth in 2012. Economies of Kazakhstan and Russian
Federation saw growth due to size in commodity prices especially of oil and natural
gas. On the other hand growth of republic of Moldeva and Ukraine was adversely
affected by the economic crisis. In all, the prospects of growth in the transition economies
still remain challenging.
To tackle these challenges the countries undergoing transition to market economy should
focus on the following:
- establishing market institutions such as stock markets and central bank;

- stabilization of macro economic conditions;
- controlling inflation and fluctuations in currency values;
- setting up good tax structure to bring a balance in internal debt;
- privatization of state owned enterprises;
- giving greater freedom to companies to operate.
Taking such measures will help the transition economies to create a niche of their own
in the market.
There are many growth avenues for transition economies but these are accompanied by
certain drawbacks. The most prominent of them are:
Drawbacks of Transition Economies

Environmental Hazards: Transition economies have more number of modern hazards
arising due to agricultural modernization, industrialization and urbanization,
environmental hazards like chemical pollution and contamination of water by human
waste is more common.
Inflation: In a transition economy, the inflation rises due to the removal of price controls
as happened in Russia after the collapse of communism. Most of the transition economies
face this problem leading to unemployment and unstable government.
Human Capital: According to Human Capital Theory, individuals invest in their human
capital by spending money and time on education and training which in turn increases
the productivity and high wages. In case of transition economies the human capital has
impact on economic growth in negative terms as the policy measures like subsidies for
research and development and education are not in place. These components form an
integral part of the human capital growth.
During the transition phase of late 20th century, the global economy could be observed
as strengthening further and marching towards greater economic freedom. The African
countries whose prospects seemed to be bleakest have also initiated structural reforms.
12
Activity 1 Pestel
Consider and obtain the data for the countries given below for the past 3 years and
assess how they have been able to perform on the economic indicators mentioned:
Country South Africa Brazil China Russia Chile

Economic
Indicators
Per-Capita
Income
Total Foreign
Exchange
Reserves
Balance of
Payments
Surplus/Deficit
Total Exports
for current
year
Total Imports
for current
year
Remarks
about the
country
4.4 SOCIAL AND CULTURAL ENVIRONMENT

In the new global environment cultural awareness about other countries is essential for
the managers. This is a critical issue and any ignorance of cultural sensitivities will
lead to dire consequences which would even jeopardize business transaction. Before
proceeding on overseas assignment managers should do their homework, try acquainting
themselves to foreign cultures. This could be done by undergoing a short course in
foreign language, cross cultural training, familiarizing themselves through cultural
descriptions like guidebooks thus avoiding mistakes.
Cultural Identification and Dynamics of Cultures

There are certain ways by which a manager can understand the dynamics of different
cultures.
Nation as a Point of Reference: Cultural differences exist usually between nations

and are considerably less within countries. Thus it becomes essential to compare
differences in national cultures.
Dynamics and Cultural Formation: Cultures are imbibed by children from their
parents in early age. Culture and value systems are also inherited from one generation
to another. There are cultural changes over time due to exposure to foreign cultures. If
a change in a country’s culture is due to forceful imposition of foreign nation’s culture
it is known as cultural imperialism.
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International Business Language creating Cultural Stability: Culture can be identified in terms of language
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spoken, such as French, English etc. Similar language spoken in an area has similar
cultural attitudes. Many countries have diverse cultures because they have different
languages spoken within their borders.
Religion creating Cultural Stability: Religion followed by people of a country also

reflects its cultural values and also affects its business practices. The holidays, working
hours, food habits and lifestyle may also be influenced by the religion practiced.
Culturally Oriented Social Practices

A Manager should be aware of the culturally oriented social practices as they influence
business.
Social Stratification
A society can be stratified on the basis of varying cultural values. A person can be
ranked on the basis of his birth or on the basis of achievement, political affiliation,
religion or other factors. Social stratification may influence the determination of target
market, human resources policies and practices and other similar activities.
Following cultural characteristics influence person’s social ranking.
Merit as basis of selection: In many advanced countries the basis of selection for job,
promotion is merit or competence. This creates healthy competition in the working
environment as each employee has opportunity to compete based on performance. In
countries like Japan seniority has greater say in promotion decisions which leads to
less competition based on performance.
Groups based on Gender: Different countries have different social approaches towards
males and females in society. In this regard we can quote Political Risk Insurance (PRI)
case of Middle-east. This case refers to Muslim laws approach towards women. The
take over of Muslim fundamentalists in certain countries prohibits women from attending
school and working in offices also.
Groups based on age: In many countries age is associated with experience, wisdom,
even the age of retirement is fixed on the basis of age i.e. 60 or 65 years. Many companies
prefer young employees and accordingly fix their selection standard. Many products
use youth for advertisement as a sign of freshness and vigor.
Groups based on Family: In some societies, instead of individual’s achievement it is

family’s social status which determines position in business. Recently, family owned
businesses are gaining importance where non-family members find it difficult to move-
up in business.
Source of Livelihood: People select their source of livelihood or occupation on the

basis of economic and social prestige attached to certain occupation. In some countries,
professionals from teaching stream are given greater importance than business
professionals. While in other societies people opt to become Doctors or Engineers on
the basis of prestige attached to jobs of science discipline.
Motivation
There can be different motivating factors for members of different cultures. Some
workers would find leisure, while others would find money as the main motivating
factor for higher productivity. We shall now discuss some of the motivating factors :
14
Leisure and Materialism: There are varying thoughts regarding leisure and materialism. Pestel
According to Max Weber, the Calvinist put greater emphasis on the importance of
materialistic pursuit of life. In such societies workers put in longer working hours and
hated retirement. Mahatma Gandhi denounced materialistic pursuits of life but regarded
‘work as worship’.
Expectation of Reward and Success: Motivation to work would be higher in societies

where reward for success is higher rather than penalization for failure. However, where
the rewards for success are low motivation to work will be low.
Masculinity Index: The masculinity index would be high where workers have “live to
work” attitude. It would be low where there is “work to live” attitude. Managers of low
masculinity countries would emphasize for smooth social relations. While managers
from high masculinity countries would emphasize on work related matters like lowering
cost and raising productivity.
Hierarchy of Needs: Needs are also chief motivators. Lower order needs like food,
shelter have to be prioritized in fulfillment. While fulfillment of higher order needs like
peer acceptance and self actualization can wait for some time.
Attitude towards Relationships

Culture influences the attitudes towards relationships. Attitudes also influence work
behaviour from country to country. We shall now discuss some of the attitudes we
come across in day to day relationships.
Relationship between Superior and Subordinate

Management style differs between high power distance countries and low power distance
countries. Management style in high power distance countries is usually autocratic and
superiors and subordinates have little interaction whereas in low power distance countries
the management style between workers and managers is consultative and participative.
Individualistic vis-à-vis Collectivist Style

Workers in countries where individualistic style is predominant will exhibit less
dependence on firm and will demonstrate more freedom, personal time and challenge.
The dependence level of workers on their firms would be high in countries exhibiting
collectivist style. They would look forward on firms for training, perks, improved
working environment and also team work.
Behaviour related to Risk-taking

The attitude of citizens of a country is affected by the following three cultural aspects.
Avoidance of Uncertainty: Workers of countries exhibiting high uncertainty avoidance

will prefer strict rules and regulations and will stay with the company for a longer
period. While those with low uncertainty avoidance will loathe strict rules and will
switch jobs frequently.
Trust: There are certain cultures which believe in trusting people e.g. Norway. While
cultures like Brazil do not believe in trusting people. The cost of doing business would
be higher in cultures exhibiting low trust as greater precaution would be required to be
taken to avoid being cheated.
Fatalism: There are two schools of thought one is fatalistic i.e. belief in predetermination
and the other is belief in self determination. The fatalistic believe that their destiny is
pre-determined as such less effort will be demonstrated to change that destiny. The
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International Business self-deterministic would instead work harder and change their destiny through
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determination.
Information and Task Processing

Different cultures collect information and process it differently.
Perceiving Cues: The cues are conveyed through precision of language and importance
is attached to object, place, animal etc. accordingly. For example, in Arabian culture
camel enjoys greater importance and almost 6000 words are found which denote camel,
camel’s body parts and equipment associated with camel. Arabic language speakers
have greater information about camels as compared to other language speakers.
Information Seeking
Low context cultures like USA and Europe attach greater importance to information
related to current decisions. High context cultures give greater importance to decisions
related to fringe issues.
Processing of Information
Information is processed differently in different cultures. In USA in telephone directories
surnames are arranged alphabetically. In Iceland names are arranged alphabetically
according to first name. Monochromic countries do their processing sequentially
finishing one item before beginning another. Polychromic cultures work simultaneously
taking all tasks in hand.
Strategies for Coping with Cultural Differences

Different countries have different cultural differences.
Appropriate strategies should be devised by managers to deal with cultural differences.
Making Slight or No Adjustment

Differences in culture require that slight adjustment should be made among people
with varying cultures. Cultures which allow greater freedom to foreigners than their
own people require less adjustment. Region wise cultural similarities may also exist for
instance those that exist between Argentina and Uruguay. Companies in these countries
will need little adjustment for expansion.
Communication
Cultural differences can be handled with the help of effective communication.
Communication includes both oral and written components and also sign language.
Oral and written language: Communication problem exists between countries due to
differences in language. It is difficult to find an exact meaning and interpretation of
words between two different languages. For example, over 4000 words in English are
spelled differently and have different pronunciation and meanings between United States
and United Kingdom.
Silent language: Nonverbal cues such as the kinesis and proximities (body movement)
like gestures, postures hap ties (touch), paralanguage (emotion), colour preferences,
can be described as “silent language”. Silent language like standing too close or too far,
or wrong body language can be misinterpreted and can ruin an important business deal.
Cultural Shock
When an employee leaves his own country and settles in a new country, he has to cope
with different culture cues and language. Various cultural training programs are organized
16
by companies before employees proceed for foreign assignment. Employees also come Pestel
across reverse cultural shocks when they return to their home country from foreign
assignment.
Management and Company Orientations

There are different ways in which companies view cultural differences. In International
business companies adopt three different approaches to staffing:
Polycentric Approach: In this approach host country nationals are hired to manage
subsidiaries, while parent country nationals occupy key positions at corporate
headquarters for e.g. Hindustan Unilever Ltd (HUL).
Ethnocentric Approach: It is about MNCs using parent country nationals for key
management positions. As expatriate managers take a long time to adopt to host countries
culture e.g. Procter & Gamble and Philips.
Geocentric Approach: In this approach the best people are selected for key jobs
throughout the organization, regardless of nationality e.g. Coca Cola.
Strategizing Change
Development of competitive environment in a country would require following some
different practices as compared to what was followed earlier. In order to gain existing
competitive advantage a company would transfer new products, services and operating
methods. The company in such a case will have to manage the impact of these changes
on local culture and company. The company will have to manage cultural change based
on following factors:
a) Value system: Every country has its own value system and changing the established
value is a difficult task. As compared to adults children have less deeply rooted
value systems.
b) Benefit - Cost of change: Since culture is imbibed at an early age, it will be

difficult for a company to change the work place culture especially with foreign
work force.
c) Opposition against too much change: Change should not be drastic, as too much
and sudden change is not liked by consumers and workers. Change should be gradual
and slow.
d) Participative: Leaders should ensure participation of stakeholders in the change

process. Stakeholders would feel less threatened in situations where they are part
and parcel of change process.
e) Sharing of rewards: Making all stakeholders party to the process of change will
make them feel comfortable with the change.
f) Opinion leaders: The opinion leaders need to feel the benefit of change before
the process of change can be supported by them.
g) Timing: The time in which any change is introduced is also very important. If
there is shortage of labourers, the employees would welcome labour-saving
techniques with open arms.
h) Gaining knowledge from abroad: Sometimes new ideas from other cultures would
also be entertained.
17
International Business Activity 2
Environment
Scan the respective website and find out how the following brands have used language
for their product packaging/marketing:
i) Coca Cola
ii) Colgate
iii) Maggi
What do you think are the reasons behind differences in language used/adopted in
some countries while retaining standardized approach in other countries?
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4.5 TECHNOLOGICAL ENVIRONMENT

Technology has been one of the biggest factors that has affected modern business. Two
facets of technology are particularly noticeable. One is the speed of communication
and the second is reduction in the cost of technology. Talking on speed of communication
you will realize that the cost of communicating in the present has also undergone massive
transformation compared to the past. From the long distance phone calls (often at the
cost of shouting) to faxes and now emails has meant faster communication and reduced
cost. While Table 4.4 shows the world internet population, Table 4.5 demonstrates the
explosive growth of the internet.
Table 4.4: World Internet Population
Year Internet Population
Dec. 1999 248 million
Sept. 2002 587 million
Dec. 2006 1.093 billion
Sept. 2010 1.971 billion
March 2013 2.749 billion
Source: www.internetworldstatis.com.(2013)
Thus, it will be seen that the internet user population world over is almost doubling
every 3-4 years. Introduction of email to the network by Ray Tomlinson in 1972, mobile
telephony, and iPhone (made possible by iPod invention) by Apple introduced millions
more to the wireless internet access. As of now 38.8 % of world population uses internet
as compared to 4.1% in 1999.
18
Table 4.5: Internet Users Globally as on 2013 Pestel
Sr. Country Internet Rank Penetration

No. Users
1. China 604,000,000 1 45.8%
2. India 302,000,000 2 25%
3. United States 254,295,536 3 81.0%
4. Japan 100,684,474 4 79.1%
5. Brazil 99,357,737 5 49.8%
6. Russia 75,926,004 6 53.3%
7. Germany 68,296,919 7 84.0%
8. Nigeria 55,930,391 8 32.9%
9. United Kingdom 54,861,245 9 87.0%
10. France 54,473,474 10 83.0%
Source: en.wikipedia.org. (June, 2013)
Though India ranks No. 3 in the world in terms of absolute number of users in different
countries, the percentage of population using internet is still the lowest among the top
10 countries surveyed (Table 4.5).
E-Commerce is another area where there is a substantial growth. The companies like
Amazon.com (a global company) to India’s largest initiative the Indian Railway Catering
and Tourism Corporation (IRCTC) portal are examples of how consumers are
increasingly looking at alternative platforms of doing business. Between the end of
1990s to the early 2000s the dot com business went through a churn and several
companies had to either close down or realign their business. Today, amazon.com or
Barnes & Noble.com or eBay have been able to come out of the trap and create a niche
in the world of e-commerce.
Technological innovations are frequent resulting in changing technologies thereby

changing strategic marketing thinking. Organizations are faced with the need to secure
a dominant market position despite start up costs being high. Companies are going in
for joint ventures to get started and seek synergies, some of which have been more
successful than others. The implications of changing electronic communications and
technological developments on international business are enormous but the need of the
hour is to innovate constantly for sustainable competitive environment. Table 4.6
summarizes the effects sequentially to enable you to grasp the effects.
19
International Business Table 4.6: The Global Challenges of Changing Electronic Communication
Environment
Technology
Challenge Response
Speed of change Shorter planning cycles, leading to effective
planning processes, faster product innovations
and marketing
Information and More options for market entry resulting in new
Communication Technology ways of communication with the market and
(ICT) effective distribution of goods and services
Internet and interactive media More E-Commerce and e-business options with
interactive media, result in changing the ethos of
the marketing strategy.
Market and organization Ability to come to terms with, and respond to,
structure electronic markets, virtual markets, borderless
organizations, virtual organizations, outsourcing,
resulting in flatter organizational hierarchies, and
symbiotic alliances with external partners
High start up and innovation Partnering and alliances
costs
Rules of competition Be ‘first’ to form alliances and continuously
innovate to sustain the market position
Disintermediation Either ‘go with the flow’ (become average)or find
new ways to compete (excel)
High risk of failure Devise an effective marketing and electronic

strategy bearing in mind the long term horizon.
Monetary transaction security, Ensure ‘electronic key’ is in place and ensure that
piracy appropriate legal norms are followed
Possible transaction Ensure e-marketing strategy is in place including
breakdown fulfillment requirements
Source: Adapted from Global Marketing Management by Kiefer Lee and Steven Carter, Oxford University
Press (2009)
Technology therefore can either be ‘constructive or destructive’. Technological

development should aim at innovating and introducing changes which improve the
quality of products and also quality of life.
4.6 ENVIRONMENTAL FACTORS/ISSUES

Environmental and ecological issues have received world wide attention. With
industrialization, development and arrival of Multi National Corporations, there has
been production of various consumer and industrial products which have harmful effect
on environment. The major factors responsible for degradation of environment have
been reckless industrialization, deforestation, traffic congestion, population and illiteracy.
The production of industrial goods have led to production of chlorofluoro carbons
causing ozone depletion. This has led to weather and climatic changes. The wastes
discharged by industries have caused air, water and soil pollution. Effective waste
management and effluent treatment is now being practiced by various business houses.
The business houses no longer hold the business monopoly. There has been emergence
of stakeholders who have their stake in businesses like shareholders, managers, workers,
20
suppliers, distributors, consumers, government officials. As a result it has been felt that Pestel
business should be socially responsible. In order to preserve environment, companies
have developed following policies and practices designed to integrate environmental
issues in their business strategies.
i) preserve and promote green and pollution free environment;

ii) support renewal energy;
iii) protect and preserve fauna and flora especially endangered species;
iv) recycle waste;
v) follow internal and international regulations related to environment and pollution;
vi) encourage manufacture of energy efficient products;
vii) achieve sustainable development by allowing markets to work within an appropriate
framework of cost efficient regulations;
viii) promote effective corporate governance by application of best management
practices, adherence to ethical standards for effective management and distribution
of wealth and discharge of social responsibility for sustainable development of all
stakeholders;
ix) corporate effort to create environment awareness campaign;
x) study the environmental impact of products over their entire life cycle;
xi) introduce incentive schemes for good environmental practices;
xii) contribution to environmental institutions such as Global Compact and the World
CSR;
Activity 3
Analyze ‘The Global Compact’ and identify the World Economic Forum in which the
call for embracing and enacting it was given.
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4.7 LEGAL ENVIRONMENT

There are different dimensions of legal environment prevailing within a country.
A) Types of Legal Systems

Common law: Laws are based on tradition, previous precedents and customs (e.g.,
United States, United Kingdom, etc).
Civil law: The legal system is based on a legal code which is a detailed set of laws
(e.g., France, Germany and Japan).
Theocratic law: The legal system is based on legal precepts (e.g., Iran).
21
International Business B) Safeguards for Consumers
Environment
International firms have to often face product liability issues as a major challenge.
Law protects consumers who often invest millions on purchase of products of
international firms. These safeguards protect consumers in case the quality of the
product is not up to the mark. Filing of product liability case by the consumer will
compensate the consumer to some extent.
C) The Legal Profession

The international firms before starting an international venture usually network
with law firms in other countries. They need the services of lawyers or law firms
for negotiating contracts and protecting intellectual property rights. At the same
time some law firms have become international through mergers with other law
firms.
D) Legal Issues related to International Business

Laws influence various aspects of international business. Laws which affect working
environment vary from country to country (working hours, minimum wage level,
length of weekdays and weekend). Laws also govern cross-border activities such
as import duties, foreign investment regulations, etc.
E) Ethical and Legal Dilemma

“When you are in Rome, do as the Romans do” is the best approach for dealing
with ethical issues globally. Merely abiding host country’s laws will not fulfill
one’s ethical responsibilities because of following reasons:
• All unethical issues need not always be illegal

• Slow development of laws in emerging areas of concern
• Moral concepts must be studied side by side with legal concepts
• Laws need to be examined by judiciary
• The law need not always be efficient.
Though law cannot solve all ethical disputes it however, serves as a guide in many
cases. Examining potential liability and legality of actions becomes difficult between
countries with varying common and civil law systems. Government laws assess the
legality of various behaviours while common law emphasizes more on cases and
precedents than on statutory regulations. In case of bone of contention over laws between
countries it is for the management to decide which law to apply.
Activity 4
Assume that you are employed in an international firm in India and that your firm is
interested in expanding its business in one of the countries out of the group of countries
known as newly emerging market economies. You have been asked by your employer
to conduct ‘economic, social, political and legal risk assessment’ of that country so that
your firm could take a decision. How would you proceed and which country would you
like to choose? Make a brief note of the reasons for your choice and the assessment of
the risks involved.
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22
Pestel
4.8 SUMMARY
The analysis of political, economic, social, technological, environmental and legal
factors, in short known as PESTEL analysis, is crucial to international business. For
countries as well as global organizations these factors are important and must be
evaluated, especially when the future looks like uncertain.
This unit, following PESTEL constituents in the order or sequence in which the
abbreviation appears, discussed political, economic, social, technological, environmental
and legal factors; and how they could affect international business. An understanding
of these factors is imperative for any manager who is concerned with international
business.
Some of the key points under economic factors included classification of countries on
the basis of income, region and economic systems. After 1991, the economic systems
of many countries changed in keeping with world wide tendency. The transition of
erstwhile USSR to the present Russia has far reaching implications for multinational
corporations intending to do business in that country. Also with increasing regionalization
of economies the imperatives are now even broader. In the units that follow there will
be discussion on Trade Blocks, a sort of Union formed by countries due to their
geographical proximity and in some cases due to the similarity in the pattern of their
economies or their economic history or economic growth.
The unit discussed the key macro-economic indicators that have affected the global
economic environment, particularly the Asian Financial Crisis of 1997, concept of
economic growth, inflationary factors affecting economy, and the debate of surplus and
deficits. The Unit also discussed about how some of the countries have followed the
transition to market economy, noticeable among them being Russia, China and some of
the Eastern European countries.
For any multinational company it is important to identify a country’s culture and its
underlying dynamics. Culture is always the invisible hand of the society which tends to
be present in watermark but practicing managers can never ignore it.
The culturally oriented social behaviors affect business. It is therefore, necessary for an
international manager to understand a country’s social stratification process, motivations
of its people, relationships, preference about risk taking, etc. How companies deal with
cultural differences and what strategies they adopt to deal with them makes the difference.
Making internal adjustments, studying aspects of communication, adopting right
management orientation, including seeking local expertise, and finally institutionalizing
the processes are critical to organizations wanting to succeed in international business.
Political environment of a country affects international business. It is imperative for an

MNE to understand the dominant political ideology prevalent in the country, and the
impact of such ideology on management decisions. In the contemporary scenario
organizations have to devise mechanisms to gauge the political tone and tenor. In a
country like India political ideologies are key to doing business.
Environment Factors refer to preservation and promotion of green and pollution free
ecology. This also includes manufacture of eco-friendly products.
Legal environment in a country is also critical to international business. With increasing

complexities, aggressive takeovers, mergers or acquisition, what it means is that the
organizations have to make it sure that all the possible legal issues are taken care of
before an action is initiated. Meeting the requirements of a foreign country legal
23
International Business environment and defending legal suits are difficult and have cost implications. It is said
Environment
that in U.K. the cost of hiring a lawyer may at times be more than the total export
consignment under legal dispute. Especially for small or medium exporters it becomes
tough.
4.9 KEY WORDS

Market economy : An economy in which resources are primarily owned
and controlled by the private sector.
Command economy : An economy (also known as a centrally planned

economy) in which all dimensions of economic
activity including pricing and production decisions
are determined by a central government plan. The
government controls all resources.
Mixed economy : An economy where the government and private have

equal opportunity to operate.
Social Stratification : The division of society into various strata. Every

culture values some people more highly than others
and determines a person’s ranking (or social
stratification)
Culture Shock : A severe frustration born from experiencing a new

culture and trying to cope with a vast array of new
cultural cues and expectations.
Polycentrism : An approach of doing business in host country

according to host country’s practices.
Political Risk Insurance : They are among the mix of service providers that
(PRI) case are working to tailor their instruments to meet Sheriah
(Muslim law) related complaint requirements.
Ethnocentrism : Applying the practices in one’s own country to the

host country.
Geocentrism : The blend of polycentric and ethnocentric approach

for doing business.
Common law : Laws based on tradition, precedent, and custom in

that country.
Civil law : Legal system based on a detailed set of laws that

make up a code for the country to operate.
Theocratic law : Legal system based on religious precepts.
4.10 SELF-ASSESSMENT QUESTIONS

1) Discuss the key macro-economic issues that affect business strategy.
2) Describe the factors that have facilitated the transition to market economy.
3) What are the cultural factors that influence business? Discuss in detail.
4) What are some of the problems that companies face when they misjudge the cultural
leanings of a country? Explain with relevant examples.
24
5) What are some of the elements of legal factors crucial to consider for a MNC Pestel
while venturing in newer markets?
6) What are the major factors to be considered in evaluating political environment in
a country? Discuss how such factors could affect international business?
7) Evaluate how technology has affected our lives over the last decade in terms of its
influence on products/services, citing examples and naming the companies behind
such products.
8) How can MNCs capture and evaluate the importance of and make a response to
changes in the global marketing environment?
4.11 FURTHER READINGS

Daniels, D. John and Radebaugh, H. Lee (2000), International Business- Environment
and Operations, New Delhi: Addison Wesley Longman Pte. Ltd. (Chapter 2, 3, 4).
Sundaram, K. Anant and Black, J. Stewart; (2000). The International Business-
Environment, New Delhi: Prentice Hall of India. (Chapter 7, 8, 9, 13).
Lee Kiefer and Carter Steven (2005).Global Marketing Management by, Oxford
University Press.
Peng W. Mike (2007).Global Strategy by, Cengage Learning, India.
Daniels, D. John, Ralibaugh, H. Lee, Sullwan P. Daniel (2007); International Business-
Environments and Operations, N.Delhi; Dorling Kindersley (India) Pvt. Ltd.
K. Aswathappa (2008); International Business, Third Edition, New Delhi: Tata McGraw
Hill (Chapter 5,6).
Gupta S.C. (2010). International Business Management, New Delhi; Ane Books Pvt.
Ltd. (Chapter 3, 15).
heritage.org
web.worldbank.org
eg.wikipedia.org
www.internetworldstats.com
25
Environment UNIT 5 WTO AGREEMENT AND ITS
IMPLICATIONS
Objectives
After reading this Unit, you should be able to explain:

• the General Agreement on Tariffs and Trade (GATT) prior to the Uruguay Round;
• the reasons and importance behind Uruguay Round;
• the new order envisaged in WTO; and
• the WTO and its implications for India.
Structure
5.1 Introduction
5.2 GATT Prior to the Uruguay Round
5.3 The Uruguay Round
5.4 World Trade Organization (WTO): The New Order
5.5 The Structure of WTO
5.6 WTO and India
5.7 WTO: Doha and Beyond
5.8 Summary
5.9 Key Words
5.1 INTRODUCTION
The General Agreement on Tariffs and Trade (GATT) was a multilateral treaty that laid
down agreed rules for conducting international trade. It came into force in January
1948. Its basic aim was to liberalize trade and for 47 years it had been concerned with
negotiating the reduction of trade barriers and maintaining international trade relations.
Overseeing the application of its rules was an important and continuing part of its
activities. GATT also provided a forum in which countries could discuss and overcome
their trade problems and negotiate to enlarge international trading opportunities. The
rapid and uninterrupted growth in the volume of international trade till 1994 is attributed
to and is taken as an indicator of the success of the GATT.
5.2 GATT PRIOR TO THE URUGUAY ROUND

GATT or General Agreement on Trade and Tariffs was formed as a rescue measure
after the abortion of the idea of forming International Trade Organization (ITO) in
1948. GATT has acted as a catalyst in establishing a strong and prosperous multi-
lateral trading system. This liberal system was developed through various rounds of
trade negotiation. The journey of such multi-trading system travelled from Geneva to
different continents via Havana (Cuba) in 1948 to Annecy (France), Torquay (UK),
Tokyo (Japan), Punta del Este (Uruguay) Montreal (Canada), Brussels (Belgium) and
finally to Marrakesh (Morocco) in 1994.
26
Eight major trade negotiations took place under the GATT auspices. The first round in WTO Agreement and Its
1947 (Geneva) saw creation of the GATT. The second round in 1949 (Annecy, France) Implications
involved negotiation with nations that desired GATT membership. The principal
emphasis was on tariff reduction. The third round in 1951 (Torquay, England) continued
negotiations on accession and tariff reduction. The fourth round in 1956 (Geneva)
proceeded along the same track as earlier rounds. The fifth round in 1960-61 (Geneva,
Dillon Round) involved further revision of the GATT and the addition of more countries.
The sixth round in 1964-67 (Geneva, Kennedy Round) was hybrid of earlier product-
by-product approach with across the board tariff reductions. The seventh round in 1973-
79 (Geneva, Tokyo Round) centered on the negotiation of additional tariff cuts and
developed a series of agreements governing the use of non-tariff measures. The
eighth round (Marrakesh, Uruguay Round) started in 1986 and was concluded in
April 1994.
As a result of these negotiations, the tariff rates for thousands of items entering into
world trade were reduced or restricted from increase again. The Kennedy Round
negotiations alone reduced the average level of world industrial tariffs by about one
third. The Tokyo Round produced comprehensive agreements on tariff and non-tariff
measures as discussed below.
The Tokyo Round of Multilateral Trade Negotiations

One hundred two countries participated in the Tokyo Round. The negotiations concluded
in 1979 with agreements covering: an improved legal framework for the conduct of
world trade (which includes recognition of tariff and non-tariff treatment in favour of
and among developing countries as a permanent legal feature of the world trading
system); non-tariff measures (subsidies and countervailing measures; technical
barriers to trade; government procurement; customs valuation; import licensing
procedures; and a revision of the 1967 GATT anti-dumping code); bovine meat; dairy
product, tropical products; and an agreement on free trade in civil aircrafts. The
agreements contained provisions for special and more favourable treatment for
developing countries.
Tariff Measures
Participating countries also agreed to reduce tariffs on thousands of industrial and
agricultural products, the cuts to be gradually implemented, for most part over a period
of seven years beginning from January 1, 1980. The total value of trade affected by
Tokyo Round Most-Favoured-Nation (MFN) tariff reductions, and prevailing tariff rates,
amounts to more than US $ 155 billion. As a result of these cuts, the weighted average
tariff (that is, the average tariff measured against actual trade flows) on manufactured
products in the world’s nine major industrial markets declined from 7.0 to 4.7 percent,
representing a 34 per cent reduction of customs collection, a cut comparable to that
achieved in the Kennedy Round (1964-67).
A number of countries especially Japan advanced the implementation of tariff cuts

negotiated in Tokyo Round.
Non-tariff Measures
As the general level of tariffs declined in the post-World War II period, the distorting
effects on world trade of non-tariff barriers became more pervasive. The Tokyo Round
was different from earlier trade negotiations in as much as it sought to tackle the problem
of these non-tariff barriers. The core of Tokyo Round results consisted of the binding
agreements, or code, aimed at reducing, and bringing these non-tariff measures under
more effective international discipline. All the agreements provided for consultation
27
International Business and dispute settlement; they also provided for special and more favourable treatment
Environment
for developing countries. These agreements included:
i) Subsidies and countervailing measures which committed signatory governments

to ensure that any use of subsidies by them did not harm the trading interest of
another signatory, and that countervailing measures did not unjustifiably impede
international trade; these measures may only be applied if it could be shown that
the subsidized imports in question were in fact responsible for causing material
injury, or threatening such injury, to the domestic industry which had lodged the
complaint.
ii) Technical barriers to trade (also known as the Standards Code) committed
signatories to ensure that when governments or other bodies adopted technical
regulations or standards, and the testing and certification schemes related to them,
they did not create unnecessary obstacles to trade.
iii) Import licensing procedures recognized that they had not only acceptable use, but
also that their inappropriate use did not hamper international trade; it aimed at
ensuring that they did not in themselves acted as restrictions on imports. By
becoming parties to the agreement, governments committed themselves to simple
import licensing procedures and to administering them in a neutral and fair way.
iv) Government procurement aimed at securing greater international competition in

the bidding for government procurement contracts. It contained detailed rules on
the way in which tenders for government purchasing contracts ought to be invited
and awarded. It was designed to make laws, regulations, procedures and practices,
for making government procurement more transparent, and for ensuring that they
did not protect domestic products or suppliers. The agreement’s provision applied
to individual government contracts worth more than SDR 130,000 (about US $
155,000).
v) Customs valuation sets provide for a fair, uniform and neutral system for the
valuation of goods for customs purposes -- a system that conforms to commercial
realities, and which outlaws the use of arbitrary or fictitious customs values. The
code provided a revised set of valuation rules, expanding and giving greater
precision to the provisions on the customs valuation already found in the GATT.
Developing countries could delay applying the code for five years, and were given
greater powers to counter potentially unfair valuation practices.
vi) Revised GATT Anti-Dumping Code interpreted the provisions of GATT’s Article
VI, which laid down the conditions under which anti-dumping duties could be
imposed as defence against dumped imports. The revised Code brings certain of
its provisions in line with the relevant provisions of the Code on Subsidies and
Countervailing Measures.
Table 5.1 presents a summary of the GATT trade rounds.

Table 5.1: GATT - Summary of Tariff and Non-tariff Measures
Year Place/ name Subjects covered Countries
1947 Geneva Tariffs 23
1949 Annecy Tariffs 13
1951 Torquay Tariffs 38
1956 Geneva Tariffs 26
1960– Geneva Tariffs 26
1961 (Dillon Round)
28
WTO Agreement and Its
1964– Geneva Tariffs and anti-dumping measures 62 Implications
1967 (Kennedy Round)
1973– Geneva Tariffs, non-tariff measures, “framework” 102
1979 (Tokyo Round) agreements
1986– Geneva Tariffs, non-tariff measures, rules, 123
1994 (Uruguay Round) services, intellectual property, dispute
settlement, textiles, agriculture, creation of
WTO, etc.
Source: www.wto.org (June, 2013).
5.3 THE URUGUAY ROUND

Uruguay Round of Multilateral Trade Negotiations was launched at Punta del Este
(Uruguay) in September 1986. These talks were the most ambitious and complex so
far. Negotiations covered not only traditional GATT subjects such as tariff measures
and the improvement of GATT rules and disciplines on subsidies, safeguards, etc. but
also extended to new areas not dealt with by GATT earlier, such as Trade Related
Intellectual Property Rights (TRIPs), Trade Related Investment Measures (TRIMs) and
Trade in Services and Agriculture.
The Uruguay Round was formally concluded at the Ministerial conference held in
Marrakesh, Morocco, from 12-15 April 1994. India, along with 110 other countries
authenticated the results of the Uruguay Round by signing the Final Act. In addition,
104 countries also signed the Agreement establishing the World Trade Organization
(WTO). The WTO Agreement has come into force from January 1, 1995 and India
became a founder member of the WTO by ratifying the WTO Agreement on 30th
December 1994.
Estimates have been made by the World Bank, Organization for Economic Co-operation
and Development (OECD) and the GATT Secretariat, which show that the income
effects of the implementation of the Uruguay Round package will add between U.S.
$213 and $274 billion annually to the world income. The GATT Secretariat’s estimate
of the overall trade impact is that the level of merchandise trade in goods will be higher
by U.S. $ 745 billion in the year 2005, than it would otherwise have been. The GATT
Secretariat further projects that the largest increases will be in the areas of clothing
(60%), agriculture, forestry and fishery products (20%) and processed food and
beverages (19%). Since India’s existing and potential export competitiveness lies in
these product groups, it is logical to believe that India will obtain large gains in these
sectors. Assuming that India’s market share in world exports improves from 0.5 per
cent to 1 per cent, and that we may conservatively be placed at U.S. $2.7 billion of extra
exports per year, a more generous estimate will range from U.S. $3.5 to 7 billion worth
of extra exports.
There are several areas in the Uruguay Round package that relate to market access. The
more important ones are tariffs, textiles, garments and agriculture.
i) Tariffs: In most developed countries, industrial tariffs have been reduced and are
now bound at very low levels (an average of 5%) and are not a significant barrier
to trade. Developing countries have also been reducing their tariffs. The overall
tariff reduction in the Uruguay Round on an average is by one-third. On industrial
raw materials, components and capital goods, India has bound tariffs at 40% (1993-
94) and at 25% in other cases. Tariff reductions where necessary were to be carried
29
International Business out in six equated annual installments from March 1, 1995. As the reference date
Environment
for reducing tariffs was January 1, 1990, when Indian tariffs were high. Substantial
autonomous tariff reductions have been undertaken since then, and in the initial
years there was no obligation to undertake significant tariff reductions. At present
50% of our tariff lines are bound and after the Uruguay Round Agreement come
into force, about 68% of tariff lines will be bound. In comparison, many developing
countries in Asia and Latin America have bound between 90 and 100% of their
tariff lines at levels comparable to or lower than India’s bindings.
ii) Textiles: The textiles and clothing agreement also forms part of the market access.
A major achievement has been the commitment to integrate this sector into a
multilateral framework. This is the first time that importing countries have agreed
to an unequivocal commitment to integrate textiles trade into GATT. The legal
commitment of the integration has been further strengthened by the provision in
the WTO text that any waiver from the obligations under an agreement involving a
transition period in the textiles agreement will enable India to devise policies and
allow strategic reactions on the part of industry so as to reap the greatest benefits
from the integration. In addition, India has linked tariff reductions and bindings in
textiles and garments to the implementation of the textiles agreement.
iii) Agriculture: On agriculture, India has ensured that all major programmes for the
development of agriculture will be exempted from the disciplines in the agricultural
agreement. The text provides for a single Aggregate Measurement of Support
(AMS), based on both product specific and non-product specific support. India’s
total AMS in the relevant base period of 1986-88 is negative (without taking into
account exemptions available on input subsidies to low income and resource poor
farmers) and there are no reduction commitments. Nor does India have any minimum
market access commitments in agriculture. The text of the Final Act clarifies that
the operation of the public distribution system will not be affected by the provisions
of the agreement. On agricultural tariffs, developing countries have the flexibility
of indicating maximum ceiling bindings; India has indicated ceiling bindings of
100% on primary products, 150% on processed products and 300% on edible oils.
The Uruguay Round Agreement has also strengthened multilateral rules and disciplines.
The most important of these relate to anti-dumping, subsidy and countervailing measures/
safeguards which are subject to differences in thinking and hence defy settlement. For
example, on matters related to subsidies, countries with a per capita income of less than
U.S. $ 1,000 have been exempted from the general exemption to phase out export
subsidies on industrial products. Regardless of the level of per capita income, all countries
will have to phase out export subsidies on products where they have a share of 3.25%
or more of the world market in two consecutive years. But this only affects India’s
exports of diamonds. In line with the new obligations on anti-dumping, subsidies and
countervailing measures, amendments in the Customs Tariff Act have been made through
an ordinance promulgated on December 31, 1994. Rules concerning dispute settlement
have been made time bound, automatic and judicial in approach.
The Agreement on Trade Related Investment Measures (TRIMs) prohibits investment

measures that are inconsistent with national treatment (Article III) or general elimination
of quantitative restrictions (Article XI). Developing countries have been allowed a
five-year transition period to phase out inconsistent TRIMs. The Agreement does not
impose any obligation to provide access to all or any particular sectors for foreign
investments.
The General Agreement on Trade in Services (GATS) has two major across the board
requirements. The first is non-discrimination on the basis of the most favoured nation
30
(MFN) clause and the second is transparency. There is no requirement for an across the WTO Agreement and Its
Implications
board opening up of the services sector. India has made an offer on the basis of the
country’s self-interest. India’s interest in the negotiations on services was primarily in
delivery of services through the modality of cross-border movements of natural persons.
The negotiations on services will come to an end six months after the entry into force of
the agreement establishing the WTO.
The agreement on Trade Related Intellectual Property Rights (TRIPs) provides norms
and standards for copyrights and related rights, trade mark, geographical indications
(Geographical indications identify goods as originating in the territory of a country,
region, or locality, with a quality, reputation or characteristic attributable to its
geographical origin; thus a geographical indication points to a specific place or region
of production that determines qualities of the product. Geographical indications are
understood by consumers to specify the origin and the quality of products), industrial
designs, patents, lay out designs of integrated circuits and protection of undisclosed
information. On copyrights and related rights, the Agreement requires compliance with
the provisions of the Berne Convention. India is already a signatory of the Berne
Convention and the new Copyright Act already meets the requirements of the TRIPs
Agreement. A Bill to amend the Trade and Merchandise Marks Act of 1958, so as to
provide for the protection of service marks, has been passed by the Lok Sabha (lower
house of Indian Parliament). In India, there is no specific law on geographical indications,
although the case law permits protection of geographical indications. A new law will
have to be enacted, but there is a five-year transition period that is allowed. This five-
year transition is also permitted for layout designs of integrated circuits and protection
of undisclosed information.
On patents, the basic obligation is that product and process patents must be permitted
in all areas. However, specific exceptions from patentability are permissible for selected
areas. Countries that do not provide patents in certain areas now, can delay the provisions
requiring product patents for another five years, beyond the five years that are granted
as a general exemption. But exclusive marketing rights will have to be provided for
products which obtain patents after January 1, 1995. The Patents (Amendment)
Ordinance of 1994 was accordingly promulgated on 31st December 1994. On plant
varieties, there is an obligation to provide for protection by patents or by an effective
sui generis system (i.e., a system of its own kind) or by a combination. The Agreement
does not spell out the ingredients of the sui generis system and each country can
determine the elements that can provide effective protection. India has decided to put
in place a sui generis system rather than product patents, as that is more in the national
interest. The Ministry of Agriculture has already begun work on the drafting of suitable
legislation that will also protect farmers and researchers’ rights adequately. A drafting
group set up by the Ministry of Environment and Forests is addressing the issue of
regulation of access to genetic material.
Agreement on Textiles
India has signed two separate agreements with the USA and the European Union (EU)
on December 31, 1994 on the subject of Market Access in Textiles. These agreements
have been entered into with a view to facilitate trade in textiles products between India
and the USA and EU countries. At present, approximately two-thirds of India’s total
textile exports are to these countries.
It has been estimated that if India is able to utilize fully the additional access gained as
a result of the two agreements, it will result in additional earnings of around Rs.1,100
crore per annum in the initial years. Because of the growth rates in the quotas built into
the Agreement on Textiles and Clothing of the Uruguay Round, the additional access
31
International Business achieved will get magnified in the second and third phases of integration and will
Environment
provide larger earnings during these periods.
In order to accommodate some of the concerns of the USA and the EU, India has agreed
to grant a phased tariff liberalization schedule for certain items with the WTO, at varying
rates, for periods commencing from three to seven years. In addition, India has also
agreed to open up its market for textile products, in a phased manner. Broadly speaking,
in the first phase India has agreed to allow fibres, yarns and industrial fabrics, which
are basic raw materials and in some of which domestic requirements are not adequately
met to be placed on the Open General License (OGL). In the next phase, fabrics and in
the subsequent phase, made-up items and garments are to be allowed to be imported
under OGL. This has been done in keeping with the policy of making available raw
materials at internationally competitive prices.
Dilution of Special and Differential Treatment

Developing countries lost a considerable part of their differential treatment (i.e., tariffs
fixed keeping in view the special/peculiar economic conditions of the countries so as to
protect and promote their interests), although differential treatment of least developed
countries was largely protected. They had to agree to a binding of tariff levels as a price
for accession to GATT/WTO. However, bound tariffs have been set at substantially
higher levels. They also lost flexibility in using trade policy measures for balance of
payments difficulties; they have committed themselves to giving preference to tariffs
over quantitative measures.
Activity 1
What are some of the key outcomes of the Uruguay Round? Visit the WTO website at
wto.org and analyse the Dunkell Draft. What were the key implications of the Dunkell
Draft against India?
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Success of GATT
The success of GATT in promoting and securing the liberalization of world trade over
47 years (1948 to 1995) cannot be contested. It was instrumental in reducing industrial
tariffs from an average of 40 per cent to less than 4 per cent and led to very high rates of
world trade growth during the 1950s and 1960s.
Trade liberalization further helped to ensure growth of trade which consistently outpaced
production growth throughout the GATT era. The increase of new members during the
Uruguay Round demonstrated that the multilateral trading system under GATT was
recognized as an anchor for development and an instrument of economic and trade
reform.
A whole corpus of jurisprudence on trade matters evolved under the aegis of GATT.
The WTO, in a large measure, is built upon the strong foundation provided by the
GATT.
32
5.4 WORLD TRADE ORGANISATION (WTO): THE Implications
NEW ORDER
The WTO was established on January 1, 1995. WTO is a successor of the GATT Uruguay
Round. Seventy Six Governments became members of the WTO on its first day. As on
May 1998, there were 132 members of the WTO and 34 countries have an observer
status. As on March 2, 2013, there are 159 members and 25 observer nations. The
WTO is based in Geneva, Switzerland. Its essential functions are:
i) Administering and implementing the multilateral and plurilateral trade agreements

which together make up the WTO;
ii) Acting as a forum for multilateral trade negotiations;
iii) Seeking to resolve trade disputes.
iv) Overseeing national trade policies; and
v) Cooperating with other international institutions involved in global policy-making.
The distinction between GATT and WTO are presented in Table 5.2.
Table 5.2: Difference between GATT and WTO
Sl. Specific Areas GATT WTO

No.
1. Institutional No institutional foundation, Permanent institution with its

Foundation only a small associated own Secretariat.
Secretariat.
2. Level of Provisional basis, no Full and permanent

commitment permanent commitment. commitment.
3. Agreement Multilateral agreement. Multilateral agreement with

commitments of entire
membership.
4. Dispute Slower, less automatic, Faster, automatic, less

Settlement system more blockages, dispute blockages, dispute findings
findings not easily assured easily assured.
5. Membership Less global. More global.
6. Policies Tolerated policies of Reversed policies of

protection in certain protection in certain sensitive
sensitive areas. areas.
7. Scope Mainly dealt in trade in Covers goods, services and

goods. intellectual property.
WTO is a watchdog of international trade, regularly examining the trade regimes of

individual members. In its various bodies, members block proposed or draft measures
by others that can cause trade conflicts. Members are also required to notify various
trade measures and statistics, which are maintained by the WTO in a large database.
As in any partnership, conflicts can arise among members. The WTO, from the very
start of these conflicts, provides several conciliation mechanisms for finding an amicable
solution to disputes. Trade disputes that cannot be solved through bilateral talks are
33
International Business adjudicated under the WTO dispute settlement “court”. Panels of independent experts
Environment
are established to examine disputes in the light of WTO rules and provide rulings. This
tougher, streamlined procedure ensures equal treatment for all trading partners and
encourages members to live up to their obligations.
The WTO is also a management consultant for world trade. Its economists keep a close
watch on the pulse of the global economy, and provide studies on the main trade issues
of the day.
5.5 THE STRUCTURE OF WTO

WTO has over 150 member countries and they account for about 97% of the world
trade. 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
represented by ambassadors and heads of delegation in Geneva, but sometimes officials
are 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.
The WTO Secretariat, based in Geneva, has around 637 staff and is headed by a director
general. It does not have branch offices outside Geneva. The Secretariat also provides
some forms of legal assistance in the dispute settlement process and advises governments
wishing to become members of the WTO. The annual budget is roughly 182 million
Swiss francs.
Activity 2
What are some of the major areas in which WTO has been focusing on? Evaluate the
current position of the WTO on the following.
i) Trade in Services ii) Agriculture iii) TRIPs

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5.6 WORLD TRADE ORGANISATION (WTO) AND

INDIA
India, as indeed many developing countries, is not too happy with the Uruguay Round
and the consequent formation of the WTO. Few developing countries had anticipated
that the Uruguay Round would turn into such a gigantic negotiation, leading to the
formation of WTO. Many developing countries are still struggling to cope with the
changes necessitated by the Uruguay Round. The most surprising and disappointing
aspect for the developing countries in the Uruguay Round was the agreement on Trade
Related Intellectual Property Rights (TRIPS). Countries such as India were taken by
surprise by the reach of the TRIPS agreement. Moreover, unlike trade liberalization,
34
where both countries gain, TRIPS is viewed as a means of transfer of wealth from the WTO Agreement and Its
Implications
users of patented technology to the holders of patents, located principally in the developed
countries. The severe limit placed on the access of the African countries to Acquired
Immune Deficiency Syndrome (AIDS) medicines by the TRIPS agreement has magnified
this anxiety.
Next, the slow pace at which the developed countries have implemented the Uruguay
Round agreement on textiles and clothing has added to the disappointment of the
developing countries. The Uruguay Round required the developed countries to disarm
or do away with their Multi Fiber Agreement by January 1, 2005 but especially the US
and the EU countries have chosen the slowest possible route to do so.
One of the main ways that India can gain is through tariff cuts in the developing country
(DC) markets. Before Uruguay Round, 18% of industrial imports by DCs faced zero
duty MFN status. Out of the remaining 82%, the Uruguay Round has achieved tariff
reductions for 64% industrial imports. The remaining 18% of industrial imports vary
from DC to DC, but generally are products like transporting equipment, leather, rubber,
footwear and travelling goods.
Broadly speaking, above-average tariff–cuts will take place in metals, mineral products,
precious stones and electric machinery, wood, pulp and paper, furniture, non-electric
machinery, chemicals and photographic supplies and other manufactured articles. These
product groups account for 71% of total imports of industrial goods by DCs.
Below-average tariff-cuts will take place in four major product groups – textiles and
clothing, leather, rubber, footwear and travel goods, fish and fish products and transport
equipments. For example, in textiles after the Uruguay round, 28% of imports of textiles
and clothing by developed countries will continue to face tariff rates over 20%.
Moreover, since in DCs tariff rates are already fairly low, the percentage reductions
tend to inflate the importance of tariff cuts. And the tariff-cuts in textiles and garments,
an area of export interest to India, are not going to matter too much.
Indian average tariff reductions are roughly 40%, with a drop in the tariff-rates from
the pre-Uruguay round of applied rate of 54% to a present rate of 32.4%.
Traditionally, the Least Developed Countries (LDCs) are more constrained by Non-
Tariff Barriers (NTBs)– LDCs exports tend to be more severe than NTBs facing DC
exports. NTBs are particularly severe on food, agricultural products, ferrous metals,
mineral fuels, leather, textile yarns and fabrics, clothing and footwear. Now, many of
the NTBs like Voluntary Export Restraints (VER) and Orderly-Market-Arrangements
(OMA) have been prohibited. Though phasing out agriculture NTBs are almost
immediate, the phasing out for textiles and garments were spread out over a period of
10 years, till 2005.
The supply side question however remains. To really gain from the Uruguay Round,
India will have to be an efficient producer of goods and services, since improved market
access does not benefit India alone, but its competitors as well. At present, India’s 0.6%
share of world exports does not suggest we are too efficient. Broadly, India’s export
basket can be divided into agro-based products and manufactured items. While the
agro-based products like food grains suffer primarily from unavailability of exportable
surplus, the main constraints faced by manufactured items are high costs, inefficient
production, outdated technology, and an inability to stick to delivery schedules and
product specifications.
35
Environment 5.7 WTO: DOHA AND BEYOND
The Fourth Ministerial Conference was held in Doha, Qatar, in November 2001. WTO
member governments agreed to launch new negotiations. They also agreed to work on
other issues, in particular the implementation of the present agreements. The entire
package is called the Doha Development Agenda (DDA). There are 19–21 subjects
listed in the Doha Declaration. Most of them involve negotiations; other work includes
actions under “implementation”, analysis and monitoring. Some of the key agenda points
of DDA are:
i) Agriculture: Member governments commit themselves to comprehensive

negotiations aimed at the following-
a) Market access: substantial reductions

b) Exports subsidies: reductions of, with a view to phasing out, all forms of the
export subsidies
c) Domestic support: substantial reductions for supports (e.g., price support,
etc.) that distort trade.
ii) Services: The Doha Declaration reaffirms the negotiating guidelines and
procedures, and establishes some key elements of the timetable including, most
importantly, the deadline for concluding the negotiations as part of a single
undertaking.
iii) Market access for non-agricultural products: It was agreed to launch tariff-
cutting exercise on all non-agricultural products. The aim is “to reduce, or as
appropriate, eliminate tariffs, including the reduction or elimination of tariff peaks,
high tariffs, and tariff escalation, as well as non-tariff barriers, in particular on
products of export interest to developing countries”.
iv) TRIPS: The DDA has set two specific tasks. The TRIPS Council has to find a
solution to the problems countries may face in making use of compulsory licensing
(if a patent is not commercially exploited within the stipulated period of time,
then any person can apply to the authorities for granting a license for its commercial
use) if they have too little or no pharmaceutical manufacturing capacity. The second
discussion is on the Geographical indications — the registration system.
Geographical indications are names of places (in some countries also words
associated with a place) used to identify products with particular characteristics
because they come from specific places. The Doha Declaration sets a deadline for
completing the negotiations by: the Fifth Ministerial Conference in 2003 in Cancun,
Mexico. These negotiations took place in special “sessions” of the TRIPS Council.
v) WTO rules on anti-dumping and subsidies: The DDA specifically mentions

fisheries subsidies as one sector important to developing countries and where
participants should aim to clarify and improve WTO disciplines.
vi) Regional Trade Agreements: In the Doha Declaration, members agreed to

negotiate a solution, giving due regard to the role that these agreements can play
in fostering development.
vii) Understanding Dispute Settlement: The Doha Declaration mandates negotiations

and states that Dispute Settlement Body (DSB) will not be part of the single
undertaking, i.e. they will not be tied to the overall success or failure of other
negotiations mandated by the declaration.
36
viii) Multilateral Environmental Agreements: Ministers agreed to launch negotiations WTO Agreement and Its
Implications
on the relationship between existing WTO rules and specific trade obligations set
out in multilateral environmental agreements. The negotiations will address how
WTO rules are to apply to WTO members that are parties to environmental
agreements, in particular to clarify the relationship between trade measures taken
under the environmental agreements and WTO rules.
ix) Electronic commerce: The Doha Declaration endorses the work already done on
electronic commerce and instructs the General Council to consider the most
appropriate institutional arrangements for handling the work programme, and to
report on further progress to the Fifth Ministerial Conference.
x) Small economies: Small economies face specific challenges in their participation

in world trade, for example lack of economy of scale or limited natural resources.
The Doha Declaration mandates the General Council to examine these problems
and to make recommendations to the next Ministerial Conference as to what trade
related measures could improve the integration of small economies.
xi) Trade, debt and finance: Many developing countries face serious external debt
problems and have been through financial crises. WTO ministers decided in Doha
to establish a Working Group on Trade, Debt and Finance to look at how trade-
related measures can contribute to find a durable solution to these problems. This
working group will report to the General Council which will in turn report to the
next Ministerial Conference.
xii) Trade and technology transfer: A number of provisions in the WTO agreements
mention the need for a transfer of technology to take place between developed
and developing countries. WTO ministers decided in Doha to establish a working
group to examine the issue.
xiii) Technical cooperation and capacity building: Through various paragraphs of

the Doha Declaration, WTO member governments have made new commitments
on technical cooperation and capacity building.
xiv) Least-developed countries (LDCs): In the Doha declaration, WTO member

governments commit themselves to the objective of duty-free, quota-free market
access for LDCs products and to consider additional measures to improve market
access for these exports.
Members also agree to try to ensure that LDCs can negotiate WTO membership
faster and more easily. The Doha Declaration urges WTO member donors to
significantly increase their contributions. In addition, the Sub-Committee for LDCs
(a subsidiary body of the WTO Committee on Trade and Development) designed
a work programme in February 2002, as instructed by the Doha Declaration, taking
into account the parts of the declaration related to trade that was issued at the UN
LDC Conference.
xv) Special and differential treatment: The WTO agreements contain special
provisions which give developing countries special rights. These special provisions
include, for example, longer time periods for implementing agreements and
commitment or measures to increase trading opportunities for developing countries.
In the Doha Declaration, member governments agree that all special and differential
treatment provisions should be reviewed with a view to strengthening them and
making them more precise.
37
International Business Ministerial Conference is the top most decision making body of the WTO and it meets
Environment
usually every two years. The Ministerial Conference can take decisions and act on
matters related to any kind of multi lateral trade.
Table 5.3 shows a list of the Ministerial Conferences held till date.
Table 5.3: List of Major ministerial Conferences held
Country of Ministerial Conference Date

Bali 3-6 December, 2013
Geneva 15-17 December, 2011
Geneva 30 November – 2 December, 2009
Hong Kong 13-18 December, 2005
Cancun 10-14 September, 2003
Doha 9-13 November, 2001
Seattle November 30 – December 3, 1999
Geneva 18-29 May, 1998
Singapore 9-13 December 1996
Source : www. wto.org (2013).
Activity 1
Arrange a meeting with an experienced executive of a company engaged in international
business/trade (if you are presently not working/employed in such a company). Write a
note on how WTO has affected the company (by comparing the position in pre-WTO
and post-WTO periods) in terms of relative advantages or otherwise.
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5.8 SUMMARY
The WTO, set up in 1995, is the successor to the General Agreement on Trade and
Tariffs (GATT). GATT came into existence in 1948 with the objective of liberalization
of trade. It also provided a forum to countries to discuss and overcome their trade
problems and negotiate to enlarge international trading opportunities.
Eight major trade negotiations took place under GATT auspices but the Uruguay Round
was the most significant which lasted for about 8-years and led to the culmination of
WTO. Its main function is to ensure that trade flows as smoothly, predictably and
freely as possible. At the heart of the system–known as the multilateral trading system–
are the WTO’s agreements, negotiated and signed by a large majority of the world’s
trading nations, and ratified in their parliaments. These agreements are the legal ground-
rules for international trade. Essentially, they are contracts, guaranteeing member
countries important trade rights. They also bind governments to keep their trade policies
within agreed limits to each country’s benefit.
38
Some of the key functions of WTO are: Administering trade agreements; Acting as a WTO Agreement and Its
Implications
forum for trade negotiations; Settling trade disputes and Reviewing national trade
policies.
WTO has over 150 members, accounting for over 97% of world trade. Decisions are
made by the entire membership through consensus. The WTO’s top level decision-
making body is the Ministerial Conference which meets at least once in every two
years. Under this is the General Council (normally ambassadors and heads of delegations)
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.
The WTO Secretariat, based in Geneva, has around 637 staff and is headed by a director
general.
India’s stand on WTO has evolved over the years. Like any developing nation the
outcome of the Uruguay round also was a setback for India. Aspects like TRIPS were
most surprising and disappointing aspect for the developing countries in the Uruguay
Round and India was taken by surprise by the reach of the TRIPS agreement. One of
the main ways that India can gain is through tariff cuts in the developing country (DC)
markets. To really gain from the Uruguay Round, India will have to be an efficient
producer of goods and services, since improved market access does not benefit India
alone, but its competitors as well.
5.9 KEY WORDS

GATT : General Agreement on Trade and Tariffs is a multilateral
treaty/agreement that laid down the rules for conducting
international trade.
Multilateral Trade : Negotiations by a large group of countries in regard to

Negotiations trade which leads to mutually agreed multilateral
agreements.
Uruguay Round : The last and the most significant of the GATT round of
negotiations which led to a large number of agenda items
for implementation during 1986 to 1994, and which led
to the formation of WTO.
WTO : World Trade Organization is a multilateral trade body

of 150 member countries and its main function is to
ensure that trade flows as smooth, predictable and free
as possible.
TRIPS : Trade related intellectual property rights.
TRIMS : Trade related investment measures that necessitate

investors to attain certain standards of performance
consistent with national treatment.
39
Environment 5.10 SELF-ASSESSMENT QUESTIONS
1) What is GATT? Give an account of its achievements and critically examine them.
2) What are the key outcomes of the Uruguay Round of GATT negotiations?
3) What necessitated the setting up of WTO? Discuss its aims and objectives.
4) What are some of the major areas in which WTO has been focusing on? Evaluate
the current stand of the WTO members in relation to the following:
i) Trade in Services ii) Agriculture iii) TRIPS
5) Discuss what possible implications the Uruguay Round /WTO negotiations had
for India and which were being feared at that time and how India has dealt with
those implications/challenges?

K. Aswathappa (2008); International Business, Third Edition, New Delhi : Tata Mc
Graw Hill (Chapter 15).
i) http://www.wto.org/english/res_e/doload_e/inbr_e.pdf
ii) http://www.wto.org/english/thewto_e/whatis_e/tif_e/understanding_e.pdf
iii) http://www.wto.org/english/thewto_e/whatis_e/tif_e/utw_chap1_e.pdf
iv) http://www.wto.org/english/thewto_e/whatis_e/tif_e/utw_chap2_e.pdf
v) http://www.wto.org/english/thewto_e/whatis_e/tif_e/utw_chap3_e.pdf
vi) http://www.wto.org/english/thewto_e/whatis_e/tif_e/utw_chap4_e.pdf
vii) http://www.wto.org/english/thewto_e/whatis_e/tif_e/utw_chap5_e.pdf
viii) http://www.wto.org/english/thewto_e/whatis_e/tif_e/utw_chap6_e.pdf
ix) http://www.wto.org/english/thewto_e/whatis_e/tif_e/utw_chap7_e.pdf
x) www.wto.org (accessed on June13, 2013)
40
UNIT 6 REGIONAL TRADE BLOCKS Implications
Objectives

• explain the types of trade blocks;
• analyze the reasons behind the upsurge in trade blocks in the recent past;
• identify the major trade blocks in the world; and
• present a brief history of European Union (EU) which is the largest trade block.
Structure
6.1 Introduction
6.2 Types of Trade Blocks
6.3 Reasons behind the Recent Upsurge in PTAs
6.4 Welfare Impact of PTAs
6.5 Trade Creation and Trade Diversion
6.6 Major Trade Blocks in the World
6.7 European Union (World’s Largest Trade Block)
6.8 Summary
6.9 Key Words
6.1 INTRODUCTION
Regional Trading Block popularly known as trading blocks is a group of countries
within a specified geographical region, which protect themselves from imports from
the non-member countries. In short they are a force of economic integration which
increasingly shapes the world trade (www.economicsonline.co.uk). Trade blocks can
be stand alone agreements between several states. Trade blocks fall into different
categories based on the economic integration. These categories are discussed in
subsequent section.
Since the 1980’s trade blocks have spread throughout the world economy like wildfire,
while multilateral GATT/WTO talks have proceeded at a glacial pace. Compared to 65
trade blocks that were notified at the GATT/WTO up to 1980, at the end of 1998 there
were 194 trade blocks – their number has almost trebled in the last 20 years. Trade
blocks now account for well over half of the world trade.
These statistics show the importance of trading blocks in the present world economy,
and provide a motivation to examine them in great detail, which is taken up in this unit.
6.2 TYPES OF TRADE BLOCKS

There are various types of trade blocks. These are:
• Preferential Trading Arrangements (PTAs)
• Free Trade Agreement (FTA)
41
International Business • Customs Markets
Environment
• Common Markets
• Economic Union
• Monetary Union
• Political Union
Preferential Trading Arrangements (PTAs): It is a kind of trading block that gives

preferential access to certain products from the member countries. It can be established
through a trade fact and is the first stage of economic integration. Owner trade blocks
like FTA, CUs etc. are advanced form of PTAs.
Free Trade Area/Agreement (FTA): In a FTA, tariffs are removed inside the
arrangement, but members keep their own external tariffs against non-member countries.
Examples of FTAs are the Canada-US FTA and the NAFTA (North American Free
Trade Agreement). Rules of origin (RoO), normally are based on value added inside
the FTA. They are used to prevent firms from non-member countries exporting into the
FTA member with the lowest tariff and then shipping the product through to the (higher
tariff) true market destination. For example, when Canada and the United States formed
the Canada-US FTA in 1989, Canada’s tariff on imported auto parts was 8% whereas
the US tariff was 3%. Foreign exporters would prefer to export to the US, pay the lower
tariff and then ship the product into Canada. Rules of origin prevent such “backdoor”
exporting.
Customs Union (CU): In a customs union, tariffs are removed inside the union, and all
member countries harmonize their tariffs against non-members. Thus, a CU has a
common external tariff (CET) against non-members. Because the tariff is the same
for all member countries, rules of origin are not necessary to prevent “backdoor” imports
from non-member countries. Mercosur (the PTA between Uruguay, Paraguay, Brazil
and Argentina) is a customs union.
Common Market: A common market is a customs union with the addition that non-
tariff barriers (NTBs) restricting internal factor (labour, capital) mobility within the
arrangement are also removed. The purpose of the European Commission (EC), 1992
process was to remove internal barriers to trade within the European Commission,
creating a common market. Central American Common market consisting of Costa
Rica, El Salvador, Guatemala, Honduras and Nicaragua, is another case in point.
Economic Union: An economic union is a common market with the addition that
economic policies are coordinated among the member countries. For example, in an
economic union, countries, normally, have a common monetary and fiscal policy and a
common currency. The purpose of the Maastricht Treaty was to move the European
Community (EC) from a customs union to an economic union, with a common currency
(the Euro) and central bank (the European Central Bank).
Monetary Union: in this case two or more states share the same currency therefore
also known as currency union. It is to be noted here that apart from having the same
currency the two states may not necessarily have any further integration e.g. Economic
and Monetary Union.
Political Union: Political union is the replacement of an economic union by full

economic and political integration; i.e., the members of the economic union agree to
become one country.
42
PTAs, FTAs and customs unions are termed as Regional Trade Agreements in the Regional Trade Blocks
terminology of WTO. From now on we will use the term PTA as a broader term to
discuss various aspects of trade blocks.
6.3 REASONS BEHIND THE RECENT UPSURGE IN

PTAs
The principle of non-discrimination is central to the final conception of the GATT,
signed on 30 October 1947 by representatives from 23 countries in Geneva. Article I
embodies the strong support for non-discrimination, requiring Most-Favored-Nation
(MFN) status for all GATT members. The only significant exception to MFN is to be
found in Article XXIV, which permits CUs and FTAs preferential trade-barrier among
a subset of GATT members, as long as they go all the way for elimination of barriers.
The first wave of ‘regionalism’ attempted in the 1960s failed mostly because USA, the
most powerful nation in the GATT and the chief proponent of multilateralism and non-
discrimination, was against it. But its recent revival since the 1980s has been quite
successful, mostly because USA, its chief opponent before turned its supporter, having
itself signed a PTA – the NAFTA. The conversion of USA is of major significance. As
the key defender of multilateralism through the postwar years, its decision now to travel
in the preferential route has tilted the balance of forces at the margin away from
multilateralism to regionalism.
Activity 1
What is the new name of GATT? Identify the issues on which the latest round of talks
was held.
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6.4 WELFARE IMPACT OF PTAs

The resurgence of PTAs has led to renewed interest as to how PTAs have an impact on
the welfare. In theoretical terms, they have four general economic effects. These are
discussed as follows:
i) Income gains from greater specialization of resources and greater opportunities

for exchange within the region. These are called the static gains from regional
integration. The static gains from trade are the result of the elimination of the
deadweight losses due to tariffs and non-tariff barriers being removed. These are
the two triangular gains [one exchange, the other specialization] that come from
removal of trade barriers.
ii) Additional long run growth opportunities from economies of scale and scope,
improved competitiveness of firms, increases in technology and inward foreign
direct investment inflows. These are called the dynamic gains from regional
integration. The dynamic gains are expected to be much larger than the static
gains from trade.
43
International Business iii) Transitional costs that fall in the short run on inefficient sectors and immobile
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factors, as firms rationalize and reallocate their activities throughout the region.
When prices of a regional partner are lower than those at home, opening up to free
trade means that demand for products of the home industry falls. Firms go out of
business as consumers switch and buy cheaper imported goods from the PTA
partner country. As firms downsize and lay off workers, the mobile workers find
jobs quickly. The immobile ones, however, may never regain full time employment.
Thus free trade has transitional costs. Often the cost comes first before the static
and dynamic trade gains hence the expression “short term pain for long term
gain”.
iv) Greater economic interdependence within the region, due to the inter-linkages
created by trade and investment flows. Such economic interdependence creates
sensitivity and vulnerability to instabilities in a trading partner but also potential
additional gains from multiplier effects of linkages with a faster growing partner.
For example, the more closely tied the Mexican economy is to the US economy,
the more Mexico benefits from the much stronger US economy. Conversely, a
currency crisis in Mexico may have substantial impact on US exports to Mexico.
The welfare impacts are expected to be particularly large for small countries (note that
“small” means small in terms of the world market for a particular product so a country
could be small in one market and large in others at the same time) because they are
price takers in world markets. These impacts are both positive and negative, but the
gains are expected to be much larger than the losses.
• Small countries gain from regional integration:

o Removal of their own tariffs and NTBs on imports from the larger country —
As price takers, small countries cannot affect the world price and so their own
tariffs and NTBs are simply reflected in their own (higher) domestic prices,
causing deadweight losses to national welfare. When the small country removes
its own tariffs, this creates real gains in national welfare for itself.
o Removal of the larger member country’s tariffs and NTBs against the small
country’s exports -- As price takers, small countries cannot affect the world
price so that a tariff levied by a large country falls mostly or wholly on the
small country. This means that from small country exporters receive “LESS”
for their products in world markets. When the large country takes off its tariff,
this is a real gain for the small country.
o Gains from economies of scale and scope are likely to be very important for
small countries that join a PTA and gain access to a much larger market. For
example, Canada joining the Canada-US FTA gained access to the 10-times
larger US market; the economies of scale from access to the larger US market
were expected to be the primary source of gains to Canada from joining the
agreement.
• Small countries lose from regional integration:

o The larger gains for small countries imply larger transition costs also; and
further
o Small countries are more vulnerable once they join a PTA with a large country
since they have to adjust to changes in the large country.
44
Regional Trade Blocks
6.5 TRADE CREATION AND TRADE DIVERSION
Let us examine the static gains from regional integration more carefully. First, the
economic welfare impacts of a PTA can be mixed; that is, it is NOT ALWAYS TRUE
that global welfare or even welfare for a member country improves as a result of a PTA.
The impacts depend upon the following:
• Trade creation occurs when production is shifted from higher cost producers to
lower cost producers within the trading block. When the trade barriers are
eliminated among PTA members, differences in comparative costs will lead to
shifts in trade, production and investment patterns. According to the law of
comparative advantage, production should shift to the lower cost producers and
this would improve economic efficiency within the PTA.
• Trade diversion occurs when production is shifted to higher cost internal producers
from lower cost external producers. This is because the products of the external
producers have become uncompetitive in the internal market due to the creation
of the preferential trading area. Before the PTA both inside and outside countries
faced the same tariff barriers. Once the PTA is formed only the outside countries
face the tariff barriers. Removal of the tariff barriers against the inside countries
may give them a competitive advantage that diverts trade and production away
from the most efficient producers (the outsiders) towards the less efficient. Thus
the PTA creates inefficiencies since trade is not with the overall lowest cost
producer.
If trade creation outweighs trade diversion, economists normally argue that world welfare
will improve as a result of an FTA (that is, the static gains are, on net, positive). If trade
diversion dominates, welfare falls. It might be helpful to illustrate the concepts of trade
diversion and trade creation with an example. Assume we have three countries: Chile,
France and Germany producing and consuming apples. Assume that Chilean apples
cost 50 cents each, French apples are 60 cents, and German apples are 70 cents. If there
are no national tariffs, Chilean producers are the most efficient apple producers and the
law of comparative advantage predicts that Chile will produce and export apples to
France and Germany. The world price of apples would be 50 cents.
Suppose Germany levies a 15-cent specific tariff on all apple imports in order to protect
its domestic industry. Then Chilean apples in Germany cost 50+15 = 65 cents, and
French apples in Germany cost 60 + 15 = 75 cents. Since German apples cost 70 cents,
German consumers continue to import Chilean apples at a price of 65 cents (i.e. the
tariff has reduced, but not eliminated, trade) between Germany and Chile. French apples
are not imported.
Now let us compare two cases:

• Case #1: Germany and Chile form a Customs Union
If Germany and Chile form a CU and remove tariffs between them, then Chilean
apples now cost 50 cents in Germany (since there is no tariff) while the price of
French apples remains at 75 cents (since French producers must still pay the German
tariff). German consumers buy Chilean apples, and the price of apples returns to
50 cents. Trade creation has occurred since the PTA generates trade with a more
efficient producer. Trade creation increases world welfare, unambiguously.
• Case #2: Germany and France form a Customs Union

If Germany and France form a CU and remove tariffs between them, then French
apples now cost 60 cents in Germany (since there is no tariff) while the price of
45
International Business Chilean apples remains at 65 cents (since Chilean producers must still pay the
Environment
German tariff). German consumers buy French apples, and the price of apples
moves to 60 cents. Trade diversion has occurred since the PTA generates trade
with the less efficient producer, i.e., France. Trade diversion may reduce world
welfare.
The United Nations Conference on Trade and Development (UNCTAD) : The

UNCTAD was set up in 1964 as a permanent body of United Nations and deals with
trade investment, and development issues. It aims to maximize the trade, investment
and development opportunities of developing countries. The UNCTAD aims to formulate
policies related to trade, finance and technology and safeguards interest of developing
countries. UNCTAD has 194 member countries and has its permanent secretariat at
Geneva, Switzerland. The conference is held once in every 4 years.
6.6 MAJOR TRADE BLOCKS IN THE WORLD

Let us now discuss some of the major trade blocks in the world.
North American Free Trade Agreement (NAFTA): The goal of NAFTA, the world’s
largest free trade area, is to eliminate barriers to trade and investment between the three
countries, the U.S.A., Canada and Mexico. The implementation of NAFTA on January
1, 1994 brought immediate elimination of tariffs on more than one half of U.S. imports
from Mexico and more than one third of U.S. exports to Mexico. Tariffs on rest of the
imports and exports were to be phased out in 15 years. Most U.S.-Canada trade is
already duty-free. NAFTA also seeks to eliminate non-tariff trade barriers. NAFTA
commits all parties to end restrictions on NAFTA–members. Foreign investors are
provided a high level of protection of intellectual property, liberalized trade in services
and there are agreements on environmental and labour standards.
Association of South East Asian Nations (ASEAN): It was formed in 1967 but started
making progress only in 1970s. Its members are Brunei, Indonesia, Laos, Malaysia,
Myanmar, Philippines, Singapore, Thailand and Vietnam. It has started through partial
liberalization of trade in select range of products. The other important step was to
identify several regional projects, which would cater to the requirements of all the
member countries. Each country will have one regional project. ASEAN has developed
a common effective preferential tariffs (CEPT) plan to reduce tariffs systematically for
manufactured and processed products. ASEAN has also decided to invite both China
and India as ‘guest country’.
Asia-Pacific Economic Cooperation (APEC): Formed in 1989 as an informal dialogue

group with limited participation, APEC has become a forum for negotiations to achieve
the goal of free trade and investment in the Asia-Pacific region. APEC has 18 members
– Australia, Brunei, Canada, Chile, China, Hong Kong, Indonesia, Japan, South Korea,
Malaysia, Mexico, New Zealand, Papua New Guinea, Philippines, Singapore, Taiwan
Thailand and USA. In Indonesia in 1994, the APEC leaders agreed via their Bogor
declaration to achieve completely free trade and investment by 2010 for the industrial
countries and by 2020 for the rest. This is potentially the most sweeping trade agreement
in history, committing half the world economy to eliminate all barriers between
themselves.
Some other lesser known trade blocks are briefly described below:
Andean Community: The Andean Community is a trade block comprising the South
American countries of Bolivia, Colombia, Ecuador and Peru. The trade block was called
the Andean Pact until 1996 and came into existence with the signing of the Cartagena
Agreement in 1969. Its headquarters are located in Lima, Peru.
46
SAPTA: South Asian Preferential Trading Arrangement (SAPTA), is an intra-regional Regional Trade Blocks
trade agreement of the SAARC countries, India, Pakistan, Sri Lanka, Bangladesh, Nepal,
Bhutan, Afghanistan and the Maldives.
SACU: The Southern African Customs Union (SACU) consists of five Member States,
Botswana, Lesotho, Namibia, South Africa and Swaziland. It was established through
the Customs Union Agreement of 1910.
GCC Countries: Gulf cooperation council is a trade block involving six Arab states of
the Persian Gulf, comprising Bahrain, Kuwait, Oman, Qatar, Saudi Arabia and the
United Arab Emirates.
Activity 2
India’s first FTA was signed with Sri Lanka. Evaluate some of the gains that both the
countries stand to gain from this FTA (Visit the website http://commerce.nic.in/trade/
international_ta_indsl.asp or http://commerce.nic.in/agree.htm) for more details on the
agreement)
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6.7 EUROPEAN UNION (WORLD’S LARGEST

TRADE BLOCK)
History: The roots of EU go back to the Second World War. Europe was split into East
and West Europe after the world war resulting in a 40 year old long cold war.
1949: The council of Europe is created by West European nations.
18th April 1951: Six nations: Germany, France, Italy, the Netherlands, Belgium and
Luxemburg join hands to sign a treaty (Coals & Steel Treaty ) to run their heavy
industries.
25th March 1957: Witnessing the success of Coals & Steel Treaty, the 6 nations expand
cooperation to other economic sectors by signing the treaty of Rome resulting in creation
of European Economic Community (EEC).
30th July 1962: The EU starts its ‘common agricultural policy’ giving the countries
joint control of food production.
20th July 1963: EU signs first big international agreement a deal to help 18 former
colonies in Africa.
1st July 1968: The 6 nations remove customs duties on goods imported from each
other, allowing for the first time free cross-border trade.
Ist July 1968: The 6 nations remove custom duties on goods allowing free cross-border
trade, worlds biggest trading group is born.
24th April 1972: The Exchange Rate Mechanism (ERM) created, which was the first
step towards the introduction of euro, 30 years later.
47
International Business 24th April 1972: An Exchange Rate Mechanism (ERM) is developed wherein members
Environment
allow their currencies to fluctuate against each other within limits. This forms the
foundation of euro.
1st January 1973: Denmark, Ireland and UK formally enter EU and the count increases
from six to nine nations.
10th December 1974: EU leaders set up the European Regional Development Fund
with a purpose to use the money for poor regions.
7-10th June 1979: EU citizen directly elect the members of European Parliament for
the first time.
1st January 1981: Greece joins EU making the count to 10.
28th February 1984: EU adopts ‘Esprit’ programme as the first research and development
programme to be fund.
17th February 1986: Single European launches a 6 year programme to sort out the
difference in national regulations.
7th February 1992: Maastricht Treaty signed and is considered to be a major EU

milestone. ‘European Community’ is officially replaced by ‘European Union’.
1st January 1993: Single market and its four freedoms are established. Four freedoms
are the free movement of goods, services, people and money.
1st January 1995: Austria, Finland and Sweden join the EU.
26th March 1995: The Schengen Agreement takes effect in seven countries.
17th June 1997: Signature of the Treaty of Amsterdam built on the achievements of
Maastricht treaty.
13th December 1997: The process of membership negotiations with 10 countries of

central and eastern Europe starts.
1st January 1999: Euro is introduced in 11 countries for commercial and financial
transactions.
Ist January 2002 : Euro notes and coins arrive.
31st March 2003: EU takes on peace keeping operations.
1st May 2004: 8 countries of Central & Eastern Europe join EU.
29th October 2004: 25 EU countries sign a treaty establishing a European constitution.
2007: Bulgaria and Romania join the EU.
1st July 2013: Croatia join EU.
The details of each event is available on the European Union website www.europa.eu.
6.8 SUMMARY
A trade block is a large Free Trade Area in which tariffs are not imposed among
members, but members keep their own external tariffs against non-members. Trade
blocks have become quite popular and account for over half of the World Trade. Trade
Pacts signed as a result of creation of such trade blocks have their own adjudication
machinery.
48
There are seven kinds of trade blocks, namely: Regional Trade Blocks
1) Preferential Trading Arrangement (PTA) : Trading block which gives preference

to certain products from member countries.
2) Free Trade Area/Agreement (FTA): In an FTA, tariffs are removed inside the
arrangement, but members keep their own external tariffs against non-member
countries.
3) Customs Union (CU): In a customs union, tariffs are removed inside the union,
and all member countries harmonize their tariffs against non-members.
4) Common Market: A common market is a customs union which includes non

tariff barriers (NTBs) restricting mobility of internal factors (labour, capital) within
the arrangement.
5) Economic Union: An economic union is a common market which coordinates

economic policies among the member countries.
6) Monetary Union: An arrangement where two or more countries share the same
currency.
7) Political Union: Political union is the replacement of an economic union by full

economic and political integration.
There are over 194 trade blocks operating today and within them some of the trade
blocks like European Union have developed even common currencies besides common
operating parliaments and trading systems.
The major trading blocks of the world are North American Free Trade Agreement
(NAFTA), Association of South East Asian Nations (ASEAN), Asia Pacific Economic
Co-operation (APEC).
Regionalism has revived since the 1980s as against multilaterism of previous years.
Regionalism has many beneficial economic effects. It leads to specialization of resources
which provides exchange benefits. There is a greater competitiveness, trade and
investment flow, and regional inter-linkages with greater scope to reallocate activities
within the region.
Small countries tend to gain more from regional trade and regional integration as a
result of trade creation and trade diversion. Regional integration in Western Europe
was initiated with the creation of European Economic Commission (EEC). In 1991,
Treaty of European Union (the Maastricht Treaty) was signed by European Commission;
the Council of Ministers changed the name to European Union. This led to creation of
Economic and Monetary Union (EMU) – with a single currency (Euro). Four bodies
govern the European Community. European Council of Ministers, European
Commission, European Parliament, European Court of Justice. In addition to these
four organizations, European Central Bank (ECB) has also been added.
6.9 KEY WORDS

Free Trade Agreement (FTA) : In FTA, tariffs are removed inside the arrangement,
but members keep their own external tariffs
against non-member countries.
Customs Union : In a customs union, tariffs are removed inside the

union, and all member countries harmonize their
tariffs against non-members.
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International Business Common Market : A common market is a customs union with the
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addition that non-tariff barriers (NTBs) restricting
mobility. Internal factors (labour, capital) within
the arrangement are also removed.
Economic Union : An economic union is a common market with the

addition that economic policies are coordinated
among the member countries.
Political Union : A Political union is the replacement of an

economic union by full economic and political
integration.
Preferential Trade : Under PTAs, trade agreement is between countries

Agreements (PTAs) on bilateral or multilateral basis for doing business
as per laid down terms and conditions.
ASEAN : A trade agreement of the South East Asian

countries comprising Brunei, Indonesia, Laos,
Malaysia, Myanmar, Philippines, Singapore,
Thailand and Vietnam.
NAFTA : NAFTA, the world’s largest free trade area, is an

association of the three countries: the U.S.A.,
Canada and Mexico.
MERCOSUR, Mercosur, or : It is a Regional Trade Agreement (RTA) among

Mercosul Brazil, Argentina, Uruguay and Paraguay, founded
in 1991 by the Treaty of Asunción, which was
later amended and updated by the 1994 Treaty of
Ouro Preto. Its purpose is to promote free trade
and the fluid movement of goods, people, and
currency.
Dead Weight Loss : It measures the value of lost output.
Tariffs : Basic custom duties included in the national

schedules of the Contracting Parties.
Rules of Origin : These rules may be called the rules of

determination of Origin of goods under the Free
Trade Agreement.
Preferential Agreement : It means any concession or privilege granted under

the agreement by a contracting party through the
elimination of tariffs on the movement of goods.
APEC : It is a forum for negotiations to achieve the goal

of free trade and investment in the Asia-Pacific
region and its members are Australia, Brunei,
Canada, Chile, China, Hong Kong, Indonesia,
Japan, South Korea, Malaysia, Mexico, New
Zealand, Papua New Guinea, Philippines,
Singapore, Taiwan, Thailand and USA.
European Union (EU) : An economic union where the countries have a

common currency, common markets and unified
EU parliament to govern the matters of the Union.
50
1) What are the different types of trading blocks? What distinguishes them?
2) Compare Customs Union with Common Market and bring out clearly the
differences.
3) Explain the concepts of trade creation and trade diversion in detail giving examples.
4) Why have trading blocs become so popular lately?
5) Write a short note on the European Union.

Daniels, D. Johan and Rade bangh, H.Lee (2000), International Business – Environment
and Operations, New Delhi . Addison Wesley Longman pvt. Ltd. (Chapter 7).
K. Aswathappa (2008); International Business, Third Edition, New Delhi: Tata McGraw
Hill, (Chapter 14).
Varshney; R.L., Bhattacharya, B. (2001); International Marketing Management, Sultan
Chand & Sons, New Delhi.
www.europa.eu.
51
Environment
APPENDIX
Most active Regional Blocs (as of 2004)

Nominal GDP (US Dollars)
Regional Population GDP 2006 GDP 2007 growth per Mem-
Bloc capita bers
AU 932,455,487 1,063,544,479,886 1,227,101,993,460 15.38% 1,316 53
Arab 331,109,238 1,298,460,306,133 1,476,119,372,181 13.68% 4,458 18+4
League
ASEAN 572,500,231 1,079,135,945,502 1,285,693,351,132 19.14% 2,246 10+1
CAIS 50,778,800 141,217,305,037 159,746,036,421 13.12% 3,146 8
CARICOM 16,525,876 60,277,532,067 66,894,485,968 10.98% 4,048 15+5
CCASG 36,154,528 724,460,151,595 802,641,302,477 10.79% 22,200 6
CEFTA 27,968,711 110,263,802,023 135,404,501,031 22.80% 4,841 8
CIS 277,863,109 1,278,421,583,732 1,668,683,151,661 30.53% 6,005 10+2
EU 494,724,415 14,573,314,304,001 16,782,876,708,653 15.16% 33,924 27+3
EFTA 12,518,316 743,965,097,722 833,692,965,348 12.06% 66,598 4
GUAM 62,861,573 139,888,538,550 186,996,463,870 33.68% 2,975 4
NAFTA 449,227,672 15,337,094,304,218 16,189,097,801,318 5.56% 36,038 3+1
PIF 33,924,883 918,205,285,031 1,102,292,450,172 20.05% 32,492 15+2
SAARC 1,567,187,373 1,162,684,650,544 1,428,392,756,312 22.85% 911 8
SCO 1,510,746,315 4,066,714,194,780 5,046,655,129,110 24.10% 3,341 6
UNASUR 383,200,768 1,930,238,243,858 2,349,528,121,496 21.72% 6,131 12
World 6,670,469,438 48,786,093,133,217 54,635,982,249,266 11.99% 8,191 210
Source: The United Nations Statistics Division. (http:/unstats.un.org/unsd/snaama/selectionbasicFast.asp)

(March 2012).
52
UNIT 7 RISK ANALYSIS
Objectives

• identify the various factors that make an economy attractive;
• assess market opportunities and industry structure in a country;
• understand various types of risks involved in operating business in a foreign country;
and
• compare investment opportunities in different countries.
Structure
7.1 Introduction
7.2 Country Attractiveness and Opportunities
7.3 Industry Opportunities
7.4 Country Risk Analysis
7.5 Summary
7.6 Key Words
7.1 INTRODUCTION
The term ‘risk analysis’ is used here in its broadest sense to include risk assessment,
risk management and risk communication. Risk assessment involves identifying sources
of potential harm, assessing the likelihood that harm will occur and the consequences if
harm does occur. Risk management evaluates the risks identified in the risk assessment
process which require management, selection and implementation of action plans to
ensure that the risks are controlled. Risk communication involves an interactive dialogue
between stakeholders on the one hand and risk assessors and risk managers on the other
hand. Put it in another way, Risk analysis = risk assessment + risk management + risk
communication.
Risk analysis and management become particularly important when a company has
decided to enter into a foreign market and it is considering various market entry strategic
options. Risk analysis helps in evaluating the pros and cons of entering into a particular
country where business prospects are being explored. In Unit 10, you will study more
about market entry strategies and modes of entry. Though there is some discussion
about risk analysis in unit 10, this unit serves as a foundation and gives you an in depth
understanding of risk analysis. In modern business, the dynamics are changing rapidly
and newer regions and countries are replacing the traditional markets for doing business.
However, each one of them comes with its share of baggage and stories which needs to
be considered. Take for instance; emerging markets in South East Asia, Latin America
or some of the African markets where there is rising potential and developed nations
are making sizeable inroads.
The Chinese invasion of some of the African markets is now discussed within and
outside the markets of opportunities. Some of the explorations of these markets are for
53
International Business meeting Chinese internal demands of energy requirement and part of this foray is also
Environment
to exploit the rich natural resources of the region. However, before the Chinese entered
into the African markets, they must have done their home work of risk analysis and it
must have formed a significant part of their journey. The classification of markets on
several parameters like resource availability, political and economic stability, global
relationships within and outside the region, infrastructure availability and several other
related factors helps in deciding whether a particular country is attractive or not.
This unit will help you to evaluate some of these factors in a more structured manner,
and it lays the foundation for market entry strategy. Take, for instance, China for which
the road map for Africa is a long term relationship which they intend to exploit, rather
than a short term one. An aspect to consider in the analysis is how much time we are
willing to invest. Traditionally, for India, Latin America has been considered a high
opportunity market, however, the physical distance remains a deterrent. This negative
factor leads to the high cost of transportation which has its effects in higher price of
goods, as against the competitive brands and countries. The risk analysis will help in
detailing out the factors which must be considered by countries and entrepreneurs who
are waiting to explore the Latin American Countries (LAC) region. The cost benefit
analysis, an integral part of the risk analysis process helps to evaluate whether it is
worth while to enter particular market(s).
One of the facets of risk analysis is about finding the country attractiveness. Theoretically
speaking, a country will be attractive for a foreign investor if, investing in that country
it gets a return that is equal to or higher than its present risk adjusted weighted cost of
capital. The weighted average cost of capital is the minimum return that a company
must earn on an existing asset base. In some cases the company intends to take risks
outside the company’s current scope. In such cases certain adjustments are to be made
to account for the differing level of risk. This adjustment in weighted cost of capital is
known as risk adjusted weighted cost of capital. The two important issues to consider
here are:
• Are the markets and the competitive conditions in a particular country such that
given a set of competitive advantages, the business is likely to generate a return
equal to or higher than the cost of capital?
• Are the risks of operating in that country acceptable for the shareholders and
employees?
High
High Attractive High Attractive

Company Attractiveness
Low Strength High Strength

(Joint Venture) (Invest)
B C
A D
Low Attractive Low Attractiveness
Low Strength High Strength
(Do not invest) (Export)
Low
Low High
Company Strength
Figure 7.1: Country Attractiveness /Company Strength Matrix
54
Figure 7.1 gives an overview about the attractiveness of the country based on the strength Risk Analysis
of the company. The matrix shows different quadrants (A, B, C, D), which helps a
nation in understanding whether it should invest in the other country or not.
Quadrant A : Shows that the country is not attractive for investment.
Quadrant B : Shows that the country is attractive but the strength of the company is
not high. In this case the foreign company may decide to go in for joint
ventures.
Quadrant C : Shows that the country and company are both attractive so the foreign
company may go for investment.
Quadrant D : Shows that country is not attracting but the company is strong. In this
case the foreign company may decide to export the goods.
Analyzing the figure we find that the country attractiveness is dependent on the market
opportunities and the risk involved.
In terms of the two yardsticks, various countries under consideration are given relative
rankings or scores based on different economic, political and social dimensions.
The market and the competitive opportunities vary according to the nature of industry
and accordingly risks are affected. For example, the sub-prime crisis in the North
American markets has badly affected several industries like IT, banking and insurance,
and not so much the other sectors like retail trade, handheld tools, textiles and related
products. Let us now discuss the relationship between country attractiveness and the
opportunities available.
7.2 COUNTRY ATTRACTIVENESS AND

OPPORTUNITIES
Country attractiveness is a function of the market prospects, the competitive context
and the risks involved in the country. While, risk analysis is an integral part of assessing
country attractiveness, the other part precedes and is concerned with assessing market
opportunities to determine the market attractiveness. We shall first discuss the market
and the industry opportunity, which will be followed by risk analysis. The market
opportunity assessment measures the potential demand in the country for the products
and services of the firm which depends on:
• The size of market

• The growth of market
• The quantity of demand
The case of competing in the country is measured by industry opportunity which depends
on:
• The competitive climate …
• The competitive structure of the industry
• The investment incentives granted by the governments
Let us understand the framework for country market and industry attractiveness
assessment. For assessment of market opportunities there are several tools used, like
the macro-economic data and trend analysis. In the macro-economic indicators, the
correlation between macro-economic social or institutional indicators such as Gross
55
International Business Domestic Product (GDP) per capita and measure of consumption of certain products is
Environment
calculated. Table 7.1 gives an idea of some of the macro-economic indicators.
Table 7.1: Macro-economic indicators in International Market Assessment
Economic Sociological Demographical Institutional

GDP size Urbanization Population Government
spending
GDP size (PPP) Socio-economic Population growth Infrastructure
distribution
CPI Measure of
Inflation
GDP* per capita Age distribution
GDP* per capita (PPP)
Disposable income Personal
spending
Income distribution Income groups
(High, Middle, Low)
Exports/Imports
Saving rate
Investment rates
GDP : Gross Domestic Product

PPP: Purchasing Power Parity
CPI : Consumer Price Index
Macroeconomic indicators and other statistical data characterize the state and efficiency
of a national economy. These indicators have a significant impact on the currency rates
of the nation, which shows the health of the nation. Based on these indicators, the
country attractiveness can be assessed.
There are several researches which are available for the purpose of finding the macro-
economic indicators for a region. The Euromonitor, the EIU (Economic Intelligence
Unit) report, and the World Competitiveness Yearbook are some of the sources which
can help in making country assessment on the basis of macro-economic indicators. The
plotting of trends for comparable countries (in terms of economic conditions, economic
factors, etc.) also gives a view about the potential future of demand on a per capita
basis as well as in absolute value.
Two interesting aspects which are discussed in the market and industry opportunities
analysis are: 1) The middle class effect and 2) Quality of demand.
1) The middle class effect: The presence of an affluent middle class creates the
demand for most of the mass consumer goods and their related inputs. The ‘middle-
class effect’ has been experienced particularly by the emerging markets. The skewed
nature of the income distribution in emerging countries is due to the middle class
effect.
In the middle class effect, when disposable income reaches a certain threshold
there emerges a demand for modern branded products. It is around 1,500-2000
56
US$ per household but this threshold varies according to the kind of goods. Those Risk Analysis
who are beyond the threshold are considered middle class. Their number increases
faster than the average income; which generates a rise in demand for branded
goods and consumer durables.
2) Quality of demand: This is representation of the kind of market segments that

exists in a given market. For example, the Chinese and the Indian markets are
more mass oriented in nature, owing to increasing middle class population. The
European markets are smaller in numbers but are more high value markets and per
customer profitability is higher than China or India. This kind of difference in the
segments leads to a differentiated nature of demand in each market. A product like
i-pad from Apple may diffuse over a bigger spread in a developed market but may
have limited diffusion in a developing market. Alternatively, a product like Nokia
Lumia costing in the range of INR 20,000 – 50,000 may have larger acceptability
in a developing market like India. The undifferentiated and price sensitive nature
of the market usually sets apart the developing nations.
The quality of demand as mentioned is dependant on the economy of the country, and
there are country life cycles that determine the level at which the economy currently
thrives. According to the country life cycle, there are four broad clusters, which are as
follows:
• Developing economies
• Emerging economies
• Newly industrialized economies
• Industrialized economies
On the basis of these clusters, the countries are classified, which helps to develop a
broad segment. Marketers can use the tool effectively to pitch the product effectively. It
also gives an indication of the total volume of demand that can be generated.
To assess the competitive advantage based on group, competitor mapping helps. Table
7.2 gives an overview of the competitor mapping.
Table 7.2 : Competitor Mapping

Target Kodak Canon Snapfish
Segments
Cost conscious - Disposable cameras - Ltd. Low end - Deals on services
- Digital cameras no Cameras - No product
deals on developing - No services - Medium
medium performance - Low performance performance
Middle – - Mid line cameras - Mid range - Services
income - Photo services high cameras developing
families with performance - No services sharing, gift cards
children - Medium
- Medium
performance performance
High income/ - High quality - High tech. - Services, though
tech. savvy accessories (papers, products limited
CDs) - Software - High performance
- Products are less - Printers
- Sophisticated - High performance
- High performance
www. gatton.wky.edu/faculty/leepost/626/analysis.ppt.
57
International Business The above details shows that cost conscious or low income group go in for medium
Environment
type of performance regarding the products with specifications whereas middle income
group prefers high-quality products with better services.
7.3 INDUSTRY OPPORTUNITIES

In assessing industry opportunities, there are certain aspects which need to be carefully
examined. The country attractiveness is dependent on the industry opportunities, which
is assessed on the basis of the competitive context, resource endowment and government
incentives.
Industry and competitive structure

The competitive context is defined on the basis of the Porter’s five forces theory. The
theory suggests the various forms of competition, which are as follows:
Entry barriers: It depends on the nature of the government and industry policies that
decides how easy it is for companies to enter into any domestic industry. For example,
before 1991, when the license Raj existed, there were numerous restrictions and entry
was restricted across industries. Currently, the FDI (Foreign Direct Investment) norms
also do not allow 100 per cent participation across certain sectors as laid down by the
government of India.
Supplier’s bargaining power: This is a phenomenon where the economy is protected,

something as discussed above, and that there is a state control. Also if there are limitations
of resources, it can lead to supplier’s monopoly. The restrictive policies of the government
before 1991 led to severe shortages across certain sectors. For example, during 1950-
1980, there was almost 8-10 years of waiting for Bajaj scooters. Since, there was a cap
on production capacity and 100% utilization of the plant was not possible, this lead to
short supply and demand-supply gap.
Buyer’s bargaining power: Sometimes the demand side scenario is strong owing to
control on distribution or distribution channel network. For example, in the automobile
segment, with the rising number of component suppliers and limited number of buyers,
there is possibility that the buyer’s bargaining power is higher.
Government regulations: At times government regulations also become entry barriers.

There are several instances within and outside the country, where because of the
government restrictions there are hindrances to growth and business development.
Threat of substitutes: Another major challenge facing modern business is the threat of
substitutes. For example, before the launch of CNG in Delhi, there was high level of
pollution, especially through the commercial vehicles. However, CNG as a substitute
has not only helped reduce pollution considerably, it has also helped in reducing the
pressure on energy requirement.
Resource Endowment
Another important aspect to be considered as a part of the industry opportunity
assessment is resource endowment. This includes:
i) Natural Resources: This refers to the kind of resource endowment like minerals,
mining, and energy and forestry resources of the country. Even geographical
location also is an important part of the opportunity analysis. The locational
advantage that some of the countries and regions enjoy is important for an
organization to make those regions/countries as hubs to do business with the
58
adjoining countries. In the African continent, South Africa in the South, Egypt in Risk Analysis
the North, Kenya in the East, or Ghana in the West could be made as hubs to do
business in the region. This is dependent on the location and also the natural
resources.
ii) Human Resources: The quality and the cost of labour is another critical part of
the resource endowment. China and India’s natural advantage in terms of cheap
and efficient labour make them natural destinations for low cost manufacturing.
iii) Infrastructure and Support Industry Resources: The third factor is about the
infrastructure and the support services within the country. Take for instance; in
India though there is low cost manufacturing efficiency but the hassles of
infrastructure and support services are at times deterrent for several organisations.
Another instance is that of Bangalore, regarded as the IT hub of India, has seen a
sudden spurt in the IT and ITES boom. A sleepy little town like Bangalore was
never ready with the infrastructure to handle such massive spurt and today the city
often witnesses traffic snarls, infrastructure breakdowns and numerous other related
problems. These are the constraints which companies should consider in deciding
whether Bangalore could be taken as a potential area for their growth. Most of the
metros in India are almost choking and therefore the potential for growth prospects
is shifting to newer and class B towns like Pune, Baroda, Lucknow, Visakhapatnam
or Indore.
Government incentives
The government incentives to attract investment are another component of the industry
opportunity analysis. According to UNCTAD report there are several incentives designed
by the government to attract investment.
Activity 1
Analyze the country attractiveness of India to a foreign investor from Korea who wants
to enter into drinking water purifier industry.
.........................................................................................................................................
.........................................................................................................................................
.........................................................................................................................................
.........................................................................................................................................
.........................................................................................................................................
7.4 COUNTRY RISK ANALYSIS

Every company faces a certain amount of uncertainty which comprises of endogenous
and exogenous factors. Endogenous factors are internal factors and exogenous factors
are external factors. The risk involved at internal level arises primarily from technological
innovation and the changes in the relative prices of inputs and outputs. The external
risk basically arises from competitors reactions and the environmental factors like social,
political, financial, etc.
The following discussion on country risk analysis is based on Poverty and Social Impact
Analysis (PSIA) Workshop.
Social Risk analysis is a thought experiment, based on context-specific knowledge of

a country and the external environment it faces, the potential factors that could affect
59
International Business the effectiveness of its policies and its people. To the extent that it involves country
Environment
stakeholders directly, social risk analysis incorporates local knowledge into policy design.
It can be used to:
a) Avoid policy choices that are likely to fail or have unacceptably high costs;
b) Change policy or design complementary measures that respond to events not
considered in initial assumptions about country conditions, policy impact or
exogenous shocks; and
c) Develop “contingency plans” for events that could either derail reform or inflict
high cost on vulnerable stakeholders.
Two approaches to social risk analysis are:
1) Social Risk Assessment

Risk assessment is an explicit statement of assumptions that underlie expected
benefits from possible reforms – what ought to happen to a policy to achieve its
goals, and a context-based assessment of the validity of the assumptions. Finally,
it explores the likely effect of invalid assumptions on policy effectiveness or on
specific stakeholders. Social risk assessment is used to estimate the possibility
that initial assumptions of reform are invalid, and to consider the consequences of
several kinds of risks. Categories of risk include:
• Country risks: Conflict and violence, political instability, ethnic or religious

tension
• Political economy: Cessation of benefits, opposition or distortion of policy
by stakeholders
• Implementation: High complexity, weak governance, limited technical
capacity
• Exogenous risk: Terms of trade, global market opportunities, competition
with other producers, regional conflicts, climate effects, etc.
2) Scenario Analysis
Scenario analysis is a process conducted with one or more focus groups composed
of key decision-makers and stakeholder representatives that helps policymakers
highlight and explore uncertainties. Several scenarios are created for a reform,
each of which is a “what if” story that is tailored to the specific goals of an
intervention and the forces that will have the most effect on the achievement of
those goals. It asks decision-makers to consider the results of their strategies in a
variety of plausible futures. Each of these futures is based on different social,
economic, political or technological outcomes that drive change in a country.
Scenario analysis can help decision-makers perceive vulnerabilities in current

strategies. Considering different futures makes it possible to “pre-test” economic
reforms in a variety of future environments, rather than rely on single forecast that
may not come to pass. Decision-makers can respond by changing strategies or
developing responses to risk, including:
Increasing the flexibility of the operation. The creation of scenarios enables

policymakers to put in place preliminary contingency plans that respond to a variety
of assumptions; and
Enhancing the legitimacy of policies: Scenario creation can be used to increase

the transparency of the policy-making process and give diverse stakeholders a
role in the assessment of risk. It can help clarify to the public the underlying
60
rationale for a policy. When carried out with the participation of different Risk Analysis
stakeholders and broadly disseminated, it can add credibility to the reform process
itself.
Country Risk Analysis
1) The country risk analysis is an important aspect of international business research.
It is important because it tries to isolate the erratic sources of potential volatility in as

country’s political, economic or social environment (Franck) (www.aiu.edu/publications/
student/english/business%20risk%), Management.html#- ToC 18816092)
To measure the country risk, the organizations involved in assessing country risk use a
weighted average of objective economic and political data (e.g. change in GDP, GDP
per capita ; industrial costs, no. of political upspring etc.).
The purpose of country risk analysis is to assess the probability that how adverse
circumstances relating to political, economic or social actions would affect business.
Country risks can be grouped into four categories i) Political risks ii) Economic risks
iii) Competitive risks iv) Operational risks.
A diagrammatic representation of the factors necessary to evaluate country risk is shown

in Figure 7.2. According to Hiranya K Nath, in his Research Paper Country Risk Analysis:
A survey of the quantitative methods, the methods used for Country Risk Analysis
(CRA) can broadly be classified into qualitative or quantitative methods. However
many agencies amalgamate both qualitative and quantitative information into a single
index or rating.
A survey conducted by the US Eximbank categorized the various methods of country

risk appraisal used mainly by the banks into one of the four types:
1) Fully qualitative method,

2) Structured qualitative method,
3) Checklist method, and
4) Other quantitative methods.
Political
Risks
Economic Country Risk Analysis Competitive

Risks Risks
Operational
Risks
Figure 7.2: Framework for Country Risk Analysis

61
International Business 1) Fully Qualitative Method
Environment
The fully qualitative method usually involves an in-depth analysis of a country
without a fixed format. It usually takes the form of a report that includes a general
discussion of a country’s economic, political, and social conditions and prospects.
It is more of an ad hoc approach which makes it difficult for users to compare one
country with another. However, one advantage of this method is that it can be
adapted to the unique strengths and problems of the country undergoing evaluation.
2) Structured Qualitative Method

The structured method uses some standardized format with specifically stipulated
scope and focus of analysis. Since it adheres to a uniform format across countries
and is supported by economic statistics, it is easier to make comparisons. Still,
considerable subjective judgments have to be made by an analyst. This method
was the most popular among the banks during the late seventies. The political risk
index provided by Business Environment Risk Intelligence (BERI) S. A. is an
example of country risk rating by structured qualitative method. Table 7.3 shows
the components of this index.
Table 7.3: The BERI Political Risk Index
Components
Political Factionalism Linguistic/Ethnic/Religious Tension
Coercive Measure to Maintain Regime Mentality : Nationalism, Corruption,
Nepotism
Social Conditions: Population, Income Radical Left Strength
Distribution
Dependence on Outside Major Power Regional Political Forces
Social Conflict History of Regime Instability
Source: Hiranya K Nath: Country Risk Analysis
3) Checklist Method
The checklist method involves scoring the country under consideration with respect
to specific variables that can be either quantitative - in which case the scoring
requires no personal judgment or even first-hand knowledge of the country being
scored -or qualitative - in which case the scoring requires subjective determinations.
Each item is scaled from the lowest to the highest score. The sum of scores is then
used as a measure of country risk. It is possible to vary the influence that each
component variable has on the final score by assigning a weight to each indicator;
this is the weighted checklist approach. An example of the ICRG Composite Rating
Systems
Table 7.4: ICRG Composite Rating System
ICRG – International Country Risk Guide
Political % Financial % Economic %

Government Stability 12 Foreign Debt as % 10 GDP per head of 5
of GDP population
Socio-economic 12 Foreign Debt service 10 Real annual GDP 10
conditions as a % of exports of growth
goods & services
62
Risk Analysis
Investment Profile 12 Current account as 15 Annual inflation rate 10
a % of exports of
goods & services
Internal Conflict 12 Net liquidity as 5 Budget balance as %
markets of import of GDP 10
cover
External Conflict 12 Exchange rate 10 Current account 15
stability balance as a % of
GDP
Corruption 6
Military in politics 6
Religious tensions 6
Law and order 6
Ethnic tensions 6
Democratic
accountability 6
Bureaucracy quality 4
Source : www.laci.com/1./html2013
4) Other Quantitative Methods

The quantitative models used in econometric/statistical studies of country risk
analysis can broadly be categorized into four groups: Discriminant Analysis,
Principal Component Analysis, Logit Analysis and Classification and Regression
Tree Method.
Activity 2
a) Take two countries of your choice and compare their country risk profiles.
.................................................................................................................................
.................................................................................................................................
.................................................................................................................................
b) Suppose, as an Indian investor, you were to start a business of marine products

(Shrimps, Lobsters, Mackerel, etc.) in Sri Lanka. How would you look at the
country in terms of risk analysis? Critically evaluate on the basis of the Figure 7.2.
.................................................................................................................................
.................................................................................................................................
.................................................................................................................................
c) A number of foreign companies are entering India as wholly owned subsidiaries

or as green field projects or by buying majority stake in firms. Select an industry
of your choice and evaluate it on the basis of the factors incorporated in the Michael
Porter Five Forces Model.
.................................................................................................................................
.................................................................................................................................
.................................................................................................................................
63
Environment 7.5 SUMMARY
In the context of International Business risk analysis is done at two levels: one, at the
level of the country where the firm intends to foray into, and two, at the level of the
industry where the firm wants to enter. For example, the recent takeover of Indian
pharmaceutical giant, Ranbaxy by Daichii of Japan, is likely to be based on risk analysis
done by company at the level of the pharmaceutical industry, and also India at the level
of the country.
Another important aspect of the risk analysis is the country attractiveness which is
linked to the risk element. More are the risks attached, lesser will be the attractiveness
of the country and vice versa. The risk analysis is explained with the help of this
formulation:
Risk analysis = risk assessment + risk management + risk communication
The market opportunity assessment measures the potential demand in the country for
the products and services of the firm in terms of:
i) Market size;
ii) Market growth; and
iii) Quality of demand.
The industry opportunity measures how easy (or difficult) it is to compete in a country
in terms of—
i) The quality of the competitive climate;

ii) The quality of the industry competitive structure; and
iii) The investment incentives granted by the government.
Two interesting aspects which are discussed in the market and industry opportunities
analysis are the middle class effect and the quality of demand. The demand for most
of the mass consumer goods and their related inputs is often triggered by the presence
of an affluent middle class. The quality of demand is about market segmentation. If the
middle class segment in a given market is high, the quality of demand would be different
as compared to a market where the affluent class is higher. This also leads to formation
of country life cycle which leads to the formation of four major segments of countries.
Another important aspect is the industry opportunity analysis, which is dependent on

the competitive structure, factor endowment and the government incentives. The
competitive structure tells us about the various kinds of forces which shape the level of
competition in an industry. The Michael Porter’s five forces model illustrates the kind
of competition which may affect business, namely, threat of new entrants, government
interventions, threat of substitutes and the bargaining power of the suppliers and buyers.
The factor endowment discusses about the kind of resources available in terms of
minerals, mines and other natural and man-made resources at disposal. The third factor
is about government incentives, which talks about the efforts and encouragement of the
government to attract new business and organisations to the country.
Risk analysis is an assessment that involves identifying sources of potential harm,

assessing the likelihood that harm will occur and the consequences if harm does occur.
In Country Risk Analysis, the probability of how the adverse circumstances relating to,
for instance, political, economic or social actions would affect business is assessed.
64
Country risk can be grouped into four categories: Political risks, Economic risks, Risk Analysis
Competitive risks, Operational risks. The methods used for Country Risk Analysis (CRA)
can broadly be classified as qualitative or quantitative. The various methods of country
risk appraisal used mainly by the banks are one of the four types: fully qualitative
method, structured qualitative method, checklist method, and other quantitative method.
7.6 KEY WORDS

Risk analysis : Risk analysis involves identifying sources of
potential harm, assessing the likelihood that harm
will occur and the consequences if harm does occur.
Country attractiveness : Country attractiveness is a function of the market

prospects, the competitive context and the risks
involved in operating in a country.
Industry and competitive : The country attractiveness is dependent on the

structure industry opportunities, which is assessed on the
basis of the competitive context. The competitive
context tells about the competition profile of the
given industry and it is one of the tools to assess
the Michael Porter’s Five Forces Model.
Porter’s Five Forces Model : The Porter’s Five Forces Model assesses five
factors, namely new entrants, bargaining power of
suppliers and buyers, threat of substitutes and role
of the government.
Resource endowment : Resource endowment assesses how endowed the

country under consideration is with respect to
natural resources. Natural resources relate to
minerals, mining, energy, forestry resources, etc.
Government incentives : There are various ways in which a government

encourages foreign participation in the country/
local business, e.g., fiscal and other concessions.
Social risk assessment : An assessment used to estimate the possibility that

initial assumptions about reforms are invalid and
to examine the consequences of several kinds of
risks.
Scenario analysis : A process conducted with one or more focus groups

composed of key decision-makers and stakeholder
representatives that helps policymakers highlight
and explore uncertainties.
Fully qualitative method : An in-depth analysis of a country without a fixed

format. It usually takes the form of a report that
includes a general discussion of a country’s
economic, political, and social conditions and its
prospects.
Structured qualitative method: A method that uses some standardized format with
specifically laid down scope and focus for analysis.
The political risk index provided by Business
Environment Risk Intelligence (BERI) S. A. is an
65
International Business example of country risk rating by structured
Environment
qualitative method.
Checklist method : A method that involves scoring the country under

consideration with respect to specific variables that
can be either quantitative - in which case the scoring
requires no personal judgment or even first-hand
knowledge of the country being scored -or
qualitative - in which case the scoring requires
subjective judgments.

1) What factors make an economy attractive?
2) What kinds of risks are involved if you wish to operate in a foreign country? Discuss
with examples.
3) What do you mean by country attractiveness and opportunities? Explain with

examples.
4) How would you assess industry opportunities in a country in which you are looking
for investment?
5) Explain the various methods of country risk analysis. Which method according to
you is the best and why?
6) Would you like to invest in a country which is not rich in resource endowment?
Why? justify.
7) Evaluate the quality of demand in India for consumer durables, e.g., automobiles,
washing machines, etc. and compare it with a developed nation like U.S.A. Has it
undergone any change in India? Support your answer with facts and figures.

Harvey, C.R (1996), “Political Risk, Economic Risk and Financial Risk.” Country Risk
Analysis, homepage; (http://www.duki.edu/-charvey/country-risk/couindex.html).
Lasserre Philippe, Global Strategic Management, Palgrave, 2003.
Nath K. Hiranya “Country Risk Analyses: A survey of the quantitative Methods,

International Economics, Journal of the Institute for International Economics Vol. LXII,
No. – 1, February 2009, pg 69.
Porter Michael, The Competitive Advantages of Nation, Free Press, 1980.
Rogers Jerry, Riverside CA Global Risk Assessments: Issues, Concepts and Applications,
Global Risk Assessment Inc., 1997.
www.laci.com/1./html2013
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MS-97

Unit 4: PESTEL Analysis

Unit 5: WTO Agreements and its Implications

Unit 6: Regional Trade Blocks

Unit 7: Risk Analysis

After reading this Unit, you should be able to:

There are three kinds of alternative ideologies. These are:

Impact of difference in political ideologies on Country’s Boundaries

i) freedom of speech, expression, press and freedom to organize;

A million dollar question is being raised globally about stability of government in

Influence of Political System on Management Decision Making

B) Extent of Government Intervention in the Economy

Designing and Implementing Political Strategies

The steps include the following:

iii) Examine the likely political actions of competing companies.

iv) Assess the role played by important individuals and institutions.

v) Evaluate the impact of implementing strategies on firm’s image.

vi) Determine the appropriate strategy and execute it.

Based on Income Region Economic System

Figure 4.1: Economic Environment

A) Classification based on Income

Table 4.1 : GNI per capita, 2011

Low income $1025 or less

Source: data.worldbank.org/about/country-classifications (retrieved on June 2013)

B) Classification based on Region

C) Classification based on Economic System

Table 4.2: Countries classified on the basis of Economic System

Categories Number of Examples of countries

D) Classification based on types of economies

Key Macro - Economic Issues

South-East Asian Financial Crisis – 1997

Latin American Crisis – 1999

The Global Financial Crisis – 2008

Transition to Market Economy

Growth Prospects of Transition Economies

- establishing market institutions such as stock markets and central bank;

Drawbacks of Transition Economies

Country South Africa Brazil China Russia Chile

4.4 SOCIAL AND CULTURAL ENVIRONMENT

Cultural Identification and Dynamics of Cultures

Nation as a Point of Reference: Cultural differences exist usually between nations

Religion creating Cultural Stability: Religion followed by people of a country also

Culturally Oriented Social Practices

Following cultural characteristics influence person’s social ranking.

Groups based on Family: In some societies, instead of individual’s achievement it is

Source of Livelihood: People select their source of livelihood or occupation on the

Expectation of Reward and Success: Motivation to work would be higher in societies

Attitude towards Relationships

Relationship between Superior and Subordinate

Individualistic vis-à-vis Collectivist Style

Behaviour related to Risk-taking

Avoidance of Uncertainty: Workers of countries exhibiting high uncertainty avoidance

Information and Task Processing

Strategies for Coping with Cultural Differences

Making Slight or No Adjustment

Management and Company Orientations

b) Benefit - Cost of change: Since culture is imbibed at an early age, it will be

d) Participative: Leaders should ensure participation of stakeholders in the change

4.5 TECHNOLOGICAL ENVIRONMENT

Table 4.4: World Internet Population

Year Internet Population

Dec. 1999 248 million

Sept. 2002 587 million