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Master of Business Administration – MBA Semester 4

MB0037 – International Business Management


Assignment Set-1

Note: Each question carries 10 Marks. Answer all the questions.

Q.1 a. How has liberalizing trade helped international business?

Sol. The Benefits of Trade Liberalization


Policies that make an economy open to trade and investment with the rest of
the world are
needed for sustained economic growth. The evidence on this is clear. No
country in recent
decades has achieved economic success, in terms of substantial increases in
living standards for its people, without being open to the rest of the world. In
contrast, trade opening (along with opening to foreign direct investment) has
been an important element in the economic success of East Asia, where the
average import tariff has fallen from 30 percent to 10 percent over the past
20 years. Opening up their economies to the global economy has been
essential in enabling many developing countries to develop competitive
advantages in the manufacture of certain products. In these countries,
defined by the World Bank as the "new globalizers," the number of people in
absolute poverty declined by over 120 million (14 percent) between 1993
and 1998. There is considerable evidence that more outward-oriented
countries tend consistently to grow faster than ones that are inward-looking.
Indeed, one finding is that the benefits of trade liberalization can exceed the
costs by more than a factor of 10. Countries that have opened their
economies in recent years, including India, Vietnam, and Uganda, have
experienced faster growth and more poverty reduction. On average, those
developing countries that lowered tariffs sharply in the 1980s grew more
quickly in the 1990s than those that did not. Freeing trade frequently
benefits the poor especially. Developing countries can ill-afford the large
implicit subsidies, often channeled to narrow privileged interests that trade
protection provides. Moreover, the increased growth that results from free
trade itself tends to increase the incomes of the poor in roughly the same
proportion as those of the population as a whole. New jobs are created for
unskilled workers, raising them into the middle class. Overall, inequality
among countries has been on the decline since 1990, reflecting more rapid
economic growth in developing countries, in part the result of trade
liberalization. The potential gains from eliminating remaining trade barriers
are considerable. Estimate of the gains from eliminating all barriers to
merchandise trade range from US$250 billion to US$680 billion per year.
About two-thirds of these gains would accrue to industrial countries. But the
amount accruing to developing countries would still be more than twice the
level of aid they currently receive. Moreover, developing countries would
gain more from global trade liberalization as a percentage of their GDP than
industrial countries, because their economies are more highly protected and
because they face higher barriers.
Although there are benefits from improved access to other countries’
markets, countries benefit most from liberalizing their own markets. The
main benefits for industrial countries would come from the liberalization of
their agricultural markets. Developing countries would gain about equally
from liberalization of manufacturing and agriculture. The group of low-
income countries, however, would gain most from agricultural liberalization
in industrial countries because of the greater relative importance of
agriculture in their economies.

b. What are the merits and demerits of international trade?


Sol. Advantages and Disadvantages of International Trade Advantages to
consider
•Enhance your domestic competitiveness
•Increase sales and profits
•Gain your global market share
•Reduce dependence on existing markets
•Exploit international trade technology
•Extend sales potential of existing products
•Stabilize seasonal market fluctuations
•Enhance potential for expansion of your business
•Sell excess production capacity
•Maintain cost competitiveness in your domestic market Disadvantages to
keep in mind:
•You may need to wait for long-term gains
•Hire staff to launch international trading
•Modify your product or packaging
•Develop new promotional material
•Incur added administrative costs
•Dedicate personnel for traveling
•Wait long for payments
•Apply for additional financing
•Deal with special licenses and regulations

Q. 2 discuss the impact of culture on International Business.

Sol. The following can be looked as the various aspects of the cultural

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

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


globalization An issue of considerable theoretical significance is concerned
with cultural changes and transformations taking place in different parts of
the world. In fact, since the landmark study of Haire et al. (1966) and the
publication of Industrialism and Industrial Man by Kerr et al. (1960),
researchers have continued to search for similarities in culture-specific
beliefs and attitudes in various aspects of work related attitudes and
behaviours, consumption patterns, and the like. If cultures of the various
locales of the world are indeed converging (e.g., Heuer et al., 1999), IB-
related practices would indeed become increasingly similar. Standard,
culture-free business practices would eventually emerge, and inefficiencies
and complexities associated with divergent beliefs and practices in the past
era would disappear. In the following section, we review the evidence on the
issue and conclude that such an outlook pertaining to the convergence of
various IB practices is overly optimistic.
2. Evolution of partial globalization Globalization refers to a ‘growing
economic interdependence among countries, as reflected in the increased
cross-border flow of three types of entities: goods and services, capital, and
know-how’ (Govindarajan and Gupta, 2001, 4). Few spoke of ‘world
economy’ 25 years ago, and the prevalent term was ‘international trade’
(Drucker, 1995). However today, international trade has culminated in the
emergence of a global economy, consisting of flows of information,
technology, money, and people, and is conducted via government
international organizations such as the North American Free Trade
Agreement (NAFTA) and the European Community; global organizations such
as the International Organization for Standardization (ISO); multinational
companies (MNCs); and cross – border alliances in the form of joint ventures,
international mergers, and acquisitions. These inter – relationships have
enhanced participation in the world economy, and have become a key to
domestic economic growth and prosperity (Drucker, 1995, 153). Yet,
globalization is not without its misgivings and discontents (Sassan, 1998). A
vivid image associated with the G8 summits is the fervent protests against
globalization in many parts of the world, as shown in television and reported
in the popular media. Strong opposition to globalization usually originates
from developing countries that have been hurt by the destabilizing effects of
globalization, but in recent times we have also seen heated debates in
Western economies triggered by significant loss of professional jobs as a
result of off shoring to low – wage countries. Indeed, workers in
manufacturing and farming in advanced economies are becoming
increasingly wary of globalization, as their income continues to decline
significantly. In parallel to the angry protests against globalization, the flow
of goods, services, and investments across national borders has continued to
fall after the rapid gains of the 1990s. Furthermore, the creation of regional
trade blocs, such as NAFTA, the European Union, and the Association of
Southeast Asian Nations, have stimulated discussions about creating other
trade zones involving countries in South Asia, Africa, and other parts of the
world. Although it is often assumed that countries belonging to the World
Trade Organization (WTO) have embraced globalization, the fact is that
the world is only partially globalized, at best (Schaeffer, 2003). Many parts of
Central Asia and Eastern Europe, including the former republics of the Soviet
Union, parts of Latin America, Africa, and parts of South Asia, have been
sceptical of globalization (Greider, 1997). In fact, less than 10% of the
world’s population is fully globalized (i.e., being active participants in the
consumption of global products and services) (Schaeffer, 2003). Therefore, it
is imperative that we analyze the issues of cultural convergence and
divergence in this partially globalized world. ‘Universal culture’ often refers
to the assumptions, values, and practices of people in the West and some
elites in non-Western cultures. Huntington (1996) suggested that it
originates from the intellectual elites from a selected group of countries who
meet annually in the World Economic Forum in Davos, Switzerland. These
individuals are highly educated, work with symbols and numbers, are fluent
in English, are extensively involved with international commitments, and
travel frequently outside their country. They share the cultural value of
individualism, and believe strongly in market economics and political
democracy. Although those belonging to the Davos group control virtually all
of the world’s important international institutions, many of the world’s
governments, and a great majority of the world’s economic and military
capabilities, the cultural values of the Davos group are probably embraced
by only a small fraction of the six billion people of the world. Popular culture,
again mostly Western European and American in origin, also contributes to a
convergence of consumption patterns and leisure activities around the world.
However, the convergence may be superficial, and have only a small
influence on fundamental issues such as beliefs, norms, and ideas about how
individuals, groups, institutions, and other important social agencies ought to
function. In fact, Huntington (1996, 58) noted that ‘The essence of Western
civilization is the Magna Carta, not the Magna Mac. The fact that non-
Westerners may bite into the latter has no implications for their accepting
the former’. This argument is obvious if we reverse the typical situation and
put Western Europeans and Americans in the shoes of recipients of cultural
influence. For instance, while Chinese Kung Fu dominates fight scenes in
Hollywood movies such as Matrix Reloaded, and Chinese restaurants abound
in the West, it seems implausible that Americans and Europeans have
espoused more Chinese values because of their fondness of Chinese Kung Fu
and food. A major argument against cultural convergence is that
traditionalism and modernity may be unrelated (Smith and Bond, 1998).
Strong traditional values, such as group solidarity, interpersonal harmony,
paternalism, and feminism, can co-exist with modern values of individual
achievement and competition. A case in point is the findings that Chinese in
Singapore and China indeed endorsed both traditional and modern values
(Chang et al., 2003; Zhang et al., 2003). It is also conceivable that, just as we
talk about Westernization of cultural values around the world, we may also
talk about Easternization of values in response to forces of modernity and
consumption values imposed by globalization (Marsella and Choi, 1993).
Although the argument that the world is becoming one culture seems
untenable, there are some areas that do show signs of convergence. We
explore in the following the roles of several factors that simultaneously cause
cultures of the world to either converge or diverge, in an attempt to identify
several productive avenues for future research.

3. Role of multiculturalism and cultural identity


The broad ideological framework of a country, corporation, or situation is the
most important determinant of the cultural identity that people develop in a
given locale (Triandis, 1994). The ‘melting pot’ ideology suggests that each
cultural group loses some of its dominant characteristics in order to become
the mainstream: this is assimilation, or what Triandis (1994) calls subtractive
multiculturalism. In contrast, when people from a cultural group add
appropriate skills and characteristics of other groups, it may be called
integration, or additive multiculturalism. Both of these processes are
essential for cultural convergence to proceed. However, if there is a
significant history of conflict between the cultural groups, it is hard to initiate
these processes, as in the case of Israelis and Palestinians. In general,
lthough there has been some research on the typology of animosity against
other nations (e.g., Jung et al., 2002), we do not know much about how
emotional antagonism against other cultural groups affects trade atterns and
intercultural cooperation in a business context. The issues of cultural identity
and emotional reactions to other cultural groups in an IB context constitute a
significant gap in our research effort in this area.

4. Implications of convergence and divergence issues


One message is clear: while convergence in some domains of IB activity is
easily noticeable, especially in consumer values and lifestyles, significant
divergence of cultures persists. In fact, Hofstede (2001) asserts that mental
programs of people around the world do not change rapidly, but remain
rather consistent over time. His findings indicate that cultural shifts are
relative as opposed to absolute. Although clusters of some countries in given
geographical locales (e.g., Argentina, Brazil, Chile) might indicate significant
culture shifts towards embracing Anglo values, the changes do not diminish
the absolute differences between such countries and those of the Anglo
countries (i.e., US, Canada, UK). Huntington, in his ‘The Clash of Civilizations’
(1996), presents the view that there is indeed a resurgence of non-Western
cultures around the world, which could result in the redistribution of national
power in the conduct of international affairs. The attempt by the Davos
group to bring about uniform practices in various aspects of IB and work
culture, thereby sustaining the forces of globalization, is certainly
worthwhile. However, our analysis suggests that there is no guarantee that
such convergence will come about easily, or without long periods of
resistance. IB scholars need to understand that although some countries
might exhibit strong tendencies toward cultural convergence, as is found in
Western countries, there are countries that will reject globalization, not only
because of its adverse economic impacts (Greider, 1997) but also because
globalization tends to introduce distortions (in their view) in profound cultural
syndromes that characterize their national character. Furthermore, reactions
to globalization may take other forms. Bhagat et al. (2003) have recently
argued that adaptation is another approach that could characterize the
tendencies of some cultures in the face of mounting pressures to globalize.
Other approaches are rejection, creative synthesis, and innovation (Bhagat
et al., 2003). These different approaches highlight once again the complex
dynamics that underlie cultural convergence and divergence in a partially
globalized world. Also, in discussing issues of convergence and divergence, it
is necessary to recognize that the shift in values is not always from Western
society to others, but can result in the change of Western cultural values as
well. For example, the emphasis on quality and teamwork in the West is
partly a result of the popularity of Japanese management two decades ago.
Scholars of IB should recognize that the issue of convergence and
divergence in this era of partial globalization will remain as a persistent and
complex issue whose direction might only be assessed on a region-by-region
basis. It is also wise to adopt an interdisciplinary perspective in
understanding the forces that create both convergence and divergence of
cultures in different parts of the world. For instance, in Understanding
Globalization, Schaeffer (2003) has provided an insightful discussion of
the social consequences of political, economic and other changes, which
have significant implications for IB. The cause-effect relationships of
globalization and its various outcomes, especially the cultural outcomes, are
not only characterized by bi-directional arrows, but are embedded in a
complex web of relationships. How these complex relationships and
processes play out on the stage of IB remains to be uncovered by IB
researchers.

5. Processes of cultural changes


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

6. The dynamics of culture as a multi-level, multi-layer construct


The proposed model consists of two building blocks. One is a multi-level
approach, viewing culture as a multi-level construct that consists of various
levels nested within each other from the most macro-level of a global
culture, through national cultures, organizational cultures, group cultures,
and cultural values that are represented in the self at the individual level, as
portrayed in Figure 2.1. The second is based on Schein’s (1992) model
viewing culture as a multi – layer construct consisting of the most external
layer of observed artifacts and behaviors, the deeper level of values, which is
testable by social consensus, and the deepest level of basic assumption,
which is invisible and taken for granted. The present model proposes that
culture as a multi – layer construct exists at all levels – from the global to the
individual – and that at each level change first occurs at the most external
layer of behavior, and then, when shared by individuals who belong to the
same cultural context, it becomes a shared value that characterizes the
aggregated unit (group, organizations, or nations). In the model, the most
macro-level is that of a global culture being created by global networks and
global institutions that cross national and cultural borders. As exemplified by
the effort of the Davos group discussed earlier, global organizational
structures need to adopt common rules and procedures in order to have a
common ‘language’ for communicating across cultural borders (Kostova,
1999; Kostova and Roth, 2003; Gupta and Govindarajan, 2000)
Figure 2.1: The dynamic of top-down–bottom-up processes across levels of
culture. Given the dominance of Western MNCs, the values that dominate
the global context are often based on a free market economy, democracy,
acceptance and tolerance of diversity, respect of freedom of choice,
individual rights, and openness to change (Gupta and Govindarajan, 2000).
Below the global level are nested organizations and networks at the national
level with their local cultures varying from one nation or network to another.
Further down are local organizations, and although all of them share some
common values of their national culture, they vary in their local
organizational cultures, which are also shaped by the type of industry that
they represent, the type of ownership, the values of the founders, etc. Within
each organization are sub-units and groups that share the common national
and organizational culture, but that differ from each other in their unit
culture on the basis of the differences in their functions (e.g., R&D vs
manufacturing), their leaders’ values, and the professional and educational
level of their members. At the bottom of this structure are individuals who
through the process of socialization acquire the cultural values transmitted
to them from higher levels of culture. Individuals who belong to the same
group share the same values that differentiate them from other groups and
create a group – level culture through a bottom-up process of aggregation of
shared values. For example, employees of an R&D unit are selected
into the unit because of their creative cognitive style and professional
expertise. Their leader also typically facilitates the display of these personal
characteristics because they are crucial for developing innovative products.
Thus, all members of this unit share similar core values, which differentiate
them from other organizational units. Groups that share similar values create
the organizational culture through a process of aggregation, and local
organizations that share similar values create the national culture that is
different from other national cultures. Both top-down and bottom-up
processes reflect the dynamic nature of culture, and explain how culture at
different levels is being shaped and reshaped by changes that occur at other
levels, either above it through top-down processes or below it through
bottom-up processes. Similarly, changes at each level affect lower levels
through a top-down process, and upper levels through a bottom-up process
of aggregation. The changes in national cultures observed by Inglehart and
Baker (2000) could serve as an example for top-down effects of economic
growth, enhanced by globalization, on a cultural shift from traditional values
to modernization. However, in line with Schein (1992), the deep basic
assumptions still reflect the traditional values shaped by the broad cultural
heritage of a society. Global organizations and networks are being formed by
having local-level organizations join the global arena. That means that there
is a continuous reciprocal process of shaping and reshaping organizations at
both levels. For example, multinational companies that operate in the global
market develop common rules and cultural values that enable them to
create a synergy between the various regions, and different parts of the
multinational company. These global rules and values filter down to the local
organizations that constitute the global company, and, over time, they shape
the local organizations. Reciprocally, having local organizations join a global
company may introduce changes into the global company because of its
need to function effectively across different cultural boarders. A study by
Erez-Rein et al. (2004) demonstrated how a multinational company that
acquired an Israeli company that develops and produces medical
instruments changed the organizational culture of the acquired company.
The study identified a cultural gap between the two companies, with the
Israeli company being higher on the cultural dimension of innovation and
lower on the cultural dimension of attention to detail and conformity to rules
and standards as compared with the acquiring company. The latter insisted
on sending the Israeli managers to intensive courses in Six – Sigma, which is
an advanced method of quality improvement, and a managerial philosophy
that encompasses all organizational functions. Upon returning to their
company, these managers introduced quality improvement work methods
and procedures to the local company, and caused behavioural changes,
followed by the internalization of quality – oriented values. Thus, a top-down
process of training and education led to changes in work behaviour and work
values. Sharing common behaviours and values by all employees of the local
company then shaped the organizational culture through bottom–up
processes. The case of cultural change via international acquisitions
demonstrated the two building blocks of our dynamic model of culture: the
multi-level structure explains how a lower-level culture is being shaped by
top-down effects, and that the cultural layer that changes first is the most
external layer of behaviour. In the long run, bottom – up processes of shared
behaviours and norms shape the local organizational culture.

7. Factors that facilitate cultural change


Culture itself influences the level of resistance or acceptance of change.
Harzing and Hofstede (1996) proposed that certain cultural values facilitate
change, whereas others hinder it. The values of low power distance, low
uncertainty avoidance, and individualism facilitate change. Change threatens
stability, and introduces uncertainty, and resistance to change will therefore
be higher in cultures of high rather than low uncertainty avoidance
(Steensma et al., 2000). Change also threatens the power structure, and
therefore will be avoided in high power distance cultures. Finally, change
breaks the existing harmony, which is highly valued in collectivistic cultures,
and therefore will not be easily accepted by collectivists (Levine and
Norenzayan, 1999).
A recent study by Erez and Gati (2004) examined the effects of three factors
on the change process and its outcomes: · the cultural value of individualism
– collectivism; · the reward structure and its congruence with the underlying
cultural values; and · the degree of ambiguity in the reward structure. The
change process examined was a shift from choosing to work alone to a
behavioural choice of working as part of a team, and vice versa. Working
alone is more prevalent in individualistic cultures, whereas working in teams
dominates the collectivistic ones.

8. Understanding when culture matters: increasing the precision of


cultural models
Beyond exploring new cultural constructs and the dynamic nature of culture,
we also argue for the importance of examining contingency factors that
enhance or mitigate the effect of national culture. Consider the following
scenario. A senior human resource manager in a multinational firm is
charged with implementing an integrative training program in several of the
firm’s subsidiaries around the globe. Over the term of her career, the
manager has been educated about differences in national culture and is
sensitive to intercultural opportunities and challenges. At the same time, she
understands the strategic need to create a unified global program that
serves to further integrate the firm’s basic processes, creating efficiencies
and synergies across the remote sites. She approaches the implementation
with trepidation. A key challenge is to determine whether the program
should be implemented in the same manner in each subsidiary or modified
according to the local culture at each site. Put another way, in
this complex circumstance, does culture matter?

Q.3. a. Explain the brief structure of WTO.


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

b. Highlight the drawbacks of GATT.

Sol. Given its provisional nature and limited field of action, the success of
GATT in promoting and securing the liberalization of much of world trade
over 47 years is incontestable. Continual reductions in tariffs alone helped
spur very high rates of world trade growth – around 8 per cent a year on
average during the 1950s and 1960s. And the momentum of trade
liberalization helped ensure that trade growth consistently out-paced
production growth throughout the GATT era. The rush of new members
during the Uruguay Round demonstrated that the multilateral trading
system, as then represented by GATT, was recognized as an anchor for
development and an instrument of economic and trade reform. The limited
achievement of the Tokyo Round, outside the tariff reduction results, was a
sign of difficult times to come. GATT’s success in reducing tariffs to such a
low level, combined with a series of economic recessions in the 1970s and
early 1980s, drove governments to devise other forms of protection for
sectors facing increased overseas competition. High rates of unemployment
and constant factory closures led governments in Europe and North America
to seek bilateral market-sharing arrangements with competitors and to
embark on a subsidies race to maintain their holds on agricultural trade.
Both these changes undermined the credibility and effectiveness of GATT.
Apart from the deterioration in the trade policy environment, it also became
apparent by the early 1980s that the General Agreement was no longer as
relevant to the realities of world trade as it had been in the 1940s. For a
start, world trade had become far more complex and important than 40
years before: the globalization of the world economy was underway,
international investment was exploding and trade in services – not covered
by the rules of GATT – was of major interest to more and more countries and,
at the same time, closely tied to further increases in world merchandise
trade. In other respects, the GATT had been found wanting: for instance, with
respect to agriculture where loopholes in the multilateral system were
heavily exploited – and efforts at liberalizing agricultural trade met with little
success and in the textiles and clothing sector where an exception to the
normal disciplines of GATT was negotiated in the form of the Multi-fibre
Arrangement. Even the institutional structure of GATT and its dispute
settlement system were giving cause for concern. Together, these and other
factors convinced GATT members that a new effort to reinforce and extend
the multilateral system should be attempted. That effort resulted in the
Uruguay Round.

Q.4. a. Give a short note on the regional economic integration.

Sol. Regional Economic Integration


Regional integration can take many forms, and nowhere is this more evident
than in the vastly different integration processes taking place in the regions
of Europe and East Asia. The subject of this paper is regional integration as it
has developed in East Asia with a focus on the drivers of that integration.
While the paper is not intended as a direct comparison of integration in East
Asia and Europe, it will include some comparisons between the two regions.
Integration in East Asia has progressed very slowly and is still in an early
stage despite that the process has continued for decades. In fact, it could be
said that the process began centuries ago – even as far back as the 15th
century. By comparison, European integration has progressed steadily and
has gradually deepened over the last 50 years to reach an advanced stage
today with a common currency and well-developed regional institutions.
Thus, the speed of progression and the level of integration attained in the
two regions are quite dissimilar.
In addition to these differences, the drivers behind the integration process in
each region are different. In Europe, the origins of integration have been
institutional in nature, and the development of institutions has been
prominent throughout the process. Thus, regional institutions have been the
driving force behind integration in Europe. In East Asia, the development of
regional institutions has also occurred; however, progress in this area has
been slow and the few existing institutions are fairly weak and ineffective.
Nevertheless, regional integration is taking place in East Asia, but the driving
force is the market rather than policy or institutions. Corporations and the
production networks they have established are driving integration in East
Asia.

b. Mention the benefits of WTO.

Sol. Ten Benefits of WTO


1. The system helps to keep the peace
2. The system allows disputes to be handled constructively
3. A system based on rules rather than power makes life easier for all
4. Freer trade cuts the cost of living
5. It gives consumers more choice and a broader range of qualities to choose
from
6. Trade raises incomes
7. Trade stimulates economic growth and that can be good news for
employment
8. The basic principles make the system economically more efficient, and
they cut costs
9. The system shields governments from narrow interests
10. The system encourages good government

Q. 5 a. Explain five-element product wave model.


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

b. What do you mean by globalization?


Sol. Economic "globalization" is a historical process, the result of human
innovation and technological progress. It refers to the increasing integration
of economies around the world, particularly through trade and financial
flows. The term sometimes also refers to the movement of people (labor)
and knowledge (technology) across international borders. There are also
broader cultural, political and environmental dimensions of globalization that
are not covered here. At its most basic, there is nothing mysterious about
globalization. The term has come into common usage since the 1980s,
reflecting technological advances that have made it easier and quicker to
complete international transactions – both trade and financial flows. It refers
to an extension beyond national borders of the same market forces that
have operated for centuries at all levels of human economic activity – village
markets, urban industries, or financial centers. Markets promote efficiency
through competition and the division of labor – the specialization that allows
people and economies to focus on what they do best. Global markets offer
greater opportunity for people to tap into more and larger markets around
the world. It means that they can have access to more capital flows,
technology, cheaper imports, and larger export markets. But markets do not
necessarily ensure that the benefits of increased efficiency are shared by all.
Countries must be prepared to embrace the policies needed, and in the case
of the poorest countries may need the support of the international
community as they do so.

Q. 6. Give some examples of companies doing international business and


discuss how they have they have managed their business in the international
markets.
Sol. A PERSPECTIVE OF THE NORTHEN ISLAND SOFTWARE COMPANIES,
RAPDM–UP Within six months of announcing it would invest $4.5 million to
establish its new software development center in Northern Ireland, IMR was
up and running with more than one-third its target staff. "The fast start-up of
the Belfast facility reaffirms our confidence to locate in Northern Ireland,"
said Sanan. "The success to date in building a quality work force has
surpassed our expectations and opens up new ambitions for our interests in
Northern Ireland." According to Arthur "Bro" McFerran, president of IMR (NI)
Ltd., the company is hiring 12 to 18 programmers a month in Northern
Ireland and is well on its way to meeting its staffing goal of 300 by 1999.
McFerran credited Northern Ireland’s Training & Employment Agency (T&EA)
with helping place the company’s staffing on the fast track. "The T&EA not
only has helped us to identify and recruit qualified software graduates from
Northern Ireland’s universities, it is also assisting us with a unique initiative
to bring additional sources of high quality talent to the company," McFerran
said.

Innovation in Training
Impressed by the number and quality of information technology graduates
from the region’s universities, MR recognized an untapped resource in the
well-educated, versatile graduates of other fields in Northern Ireland.
Working with the T&EA, IMR developed "IMR Academy," an intensive 20-
week training program at the Belfast Institute of Further and Higher
Education, to expand the skills of qualified applicants who are not computer
software graduates, but who are equally well-educated in other
Disciplines and who have demonstrated aptitude for learning computer
software programming. Tom Scott of the T&EA said IMR applicants are
assessed throughout the program and those who successfully complete the
course are awarded a National Computing Certificate and full-time
employment with IMR. Approximately 40 trainees have already participated
in the program. "IMR is extremely pleased with the T&EAs ability to design
and deliver a training program customized to our needs, and one that is
delivering us an impressive pool of incremental programming talent,"
McFerran said.

Smart and Available


"The recent software investments by IMR and other companies provide a
new opportunity for Northern Ireland’s computer graduates," McFerrin said.
Recruitment research by IMR indicates that traditionally, nearly half of the
region’s computer graduates have been forced to seek jobs outside Northern
Ireland due to the lack of available information technology positions. Now IT
graduates have the chance to find good jobs in Northern Ireland, and
graduates from other fields can take advantage of the IMR Academy training
program to get a head start on a career in the growing software sector.
McFerrin said. Recruitment research by IMR indicates that traditionally,
nearly half of the region’s computer graduates have been forced to seek jobs
outside Northern Ireland due to the lack of available information technology
positions.

Competitive Advantage
Northern Ireland recently has attracted information technology – based
investments from other multinational companies such as BT, Fujitsu,
Liberty Mutual Group, Seagate Technology, STB Systems and UniComp.
These companies cite Northern Ireland’s work force and favorable cost base
in their decisions to locate in the region. "The availability of high-quality
graduates combined with the region’s competitive operating costs and
attractive incentives made Northern Ireland the best possible location for
STB," said Richard W. Cooke, STB’s director of engineering operations. With
salaries and fringe costs for well trained software engineers in Northern
Ireland approximately 50 percent lower than costs for US engineers, and low
employee turnover and favorable rates for office space, the overall annual
per capita operational costs to develop high quality software can be
significantly less compared with these same costs in the United States.
Typical starting salaries for IT graduates in Northern Ireland are $22,000 to
$25,000 annually. At less than three percent annually, Northern Ireland’s
employee turnover rate is a fraction of the rates typically experienced in
other parts of Europe and the United States. Annual costs per square foot for
office space, exclusive of property taxes and service charges, range from as
low as $5 per square foot in some development areas, to approximately $14
in Belfast. These costs can be as much as 50 percent lower than office space
costs in other European cities.
Master Of Business Administration-MBA Semester 4
MB0037 – International Business Management
Assignment Set-2

Q.1 Evaluate the monetary system and currency markets in


international business management.
Sol. The IMF is an international organization of 185 member countries. It was
established to promote international monetary cooperation, exchange
stability, and orderly exchange arrangements; to foster economic growth
and high levels of employment; and to provide temporary financial
assistance to countries to help ease balance of payments adjustment. The
International Monetary Fund (IMF) is the intergovernmental organization that
oversees the global financial system by following the Macroeconomic policies
of its member countries, in particular those with an impact on exchange rate
and the balance of payments. It is an organization formed with a stated
objective of stabilizing international exchange rates and facilitating
development through the enforcement of liberalizing economic policies on
other countries as a condition for loans, restructuring or aid. It also offers
highly leveraged loans, mainly to poorer. Its headquarters is in Washington,
D.C., United States. Countries

Organization and purpose


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

Data dissemination systems


In 1995, the International Monetary Fund began work on data dissemination
standards with the view of guiding IMF member countries to disseminate
their economic and financial data to the public. The International Monetary
and Financial Committee (IMFC) endorsed the guidelines for the
dissemination standards and they were split into two tiers: The GDDS and
the SDDS. The International Monetary Fund executive board approved the
SDDS and GDDS in 1996 and 1997 respectively and subsequent
amendments were published in a revised "Guide to the General Data
Dissemination System". The system is aimed primarily at statisticians and
aims to improve many aspects of statistical systems in a country. It is also
part of the World Bank Millennium Development Goals and Poverty
Reduction Strategic Papers. The IMF established a system and standard to
guide members in the dissemination to the public of their economic and
financial data. Currently there are two such systems: General Data
Dissemination System (GDDS) and its superset Special Data Dissemination
System (SDDS), for those member countries having or seeking access to
international capital markets. The primary objective of the GDDS is to
encourage IMF member countries to build a framework to improve data
quality and increase statistical capacity building. This will involve the
preparation of meta data describing current statistical collection practices
and setting improvement plans. Upon building a framework, a country can
evaluate statistical needs, set priorities in improving the timeliness,
transparency, reliability and accessibility of financial and economic data.

Q.2 a. Mention the different entry strategies to enter international markets.


Sol. Entry Strategies Methods of entry With rare exceptions, products just
don’t emerge in foreign markets overnight – a firm has to build up a market
over time. Several strategies, which differ in aggressiveness, risk, and the
amount of control that the firm is able to maintain, are available: · Exporting
is a relatively low risk strategy in which few investments are made in the
new country. A drawback is that, because the firm makes few if any
marketing investments in the new country, market share may be below
potential. Further, the firm, by not operating in the country, learns less about
the market (What do consumers really want? Which kinds of advertising
campaigns are most successful? What are the most effective methods of
distribution?) If an importer is willing to do a good job of marketing, this
arrangement may represent a "win-win" situation, but it may be more
difficult for the firm to enter on its own later if it decides that larger profits
can be made within the country.
Licensing and franchising are also low exposure methods of entry – you allow
someone else to use your trademarks and accumulated expertise. Your
partner puts up the money and assumes the risk. Problems here involve the
fact that you are training a potential competitor and that you have little
control over how the business is operated. For example, American fast food
restaurants have found that foreign franchisees often fail to maintain
American standards of cleanliness. Similarly, a foreign manufacturer may use
lower quality ingredients in manufacturing a brand based on premium
contents in the home country. · Contract
manufacturing involves having someone else manufacture products while
you take on some of the marketing efforts yourself. This saves investment,
but again you may be training a competitor. · Direct entry strategies, where
the firm either acquires a firm or builds operations "from scratch" involve the
highest exposure, but also the greatest opportunities for profits. The firm
gains more knowledge about the local market and maintains greater control,
but now has a huge investment. In some countries, the government may
expropriate assets without compensation, so direct investment entails an
additional risk. A variation involves a joint venture, where a local firm puts up
some of the money and knowledge about the local market.

b. How has E-commerce helped in international marketing?


Sol. Electronic Commerce1 Prospects for electronic commerce
1. Electronic commerce
Usually in the form of sales, promotion, or support through the Internet – is a
hot topic at the moment, evidenced by the high market capitalization of
firms involved in this kind of business. Growth rates have been considerable
over the last two years and are expected to persist, at least to some extent,
for at least the next several years. Yet, it should be recognized that so far,
sales over the Internet account for only a small portion of sales – especially
outside the U.S.

2. Obstacles to diffusion
Obstacles to the diffusion of Internet trade come both from enduring sources
and temporary roadblocks which may be overcome as consumer attitudes
change and technology is improved. Currently, Internet connections are
slower than desired so that downloading pictures and other information may
take longer than consumers are willing to wait. "Glitches" in online ordering
systems may also frustrate consumers, who are unable to place their orders
at a given time or have difficulty navigating through a malfunctioning site.
The lack of non- English language sites in some areas may also be off-putting
to consumers, and registering domain names in some countries is difficult.
Further, shipping small packages across countries may be inefficient due to
high local postage rates and inefficiencies in customs processing. Most of
these obstacles may be overcome within next few years. Other obstacles
may, however, have considerably greater staying power. First, there are
legal problems, as several different countries may seek to impose their
jurisdiction on advertising and laws of product assortment and business
practices. Further, the maintenance of databases, which are essential to
delivering on the promises of e-commerce, may conflict with the privacy
rules of some countries – this is currently a hot issue of contention between
the United States and the European Union. Finally, there are issues of
taxation and collection. While the Clinton Administration has sought to get
the WTO to go along with a three year tax "moratorium" on Internet
purchases much like the one observed in the U.S., strong opposition is
expected. A great attraction of e-commerce in Europe is that people may
order from other countries and thus evade local sales taxes, which can be
prohibitive (e.g., 25% in Denmark and 16% in Germany). Some firms will ship
to customers in neighbouring countries without collecting sales taxes or
duties, with the responsibility of paying falling on the consumer. Although
most consumers who order and do not arrange to pay for these taxes get
away with it, fines for those caught through random checks can be severe.

3. Locus of the site


Some firms have chosen to maintain a global site, with reference only to
local sales or support offices; others, in contrast, have unique sites for each
country. In some cases, global sites will hyperlink surfers to a country or
region relevant to the site. Note that some confusion exists since many sites
outside the U.S. maintain the ".com" designation rather than their countries’
respective suffix (e.g., ".de" for Germany, ".se" for Sweden, and ".au" for
Australia). Some firms have experienced problems getting their banks to
accept credit card charges in more than one currency, and thus it may be
difficult to indicate precise prices in more than one denomination (one site
based in Britain offered its American customers to be as accurate as
possible, based on current exchange rates, although the charge could be off
"by a few pennies.")

4. Lifecycle stages across the World


It has been suggested that Europe runs some five years behind the U.S. in
electronic commerce, but some sources dispute this, suggesting that lack of
success among American retailers may have other origins, such as
inadequate adaptation (for example, some British users are put off by
American English). There are, however, some factors which cause most
countries run behind. Even in Europe, Internet access penetration rates are
lower than they are in the U.S., and the slower speed associated with
downloading Asian characters is discouraging. In some countries, credit card
penetration is lower, and even in European countries with high penetration
rates, consumers are reluctant to use them. Further, the fact that consumers
in most countries have to pay a per minute phone charge discourages the
essential casual and relaxed browsing common in the U.S. so long as
unlimited cable or hardwired access is not offered.

Q.3 a. Explain Bill of Lading and Letters of credit.


Sol. A bill of lading (sometimes referred to as a BOL, or B/L) is a document
issued by a carrier to a shipper, acknowledging that specified goods have
been received on board as cargo for conveyance to a named place for
delivery to the consignee who is usually identified. A thorough bill of lading
involves the use of at least two different modes of transport from road, rail,
air, and sea. The term derives from the verb "to lade" which means to load a
cargo onto a ship or other form of transportation.
A bill of lading can be used as a traded object. The standard short form bill of
lading is evidence of the contract of carriage of goods and it serves a
number of purposes:
It is evidence that a valid contract of carriage, or a chartering contract,
exists, and it may incorporate the full terms of the contract between the
consignor and the carrier by reference (i.e. the short form simply refers to
the main contract as an existing document, whereas the long form of a bill of
lading (connaissement intégral) issued by the carrier sets out all the terms of
the contract of carriage);
It is a receipt signed by the carrier confirming whether goods matching the
contract description have been received in good condition (a bill will be
described as cleanif the goods have been received on board in apparent
good condition and stowed ready for transport); and
It is also a document of transfer, being freely transferable but not a
negotiable instrument in the legal sense, i.e. it governs all the legal aspects
of physical carriage, and, like a cheque or other negotiable instrument, it
may be endorsed affecting ownership of the goods actually being carried.
This matches everyday experience in that the contract a person might make
with a commercial carrier like FedEx for mostly airway parcels, is separate
from any contract for the sale of the goods to be carried; however, it binds
the carrier to its terms, irrespectively of who the actual holder of the B/L, and
owner of the goods, may be at a specific moment.
A standard, commercial letter of credit is a document issued mostly by a
financial institution, used primarily in trade finance, which usually provides
an irrevocable payment undertaking. The letter of credit can also be source
of payment for a transaction, meaning that redeeming the letter of credit will
pay an exporter. Letters of credit are used primarily in international trade
transactions of significant value, for deals between a supplier in one country
and a customer in another. They are also used in the land development
process to ensure that approved public facilities (streets, sidewalks, storm
water ponds, etc.) will be built. The parties to a letter of credit are usually a
beneficiary who is to receive the money, the issuing bank of whom the
applicant is a client, and the advising bank of whom the beneficiary is a
client. Almost all letters of credit are irrevocable, i.e., cannot be amended or
canceled without prior agreement of the beneficiary, the issuing bank and
the confirming bank, if any. In executing a transaction,
letters of credit incorporate functions common to giros and Traveler 's
cheques. Typically, the documents a beneficiary has to present in order to
receive payment include a commercial invoice, bill of lading, and documents
proving the shipment was insured against loss or damage in transit.
However, the list and form of documents is open to imagination and
negotiation and might contain requirements to present documents issued by
a neutral third party evidencing the quality of the goods shipped, or their
place of origin.

b. What is UNCITRAL and what it does?


Sol. The United Nations Commission on International Trade Law (UNCITRAL)
was established by the United Nations General Assembly by its Resolution
2205 (XXI) of 17 December 1966 "to promote the progressive harmonization
and unification of international trade law. When world trade began to expand
dramatically in the 1960s, national governments began to realize the need
for a global set of standards and rules to harmonize national and regional
regulations, which until then governed

Q.4. Explain the importance of STP in international markets.


Sol. The importance of STP
Segmentation is the cornerstone of marketing – almost all marketing efforts
in some way relate to decisions on who to serve or how to implement
positioning through the different parts of the marketing mix. For example,
one’s distribution strategy should consider where one’s target market is
most likely to buy the product, and a promotional strategy should consider
the target’s media habits and which kinds of messages will be most
persuasive. Although it is often tempting, when observing large markets, to
try to be "all things to all people," this is a dangerous strategy because the
firm may lose its distinctive appeal to its chosen segments. In terms of the
"big picture," members of a segment should generally be as similar as
possible to each other on a relevant dimension (e.g., preference for quality
vs. low price) and as different as possible from members of other segments.
That is, members should respond in similar ways to various treatments (such
as discounts or high service) so that common campaigns can be aimed at
segment members, but in order to justify a different treatment of other
segments, their members should have their own unique response behavior.

Q. 5 a. Write a short note on branding and trademarks.


Sol. Branding and trademarks
As mentioned in chapter four, it is difficult to protect a trademark or brand,
unless all countries are members of a convention. Brand "piracy" is
widespread in many developing countries. Other aspects of branding include
the promotional aspects. A family brand of products under the Zeneca (ex
ICI) label or Sterling Health are likely to be recognized worldwide, and hence
enhance the "subjective" product characteristics.

Warranty
Many large value agricultural products like machinery require warranties.
Unfortunately not everyone upholds them. It is common practice in Africa
that if the original equipment has not been bought through an authorized
dealer in the country, that dealer refuses to honour the warranty. This is
unfortunate, because not only may the equipment have been legitimately
bought overseas; it also actually builds up consumer resistance to the dealer.
When the consumer is eventually offered with a choice, the reticent dealer
will suffer, for example, with the new dealers coming up. Cotton
Production/Marketing Interface
Spinners
Machines are highly flexible, that is they can usually switch to a variety of
yarn requirements. The machines are geared to high production, are
automated and are of a precision for constant quality provision. There are
strict process controls and built – in quality control. Poor raw material,
especially when contaminated with metal particles, damages opening mills,
grid knives, fans and card clothing. Previous devices employed to remove
these (magnets) are becoming less effective. The consequences are damage
in the blow room and carding and danger of fire. Quality is therefore defined
as properties of the end use (clothing etc.), efficiency of weaving and knitting
and the efficient running of the spinning plant. Spinners require raw cotton
which is free of trash; dust, sugar and honey dew contamination, seed coats,
bark and foreign fibres and, will not nep the cloth. Further requirements are
a certain length (could be short, medium or long), uniformity of length,
strength, fineness, maturity and a certain elongation and colour.
Suppliers
In order to meet these high quality demands, the growers have to ensure
that the production, picking and ginning is of a very high standard.
Cotton grading
The Liverpool Cotton exchange, for one, relied on the skills of its experts to
manually classify raw fibre purchases for its clients. It still holds the
"standards" for length, colour and trash content. As well as the demands of
modem machinery, the lack of standardized measuring and cotton
classification procedures has resulted in commercial conflict and legal
disputes about the true nature of traded cotton. Now, computer based high
volume instrument listing systems of raw cotton (HVI systems) are available.
The system can handle large numbers of bales, reduce variation in
classification and the need for highly trained bate classifiers. For cotton
exporters the system offers the following advantages: · enhanced objectivity
in classification · improve communication if similar systems are used by
sellers or buyers · reduced conflict and need for arbitration · enhanced
competitiveness against synthetic fibres · improved integration with modern
spinning machines · reduced costs on training of experts and in measuring
time. The system can process 2000 bales per day and give a printout on the
seven parameters of grading. These include length and length uniformity,
strength and elongation, micronaire or fineness, leaf and colour.
Manufacturers include SPINLAR INC. of Knoxville, USA.
Service
In agricultural machinery, processing equipment and other items which are
of substantial value and technology, service is a prerequisite. In selling to
many developing countries, manufacturers have found their negotiations at
stake due to the poor back-up service. Often, this is no fault of the agent,
distributor or dealer in the foreign country, but due to exchange regulations,
which make obtaining spare parts difficult. Many organisations attempt to
get around this by insisting that a Third World buyer purchases a percentage
of parts on order with the original items. Allied to this problem is the poor
quality of service due to insufficient training. Good original equipment
manufacturers will insist on training and updating as part of the agency
agreement. In order to illustrate the above points, cotton can be used as an
example. Cotton is a major foreign exchange earner for Zimbabwe. In
1990/91, 52,000 tons were sold overseas at a value of Zim $ 238 million. As
the spinners, particularly those in the export market are in a highly
competitive industry, it is essential that the raw material is as clean as
possible. Also today’s spinning equipment is highly technical and the spinner
wishes to avoid costly breakdowns by all means.

Product strategies
There are five major product strategies in international marketing.
Product communications extension
This strategy is very low cost and merely takes the same product and
communication strategy into other markets. However it can be risky if
misjudgements are made. For example, CPC International believed the US
consumer would take to dry soups, which dominate the European market. It
did not work.
Extended product – communications adaptation
If the product basically fits the different needs or segments of a market it
may need an adjustment in marketing communications only. Again this is a
low cost strategy, but different product functions have to be identified and a
suitable communications mix developed.
Product adaptation – communications extension
The product is adapted to fit usage conditions but the communication stays
the same. The assumption is that the product will serve the same function in
foreign markets under different usage conditions.
Product adaptation – communications adaptation
Both product and communication strategies need attention to fit the peculiar
need of the market.
Product invention
This needs a totally new idea to fit the exclusive conditions of the market.
This is very much a strategy which could be ideal in a Third World situation.
The development costs may be high, but the advantages are also very high.
Table 9.2 summarizes the strategic alternatives with examples. The choice of
strategy will depend on the most appropriate product/market analysis and is
a function of the product itself defined in terms of the function or need it
serves, the market defined in terms of the conditions under which the
product is used, the preferences of the potential customers and the ability to
buy the product in question, and the costs of adaptation and manufacture
to the company considering these product –
communications approaches.

Table 9.2 International strategic alternatives

b. What are the features of exchange and currency markets?


Sol. The exchange rate regimes adopted by countries in today’s international
monetary and financial system, and the system itself, are profoundly
different from those envisaged at the 1944 meeting at Bretton Woods
establishing the IMF and the World Bank. In the Bretton Woods system: ·
exchange rates were fixed but adjustable. This system aimed both to avoid
the undue volatility thought to characterize floating exchange rates
and to prevent competitive depreciations, while permitting enough
flexibility to adjust to fundamental disequilibrium under international
supervision; · private capital flows were expected to play only a limited role
in financing payments imbalances, and widespread use of controls would
prevent instability in such flows; · temporary official financing of payments
imbalances, mainly through the IMF, would smooth the adjustment process
and avoid unduly sharp correction of current account imbalances, with their
repercussions on trade flows, output, and employment. In the current
system, exchange rates among the major currencies (principally the U.S.
dollar, the euro, and Japanese yen) fluctuate in response to market forces,
with short-run volatility and occasional large medium-run swings (Figure 1).
Some medium-sized industrial countries also have market – determined
floating rate regimes, while others have adopted harder pegs, including
some European countries outside the euro area. Developing and transition
economies have a wide variety of exchange rate arrangements, with a
tendency for many but by no means all countries to move toward increased
exchange rate flexibility (Figure 2). This variety of exchange rate regimes
exists in an environment with the following characteristics: · partly for
efficiency reasons, and also because of the limited effectiveness of capital
controls, industrial countries have generally abandoned such controls and
emerging market economies have gradually moved away from them. The
growth of international capital flows and globalization of financial markets
has also been spurred by the revolution in telecommunications and
information technology, which has dramatically lowered transaction costs in
financial markets and further promoted the liberalization and deregulation of
international financial transactions; · international private capital flows
finance substantial current account imbalances, · developing and transition
countries have been increasingly drawn into the integrating world economy,
in terms of both their trade in goods and services
and of financial transactions. Lessons from the recent crises in emerging
markets are that for such countries with important linkages to global capital
markets, the requirements for sustaining pegged exchange rate regimes
have become more demanding as a result of the increased mobility of
capital. Therefore, regimes that allow substantial exchange rate flexibility
are probably desirable unless the exchange rate is firmly fixed through a
currency board, unification with another currency, or the adoption of another
currency as the domestic currency (dollarization). Flexible exchange rates
among the major industrial country currencies seem likely to remain a key
feature of the system. The launch of the euro in January 1999 marked a new
phase in the evolution of the system, but the European Central Bank has a
clear mandate to focus monetary policy on the domestic objective of price
stability rather than on the exchange rate. Many medium-sized industrial
countries, and developing and transition economies, in an environment of
increasing capital market integration, may also continue to maintain market-
determined floating rates, although more countries could may adopt harder
pegs over the longer term. Thus, prospects are that: · exchange rates among
the euro, the yen, and the dollar are likely to continue to exhibit volatility,
and schemes to reduce volatility are neither likely to be adopted, nor to be
desirable as they prevent monetary policy from being devoted consistently
to domestic stabilization objectives; · several of the transition countries of
central and eastern Europe, especially those preparing for membership in
the European Union, are likely to seek to establish over time the policy
disciplines and institutional structures required to make possible the
eventual adoption of the euro. The approach taken by the IMF continues to
be to advise member countries on the implications of adopting different
exchange rate regimes, to consider the choice of regime to be a matter for
each country to decide and to provide policy advice that is consistent with
the maintenance of the chosen regime (Box 3).
but the changes in these flows appear also sometimes to be a cause of
macroeconomic disturbances or an
important channel through which they are transmitted to the international
system;

Q. 6 Discuss the various International product and pricing decisions.


Sol. Production decisions
In decisions on producing or providing products and services in the
international market it is essential that the production of the product or
service is well planned and coordinated, both within and with other
functional area of the firm, particularly marketing. For example, in
horticulture, it is essential that any supplier or any of his "out grower" (sub-
contractor) can supply what he says he can. This is especially vital when
contracts for supply are finalized, as failure to supply could incur large
penalties. The main elements to consider are the production process itself,
specifications, culture, the physical product, packaging, labelling, branding,
warranty and service.
International Pricing In New Open-Economy Models
Recent developments in open-economy macroeconomics have progressed
under the paradigm of nominal price rigidities, where monetary disturbances
are the main source of fluctuations. Following developments in closed-
economy models, new open-economy models have combined price rigidities
and market imperfections in a fully micro founded inter-temporal general
equilibrium setup. This framework has been used extensively to study the
properties of the international transmission of shocks, as well as the welfare
implications of alternative monetary and exchange rate policies. Imperfect
competition is a key feature of the new open-economy framework. Because
agents have some degree of monopoly power instead of being price takers,
this framework allows the explicit analysis of pricing decisions. The two polar
cases for pricing decisions are producer-currency pricing and local-currency
pricing. The first case is the traditional approach, which assumes that prices
are preset in the currency of the seller. In this case, prices of imported goods
change proportionally with unexpected changes in the nominal exchange
rate, and the law of one price always holds.’ In contrast, under the
assumption of local-currency pricing, prices are preset in the buyer’s
currency. Here, unexpected movements in the nominal exchange rate do not
affect the price of imported goods and lead to short-run deviations from the
law of one price. Empirical evidence using disaggregated data suggests that
international markets for tradable goods remain highly segmented and that
deviations in the law of one price are large, persistent, and highly correlated
with movements in the nominal exchange rate, even for highly tradable
goods. Moreover, there is strong evidence that the large and persistent
movements that characterize the behaviour of real exchange rates at the
aggregate level are largely accounted for by deviations in the law of one
price for tradable goods. In this article I make use of a simplified version of a
two-country model where the two markets are segmented, allowing firms to
price discriminate across countries, and where prices are preset in the
consumer’s currency. This model generates movements in the real exchange
rate in response to unexpected monetary shocks, which are a result of the
failure of the law of one price for tradable goods. I then compare this model
to a version in which prices are preset in the producer’s currency and
examine the implications of these two alternative price-setting regimes for
several key issues. The price-setting regime determines the currency of
denomination of imported goods and the extent to which changes in
exchange rates affect the relative price of imported to domestic goods and
the international allocation of goods in the short run. That is, different pricing
regimes imply different roles for the exchange rate in the international
transmission of monetary disturbances. As we shall see, this assumption has
very striking implications for several important questions, namely real
exchange rate variability, the linkage between macroeconomic volatility and
international trade, and the welfare effects of alternative exchange rate
regimes, among others. While generating deviations from the law of one
price that are absent from models assuming producer-currency pricing, the
assumption of local-currency pricing still leaves important features of the
data unexplained. The key role of this assumption in the properties of open-
economy models suggests that it is necessary to keep exploring the
implications of alternative pricing structures in open-economy models. In
Section 1, I review the empirical evidence on the behaviour of real exchange
rates and on international market segmentation and pricing. In Section 2, I
present the model with local-currency pricing and explore the main
implications of this pricing assumption. The final section concludes.
1. Some Evidence on Real Exchange Rates
I first review some empirical evidence on the behaviour of real exchange
rates using aggregate data. I then turn to a review of the evidence on the
sources of movements in real exchange rates. The real exchange rate
between two countries represents the relative cost of a common reference
basket of goods. For two countries, say the United States and Japan, the real
exchange rate is given by where P^sub US^ and P^sub JP^ represent the
American and Japanese price levels (measured in terms of dollars and yen,
respectively) and where e denotes the nominal exchange rate (defined as
the dollar price of one yen). The theory of purchasing power parity (PPP)
predicts that real exchange rates should equal one, or at least
show a strong tendency to quickly return to one when they differ from this
value. The fundamental building block of PPP is the law of one price: due to
arbitrage in goods markets, and absent barriers to trade, similar products
should sell in different countries for the same price (when converted in the
same currency). Large international price differentials would be only
temporary, as profit-maximizing traders would quickly drive international
goods prices back in line. Therefore, if arbitrage in goods markets ensures
that the law of one price holds for a sufficiently broad range of individual
goods, then aggregate price levels (when expressed in a common currency)
should be highly correlated across countries. Because aggregate prices are
reported as indices rather than levels, most empirical work has tested the
weaker hypothesis of relative PPP, which requires only that the real
exchange rate be stable over time. Figure 1 show the log changes in the CPI-
based dollar-yen real and nominal exchange rates and the relative price
level. In this figure, which is typical for countries with floating exchange rates
and moderate inflation, it clearly stands out that short-run deviations from
PPP are large and volatile.(Delete) In the short run, movements in the real
exchange rate mimic those in the nominal exchange rate, with no offsetting
movements in the relative price level. Not surprisingly, early empirical work
based on simple tests of short-run PPP produced strong rejections of this
hypothesis for moderate inflation countries. However; these studies did not
allow for any dynamics of adjustment to PPP and therefore did not address
the validity of PPP as a medium- or long-run proposition. The conventional
explanation for the failure of short-run PPP is the presence of nominal price
rigidities. If the short-term volatility of nominal exchange rates were due
mostly to monetary and financial disturbances, then nominal price stickiness
would translate these disturbances into short-run fluctuations in the real
exchange rate. If this were true, however, we should observe a substantial
convergence to PPP in one to two years, as the adjustment of prices and
wages takes place. Purchasing power parity, therefore, would be re-
established in the medium to long run.
An extensive body of empirical literature has tested the hypothesis of long
run PPP by looking at the mean-reverting properties of real exchange rates.
As is well known, it has proved rather difficult to find evidence supporting
convergence of real exchange rates to PPP even in the long run. Earlier
empirical studies, which used only post-Bretton Woods data, found it difficult
to reject the hypothesis that bilateral real exchange rates for industrialized
countries follow a random walk under floating exchange rates. But if PPP
deviations are very persistent, then it may be difficult to distinguish
empirically between a random walk model and a slow mean-reversion model
for the real exchange rate, especially when this variable is
highly volatile. As shown in Frankel (1986), the post-Bretton Woods period
may simply be too short to reliably reject the random walk hypothesis. To
overcome this problem of low power in tests of the random walk hypothesis,
Frankel used an extended data set (annual data for the dollar-pound
exchange rates from 1869 to 1984) and rejected the random walk model in
favour of a mean-reverting model for the real exchange rate. His point
estimate for the rate of decay of real exchange rate deviations was 14
percent per year, which implies a half-life of PPP deviations of 4.6 years.
Other studies that test convergence to PPP using long-horizon data sets tend
to find values for the half-life of PPP deviations between three to five years.
An alternative way to increase the power of unit root tests is to expand the
number of countries in the sample and to perform panel tests of
convergence to PPP. Frankel and Rose (1996), for example, use a panel set
of annual data from 1948 to 1992 for 150 countries. They estimate half-lives
for PPP deviations of about four years. Other studies using panel data sets
report similar estimates. Interestingly, these estimates are also similar to
those obtained using long- time series data sets. In brief, studies using
aggregate data provide strong evidence that deviations from PPP are highly
volatile and persistent. Consensus estimates suggest that the speed of
convergence to PPP is roughly 15 percent per year, implying a half-life of PPP
deviations of about four years. As we shall see next, a look at disaggregated
data will provide us with a much richer analysis of the sources of PPP
deviations. The Law of One Price: Market Segmentation and International
Pricing As I pointed out earlier, the idea underlying
PPP is that the law of one price holds for a wide range of individual goods. It
has long been recognized, however, that even for highly tradable goods and
at different levels of aggregation, deviations in the law of one price are large,
persistent, and highly correlated with movements in the nominal exchange
rate. One possible explanation for the failure of the law of one price is that
international markets are segmented by physical distance, like different
markets within a country. Engel and Rogers (1996), however, show that both
the distance and the physical border between countries are significant in
explaining the variation in prices of similar goods across different U.S. and
Canadian cities. They find that price dispersion is much higher for two cities
located in different countries than for two equidistant cities in the same
country. In fact, the effect of the border is estimated to be equivalent to a
distance of 1780 miles between cities within one country. Engel and Rogers
also show that nominal price stickiness accounts for a large portion of the
border effect, suggesting that prices are sticky in the local currency and that
changes in the exchange rate lead to deviations in the law of one price. Not
only are failures of the law of one priced significant but, as recent evidence
suggests, they also play a dominant role in explaining the behaviour of real
exchange rates. Engel (1999) measures the proportion of U.S. real exchange
rate movements that can be accounted for by movements in the relative
prices of non-traded goods. Engel decomposes the CPI real exchange rate
into two components: a weighted difference of the relative price of non-
traded to traded-goods prices in each country, and the relative price of
traded goods between the countries. If tradable, as a category, closely
followed the law of one price, then all variability in the real exchange rate
would be explained by movements in the first component. However, Engel
finds that movements in the relative price of non-traded goods appear to
account for almost none of the movement in U.S. real exchange rates, even
at long time horizons. Instead, nearly all the variability can be attributed to
movements in the relative price of tradable. This finding strongly suggests
that consumer markets for tradable goods are highly segmented
internationally and that movements in the international relative price of
consumer tradable are very persistent. Moreover, given the high volatility of
nominal exchange rates, these findings indicate that consumer prices of
most goods (either imported or domestically produced) seem to be sticky in
domestic currency terms. An alternative approach to studying the
relationship between exchange rates and goods prices is examining how
firms in an industry (or country) pass through changes in exchange rates to
export prices. Knetter (1989, 1993) measures the degree of price
discrimination across export destinations that is associated with exchange
rate changes for U.S., U.K., German, and Japanese industry-level data. He
finds that the amount of exchange rate pass-through differs considerably
depending on the country and industry. Goldberg and Knetter (1997) provide
an extensive survey of the literature and find that local currency prices of
foreign products do not respond
fully to exchange rate changes. While the response varies by industry, on
average exchange rate pass-through to U.S. import prices is only about 50
percent after one year, mainly reflecting changes in destination-specific
markups on exports. In brief, there is strong evidence that international
markets for tradable goods remain highly segmented and that deviations
from PPP are largely accounted for by movements in the relative price of
tradable goods across countries. At the consumer level, exchange rate pass-
through to import prices is virtually zero (suggesting that consumer prices
are sticky in domestic currency). At the producer level, however, exchange
rate pass-through is generally positive, but substantially below one.
Transaction Costs and the Adjustment of PPP and Law of One Price
Deviations Some recent empirical tests of long-run PPP and the law of one
price have abandoned the conventional framework, which assumes a linear
autoregressive process for the price differential. Instead, these studies have
started to look into nonlinear models of price adjustment, where the speed at
which price differentials die out depends on the size of the deviation itself.
This alternative framework for the empirical analysis of price differentials is
motivated by the observation that commodity trade is not costless.
Persistent deviations from the law of one price are implied as an equilibrium
feature of models with transaction costs, for deviations will be left
uncorrected as long as they are sufficiently small relative to the shipping
cost. The simplest econometric model that implements the notion of a
nonlinear adjustment for price differentials assumes that the process is well
described by a random walk for small deviations (that is, when deviations are
within a "band of inaction") and an autoregressive process for large
deviations (that is, when deviations are outside the band). Taylor (2001)
shows that the improper use of linear models when the true model is
nonlinear may produce a large bias towards finding a low speed of
convergence. Intuitively, a linear model will fail to support convergence to
PPP if the true model is nonlinear and the process spends most of the time in
the random-walk band. Using both monthly data from the 1920s and annual
data spanning two centuries, Michael, Nobay, and Peel (1997) reject the
linear adjustment model in favour of a nonlinear model and provide strong
evidence of mean-reverting behaviour for PPP deviations for every exchange
rate considered.

2. International Pricing in New Open-Economy Macroeconomic Models


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