5UIBE StudyGuide

Yo u r road to success
Your road to success
LEVEL 5
INTERNATIONAL
BUSINESS ECONOMICS
AND MARKETS
BE •
• A
OF
IDE
FICI
GU
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STUDY
abeuk.com
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ISBN: 978-1-911550-19-8
Copyright © ABE 2017

First published in 2017 by ABE
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All facts are correct at time of publication.
Author: Dr Bruce Johnstone

Reviewer: Peter Rumble CertEd MCIM DipM
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Acknowledgements:
p4 michaeljung/Shutterstock; p14 Maksimilian/Shutterstock; p17 Uber
Images/Shutterstock; p28 ivosar/Shutterstock; p32 Pressmaster/Shutterstock;
p37 P Maxwell Photography/Shutterstock; p58 VGstockstudio/Shutterstock.
ii © ABE
Contents
Using your study guide iv
Chapter 1 Economic Principles 2
1.1 Why organisations engage in international trade 3

1.2 Arguments for and against free trade 9
1.3 The impacts of globalisation 16
Chapter 2 International Markets 20
2.1 How markets are selected 21

2.2 Assessing the main market entry methods 23
2.3 Conducting a structured analysis of a market 26
2.4 Marketing mix strategies for different contexts 35
Chapter 3 International Trading Blocs 40
3.1 Different types of economic co-operation and preferential trade arrangements 41

3.2 Evaluate the purposes and operations of intergovernmental bodies 45
3.3 The major trade blocs and regional groupings 48
Chapter 4 International Finance 54
4.1 Key international financial institutions in world trade 55

4.2 The impact of foreign currency exchange and interest rates on international business 57
4.3 A country’s balance of payments and balance of trade 60
Glossary
63
© ABE iii
Using your study guide
Welcome to the study guide for Level 5 International Business Economics and Markets, designed
to support those completing their ABE Level 5 Diploma.
Below is an overview of the elements of learning and related key capabilities (taken from the
published syllabus).
Element of learning Key capabilities

Element 1 – Economic principles of Awareness of the different economic and socioeconomic
international business factors that affect how companies conduct business
internationally and how the behaviours of customers and
employees directly affect the workplace.
Analysis, justification, presenting reasoned arguments,

communication
Element 2 – Markets from an Ability to recognise and adapt to the impacts on products
international perspective and markets arising from the availability of products,
services and marketing communications from abroad.
Commercial awareness of cultural aspects and the direct

impact of globalisation.
Analysis, commercial awareness, cultural awareness,

decision-making, communication
Element 3 – International trading Ability to view the world not only in terms of an own
blocs and organisations country perspective, but to work within the wider
sphere of global cooperation, treaties, and changing
relationships.
Global perspective, relationships, communication

Element 4 – International financial Gaining an acceptance of the financial impacts and
aspects implications of being involved in global activity that are
apparent in commercial activities of all businesses.
Financial awareness, analysis
This study guide follows the order of the syllabus, which is the basis for your studies. Each chapter
starts by listing the syllabus learning outcomes covered and the assessment criteria.
iv © ABE
L5 descriptor
Knowledge descriptor (the holder…) Skills descriptor (the holder can…)
• Has practical, theoretical or technological • Determine, adapt and use appropriate
knowledge and understanding of a subject methods, cognitive and practical skills
or field of work to find ways forward in to address broadly defined, complex
broadly defined, complex contexts. problems.
• Can analyse, interpret and evaluate relevant • Use relevant research or development to
information, concepts and ideas. Is aware of inform actions. Evaluate actions, methods
the nature and scope of the area of study or and results.
work.
• Understands different perspectives,
approaches or schools of thought and the
reasoning behind them.
The study guide includes a number of features to enhance your studies:
’Over to you’: activities for you to complete, using the space provided.
ase studies: realistic business scenarios to reinforce and test your understanding of what
C
you have read.
REVISION
on the go
’Revision on the go’: use your phone camera to capture these key pieces of learning, then
save them on your phone to use as revision notes.
’Need to know’: key pieces of information that are highlighted in the text.
Examples: illustrating points made in the text to show how it works in practice.
Tables, graphs and charts: to bring data to life.
Reading list: identifying resources for further study, including Emerald articles (which will be
available in your online student resources).
Source/quotation information to cast further light on the subject from industry sources.
Highlighted words throughout denoting glossary terms located at the end of the book.
Note
Website addresses current as of August 2017.
© ABE v
Chapter 1
Economic Principles
Introduction
We will begin our study of international business by looking at the economic principles that drive
organisations to do business beyond their national borders; in the process, we will highlight the
main arguments for and against free trade. Once we have understood those economic principles,
we will be able to better appreciate how globalisation is changing economies, countries, cultures
and the international business environment.
Learning outcomes
On completing this chapter, you will be able to:
1 Analyse economic principles associated with international business
Assessment criteria
1 Analyse economic principles associated with international business
1.1 Explain the reasons why organisations engage in international trade
1.2 Justify the arguments for and against free trade with reference to restrictions in trade
1.3 Demonstrate an awareness of the impact of international issues such as globalisation on

organisations trading internationally
© ABE
Level 5 International Business
Economics and Markets
1.1 Why organisations engage in international

trade
To compete successfully in sporting contests or artistic endeavours it is essential to have an
advantage. This is also true of business, where having an advantage means being able to create
more value compared to others; having an advantage supports economic success. Nations can also
have different advantages that allow them to create value by trading internationally.
Our understanding of how nations can create wealth by trading with other nations has evolved
over the centuries as a series of trade theories emerged; earlier ones are classed as classical
trade theories and the more recent ones as modern trade theories. Let us begin by looking at the
classical theories of mercantilism, absolute advantage and comparative advantage.
Mercantilism
Developed in the 1600s and 1700s, and associated with the French politician Jean-Baptiste Colbert,
the theory of mercantilism sees international trade as a zero sum game where the goal is to
secure as much wealth as possible. Wealth was valued in terms of gold, and there was only so much
of it. According to the theory of mercantilism, if a country sells valuable goods and services to other
countries, it gains gold and becomes richer at the expense of the country receiving those goods or
services. A country succeeds over other countries by having more gold coming in than there is gold
going out. If I have more gold, it means you must have less and vice versa. Mercantilism is a win-lose
view of international trade.
The theory of mercantilism still exists today in the form of protectionism: the idea that governments
should promote their country’s exports while they put up barriers against imports. This is justified
through the protection of jobs and wealth in their own countries and is a view that opposes free trade.
Absolute advantage
The economist Adam Smith was an early advocate of the idea of free trade. In his 1776 book
The Wealth of Nations, Smith explained that markets could work well without the interference of
governments, as if controlled by an invisible hand. This applied to international markets as well as
national markets.
Smith explained that a country could have an absolute advantage over other countries. For example,
Portugal had an absolute advantage over England in producing grapes and wine because of its better
climate and soil. However, England had an absolute advantage over Portugal in producing sheep and
wool because of its climate.
© ABE 3
Chapter 1 Economic Principles
Absolute advantage
The theory of absolute advantage explained that Portugal should sell wine to England and that
England should sell wool to Portugal. By specialising in what they were good at both
countries could produce more. By trading with each other both could still have the
goods they needed, including goods they could not produce efficiently themselves. REVISION
on the go
The mercantilism theory called for a country to import as little as possible and be self-sufficient, but
the theory of absolute advantage explained that this would make a country worse off in the long
run. Mercantilism saw international trade as win-lose, but Smith’s theory of absolute advantage
recognised that free trade could be win-win.
Comparative advantage
But what should a country do if it does not have an absolute advantage? David Ricardo’s 1817 theory
of comparative advantage demonstrated that a country could still benefit from exporting goods and
services without having an absolute advantage, provided it has a relative or comparative advantage.
NEED TO KNOW
An importing country can be better off importing goods it could easily produce itself if by doing
so it is able to concentrate its resources on other activities that produce more value.
To understand this, think about the many things you buy yourself even though you could make
them. For example, you might purchase a knitted garment, even though you know how to knit.
You might buy a burger, even though you could easily make one yourself. You make these choices
because you know your resources of time and energy are better spent on the things you would
rather do, such as studying in order to have a more successful career. You anticipate that in the
long run your career will pay you more than you would earn by knitting or cooking burgers – even
though you are also great at knitting and cooking.
Comparative advantage seems to offer another way for free trade to produce a win-win situation.
Let us consider the case of Abeke and Barika below to understand how people, or countries, can
benefit from a comparative advantage, even without an absolute advantage.
CASE STUDY: COMPARATIVE ADVANTAGE

Abeke and Barika
Abeke is a lawyer who can also type, and Barika is a
typist.
Abeke can sell her time at $100 per hour as a lawyer,
and can type 100 words per minute.
Barika can type 50 words per minute and charges
$20 per hour as a typist.
Abeke therefore has an absolute advantage over
Barika in both legal work and typing.
4 © ABE
Economic Principles Chapter 1
However, if Abeke hires Barika to do her typing, both Abeke and Barika are better off.
Barika earns $20 per hour for her typing and Abeke is able to charge her time at $100 per hour
as a lawyer.
If Abeke did her own typing, she would save $40 per hour because she types at twice the speed
of Barika, but she is able to create an even greater value by selling her time as a lawyer. After
paying Barika $40 for two hours’ work, she still makes $60.
Name Abeke Barika
Occupation Lawyer Typist
Typing speed 100 wpm 50 wpm
Hourly rate $100/hour as a lawyer $20/hour as a typist
Value to Abeke of doing own

$20 × 2 = $40/hour
typing
Value created by hiring Barika $100 − $40 = $60/hour $20/hour
Comparative advantage in services also exists between countries. For example, because they
possess plentiful low-cost labour with English language skills and a good information communication
technology (ICT) infrastructure, the Philippines and India have a comparative advantage over
countries such as the UK, the United States of America (USA) or Australia in providing call centre
services. Businesses in Australia could easily operate their own call centres, but many of them benefit
from outsourcing their routine call centre tasks to the Philippines or India, as this allows them to
concentrate their own resources on performing higher value work.
A telecommunications firm in Australia might use a call centre in the Philippines to handle calls
from household customers, but maintain a smaller call centre in Australia to deal with its more
valuable corporate customers. When an individual customer has a problem that the call centre in
the Philippines cannot deal with, the call is simply transferred to a supervisor in Australia. In these
ways, the Australian firm outsources simple work to where the Philippines have an advantage, while
retaining the more complex client service work where Australia retains an advantage.
OVER TO YOU
Activity 1: What is your country’s comparative advantage?
Can you think of goods that are imported into your own country, even though your
country could grow or create those products itself?
© ABE 5
Can you think of services that are provided from outside your country, even though
your country could provide those services?
How can you explain the benefits of sourcing these goods or services from outside
your country?
The factor endowment theory

David Ricardo saw comparative advantage as coming from differences in productivity between
countries. He explained that a country gained a comparative advantage by applying more
productive labour to its resources, but modern theorists realised this was not the whole story.
Swedish economists, Eli Heckscher and Bertil Ohlin, provided a more complete explanation in the
twentieth century. The factor endowment (or Heckscher–Ohlin) theory held that countries
derived comparative advantage from factor endowments. Factors might be: land, location or
natural resources, such as minerals, energy, and labour or population size. This theory suggests
countries will export goods that make use of factors they have inherited in abundance, and import
goods that make use of factors that they lack. The factor endowment theory states that it is the
relative abundance of these inherited factor endowments that counts.
6 © ABE
This theory explains why China, with a large low-cost labour force, exports manufactured
electronic goods that are labour-intensive to produce. The USA lacks this low-cost labour force
so the US company Apple has its popular iPhones manufactured in China, to take advantage of
China’s factor endowment.
NEED TO KNOW
Trade theories and theorists
• Mercantilism – Jean-Baptiste Colbert
• Absolute advantage – Adam Smith
• Comparative advantage – David Ricardo
• Factor endowment theory – Eli Heckscher and Bertil Ohlin
New trade theory

During the 1970s, economists also noticed that being the first to innovate could be an
important advantage for a country, especially if the world market was small. This is called a
first-mover advantage. A good example is the manufacturing of large passenger aircraft,
which require a large investment in manufacturing facilities and technology to produce a small
number of very expensive aircraft every year, and the first country to develop this industry has
a compelling advantage. Learning effects are cost savings that come from learning by doing.
Once a manufacturer has built one aeroplane, the next one is much easier. This, combined with
economies of scale, gives the first mover an almost unassailable advantage, and explains why
there are only really two significant manufacturers of large passenger aircraft in the world: Boeing
in the USA and Airbus in Europe.
Porter’s five factors

The factor endowment theory implies a passive approach can be adopted by governments and
firms that simply make use of the factor endowments they have inherited. Management thinker,
Michael Porter, pointed out that sustained industrial growth is rarely based on such inherited factor
endowments. He noticed that sustained industrial growth tended to occur in “clusters”, which
are groups of interconnected firms, suppliers, related industries and institutions that arise, or are
created, in particular locations.
Michael Porter’s diamond model (Figure 1) explains how governments and firms can build export
industries by creating competitive advantage. The four facets of the diamond are:
1 Firm strategy, structure and rivalry – direct competition between firms boosts innovation
and productivity.
2 Demand conditions – demanding customers put pressure on firms to constantly innovate,
improve quality and become more competitive.
3 Related and supporting industries – having these nearby helps with the communication of
ideas, innovation and improvements.
4 Factor conditions – Porter argues that the key factors are created, not inherited. They are
such things as skilled labour, capital and infrastructure.
© ABE 7
Firm strategy,
structure and
rivalry
Factor Demand
conditions Government conditions
Related and
supporting
industries
Figure 1: Michael Porter’s diamond model for creating competitive advantage REVISION
on the go
A good example of a successful cluster is the area known as Silicon Valley in California, USA, where the
factors in Porter’s diamond model have come together to create a hugely productive cluster containing
many of the world’s most successful information technology and communication businesses.
There are examples around the world of smaller successful industry clusters. For example, the
city of London in the United Kingdom can be seen as a financial services cluster. The Cape vineyards
in South Africa is another good example of an industry cluster, as is the cluster of businesses
involved in manufacturing ceramic tiles in Sassuolo, Italy. The Cape winemakers and Sassuolo tile
makers make use of the factors in Porter’s diamond model to produce world-class merchandise.
OVER TO YOU
Activity 2: Clustered competition
How do you think businesses in the Cape vineyards, Sassuolo, London’s financial
district or Silicon Valley might benefit in practical terms from being clustered close to
competitors, customers and suppliers?
8 © ABE
What can governments do in the role of a catalyst and challenger to support

clusters?
1.2 Arguments for and against free trade

The theories of international trade tell us that trade between nations should be good for everyone,
a win-win situation, and it would seem to follow that international trade should be as free as
possible to capture those benefits. Many countries form a free trade area to make the most of
the benefits of trade between each other. A very large free trade area, covering 450 million people,
was formed by the USA, Canada and Mexico, who signed the North American Free Trade
Agreement (NAFTA) in 1994. NAFTA’s stated purpose was to:
• eliminate barriers to trade in, and facilitate the cross-border movement of goods and services
between the territories of the parties;
• promote conditions of fair competition in the free trade area;
• substantially increase investment opportunities in the territories of the Parties;
• provide adequate and effective protection and enforcement of intellectual property rights in
each party’s territory;
• create effective procedures for the implementation and application of this agreement, for its
joint administration and for the resolution of disputes;
• establish a framework for further trilateral, regional and multilateral cooperation to expand and
enhance the benefits of this agreement.
Let us consider some of the positive things that come from free trade.
• Economic growth is boosted by free trade. NAFTA is estimated to have boosted the economic
growth of the USA by 0.5% per year.
• Free trade increases jobs, with NAFTA being credited for creating five million new jobs in the USA.
• Free trade increases direct foreign investment that provides capital for businesses.
• Free trade creates a more dynamic business environment, challenging businesses to
compete globally.
• Nations stop spending money to subsidise industries and put the funds to better use.
• Technology and expertise can be transferred to developing countries.
© ABE 9
However, it is not always that simple and there are a number of problems blamed on
international trade:
• Well-paid workers in the developed world have to compete with low-paid workers in developing
countries, potentially resulting in job losses and social problems.
• There is the potential for exploitation of workers in developing countries, including slave labour,
child labour and people working gruelling jobs in unsafe conditions.
• People in developing countries are moved from rural areas to crowded cities, causing a
breakdown of their social safety nets.
• In developing countries with little protection of the environment, natural resources can often be
degraded or polluted as a result of international trade. For example, deforestation and strip-
mining of natural environments.
• Indigenous cultures can be uprooted and destroyed as natural environments such as jungles
are exploited.
• A country’s agricultural sector can struggle to compete with cheaper imports, resulting in job
losses and the country losing the ability to produce its own food.
• Some countries export more value than they import and subsequently have a trade surplus, other
countries import more value than they export and have a trade deficit. A trade deficit over a long
period can lead to a high national debt.
• Defence technology from advanced nations might fall into the hands of oppressive regimes.
• A country might use subsidies, incentives or aid deals to gain an unfair trade advantage over
other countries.
• An organisation might compete unfairly when it exports to another country. For example, by not
meeting quality, health or safety standards, stealing intellectual property or dumping (selling
goods below their cost to destroy competition).
These are all potential reasons why a nation might wish to control or restrict international trade.
Nations are said to have sovereignty, which means they can make their own rules and laws that
they believe to be in their own national interests, and do not usually have to be concerned with
how those rules and laws affect other nations. They can use this law-making power to gain a trade
advantage, reduce a disadvantage or prevent some kind of harm to their people. Nations are able
to control or restrict trade in the ways listed below.
Import tariffs or duty

A nation can impose a form of tax called an import tariff or duty on the goods that cross its
borders. This provides an advantage to any local producers of the same goods as it increases the
market price of imported goods compared to goods produced domestically. Tariffs can be so much
per unit, or a percentage of the item’s value. They can be aimed at reducing imports overall, or
targeted at particular products. A nation might decide some goods should have low or no tariffs,
while other goods must face very high tariffs such as those imposed on imported luxury cars in India.
Currency manipulation
If a nation can lower the value of its currency, it makes its goods cheaper and more competitive in
foreign markets while at the same time making foreign goods more expensive and less competitive
in its home market. (See currency fluctuations in Section 4.2.)
10 © ABE
Non-tariff barriers
A nation might restrict trade by imposing a quota, so that only a certain quantity of a particular
type of good can be imported or exported in a particular period. A quota becomes an embargo if
all trade in a category of goods is stopped.
A government might require an importer or exporter to apply for a licence and receive specific
permission for their imports or exports. Governments can then restrict trade by refusing or delaying
the issue of a licence, or making the process lengthy or expensive.
Nations can raise barriers to trade in less obvious ways. For example, simply by subsidising their
domestic industries or agriculture. Subsidies make it more difficult for foreign competitors to
compete on price and may also give exporters a competitive advantage in foreign markets. Nations
can also support their local industries by providing aid or loans to developing countries in exchange
for large export orders.
Quality standards and labelling rules applied to local goods can become an effective barrier to
imports by making it difficult, particularly for smaller enterprises, to sell into foreign markets.
Service industries also face non-tariff barriers in the form of licensing occupations and differing
standards. Professionals such as engineers, lawyers, doctors, nurses and real estate agents generally
need to be locally qualified and there is little mutual recognition of these qualifications between
countries. For example, a tax accountant will usually have served experience requirements, spent
time at a local university and belong to a local professional organisation. Outsourced accounting
services in India often have staff who have gone through a lengthy process of qualifying as
accountants in the United Kingdom, the USA or Australia, in order to offer their low-cost back-office
services to accountants in those countries.
What is a tariff?
A tariff is a tax that a nation imposes on the value of goods that are imported. This makes the
imported goods more expensive and gives local producers an advantage in their home market.
Tariffs are usually a percentage of the value of the goods, but can also be an
amount per unit. REVISION
on the go
OVER TO YOU
Activity 3: Could you overcome the non-tariff barriers to export your goods?
Imagine you have a small factory where you make delicious noodles that you sell in your
local market and to restaurants. You decide to package your noodles in sealed plastic
bags to sell in supermarkets, and export them to countries around the world.
What information about your noodles would you need to put on the label to meet the
rules for sale in the USA, Europe or China? In which languages would it need to be
written? Would you need to provide nutritional information as well as ingredients? Is
there a special printed format you would need to follow for each country? Would your
noodles have to pass tests? How would you find this information?
© ABE 11
We can see that there are a number of rules and laws available to a sovereign nation that wants
to restrict international trade. Let us now consider some of the reasons why a nation would want
to do this.
Reducing unemployment
Unemployed people in a democracy are voters with lots of time on their hands to put pressure on
politicians. Every country desires full employment and politicians can decide to put up trade barriers
to protect an industry from foreign competition. This may appear to succeed in protecting jobs
but comes at a cost to the country in the form of more expensive imported goods for consumers.
Restricting imports might protect jobs for some people at the cost of higher prices for others.
Protecting emerging industries

Politicians may put up trade barriers to protect their nation’s infant industries, arguing that they need
to be protected from more efficient foreign competition until their production costs decrease and they
become competitive. They might argue that the new industry needs time for its workers to become
more experienced and productive, as well as gaining the size and economy of scale to compete
internationally. The risk is that this never happens and the industry remains inefficient and uncompetitive.
Promoting industrialisation
Developing nations with economies that rely on agriculture may restrict imports in order to develop
an industrial base of their own. They want to attract foreign capital to build factories, employ
people and boost the nation’s wealth by producing valuable industrial products, not just agricultural
commodities that are often of fluctuating value. Import restrictions that aim to spur industrialisation
may cause international companies to move some of their manufacturing into the country, boosting
foreign direct investment (FDI), and subsequently providing jobs and technology.
Industrialisation of developing countries creates economic growth because people are moved
from being under-employed in rural villages to being more productively employed when living in
cities and working in factories. The downside is that people may lose the social safety net of their
extended families and suffer harsh working and living conditions in cities.
Trade strategy reasons

A country may restrict imports from another country to balance levels of trade, perhaps to reduce a
trade deficit. It may restrict imports to retaliate against restrictions from the other country, to seek
to make trade access comparable or fair, or as a bargaining tool.
12 © ABE
Selling goods below cost is referred to as dumping. Companies might engage in this strategy to
build new markets or because they receive government subsidies. If an industry believes foreign
competitors are selling goods into their market at below cost, they might lobby their government
to restrict trade. This is often difficult to prove and can lead to trade disputes.
An import tariff could be seen as an opportunity to tax the profits of foreign firms. This occurs when
a foreign company lowers its prices to remain competitive because of a tariff.
Non-economic reasons
In addition to economic arguments for trade barriers, there are a number of non-economic
reasons often used by governments to restrict or block imports. For example, a country, or group
of countries, might wish to apply trade sanctions in order to put pressure on another country to
improve its environmental standards or human rights, or to halt its development or use of chemical
or nuclear weapons.
Protecting essential industries

Some industries are considered to be essential to a country for reasons of national security.
This can include industries associated with defence, food security, key infrastructure and other
capabilities that a country might need in a time of war. An industry might also be considered
essential because other industries depend on it. A difficulty with this approach is that almost
anything can be seen as essential and it can be difficult politically to remove protection once it
is in place. For example, the USA continued the subsidy of mohair for 20 years after the military
stopped using it to make uniforms.
Losers and winners of free trade

People who become unemployed because they worked in factories that could not compete with
foreign imports can be seen as losers of free trade. A prominent example is the decline of the steel
and heavy manufacturing industries in the USA. The formerly dominant industrial states of Illinois,
Indiana, Michigan, Ohio and Pennsylvania are now referred to as the Rust Belt and have suffered from
population loss and urban decay because the USA’s steel manufacturing industry could not compete
with producers in China, India and Japan, even though worldwide demand for steel was still strong.
Winners of free trade are all the citizens of a country that enjoy a better quality of life as a result of
their access to the best goods and services in the world at a fair price. These winners tend to be
less vocal in pressing for free trade than the losers pressing for political protection. A closed down
factory with thousands left unemployed makes headlines, whereas the fact that millions of people
may now enjoy more economical and reliable motor vehicles may go unnoticed. The role of the
government is to manage structural changes by initiatives such as the retraining of unemployed
workers and incentivising start-ups in new industries, for example solar power.
NEED TO KNOW
Why do governments restrict trade?
• Reducing unemployment
• Protecting emerging industries
• Promoting industrialisation
• Trade strategy – political reasons
• Protecting essential industries such as defence
© ABE 13
CASE STUDY
What caused the loss of jobs in the Rust Belt?
When Donald Trump was sworn in as the 45th
President of the USA, his victory in the 2016 election
was a surprise to many, and his success in the so-called
Rust Belt was a predominant factor in helping him
achieve it. Wisconsin, Michigan and Pennsylvania all
went to Trump, something that had not happened for a
Republican candidate since Ronald Reagan in 1984.
During his campaign, Donald Trump promised to boost
US manufacturing and punish companies for moving
jobs overseas. He threatened that any company that lays off American workers to move to
another country will face a “substantial penalty” when trying to sell their products in the USA.
Unfortunately for America’s struggling working class, the majority of manufacturing jobs that
have disappeared over the past few decades are never coming back, for one simple reason:
they no longer exist. This reality is evidenced by a simple trend in manufacturing in America
since the end of the Great Recession: while manufacturing output has increased more than 20%
since 2009, manufacturing employment has grown by just 5%.
In other words, manufacturers have been returning to America in recent years, but they have
not been bringing a whole lot of jobs with them, as Trump had initially expected. It has not
been the Chinese or Mexicans who have been taking the majority of American manufacturing
jobs, but machines. Of the millions of manufacturing jobs lost over the past decade, more than
80% have been replaced by automation technologies, not foreign workers. It is, of course, much
easier to scapegoat (i.e. blame) foreigners and immigrants than to blame robots.
And so the “good old days” of American manufacturing, when hard-working Americans
could reach the middle class by working in the same local factory for 30 years, are long
gone. No president, not even a strongman like Trump, can reverse the tide of “creative
destruction.” This process – which was first detailed in the writings of Karl Marx – is endemic
to the capitalist system. Economist Joseph Schumpeter, who described creative destruction
as a “process of industrial mutation that incessantly revolutionizes the economic structure
from within, incessantly destroying the old one, incessantly creating a new one,” called it the
“essential fact about capitalism.”
Throughout the history of industrial capitalism, creative destruction has frequently caused social
strife and recurrent economic crises, eliminating countless jobs and wiping out whole industries.
(The Luddites famously responded to this in the early days of capitalism by destroying factory
machinery, which, of course, proved futile.) In the long run, however, creative destruction has
been a supremely positive force for humanity in transforming our standard of living. Moreover,
technological advancements have created more jobs than they have destroyed by establishing
new industries and expanding markets – resulting in globalisation.
With this in mind, one might assume that this historical trend will continue unabated, and new
twenty-first-century technologies will end up creating even more jobs, while continuing to
improve our lives.
However, this may not be the case, as new technologies – such as robotics, computerisation and
artificial intelligence – are fundamentally different from past technologies, with the potential
to emulate human labour itself, thus making human workers and their flaws obsolete. In a widely
shared article published on BigThink.com, writer Phillip Perry warned of this possibility, which
could ultimately produce a global crisis so devastating it would make the Great Recession look
like a bad day at the stock market. Perry wrote:
14 © ABE
“Unemployment today is significant in most developed nations and it is only going to get
worse. By 2034, just a few decades [from now], mid-level jobs will be largely obsolete. So far the
benefits have only gone to the ultra-wealthy, the top 1%. This coming technological revolution
is set to wipe out what looks to be the entire middle class. Not only will computers be able to
perform tasks more cheaply than people will, but they will be more efficient too.”
Perry cited a 2013 study at the University of Oxford that found as many as 47% of the jobs in
the USA were at risk of being automated within the next two decades. “Accountants, doctors,
lawyers, teachers, bureaucrats, and financial analysts beware: your jobs are not safe,” Perry
insisted.
Sources:
https://www.forbes.com/sites/adammillsap/2017/01/09/the-rust-belt-didnt-adapt-and-it-paid-the-
price/#b3f2227a3d6d
http://www.abc.net.au/news/2017-02-18/trump-threatens-to-punish-us-companies-for-moving-jobs-overseas/8282600
https://www.salon.com/2017/01/11/sorry-trump-voters-those-factory-jobs-arent-coming-back-because-they-dont-exist-
anymore/
OVER TO YOU
Activity 4: Rust Belt
Read these articles online:

https://www.forbes.com/forbes/welcome/?toURL=https://www.forbes.com/sites/
adammillsap/2017/01/09/the-rust-belt-didnt-adapt-and-it-paid-the-price/&refURL=&refe
rrer=#b3f2227a3d6d
http://www.abc.net.au/news/2017-02-18/trump-threatens-to-punish-us-companies-for-
moving-jobs-overseas/8282600
https://www.salon.com/2017/01/11/sorry-trump-voters-those-factory-jobs-arent-coming-
back-because-they-dont-exist-anymore/
What do YOU think caused the massive loss of American manufacturing jobs in the so-
called Rust Belt? Which of these answers seem true?
• Free trade destroyed jobs in the Rust Belt.
• Jobs in US manufacturing have been replaced by robots and automation.
• Most traditional jobs will be replaced by automation.
• People left the Rust Belt because improved air-conditioning made it more desirable
to live in Florida.
• American businesses should have bought American cars and steel, instead of foreign
cars and steel.
• There was not enough US investment in new technology such as steel mini-mills.
• Unions prevented investment by demanding a share of the profits for workers.
• Businesses failed to innovate and ultimately could not compete with foreign firms.
• American workers could not compete with workers in Japan, China and Germany.
• American managers could not compete with workers in Japan, China and Germany.
© ABE 15
1.3 The impacts of globalisation

What is globalisation?
The world is divided into nations and we have examined the idea of sovereignty that empowers
each nation to make its own rules and laws. Sovereign nations often create rules and laws in areas
such as trade and immigration that exclude and disadvantage the people of other nations.
However, the people of the world have become increasingly connected to resources that lie outside
of their own nation. Information flows much more freely from outside our own domain and connects
us to new ideas about technology, goods, services and resources, and provides us with new ideas
about how we should expect to live.
People have become more connected globally and nations have become more interdependent on
other nations. In 1950, about 7% of the world’s production was sold outside its country of origin;
today it is more like 25%.
Globalisation can be defined as an ongoing process by which societies, cultures and economies are
becoming more joined together by the world’s developing networks of trade and communication.
The economies of nations are brought closer together by trade, foreign direct investment, capital
flows and the spread of technology; societies and cultures become more integrated as a result.
Key drivers of globalisation

Globalisation is driven by technology, trade liberalisation and co-operation between nations, and
the development of services that support international business.
Developments in information and communication technology (ICT) have been a key driver of
globalisation. The internet and the World Wide Web, faster microprocessors and technological
improvements to telecommunications and transportation all continue to play a part.
Transportation of goods between countries has been made much more efficient – by air, through
jumbo jets, on sea through specialised ships for bulk goods and items such as cars, and on land
through improvements in road and rail infrastructure. All forms of transport have been made more
efficient through technological advances in global positioning systems (GPS) and the adoption of
containerisation, which allows cargo to move efficiently between sea, rail and road transport,
and through ports and warehousing.
16 © ABE
Major investment in new rail and sea corridors between China and Europe was announced in
2015 by the government of China. Referred to as the Belt and Road Action Plan and the New
Silk Road, this will continue the process of globalisation and boost global trade by developing
transportation infrastructure and building economic activity and trade between the 68 countries
along the routes.
How does globalisation affect organisations trading internationally?

Advances in technology and communications make it easier for businesses to operate globally.
Businesses have a much greater ability to source components, ingredients and specialised skills
from different parts of the world, and this is true of businesses large and small. Technology
platforms such as PayPal, Alibaba, eBay, Amazon, Etsy and Shopify make it possible for tiny
businesses to trade globally.
CASE STUDY
Beads by Bheka
Bheka lives in Malawi where she runs a small home
business making unique and attractive designer
jewellery out of beads, using her own designs. She
is able to purchase a dazzling selection of beads
online direct from manufacturers in China using
Alibaba.com, an online platform that connects
buyers with sellers in China, which has become the
world’s largest retailer.
Bheka photographs her designer bead creations,
sets a price and sells them globally using selling
platforms such as eBay, Amazon, Etsy and Shopify. She ships her creations direct to clients
almost anywhere in the world and accepts payment in most currencies via PayPal or Stripe
payment platforms.
Beads by Bheka is a micro global business that would have been impossible a few decades ago.
Because it has always shipped its goods and sourced its supplies worldwide it can be described
as a born global firm, and this has been made possible by technology, trade liberalisation
and the development of services that support international business.
OVER TO YOU
Activity 5: Starting up a micro business
What sort of micro business could you start that would make use of buying, selling and
payment platforms that support global business?
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Globalisation of markets
Formerly distinct world markets are tending to merge and integrate into single world markets. For
example, the types and styles of clothing worn by young people largely follow global fashions that
cut across different cultures and societies. Markets become more globalised when people from
different societies and cultures find common preferences and tastes, and establish norms. The jeans
and t-shirts adopted by students and the suits worn by business people are examples of common
preferences, tastes or norms that have spread globally. Markets for popular entertainment are also
increasing globally.
It is important to note that some distinctions between national and regional markets exist, even in
markets that have become quite globalised. Global businesses often need to adjust their marketing
strategies to suit local conditions and differences in local markets as they compete with local
businesses as well as other global businesses.
The globalisation of markets is enabled by the mass production of goods and the desire of
companies to globalise markets in order to increase profits and achieve company goals. Companies
will often move into a market to cater for a demand for their products. While entering a foreign
market often increases the risk of doing business, selling into a number of different markets can
also increase the chances of success for the product or service.
OVER TO YOU
Activity 6: Globalising markets
Think about your everyday clothing choices. Are they different from those of a person
your age and gender living in other cities – such as Lilongwe, Nairobi, Beijing or London?
Other than clothing, can you think of more markets that are increasingly globalised?
Globalisation of production
The factors that influence the location of manufacturing facilities include access to labour (which
might be plentiful or skilled), capital and raw materials, and being close to supporting businesses,
suppliers and markets. All these factors differ from country to country and a multinational
corporation or global business weighs up the advantages and risks, and then looks for the best
combination when it comes to deciding the most beneficial place in the world to locate production.
Government support, or lack of support, might also be a factor. Subsidies, taxes and tariffs, along
with quotas and other restrictions, can drive the globalisation of production by encouraging firms to
invest in establishing manufacturing in a different country.
18 © ABE
Globalisation to some extent takes some power away from nations and gives it to global businesses
who can now decide where they will produce and market their products and services, and where
they will invest, provide jobs and pay tax.
Multinational brands such as Zara and Adidas take advantage of the ability to shift their production
to countries such as Bangladesh where labour costs are low and worker rights are not as strong.
These companies operate factories without many of the regulations that apply in their home
countries and are challenged to act ethically in managing their employees and the environment.
What drives globalisation?

The rise of free trade, better transportation, the internet and World Wide Web, and
new information and communication technology that better connects people
around the world has led to the phenomenon called globalisation. REVISION
on the go
READING LIST
• Obadic’, A. (2013), “Specificities of EU cluster policies”, Journal of Enterprising Communities:
People and Places in the Global Economy, Vol. 7 Issue: 1, pp. 23–35. (This article will be
available in your online student resources.)
• Mutalemwa, D. K. (2015), “Does globalisation impact SME development in Africa?”, African
Journal of Economic and Management Studies, Vol. 6 Issue: 2, pp.164–182. (This article will
be available in your online student resources.)
• Alberti, F. G., Pizzurno, E. (2015), “Knowledge exchanges in innovation networks: evidences
from an Italian aerospace cluster”, Competitiveness Review, Vol. 25 Issue: 3, pp. 258–287.
(This article will be available in your online student resources.)
• Expósito-Langa, M., Tomás-Miquel, J., Molina-Morales, F. X. (2015), “Innovation in clusters:
exploration capacity, networking intensity and external resources”, Journal of Organizational
Change Management, Vol. 28 Issue: 1, pp. 26–42. (This article will be available in your online
student resources.)
• O’Dwyer, M., O’Malley, L., Murphy, S., McNally, R. C. (2015), “Insights into the creation of a
successful MNE innovation cluster”, Competitiveness Review, Vol. 25 Issue: 3, pp. 288–309.
(This article will be available in your online student resources.)
• Spich, R. S. (1995), “Globalization folklore problems of myth and ideology in the discourse on
globalization”, Journal of Organizational Change Management, Vol. 8 Issue: 4, pp. 6–29. (This
article will be available in your online student resources.)
Summary
After working through this first chapter you will now understand something about the economic
principles that underpin international business. You will have knowledge of the theories that
explain why firms engage in international trade, and this will have provided you with insights into
the potential benefits of free trade and globalisation. You will also be able to discuss some of the
potential negative impacts of free trade and globalisation, and understand why governments might
want to restrict imports from other countries.
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Chapter 2
International Markets
Introduction
Companies begin to engage in international business when they start doing business in another country.
In this chapter, we will look at how companies use a process of decision-making to decide which
international markets they should enter, and how they should go about entering those markets.
Learning outcomes
2 Evaluate markets from an international perspective
Assessment criteria
2 Evaluate markets from an international perspective
2.1 Evaluate the methods and criteria by which markets are selected
2.2 Assess the characteristics and applicability of the main market entry methods across a range
of industry sectors
2.3 Conduct a structured analysis of a country/market from both external and internal perspectives
2.4 Recommend appropriate marketing mix strategies for different contexts
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2.1 How markets are selected

Let us begin by considering the reasons a business might want to establish itself in a foreign country.
• Resource seeking – the country has resources that make it attractive to the business.
• Efficiency seeking – there is an opportunity to reduce costs.
• Innovation seeking – the business can access new ideas and technologies.
• Market seeking – the country has potential customers for the business.
Resource seeking
Firms that work with natural resources such as oil or minerals, or renewable resources such as
agricultural produce or timber, are very keen to secure access to them. They will often seek them out
in foreign countries and enter those markets because they are rich in the resources they need. This is
why oil companies operate all over the world; they depend on having access to resources of oil.
Efficiency seeking
Firms can make their operations more efficient by reducing labour costs, the costs of raw materials
or the cost of getting their goods to market. They may enter a foreign market to take advantage
of lower costs for resources or higher availability of those resources. Economies of scale might also
be created by the higher capacity of suppliers or higher demand from local consumers. Being close
to customers also creates efficiencies. For example, a British law or accounting firm might open an
office in Hong Kong to be close to the many head offices that are based there.
Innovation seeking
Innovation seeking firms are looking for new ideas and technologies that will give them an
advantage. They want to stay in touch with the latest developments in their industry and develop
their own innovations as quickly as possible. For example, a South African technology firm might
open an office in California’s Silicon Valley in the USA in order to have a better ability to innovate.
Market seeking
Many firms invest in a foreign country to take advantage of bigger markets for their goods or
services. Sure, they could just export their goods, but setting up production locally will save the
costs of serving the market from a distance. The firm can more easily adapt their goods to local
© ABE 21
Chapter 2 International Markets
tastes or needs, and their presence in the market might overcome tariff and non-tariff barriers and
transport costs they faced as exporters. The firm may also be keen to establish themselves and
dominate the market to discourage competitors from entering.
Growth markets
Growth markets are particularly attractive to multinational enterprises (MNEs) because
the economic growth going on in those countries can translate into growing sales and profits for
the business. A feature of growth markets is that they have rapidly growing middle classes. As
more people in a country move out of poverty, those people start consuming more household
goods, clothing, food, motorbikes, cars and trucks, and this further drives growth in demand for
manufactured goods. Let us look at where this growth is going on.
BRICS countries
Brazil, Russia, India and China, collectively known since 2001 as the BRIC countries, are considered
the world’s main emerging economies. South Africa was later invited to join the group (renamed
BRICS) in 2010. Together, these five countries are home to 40% of the world’s population (nearly
3.6 billion people in 2015), and cover a quarter of the world’s land area.
In economic terms, the BRICS are currently about 30% of the world’s gross domestic product
(GDP).
Speaking at a 2015 meeting of the BRICS Trade Ministers, Russian Minister of Economic Development
Alexei Ulyukayev said, “Our countries accounted for over 17% of global trade, 13% of the global
services market and 45% of the world’s agricultural output and the combined GDP of the five BRICS
countries surged from US $10 trillion in 2001 to US $32.5 trillion in 2014.”1 He also pointed out that
trade between the BRICS countries in 2014 was up by more than 70% to US $291 billion.
The economic growth powerhouses within the BRICS group are China, with an estimated growth of
6.5%, and India, with an estimated growth of 7.2% in 2017.
MINT/MIST countries
Mexico, Indonesia, Nigeria and Turkey are referred to as the MINT countries, while Mexico,
Indonesia, South Korea and Turkey are referred to as MIST countries. Both these terms were
created by Jim O’Neill of the investment bank Goldman Sachs, who created the BRIC acronym.
MINT/MIST countries are relatively smaller emerging economies with growing populations that are
likely to experience economic growth at different rates.
Less developed countries (LDCs)

Less developed countries (LDCs), also known as developing countries, have an industrial base that
is less developed than other so-called developed countries. LDCs generally have faster growth rates
than developed countries and their people are often transitioning from traditional lifestyles towards
the modern lifestyles led by people in the developed world. This move towards development
brings benefits such as longer life expectancy, higher literacy rates and incomes. However,
development and industrialisation is not always good for people and it is often difficult to say if a
particular country is developed or undeveloped. Organisations such as the World Bank now
1 BRICS (2015) BRICS reach 30 percent of global GDP [online]. Retrieved from: http://en.brics2015.ru/news/20150707/277026.
html [Accessed on 24 July 2017]
22 © ABE
International Markets Chapter 2
prefer to classify countries by their gross national income (GNI) per person, rather than referring to
them as either developed or undeveloped.
Researching markets – sources of information

Any organisation planning to invest directly into a foreign country will want to conduct thorough
research to understand the potential risks and rewards of doing so.
Much of the information we need to conduct research into an international market is available to us
through the internet, published documents or by communicating with people via email or over the
telephone. This research can be carried out from a desk and is referred to as desk research.
Good desk research is more than just a search of the open internet and will include academic and
commercial databases for peer-reviewed academic journal articles, official reports from government
and non-government organisations and news articles from reputable sources. Useful information
sources include The Economist, CIA and UNCTAD.
Field research usually involves going to the country to observe, ask questions or conduct
experiments such as test marketing products or services. If you are planning to sell a particular type
of product, it is a good idea to talk to the people that you hope will be your customers and ask
them questions such as:
• Would you buy this product?
• How many would you buy and how often?
• How would you use this in your home or business?
• How could this be changed to better suit your needs?
• What would you expect to pay for this?
• Whom would you expect to buy this from?
Do not expect that consumers in different countries will all use your product in the same way.
For example, while a student in South Africa may use a mobile phone for social networking and
news, a farmer in Uganda may use it to manage mobile money micropayments and find out the
best time to plant and harvest.
Answers to the last question (Whom would you expect to buy this from?) can be especially useful
in identifying the industry systems and distribution channels being used, and the particular firms
that are respected by locals.
2.2 Assessing the main market entry methods

When a business decides to enter a foreign market, it must decide its means of market entry. There
are many options that might be chosen, all with their pros and cons. Selecting the best method
requires considering the unique combination of factors relating to the home country and host
country, the industry sector, competition and the resources of capital and management available, as
well as the business, appetite for risk. Let us consider the main options for market entry.
Direct export
A company can simply pack its goods into a shipping container and ship that container to a
customer in a foreign country. That makes them a direct exporter and this is a simple way to enter
a foreign market. An advantage of this approach is that it can increase production in your factory,
© ABE 23
because it is now supplying an additional market. The company might introduce a night shift to
make the extra goods, which can mean more sales and profits without having to invest in new
factories and equipment.
The direct exporter or its customers must pay the cost of shipping its goods and any tariffs that are
charged by the foreign government, and direct exporters are also subject to any quotas and other
non-tariff barriers.
The company is also likely to need sales representatives to look after its customers in the foreign
market and may need to operate a sales office in the country.
Agents and distributors

An alternative to directly exporting is to work with intermediaries in the foreign country, referred
to as agents or distributors. As locals, these intermediaries know their local market well and may
be much better at making sales. This means the business can avoid the cost of having a sales office
and its own sales people in the market. Agents represent the business in the foreign market and
make sales on its behalf. Distributors usually import goods in bulk into their own warehouse, and
distribute smaller quantities to their customers.
Agents and distributors make money out of handling imported goods in the form of a fee,
commission, discount or mark-up.
Sometimes a company takes advantage of a distribution network set up by another company in the
foreign market. This arrangement is called “piggyback marketing” and usually occurs when the two
companies have products that complement each other, but do not directly compete.
Licensing
A business can enter a foreign market by allowing a business in that market to manufacture its
goods and sell them in the foreign country. The business provides the rights to use its intellectual
property, such as designs, patents and copyrights, and transfers knowledge and technology to the
foreign manufacturer. In exchange, it receives a licence fee or royalty payment for all the goods
produced under the arrangement.
The advantage of licensing is that the goods are manufactured inside the foreign country and this
provides a way to get around the costs of shipping, tariffs and non-tariff barriers.
Another advantage of licensing is that the business receives extra revenue without having to
manufacture or distribute the goods itself, and it has less risk as it does not have to make a big
investment to enter the market itself. The local business may do a better job of selling the goods in
its home market.
A disadvantage of licensing is having to share profits with a local manufacturer. There is also the
risk that once the local business has learned how to make the product, it will end the licensing
arrangement, then produce and sell its own similar product instead.
Franchising
Franchising is like licensing but usually refers to a branded service business rather than a manufactured
product. Fast food restaurant chains, hotels and retail brands are often run as a franchise and operate
under strict rules so that the quality standards of the business are maintained. It can be difficult to set
up and run a business in a foreign country, and some governments do not allow foreign ownership of
certain businesses. Franchising to a local business operator overcomes this.
24 © ABE
Turnkey contracts
A business can enter a foreign market by building and equipping a new factory in that market, and
selling it to new owners in that market. This is called a “turnkey contract” because the new owners
take delivery of a factory that is ready to have its doors opened and start producing goods. A business
agrees to build and then hand over a new operational factory that incorporates its technology.
The business can expect to be paid for providing its technology and knowledge in the form of a
working factory. It might also transfer technology that has become obsolete in its home market, or
dismantle a disused manufacturing facility and ship it to another country, where a new factory is built
to continue production. By doing this, the business extracts value from its old technology without
giving away the competitive advantage it derives from its new technology. An example of this is
the Volkswagen Beetle car, which became no longer viable to manufacture in Germany. The ageing
equipment to make it was moved to Brazil and Mexico where the model was still in demand.
The disadvantage for the business providing a turnkey factory is that it probably now cannot export
its goods to that country in the future, so it would only do this if more attractive alternatives were
not available. There is always the danger that it will be setting up a business that might become a
competitor in other markets in the future.
Contract manufacturing
Hiring a local business to manufacture goods in a foreign market can be a better option than
direct exporting, licensing or turnkey contracts. Import costs and restrictions are overcome and
the contract manufacturer produces goods in the foreign market for the business to sell to its local
customers. The contract-manufactured goods might also be exported to other countries.
The business should be able to capture more of the profits, compared to licensing arrangements,
and may be able to rationalise its global manufacturing operations and make them more efficient.
There is a risk that its technology and knowledge will leak out to other manufacturers in the foreign
market and it may find that similar or even counterfeit products soon start to appear.
Joint ventures
Forming a joint venture with a foreign business can allow a business to set up in a new market
without having to take all the risks on their own. This can make the joint venture an attractive
option in volatile emerging markets. The joint venture partner can potentially contribute valuable
local knowledge, manufacturing, distribution and investment. Of course, both joint venture partners
will expect to share in the profits.
In some countries, it may even be necessary to form a joint venture to overcome legal or political
barriers. For example, entering China in a type of business controlled by the Chinese government
usually requires establishing a joint venture with a Chinese firm.
Strategic alliances
Strategic alliances occur when businesses co-operate to achieve a goal. A business entering a
market can form strategic alliances with its suppliers or customers for short, medium or long
periods. To be successful, a strategic alliance must be a win-win situation in which both partners
receive a benefit. Benefits would include access to customers or natural resources, or operational
efficiencies of some kind. Innovation can also be an important strategic goal and businesses often
form alliances with universities and innovative organisations to have access to new technologies
they can exploit.
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Foreign direct investment

A business can enter a market by making a foreign direct investment (FDI) in that market. For
example, buying land, building a factory, installing equipment, hiring local people and producing
goods in the foreign country. FDI can also take the form of buying agricultural land, farming
operations, office buildings or existing businesses producing goods or services.
FDI without a local partnership of any kind results in a wholly owned subsidiary, entirely under the
control of the business making the investment. While this promises greater returns than other forms
of market entry, it also comes with the highest risk as the business is committing all the capital and
is going it alone in the foreign market without a joint venture partner, strategic alliance, agent or
distributor.
Direct marketing
Direct marketing is when a business sells its goods direct to consumers in a market. For example, a
South African firm might sell its goods on the internet and ship them direct to customers worldwide.
It might reach customers in the USA by advertising on television shopping networks.
NEED TO KNOW
Methods of market entry
• direct export
• agents and distributors
• licensing/franchising
• turnkey contracts
• contract manufacturing
• joint ventures
• strategic alliances
• foreign direct investment
• direct marketing
2.3 Conducting a structured analysis of a market

Macro analysis – based upon political, economic, social/cultural, technological,
ecological and legal factors
One strategic tool for understanding a market is to conduct a PESTLE analysis, which
covers political, economic, social, technological, legal and environmental factors. These are
the environmental factors likely to have an impact on business and are referred to as macro
environmental factors.
Political – for example, how stable is the government and does it intervene in the economy
using tax, labour laws, trade restrictions and tariffs? How does it manage health, education and
infrastructure?
26 © ABE
Economic – for example, what is the GDP? What is the distribution of incomes? What are the interest
rates, exchange rates and rates of inflation and growth? How do people spend their incomes?
Social – for example, how will the local culture affect doing business? How is the population
changing? Is it growing or ageing? What are the differences between urban and rural living? What
are people’s attitudes to health and safety? Marketers are keen to understand what drives buyer
behaviour in the market.
Technological – for example, how good is information communication technology infrastructure

such as fixed and mobile networks? How many people have internet access or mobile devices?
Technological factors can allow for new ways to produce or deliver goods and services, and new
ways to communicate with customers.
Legal – a business must understand how the legal environment of a country might affect its
operations. Laws covering consumers, employment, discrimination, health and safety, and anti-trust
are all relevant. Global businesses have to comply with the different laws that apply in all the different
jurisdictions in which they operate. Laws in places like Australia and the USA may apply to the whole
country, but some are made at state level, making compliance quite complicated.
Environmental – factors such as weather, climate and climate change can have a big impact on
how a business operates its expenses and the customer demand for its goods. Consumers are
demanding higher standards of sustainable sourcing of raw materials and ethical behaviour from
businesses.
A PESTLE analysis helps a business understand opportunities and threats in the market. These,
together with strengths and weaknesses, allow an analysis of strengths, weaknesses, opportunities
and threats (SWOT).
P Political
E Economic
S Social
T Technological
L Legal
E Environmental
Figure 1: The PESTLE model used to review the macro factors in an

environment REVISION
on the go
© ABE 27
CASE STUDY: A PESTLE ANALYSIS OF SOMALIA

Political
The Federal Parliament of Somalia is the national
parliament that contains the national bicameral
legislature. It consists of House of Representatives
(lower house) and senate (upper house), whose
members are elected to serve four-year terms.
The parliament elects the president, speaker of
parliament and deputy speakers, and has the
authority to pass and veto laws.
Economic
Somalia is classified by the United Nations as a less developed country. Despite experiencing two
decades of civil war, the country has maintained an informal economy, based mainly on livestock,
remittance/money transfers from abroad, and telecommunications. In 2014, the International
Monetary Fund (IMF) estimated economic activity to have expanded by 3.7%, primarily
driven by growth in the primary sector and secondary sector. Currency: Somali shilling.
Social
Somalis are predominantly Muslims, the majority belonging to the Sunni branch of Islam and
the Shafi`i school of Islamic jurisprudence, although some are also adherents of the Shia Muslim
denomination.
The clan groupings of the Somali people are important social units, and clan membership plays
a central part in Somali culture and politics. Clans are patrilineal and are divided into sub-clans
and sub-sub-clans, resulting in extended families.
Technological
Technological help is sourced from various parts of the world, as it is one of the least
developed countries.
Legal
The Provisional Constitution of the Federal Republic of Somalia is the supreme law of Somalia.
It provides the legal foundation for the existence of the Federal Republic and source of legal
authority. It sets out the rights and duties of its citizens, and defines the structure of government.
Environment
Somalia is a semi-arid country with about 1.64% arable land. From 1971 onwards, a massive
tree-planting campaign on a nationwide scale was introduced by the Siad Barre government
to halt the advance of thousands of acres of wind-driven sand dunes that threatened to engulf
towns, roads and farmland.
Source: Gupta, S. K. (2016), “Pestel of Somalia”, Retrieved from: http://www.sachdevajk.in/2016/12/19/pestel-of-
somalia/ [Accessed on: 19 September 2017]
Porter’s Five Forces

In 1979, management thinker Michael Porter put forward the idea that there were five forces that
should be considered in analysing an industry’s likely profitability and attractiveness: competitive
rivalry, supplier power, buyer power, the threat of substitution and the threat of new entry by a rival.
28 © ABE
Threat of new entrants Rivalry among existing competitors

• Time and cost of entry • Number of competitors
• Specialist knowledge • Quality differences
• Economies of scale Threat of • Other differences
• Cost advantages new entrants • Switching costs
• Technology protection • Customer loyalty
• Barriers to entry
Rivalry among Bargaining power

Bargaining power
of suppliers
existing of buyers
competitors
Bargaining power of suppliers Bargaining power of buyers

• Number of suppliers • Number of customers
• Size of suppliers • Size of each order
• Uniqueness of service • Differences between
• Your ability to substitute competitors
• Cost of changing Threat of • Price sensitivity
substitute • Ability to substitute
Threat of substitute products products or • Cost of changing
or services services
• Substitute performance
• Cost of change
Source: Adapted from Porter, M. E. (1979) “How Competitive Forces Shape Strategy.” Harvard Business
Review 57, no. 2 (March–April): 137–145
Figure 2: Porter’s Five Forces model REVISION

on the go
Let us look at Porter’s Five Forces to understand their importance:
Rivalry among existing competitors is the number and strength of the organisation’s rivals. How
many competitors does it have, how good are they and how does the quality of their products and
services compare? If competitive rivalry is low, the organisation is in a strong position to make good
profits. If, on the other hand, the organisation has strong rivals, it is likely to have to cut price and
advertise aggressively to attract customers.
Bargaining power of suppliers is determined by how easy it is for suppliers to increase their
prices. Ideally, the business buys readily-available inputs and has many alternative suppliers. The
more choices the business has, the greater its power to negotiate lower prices. The more special
and unique the product being supplied, the more power the supplier has to increase prices, and
this cuts into the potential of the business to make profits.
Bargaining power of buyers is high when buyers have the ability to negotiate lower prices. This
tends to occur when there are only a few large buyers. An example would be a small farmer who
sells to one or two large supermarkets that are able to dictate prices and terms. The buyers hold all
the power and the farmer is not able to make big profits.
Threat of substitute products or services is a force that weakens a business’ ability to raise prices
and boost profits. For example, let us imagine a business that operates the only hotel at a tourist
destination. The hotel might seem to have no competition, but people going on holiday can choose
a completely different destination for their holiday, or perhaps go on an ocean cruise. The hotel
must compete with substitutes and this keeps it from being able to put its prices up.
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Threat of new entrants also constrains pricing and profits. A sector that is highly profitable is likely to
attract the attention of other businesses who might move into the market to get a piece of the action.
Threat of new entry is reduced when the barriers to a new entrant are high. These barriers might be
the need for a big investment, special technology, intellectual property or a government licence.
Michael Porter stressed that these five forces are the fundamental and structural sources of
competitive pressure in an industry. Other factors such as new technology, government intervention
or industry growth rate are likely to be temporary.
The Five Forces model gives a way of understanding competition in a market or an industry that can
be used from the point of view of a business in the market, a business contemplating entering the
market, market regulators, suppliers and customers. Once the structure of competition in a market
is understood, we can begin to identify ways to improve our competitive position.
OVER TO YOU
Activity 1: Porter’s Five Forces
Think about a business or industry in your own country that you know something about.
Look at each of the forces in turn; what observations are you able to make?
Competitive rivalry
Buyer power
Supplier power
30 © ABE
Threat of substitution
Threat of new entry
Is this business in a competitive position that is strong or weak?
SWOT analysis
Following on from an analysis using tools such as PESTLE and Porter’s Five Forces, an analysis
of strengths, weaknesses, opportunities and threats (a SWOT analysis) is a great next step in
developing a strategic plan. Originated by Albert S. Humphrey in the 1960s, it is a tool that can be
applied to any business and you too can make use of it to plan your personal career strategy.
Strengths and weaknesses are internal factors – we must normally look inside our business or
ourselves to identify these. Opportunities and threats are external factors that we must look outside
our business to identify. It is also sometimes referred to as an internal/external, IE analysis or matrix.
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Here are some useful questions that could help you conduct a SWOT analysis for a business.
Strengths
• What advantages does your business have?
• What do you do better than anyone else?
• What unique or lowest-cost resources can you draw upon that others cannot?
• What do people in your market see as your strengths?
Weaknesses
• What could you improve?
• What should you avoid?
• What are people in your market likely to see as weaknesses?
• What factors lose you sales?
Opportunities
• What good opportunities can you spot?
• What interesting trends are you aware of?
• Useful opportunities can come from changes:
• Have there been changes in technology, markets or government policy related to your field?
• Have there been changes in social patterns, population profiles, lifestyle changes, etc.?
Threats
• What obstacles do you face?
• What are your competitors doing?
• Are quality standards or specifications for your job, products or services changing?
• Is changing technology threatening your position?
• Could any of your weaknesses seriously threaten your business?
CASE STUDY
SWOT analysis for Beko Consultants
Beko Consultants is a small start-up engineering
consultancy in South Africa.
Strengths
We are able to respond very quickly as we
have no red tape, and no need for higher
management approval.
We are able to give great customer care, as our
current small amount of work means we have
plenty of time to devote to customers.
32 © ABE
Our lead consultant has a strong reputation in the market.

We can change direction quickly if we find that our marketing is not working.
We have low overheads, so we can offer good value to customers.
Weaknesses
Our company has little market presence or reputation.
We have a small staff, with a shallow skills base in many areas.
We are vulnerable to vital staff being sick or leaving.
Our cash flow will be unreliable in the early stages.
Opportunities
Our business sector is expanding, with many future opportunities for success.
Local government wants to encourage local businesses.
Our competitors may be slow to adopt new technologies.
Threats
Developments in technology may change this market beyond our ability to adapt.
A small change in the focus of a large competitor might wipe out any market position we achieve.
As a result of its analysis, the consultancy may decide to specialise in rapid response, good
value services to local businesses and local government.
Conclusions
Marketing would be in selected local publications to get the greatest possible market presence
for a set advertising budget, and the consultancy should keep up-to-date with changes in
technology where possible.
As a result of their analysis, the consultancy may decide to specialise in rapid response, good
value services to local businesses and local government.
OVER TO YOU
Activity 2: A SWOT analysis for a market in your country
Can you think of a market within your own country in which you would like to start a
business? Imagine you have financial backing to start this business and operate in this
market. Conduct an analysis of what would be the strengths, weaknesses, opportunities
and threats for your new business.
What would be the strengths of your new business in this market and how can you
make the most of them?
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What would be the weaknesses of your new business in this market, and how can you
minimise their effect or become stronger?
What would be the opportunities for your new business in this market? How can you
seize them?
What would be the threats to the success of your new venture? How can you avoid or
overcome them?
Conducting a structured analysis of a market

We conduct market analysis when we want to understand how a particular market is structured,
how attractive it is now, and how that might change.
We are likely to want information about the size of the market now, and how that might change in
the future. Market trends, growth rate and profitability would be important and we would want to
understand the industry systems operating in the market, for example cost structures, distribution
channels and the practices followed by the successful players. We would want to identify the key
success factors and details to which the market’s successful firms pay attention.
34 © ABE
2.4 Marketing mix strategies for different contexts

The marketing mix
The term “marketing mix” describes the many decisions a business has to make in the process of
bringing a product or service to market.
The 4Ps, originated in the 1960s by E.J. McCarthy, is perhaps the most popular way of categorising
the elements that make up a marketing mix. The 4Ps are:
• product (or service)
• place
• price
• promotion.
Marketing mix
Product: Place: Price: Promotion:

• Quality • Coverage • List price • Advertising
• Design • Location • Discounts • Public relations
• Features • Channels • Credit terms • Sales promotion
• Brand name • Inventory • Payment periods • Sponsorships
• Packaging • Logistics • Direct marketing
• Services
Figure 3: The marketing mix, made up of product, place, price and

promotion REVISION
on the go
To create a marketing mix, decisions must be made about each of these categories. Here are some
of the questions a business needs to carefully consider and answer for each of the 4Ps.
Product/service
• What customer needs does the product satisfy?
• What problems does it solve for customers?
• What features does it need to meet these needs?
• Are you adding any unnecessary features customers do not value?
• How and where will your customers use it?
• Do different demographics of market segments use it differently?
• What does it look like? How will customers experience it?
• What options are available, such as size or colour?
• What is the name and brand and how is it branded?
• How is it different from what your competitors offer?
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Place
• Where will buyers expect to find your product or service? Will they look in a store, if so, what
kind? A specialist shop or a supermarket, or both? Will they buy online, or respond to an
advertisement or infomercial?
• What are the right distribution channels, and how can you access them? Do you need sales
people or telemarketers?
• What do your competitors do? How can you be better?
Price
• What is the value of your product or service to your customers?
• What are the normal price points for products or services like yours?
• How much do your customers care about price? Will they care if the pack is smaller or if there is
a price increase?
• Will you need different prices for different customers, such as resellers, trade customers, and
bulk buyers?
• Will your process be cheaper or more expensive than your competitors?
Promotion
• How will you communicate your sales messages to your target market?
• What mix of advertising media will you use?
• Is your product promoted at certain times of the year?
• How do your competitors promote their products? How can you be different and better?
Many more questions can be added to the above and the 4Ps are sometimes extended to 7Ps with
the addition of categories for people, processes and physical layout decisions.
An alternative approach is Lauterborn’s 4Cs, which consider the elements of the marketing mix
from the buyer’s point of view. It is made up of customer needs and wants (the equivalent of
product), cost (price), convenience (place), and communication (promotion).
The important point to note is that successful marketing requires a mixture of marketing that all
works together to achieve the best possible result.
Developing a marketing strategy for foreign markets

A business entering a foreign market is usually already successfully marketing its products or
services in its home market, and is possibly already successfully marketing in other foreign markets.
Even global businesses that may see themselves as marketing to the whole world have to consider
if and how their strategy will need to change to get the best result in each market.
On the one hand, it is efficient to standardise products and services as much as possible across
different markets, but it is also often necessary to adapt to local conditions.
McDonald’s is a powerful global brand that standardises its business systems and many of its menu
items worldwide, but it is also necessary for it to adapt its products to meet local conditions in
different foreign markets (see case study).
36 © ABE
CASE STUDY
How McDonald’s both standardises and adapts
The global success of McDonald’s fast food restaurants is
based on the standardisation of their products and services
offered around the world. Certainly, it is possible to walk into a
McDonald’s in any of the countries in which they operate and
purchase an almost identical Big Mac hamburger. Economists
are able to use a tool called the Big Mac Index to compare the
purchasing power of different currencies. McDonald’s official
company history shows that they do not modify their business
systems and processes in order to adapt to cultures across
national boundaries but instead seek to impose their approach
to fast food onto local cultures to meet their own needs –
seeming to ignore differences between places.
McDonald’s seem to standardise the name and presentation of their main menu items in
the majority of markets, but there are also examples of decisions to adapt in order to meet
customer expectations in markets outside of the USA.
Examples of McDonald’s adaptations

Of the standard USA burger selection, only the McChicken and the Filet-o-Fish are also offered
in India.
Wine is offered in France, beer is offered in Germany and tea is offered in England.
In the Netherlands, fries are served with mayonnaise dip instead of ketchup.
A burger with egg and beetroot is offered in New Zealand and Angus beef burgers are sold
in Canada.
Conclusion
Even a powerful global brand like McDonald’s, that sets out to standardise as much as possible,
will adapt to differences in cultures and customs. This is because failing to do so would reduce
or jeopardise the performance and profits of the business in those markets.
A multinational enterprise (MNE) operates in multiple countries and has to adapt its operations to
local conditions. Distribution systems for goods can vary considerably between countries and are
entwined with the local economic, cultural and legal environments. For example, the cost of paying
retail workers and their conditions of employment, the efficiency of delivery systems and consumer
preferences.
Cosmetics giant Avon Products, Inc. has a strategy of selling directly through independent
representatives but has had to adapt its approach to distribution in order to adjust to local
conditions in a number of countries.
For example, Avon operates a thriving mail-order business in Japan, where mail order is popular,
and has beauty counters in China because of regulations on house-to-house sales. The firm
operates franchise centres in the Philippines because of infrastructure inefficiencies and beauty
centres in Argentina, where many customers want services together with cosmetic purchases.
© ABE 37
Another example of how distribution systems can vary between countries is to compare supermarkets
in the USA with those in Hong Kong. Hong Kong stores are much smaller and closer together and
carry a higher proportion of fresh foods. A company from the USA selling packaged foods products
will find there is much less demand per store. They will have to make many smaller deliveries and have
a harder time fighting for shelf space.
OVER TO YOU
Activity 3: Distribution of goods in your country
Think about the way international companies sell their goods in your country. Can you
give an example of how have they adapted to your local conditions?
NEED TO KNOW
Marketing mix – 4Ps
• Product (or service)
• Place
• Price
• Promotion
READING LIST
These websites provide useful additional reading:
• https://www.wto.org
• http://www.export.org.uk
• http://www.worldbank.org
• http://reports.weforum.org
38 © ABE
• http://www.oecd.org
• http://www.bankofengland.co.uk
• https://www.cia.gov/library/publications/the-world-factbook
• http://www.un.org/en
• http://en.unesco.org
• https://www.mckinsey.com
• http://knowledge.wharton.upenn.edu
• https://www2.deloitte.com/global/en.html?icid=site_selector_global
• https://dupress.deloitte.com
• https://www.accenture.com/gb-en
• https://home.kpmg.com/uk/en/home.html
• http://marketingsherpa.com
• https://www.mindtools.com
• https://hbr.org
• https://www.forbes.com
• https://www.economist.com
Summary
Completing this chapter will have helped you to evaluate markets from an international perspective
and understand how firms decide which international markets they will enter, and which method
of market entry they will use. You now have some insights into how international markets can be
analysed and marketing strategies can be created.
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Chapter 3
International Trading Blocs
Introduction
The world of international trade can be viewed as a patchwork of overlapping trade agreements
between countries and groups of countries. In this chapter, we examine different types of economic
co-operation and some of the more important trading blocs.
Learning outcomes
3 Evaluate the significance of international trading blocs and organisations
Assessment criteria
3 Evaluate the significance of international trading blocs and organisations
3.1 Assess the characteristics of different types of economic cooperation and preferential
trade arrangements
3.2 Evaluate the purposes and operations of intergovernmental bodies
3.3 Evaluate the international market in terms of the major trade blocs and regional groupings
© ABE
3.1 Different types of economic co-operation and

preferential trade arrangements
Trade within trade blocs accounted for about half of the world’s trade in 2014. The major trade
blocs of the world include:
• The European Union (EU), which is made up of 28 countries.
• The European Free Trade Association (EFTA), which includes the EU and adds a further
four countries.
• EU preferential trade agreements with 58 countries (including the EFTA).
• The three countries of the North American Free Trade Agreement (NAFTA): Canada, Mexico and
the USA.
• Trade agreements Mexico has with the EU, EFTA and Chile, Costa Rica, Columbia, El Salvador,
Guatemala, Honduras, Israel, Japan, Nicaragua, Peru and Uruguay, in addition to its membership
in NAFTA.
• The seven countries of the Central American Free Trade Area (CAFTA-DR).
• The freetrade areas that the USA has with Australia, Bahrain, Chile, Colombia, Israel, Jordan,
South Korea, Morocco, Oman, Panama, Peru and Singapore, in addition to its memberships in
NAFTA and CAFTA-DR.
• The five countries of MERCOSUR (with a sixth country, Bolivia, in the process of acceding to
full membership) and its trade association agreements with Chile, Colombia, Ecuador, Guyana,
Peru and Suriname.
• The trade agreements that Turkey has with the EU, EFTA and 16 other countries.
There are now more than 250 preferential trade agreements in force and together they cover most
of the world in what can perhaps be described as a tangled web. In fact, only four countries that
are members of the World Trade Organisation (WTO) are not members of any trade bloc:
Congo, Djibouti, Mauritania and Mongolia.
Trade discrimination
There are two kinds of trade barriers that are designed to discriminate:
1 Trade blocs – each member country can import from other member countries freely, or at
least cheaply, while imposing barriers against imports from outside countries. The European
Union (EU) has done this, allowing free trade between members while restricting imports from
other countries.
© ABE 41
Chapter 3 International Trading Blocs
2 Trade embargoes – some countries discriminate against certain other countries, usually because
of a political dispute. They prevent the outflow of goods, services, or assets to a particular
country while allowing exports to other countries, discriminate against imports from the targeted
country, or block both exports to and imports from the target.
When countries create a trade bloc or embargo, they are enacting a form of discrimination by
deciding to favour trade with certain countries over trade with others. Whether this is a good or a
bad thing depends on your point of view.
We have already understood that, while there are losers, in general the world benefits from free
trade. Forming trade blocs and embargos can be seen as bad because it means restricting free
trade to certain countries and putting up or maintaining barriers that discriminate against imports
from other countries.
Alternatively, we can see a trade bloc as a good thing for the world if it creates more free trade
than there was before. It at least removes barriers between some countries, so is a step in the right
direction. The problem is that a trade bloc encourages imports from higher cost suppliers within
the bloc and discourages imports from countries outside, with goods that may be more efficiently
produced and less expensive. Consumers may pay more for the things they buy to support
inefficient producers within the trade bloc.
Less developed countries in particular may be disadvantaged by being outside of the world’s
major trade blocs and facing tariff barriers that restrict their exports and their opportunity for
economic growth.
Another problem with trade blocs is that they can cause international friction, especially when
countries find they are being discriminated against by being left out of the bloc.
Because of this, the WTO is opposed to trade discrimination in principle. A basic WTO rule is that
trade barriers should be lowered equally and without discrimination for all foreign trading partners.
The WTO follows the Most Favoured Nation (MFN) principle that says that any concession given to
any foreign nation must be given to all nations having MFN status.
How then is it possible to form a trade bloc without breaking WTO rules? Other parts of WTO rules
permit deviations from MFN under specific conditions. Trade blocs involving industrialised countries
are allowed if the trade bloc removes tariffs and other trade restrictions on most of the trade among
its members, and if its trade barriers against non-members do not increase on average.
WTO rules also allow special treatment for developing countries, which can exchange preferences
among themselves and receive preferential access to markets in the industrialised countries.
In practice, the WTO has applied its rules loosely and no trade bloc has ever been ruled in violation.
Types of trade blocs

Trade blocs can be simple arrangements between neighbouring countries, or represent strong
arrangements of insiders discriminating against outsiders, and acting almost like states within a
single country. Let us look at the different types of trade blocs that exist in the world.
Economic co-operation
Regional economic integration takes the form of an agreement between countries within a
geographic region. Neighbouring countries tend to ally because of their proximity to one another,
somewhat similar regional tastes, the relative ease of establishing channels of distribution and a
42 © ABE
International Trading Blocs Chapter 3
willingness to co-operate with one another for the greater benefit of all allied parties. An example
is the Association of Southeast Asian Nations (ASEAN), which exists to promote co-operation
between 10 states in the Southeast Asia region.
Bilateral or multinational trade agreements

A trade agreement (also sometimes calls a treaty or a pact) is a tax, tariff and trade agreement
that often includes investment arrangements. The most common trade agreements are of the
preferential and free trade types, and are concluded in order to reduce (or eliminate) tariffs, quotas
and other trade restrictions on items traded between the sides that sign the agreement. A trade
agreement is classified as bilateral (BTA) when it is between two sides. Each side could be a country,
group of countries or a trade bloc of some kind. A trade agreement signed between more than two
sides is referred to as multilateral.
Preferential trade agreement

A preferential trade agreement (PTA) is a trading bloc that gives preferential access to certain
products from the participating countries. This is done by reducing tariffs but not abolishing them
completely. A PTA is often the first stage of economic integration. The line between a PTA and
a free trade area (FTA) may be blurred, as almost any PTA has a main goal of becoming a FTA in
accordance with the General Agreement on Tariffs and Trade.
PTAs create departures from the normal trade relations rule that World Trade Organisation (WTO)
members should apply the same tariffs to imports from all other WTO members.
An example of a PTA is the Global System of Trade Preferences among Developing Countries
(GSTP). This has operated since 1988 with the aim of increasing trade between developing
countries. Original member states, participating since 1989, are: Bangladesh, Cuba, Ghana, India,
Nigeria, Singapore, Sri Lanka, Tanzania and Zimbabwe. Members that have been added since
then are: Algeria, Argentina, Benin, Bolivia, Brazil, Cameroon, Chile, Colombia, Ecuador, Egypt,
Macedonia, Guinea, Guyana, Indonesia, Iran, Iraq, North Korea, South Korea, Libya, Malaysia,
Mexico, Morocco, Mozambique, Myanmar, Nicaragua, Pakistan, Peru, Philippines, Sudan, Thailand,
Trinidad and Tobago, Tunisia, Venezuela, Vietnam and the trade bloc of MERCOSUR. Applicants
are (at 2014): Burkina Faso, Burundi, Haiti, Madagascar, Mauritania, Rwanda, Suriname, Uganda
and Uruguay.
Free trade area

A free trade area (FTA) is formed when members remove trade barriers among themselves but
keep their separate national barriers against trade with the outside world. Most trade blocs
operating today are FTAs. One example is the North American Free Trade Area (NAFTA), which
formally began at the start of 1994.
Customs union
A customs union is formed when members remove barriers to trade among themselves and
adopt a common set of external barriers. The European Economic Community (EEC) from 1957 to
1992 included a customs union along with some other agreements. The Southern Common Market
(MERCOSUR), formed by Argentina, Brazil, Paraguay and Uruguay in 1991, is an example of a
customs union.
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Common market
In a common market, members allow full freedom of movement for people, goods, services and
capital among themselves, in addition to having a customs union. Despite its name, the European
Common Market (EEC, which became the European Community, EC, and is now the European
Union, EU) was not a common market through the 1980s because it still had substantial barriers to
the international movement of labour and capital. The EU became a true common market at the
end of 1992.
Economic union
Full economic union is said to occur when member countries unify all their economic policies,
including monetary and fiscal policies, as well as policies toward trade and migration of people and
investment. Belgium and Luxembourg have had such a union since 1921 and the EU is on a path
toward economic unity.
Political union/federation
A political union, or federation, occurs when countries join together politically. For example,
Australia is made up of member states (New South Wales, Victoria, Queensland, Tasmania, South
Australia, Western Australia and the Northern Territory) that make most of their own laws, but are
part of a federal system that binds them together as a single country.
NEED TO KNOW
Types of trade blocs

• Economic co-operation
• Bilateral or multilateral trade agreement
• Preferential trade agreement
• Free trade area
• Customs union
• Common market
• Economic union
• Political union/federation REVISION
on the go
OVER TO YOU
Activity 1: What trade blocs does your country belong to?
Do some research online and find out what trade blocs and free trade areas your
country belongs to.
44 © ABE
3.2 Evaluate the purposes and operations of

intergovernmental bodies
Governments of individual countries need to work together, and in this section we will look at the
purposes and operations of the key intergovernmental bodies that help to make this possible.
World Trade Organisation (WTO)

When trade between nations operates smoothly and predictably, and follows a system of basic rules
that all countries have agreed, the world is a more peaceful and stable place as a result. This is the
objective of the World Trade Organisation (WTO): to provide legal rules for international trade and a
system for international commerce.
The WTO was formed in 1995, taking the place of the General Agreement on Tariffs and Trade (GATT),
which had begun in 1947. As the world recovered economically from the Second World War, the
objective of GATT was to facilitate trade between nations by reducing tariffs. Under GATT, countries
could give each other the status of most favoured nation (MFN), which meant it had privileged trading
rights. GATT aimed to help countries obtain MFN status.
The Uruguay round of GATT negotiations ran from 1986 to 1994, and created the rules about trade
between countries in goods that the WTO still upholds. These include how trade in agriculture
operates and anti-dumping policies.
Trade in services was also covered in the Uruguay round, resulting in the General Agreement on
Trade in Services (GATS). This agreement covered protection for intellectual property rights in the
form of copyright and patents.
There are more than 140 member countries in the WTO, covering 97% of the world’s trade.
Member countries adopt the WTO regulations by ratifying them, effectively making those rules part
of their legal system, as well as agreeing that they will not pass other laws that do not follow the
WTO rules. This means that a business can invest in another member country, perhaps setting up an
office there, and rely on the protection of the WTO rules.
The WTO Ministerial Committee meets in Switzerland to make decisions, usually by consensus
rather than a vote. There are WTO councils that make recommendations on goods trade, services
trade or intellectual property rights, and a general council, as well as a number of committees and
working groups. The WTO can resolve disputes between nations, usually through negotiation,
although it can also impose sanctions on countries that break the rules.
© ABE 45
Nevertheless, a critic of the WTO, international law scholar Steve Charnovitz, points out that countries
are prevented from passing laws that might protect workers, industries or the environment because of
the requirement to follow WTO rules.
The sovereignty of countries is compromised in the name of free trade and this can make it unable
to act in the best interests of its people. An example is when the governments of less developed
countries in Africa want to allow the manufacture of generic versions of drugs to treat HIV/AIDS,
because they simply cannot afford the expensive patented drugs. Because WTO rules on intellectual
property protection for the rights of drug companies that own the patents, governments that allow
generic drugs face the possibility of WTO trade sanctions.
Another critic of the WTO, Martin Khor, pinpoints that, by protecting investment, the WTO gives an
advantage to rich countries as most investment flows from rich countries to poor countries. There
are also those who criticise the ideas of free trade on which the WTO is based upon and call for
protectionist trade policies. The election of Donald Trump as president of the USA was due, at least
in part, to a rising call for the USA to put its own interests first when it comes to trade.
The Organisation for Economic Co-operation and Development

(OECD)
Established in 1961, the Paris-based Organisation for Economic Cooperation and
Development (OECD) provides a forum in which governments can work together to share
experiences and seek solutions on common problems. The OECD provides independent
research and analysis to help improve the lives of people in its member countries and globally,
but has no ability to make or enforce rules and relies on negotiation and consensus to influence
governments.
Members of the OECD are Australia, Austria, Belgium, Canada, Chile, Czech Republic, Denmark,
Estonia, Finland, France, Germany, Greece, Hungary, Iceland, Ireland, Israel, Italy, Japan, South
Korea, Latvia, Luxembourg, Mexico, Netherlands, New Zealand, Norway, Poland, Portugal, Slovak
Republic, Slovenia, Spain, Sweden, Switzerland, Turkey, the United Kingdom and the USA.
The G8 and G20

The G8 and G20 are groups of nations that come together to discuss and decide on important
world issues. They have replaced the G7 – a group of seven countries that came together in 1975
over the conflict between the Arab world and Israel.
The USA and the United Kingdom backed Israel with military aid, while the USSR supported the
Arab nations – an action that kept it from being invited to join the G7.
Officially called the Group of Seven Industrialised Nations, the G7 consisted of the United Kingdom,
the USA, France, Canada, Japan, Italy and Germany. It was renamed the G8 in 1997 when Russia
joined after the dissolution of the USSR in 1991.
The main role of the G8 is to work towards political and economic stability, whilst also achieving the
interests of its members on the world stage, tackling issues such as climate change.
Formed in 1999 as an extension of the G8, the G20 is a larger club, which includes the nations
of Brazil, China, Saudi Arabia, South Korea, France, Australia, China, Canada, Germany,
Indonesia, Argentina, Turkey, India, Russia, South Africa, Mexico, Japan, the United Kingdom,
the USA and the European Union. The G20 does not make any decisions that are binding on
46 © ABE
its members but provides an international forum for discussions between the governments
and central bank governors from these major economies. The G20 has the goal of promoting
balanced and sustainable economic development and reducing the world’s imbalances and
poverty. It also wrestles with such issues as transnational corporate tax evasion and corruption.
Organisation of Petroleum Exporting Countries (OPEC)

The Organisation of Petroleum Exporting Countries (OPEC) represents 12 of the world’s major
oil-exporting nations. Founded in 1960, OPEC has this stated mission:
To co-ordinate and unify the petroleum policies of its Member Countries and
ensure the stabilization of oil markets in order to secure an efficient, economic and
regular supply of petroleum to consumers, a steady income to producers, and a fair
return on capital for those investing in the petroleum industry.
In fact, OPEC is a cartel that manages the supply of oil in an effort to set the price of oil on the
world market, aiming to keep prices high and maximise the revenues and profits their members
receive for their oil exports. Most countries have laws that prevent companies forming price
price-fixing cartels, but the existence of OPEC suggests there is nothing much to stop sovereign
states doing this.
OPEC’s founding members were Iran, Iraq, Kuwait, Saudi Arabia and Venezuela. They have since
been joined by Qatar, Indonesia, Libya, the United Arab Emirates, Algeria, Nigeria, Ecuador, Gabon
and Angola. Together, its members hold around 80% of the world’s crude oil reserves and half of its
natural gas.
Russia, China and the USA are also major oil producers, but not members of the OPEC club.
Fracking technology, especially in the USA, has unlocked new sources of oil and weakened OPEC’s
control over the global market.
The World Economic Forum (WEF)

The World Economic Forum (WEF) is a Swiss non-profit foundation, based in Cologny, Geneva.
It summarises its mission statement as being:
… committed to improving the state of the world by engaging

business, political, academic, and other leaders of society to shape global,
regional, and industry agendas.
The WEF is best known for its annual meeting at the end of January in Davos, a mountain resort
in Graubünden, in the eastern Alps region of Switzerland. The meeting brings together business
leaders, politicians, economists and journalists for a four-day discussion of the most pressing
global issues.
There are also annual regional meetings each year in Africa, East Asia and Latin America, as well
as annual meetings in China and the United Arab Emirates. The WEF publishes a series of research
reports and co-ordinates initiatives involving its members.
© ABE 47
OVER TO YOU
Activity 2: What does the OECD say about your country?
The OECD publishes reports about countries and regions of the world, many of them
available online. Find an OECD paper or report that relates to your country or region.
What does it say about your country?
WTO rules
The World Trade Organisation (WTO) has over 140 member countries and sets regulations that
govern 97% of the world’s trade. When member countries ratify WTO regulations,
they make them part of their own legal system. These regulations provide some
certainty to firms doing business in other countries. REVISION
on the go
3.3 The major trade blocs and regional groupings

In this section, we will review the international market in terms of the major trade blocs and
regional groupings.
Europe’s single market

The European Coal and Steel Community (ECSC) was formed in 1952 as an alliance of six
European countries involved in the production of iron and steel. This was a first step in a growing
economic co-operation that led to the European Union.
When the European Customs Union was formed in 1958, it was the world’s first major trade bloc in
modern times. While the people of Europe benefitted from free trade in goods, they had to carry the
cost of the common agricultural policy, which was an expensive system to provide welfare for farmers.
In the 1980s, European countries progressed from being a customs union and became a single
common market. The Single European Act in 1992 eliminated many national product standards
48 © ABE
that had been non-tariff barriers, which protected high cost local producers from more efficient
competitors in other European countries. Belgium could no long apply strict rules on chocolate
ingredients, Germany could no longer restrict imports of beer that did not meet strict brewing
standards and Italy could no longer keep out imported pasta. The shift to become a common
market also meant that workers could move between countries and financial investments could
flow freely across European borders.
In 1999, the EU took the further step of establishing a single currency for Europe: the euro. At first,
European countries retained their own currencies and the euro was simply an overarching currency
that made it much easier to conduct financial transactions across borders. It became possible to
compare prices of goods within Europe without having to make currency calculations, and the risk
of currency fluctuations was eliminated.
Within three years, the euro was adopted by most European countries as their only domestic
currency (the United Kingdom was a notable exception and retained its own currency: the pound
sterling). Countries that adopted the euro had to give up the ability to manipulate the value of their
currency to meet their own economic objectives. The European Central Bank manages the euro, so
its value cannot be controlled by any one country.
The EU became a lot larger from 2003 to 2013 when 13 additional countries joined. The EU
population grew by 27%, although these were poorer former Eastern Bloc countries, meaning they
only added 6% to the size of the EU economy. The new member countries needed to be democratic
market economies that would commit to respect for human rights and agree to meet exact EU
standards, described in 80,000 pages of documents.
People in the new member nations did not enjoy the same farm subsidies and freedom of movement
immediately, but did have access to a greater variety of imported goods and opportunities to grow
their economies.
Still possibly to join at some time in the future are the Balkan countries of Serbia, Montenegro,
Bosnia, Macedonia and Albania. In a more distant future, Ukraine, Moldova and Georgia may be
able to join. Turkey would like to join but it is considered unlikely that such a large and relatively
poor country could make the necessary political changes and be successfully integrated.
North American Free Trade Area

The North American Free Trade Area (NAFTA) began to emerge in 1989 with the formation of the
Canada–US Free Trade Area (CUSFTA). Talks between the USA and Mexico began in 1990 and,
in 1991, became talks to create a free trade area that would include Canada. CUSFTA was later
replaced with NAFTA in 1994.
NAFTA removed nearly all tariffs and some non-tariff barriers within the three North American
countries. Barriers to investment across the two borders were removed, along with rules restricting
US and Canadian businesses in Mexico, but an important difference compared to the EU is that
NAFTA does not allow free movement of labour.
Critics of NAFTA in the USA, such as the American Federation of Labor and Congress of Industrial
Organizations, say that their jobs are lost to cheaper Mexican labour and that it supports a corrupt
political system in Mexico. Mexican critics of NAFTA fear a loss of sovereignty, as the USA uses
NAFTA rules to force changes to policies in Mexico. NAFTA is also blamed for environmental pollution
in industrial border towns and increasing inequality between rich and poor people in Mexico.
However, Mexico benefits from investment from foreign businesses that can manufacture goods
cheaply in Mexico to sell into the huge US market. It is estimated that NAFTA has boosted foreign
© ABE 49
investment in Mexico by 40%. Market and political reforms in Mexico are making life better for its
people and making it a better neighbour and ally for the USA.
NAFTA improves productivity in the three countries in two main ways. Firstly, the increased
competition from within the larger market drives innovation as manufacturers come under pressure
to improve production methods and design better products.
Secondly, because a factory in one of the three countries can now supply a larger market,
economies of scale can be created as factories can have longer production runs – making a smaller
range of goods in higher quantities is more efficient.
Mexico’s plentiful low-cost labour gives it a comparative advantage over the USA and Canada. This
makes it good at manufacturing clothing, furniture and other product assembly work, as well as
growing fruit and vegetables to export to the USA. It sells huge quantities of these goods to the
USA while at the same time buying more from the USA in areas where they have a comparative
advantage, such as financial services, chemicals and technology.
It is difficult to calculate the overall benefits of NAFTA. Trade has certainly increased but much
of this is diverted from other trade relationships rather than created by it. Economists mostly
agree that NAFTA has been modestly good for all three countries, adding a tenth of 1% to the US
economy, 1% to Canada and 2% to Mexico.
It is important to note that economists have not observed the massive loss of US jobs that many
predicted would occur as a result of NAFTA.
NAFTA rules of origin

Under NAFTA, the USA imposes no tariffs on clothing manufactured in Mexico, but retains tariffs
on other countries such as China. What is to stop a business bypassing US tariffs by shipping their
goods in through Mexico?
The answer is the rules of origin that are part of the NAFTA agreement and rigorously enforced by
the US authorities.
NAFTA rules of origin have to guard against all the different ways importers might try to beat the
system, such as making 90% of a garment in China, then finishing it in Mexico and sewing on the
“Made in Mexico” label.
The NAFTA rules of origin have thousands of rules to guard against this sort of thing in different
industries, covering 200 pages. For example, clothing manufacturers must prove they actually made
the fabric in Mexico to qualify for duty-free shipping. Many of the rules are so strict and require
so much documentation that they act as protectionist non-tariff barriers. The fabric rule protects
US fabric manufacturers but harms much lower cost fabric producers in Asia, along with the US
consumers who pay more for clothing.
Asia-Pacific Economic Co-operation (APEC)

The Asia-Pacific Economic Cooperation (APEC) forum was established to “further enhance
economic growth and prosperity for the region and to strengthen the Asia-Pacific community”,
and sets out to be “the premier forum for facilitating economic growth, co-operation, trade and
investment in the Asia-Pacific region.”
Established in 1989, APEC now includes 21 economies that mostly have a Pacific Ocean coastline.
APEC refers to member economies, not countries, as this allows both China and Taiwan to be
members, even though China does not recognise Taiwan as a country. Hong Kong is also a member
50 © ABE
although it is officially part of China. Other members are Australia, Brunei Darussalam, Canada,
Indonesia, Japan, South Korea, Malaysia, New Zealand, the Philippines, Singapore, Thailand,
the USA, Mexico, Papua New Guinea, Chile, Peru, Russia and Vietnam.
Member economies make voluntary commitments and decisions are reached by consensus.
Representatives are not all politicians – business leaders from the member economies also take
part in the APEC Business Advisory Council (ABAC). The idea is to make doing business between
the member economies easier by reducing the cost of trading across borders, providing access to
trade information and simplifying processes, and investing and doing business behind the borders
of different economies.
Member economies take turns hosting an annual APEC meeting and the APEC secretariat is based
in Singapore.
Contemporary developments in a dynamic world

International markets change and shift over time as alliances between nations are formed and
reformed. Recent developments have included the proposal for a Regional Comprehensive
Economic Partnership that will cover half of the world’s population, the last minute rejection by
the USA of the proposed Trans-Pacific Partnership and Britain’s decision to exit from the EU. These
three developments are detailed below.
Regional Comprehensive Economic Partnership (RCEP)

The Regional Comprehensive Economic Partnership (RCEP) is a proposal that emerged in 2012
for a regional free trade area, which would initially include the ten ASEAN member states and
those countries that have existing FTAs with ASEAN: Australia, China, India, Japan, South Korea
and New Zealand.
The 16 RCEP participating countries account for almost half of the world’s population, almost 30%
of the global GDP and over a quarter of world exports.
The objective of the RCEP is to bring together a patchwork of trade deals that exist between
nations in the region to achieve a modern, comprehensive, high quality and mutually beneficial
economic partnership agreement. RCEP will cover trade in goods, trade in services, investment,
economic and technical co-operation, intellectual property, competition, electronic commerce and
dispute settlement.
Trans-Pacific Partnership (TPP)

The TPP is an ambitious proposed free trade agreement between 12 countries that aimed to
establish a more seamless trade and investment environment by setting commonly agreed rules
and promoting transparency of laws and regulations. The TPP aimed to provide greater certainty
for businesses, reduce costs and red tape, and facilitate in regional supply chains.
The proposed members were Australia, Brunei Darussalam, Canada, Chile, Japan, Mexico, New
Zealand, Malaysia, Peru, Singapore, Vietnam and the USA, with the possibility of more countries
joining in the future.
Unfortunately, the TPP was derailed when incoming US President Donald Trump refused to agree
to it. Without the participation of the world’s biggest economy, many of the trade advantages were
lost to the other proposed members and the future of the TPP was cast into doubt. At time of
writing, it seems possible it will go ahead in an amended form without the USA.
© ABE 51
Britain’s exit from the EU – “Brexit”

In a controversial referendum in 2016, the people of the United Kingdom voted by a narrow margin
to leave the EU – a process referred to as Brexit. At the time of writing, the terms of Brexit are
still being negotiated and people in both the UK and the EU are still coming to terms with the
implications for their economies.
While still part of the EU, the UK can have no trade agreements of its own with any other countries.
If and when a separation from the single European market takes place, the UK will need to work
quickly to secure access to markets for its goods and services to minimise economic damage.
The free movement of people between Europe and the UK is expected to end, causing problems
for people who have moved across borders to live and work, potentially harming the UK economy
by cutting the flow of both highly skilled and less skilled workers.
UK-based businesses, such as motor vehicle manufacturers that rely on supplying the single EU
market, or need to move goods, services and skilled people across borders, now face uncertainty
about what the future might hold. In particular, London’s financial services and banking industry is
likely to find it harder to do business in the EU.
OVER TO YOU
Activity 3: What problems will Brexit cause for UK businesses?
What problems will UK businesses face if they can no longer be part of the EU single
market, which allows free movement of goods, services and labour between member
countries?
NAFTA has produced gains
The North America Free Trade Agreement (NAFTA) has proved modestly good for all
three countries. Economists calculate it has added a tenth of 1% to the US economy,
1% to Canada and 2% to Mexico. The major loss of US jobs predicted by labour
unions did not occur. REVISION
on the go
52 © ABE
READING LIST

• http://reports.weforum.org
• http://www.oecd.org
• http://www.un.org/en
• http://en.unesco.org
• http://www.economist.com REVISION
on the go
Summary
After completing this chapter, you should be able to discuss the significance of international trading
blocs and organisations, and the characteristics of different types of economic co-operation and
preferential trade arrangements. In addition, you now have some insights into the purposes and
operations of intergovernmental bodies, and understand how the international market is divided
into a patchwork of overlapping trade blocs and regional groupings.
© ABE 53
Chapter 4
International Finance
Introduction
International trade could not operate smoothly without international financial systems and the
institutions that maintain them. In this chapter, we will gain some insights into the world of
international finance.
Learning outcomes
4 Discuss the key aspects of international finance
Assessment criteria
4 Discuss the key aspects of international finance
4.1 Analyse the aims and roles of key international institutions in the financial aspects of
world trade
4.2 Evaluate the impact of foreign currency exchange and interest rates on international
business
4.3 Analyse the trading position of a country with reference to balance of trade/payments
© ABE
4.1 Key international financial institutions in

world trade
World Bank
The World Bank is an international organisation dedicated to providing financing, advice and
research to developing nations to aid their economic advancement. It is headquartered in
Washington D.C., USA, and has more than 10,000 employees in over 120 offices worldwide.
Created out of the United Nations’ Bretton Woods conference at the end of the Second World
War, the World Bank was originally needed because many European and Asian countries needed
finance to pay for reconstruction. Today, the Bank mostly attempts to fight poverty by providing
development aid to low income countries.
The World Bank is really five organisations:

1 International Bank for Reconstruction and Development (IBRD) – an institution that provides
debt financing to governments that are considered middle income.
2 International Development Association (IDA) – a group that gives interest-free loans to
governments of poor countries.
3 International Finance Corporation (IFC) – focuses on the private sector and provides
developing countries with investment financing and financial advisory services.
4 Multilateral Investment Guarantee Agency (MIGA) – an organisation that promotes foreign
direct investments in developing countries.
5 International Centre for Settlement of Investment Disputes (ICSID) – an entity that provides
arbitration on international investment disputes.
The World Bank aims to end extreme poverty by reducing the number of people living on less than
$1.90 a day to less than 3% of the world population. It also wants to increase income growth in the
bottom 40% of the world’s population.
It provides governments with low-interest loans, zero-interest credits and grants to help with
education, health care, public administration and development. The World Bank also helps
governments with policy advice, research, analysis, and technical assistance.
© ABE 55
Chapter 4 International Finance
International Monetary Fund

The International Monetary Fund (IMF) works hand-in-hand with the World Bank. While the
World Bank focuses on long-term economic solutions and the reduction of poverty, the IMF
is more focused on economic policy solutions and providing shorter-term loans. The IMF also
aims to stabilise financial relations and exchange rates and economically strengthen its member
countries. It was created with these aims:
1 Promoting global monetary and exchange stability.
2 Facilitating the expansion and balanced growth of international trade.
3 Assisting in the establishment of a multilateral system of payments for current transactions.
The IMF played a large role in the economic restructuring of the post-Second World War world.
After the war, some countries were in economic distress, and others were reluctant to trade with
certain other countries after the fighting. The Fund helped smooth over the economic post-war
transition period and re-stabilise the world economy.
A system of fixed exchange rates, established by the IMF, operated until 1971. Since then, the IMF
has promoted floating exchange rates, which allows the value of a currency to change relative to
the value of another.
The 188 countries that belong to the IMF contribute money in the form of quotas based on the size
of their economies. The IMF pools these funds and uses them to make loans to countries in need
and impose a code of conduct on its members. It requires countries that are seeking to borrow to
meet that code of conduct too, and sometimes even stricter rules.
The financial crisis in Greece was an example of how the IMF gets involved to help economies that
are in trouble by contributing funds, helping to decide how to handle the debt and the changes
needed to return stability to the economy.
European Central Bank (ECB)

The European Central Bank (ECB) formulates monetary policy, conducts foreign exchange,
holds currency reserves and authorises the distribution of euro bank notes and coins. It began in
1999, when members of the EU (not including the UK, Sweden and Denmark) created the euro
as a common currency. The ECB was a new central bank that was established to manage the new
currency and with it the monetary system of the EU.
Before the introduction of the euro, EU finances were managed by the European Monetary
System (EMS), which was an arrangement between European countries, set up in 1979, to link
their currencies and stabilise the exchange rate. The UK withdrew from the EMS in 1992 and later
refused to join the Eurozone along with Sweden and Denmark. The European Economic and
Monetary Union (EMU), which created the euro, later replaced the EMS.
The introduction of the euro and the ECB was a step towards European political unity, and
supported efforts by Eurozone nations to reduce debt, curb excessive public spending and attempt
to tame inflation.
The European sovereign debt crisis

The global economic crisis of 2008 exposed weaknesses in the EU’s finances. Greece, Ireland, Spain,
Portugal and Cyprus had high national deficits that created a European sovereign debt crisis. The
UK, having stayed outside the euro, simply saw the value of its currency devalue, but the troubled
56 © ABE
International Finance Chapter 4
Eurozone countries did not have this option. Instead, the value of assets inside those countries, such
as houses, plummeted.
The idea of bailing out troubled EU countries was not popular with people in the wealthier
EU countries such as Germany, but bailouts finally went ahead. In 2012, the European Stability
Mechanism provided further bailouts while forcing austerity measures in the afflicted countries.
Ireland, Portugal and Spain have managed a tentative recovery, but Greece remains in economic
recession with political strife, very high unemployment and an uncertain future.
Aims of the World Bank
The World Bank has the aim of ending extreme poverty in the world. It wants to increase
income growth for the poorest 40% of the world’s people and cut the number who
live on less than $1.90 a day to less than 3%. REVISION
on the go
4.2 The impact of foreign currency exchange and

interest rates on international business
Currencies can be bought and sold like any product. Buying a currency with another currency
means the currencies are being traded for one another. But how do we know what our buying and
selling currencies are worth relative to each other? Most industrialised countries allow the value of
their currency to fluctuate. Setting exchange rates for these currencies is the function of banks that
create exchange rates by trading currencies between each other.
Foreign exchange markets and rates are relevant to all businesses that buy, sell or invest in more
than one currency. Simply buying goods that come from another country with a different currency
involves the risk that the price you pay could rise due to a change in the rate of exchange. If you are
buying goods in one currency and selling them in another, you face exchange risk.
Exchange risk also occurs if you are investing in a foreign business or security, and interest rates can
also rise or fall differently from those at home, possibly a further risk.
Financial managers have to be concerned with exchange risk even if they do not do business
internationally. Exchange rate changes could change the price of any imported raw materials or
other inputs the business uses, and increased costs spell reduced profits. Exchange risk is even
more of a problem if a business is doing business across borders and buying, selling, investing or
borrowing money in more than one currency.
For example, investing in a US dollar account that pays 5% per year is better than investing in a
Swiss franc account that pays 10% per year if, during the year, the franc devalues by 6%.
Exchange risk can be eliminated or reduced in a number of ways. These alternatives fall into four
categories:
• risk avoidance
• risk adaptation
• risk transfer
• diversification.
© ABE 57
Risk avoidance
You can try to avoid exchange risk by only selling and buying in your local currency. This may not be
an effective strategy as your business can still be affected by the price of imported goods you need
to buy, such as vehicles, machinery, steel or chemicals.
Risk adaptation
Exchange risk adaptation involves hedging the risk. You can protect liabilities denominated
in foreign currency with equal-value, equal-maturity assets denominated in that foreign currency.
For example, let us imagine you have agreed to buy machinery from Germany at a cost of €100,000
to be paid in 180 days. To fix the cost at today’s rate you could purchase an asset in euros, such as
a certificate of deposit, that will also be worth €100,000 in 180 days. When the time comes to pay
for your German machinery, you sell the asset and, no matter how much your currency has changed
against the euro, you have exactly the amount you need to complete the purchase.
Even simpler, deposit the €100,000 in a euro-denominated bank account. An alternative approach
might be to agree to sell a shipment of your company’s products for €100,000 in 180 days.
Risk transfer
Another strategy for reducing exchange risk is exchange risk transfer. This involves a guarantee
or insurance contract that transfers the risk to a guarantor or insurer. A business can insure against
exchange risk and, in some countries, the central bank offers exchange risk guarantees to importers
and exporters.
Diversification
If your business holds assets in a variety of different currencies this provides some protection against
exchange risk. This is referred to as currency diversification. If you hold half your assets in US
dollars and the other half in euros, changes in the exchange rate between these two currencies will
not be a problem for you. While one asset will be worth less, the other is worth more.
CASE STUDY
Exchange risk makes the profit disappear
at a $2 Store
Amara has a variety store called The $2 Store that sells
everything for $2 in her local currency.
She buys goods from another country for an average landed

cost per item of US$1, and needs 75 cents from each sale to
cover the overhead costs of her business. This leaves her with
a profit of 25 cents for each item she sells.
Amara’s local currency had been worth the same as the US dollar and her business had been
profitable until bad economic news about her country’s prospects caused her local currency to
drop in value against the US dollar by 20%.
The average landed cost of Amara’s goods is still US.$1, but this is now $1.25 in her local
currency. Her overhead costs are still 75 cents so she can no longer make any profit from
operating The $2 Store.
58 © ABE
OVER TO YOU
Activity 1: Managing exchange risk for your own $2 Store
What could you theoretically do to minimise the exchange risk at your $2 Store?
Choose one of the solutions below, or one of your own, and explain why.
• Insist that you purchase from your supplier in China using your local currency.
• Sell everything in your store for the local currency equivalent of US $2 dollars so the
price goes up and down with the exchange rate.
• Buy a forward contract from your bank to cover the foreign exchange needed for
each order you place.
• Change the name of your store to The $3 Store.
NEED TO KNOW
Hedging exchange risk

Exchange risk adaptation involves hedging the risk. You can protect liabilities
denominated in foreign currency with equal-value, equal-maturity assets
denominated in that foreign currency. REVISION
on the go
© ABE 59
Currency devaluation
If the currency of your country devalues, it becomes more expensive to import goods, so of course
you will have to pay more to buy imported goods. At the same time, the goods that your country
exports become less valuable. This initially makes your country’s balance of trade less favourable.
However, because the devaluation has made the goods your country produces less expensive in
other countries, demand for those goods soon rises and the value of your exports starts to increase.
At the same time, people in your country start buying less imported goods, because they are now
more expensive. They may start replacing some of those imported goods with local products.
So your country may become initially worse off after a devaluation but then exports rise, imports
reduce, and the position of the country improves. If you drew a graph of the country’s balance of
payments after a devaluation it would show a dip followed by a rise. Economists describe this as
a J curve.
The opposite occurs if your currency appreciates in value. Exports fall, because your country’s
goods now cost more in other countries, and imports increase because the strong currency makes it
cheaper to buy imported goods. The result of a currency appreciation can be a reverse J curve.
4.3 A country’s balance of payments and balance

of trade
The balance of payments (BOP) is a record of transactions that take place between the people,
organisations and government of one country and the people, organisations and governments of
all other countries. Double entry bookkeeping is used so for all value that flows out as a payment,
some corresponding value flows in as a receipt, therefore there cannot be a deficit.
A BOP records transactions rather than actual payments, which is important because some
transactions are exchanges that do not involve actual payment of money. BOP transactions are
classified as current account (mostly goods and services) or capital account (mostly financial
instruments). This information is used by governments to see trade imbalances or how much foreign
investment is taking place.
Governments formulate economic policy, perhaps deciding to lower their exchange rate to
stimulate exports and build up cash reserves, or perhaps seeking to attract investment in certain
sectors. The BOP is used to measure the success of such economic policies.
Balance of trade
Balance of trade is different from balance of payments and can show a surplus or a deficit. A surplus
in the balance of trade occurs when exports exceed imports and a deficit occurs when imports
are greater than exports. The balance of trade shows the amount of visible trade and is the major
component of a country’s balance of payments.
Visible trade is the exchange of physically tangible goods between countries, involving the export,
import, and re-export of goods at various stages of production and includes equipment used
directly in the production of goods.
Invisible trade is the exchange of physically intangible items between countries and is primarily
services or transactions when physical goods do not change hands. Invisible trade includes income
from foreign investment in the form of interest, profits, and dividends; private or government
transfers of monies from one country to another; and intellectual property and patents.
60 © ABE
NEED TO KNOW
Balance of trade
The balance of trade shows the amount of visible trade that has taken place. It is the
major component of a country’s balance of payments.
When exports exceed imports there is a surplus, however, when the opposite
occurs, imports are more valuable than exports, and a deficit in the balance of
trade is created. REVISION
on the go
Current account deficits

A deficit in the current account of the balance of payments occurs when the value of the goods and
services a country imports exceeds the value of the goods and services it exports.
Developed countries, such as the USA, often run current account deficits, as do countries that are
very poor. Emerging economies often run current account surpluses.
Is a current account deficit a bad thing? It depends. If it means that a country is simply living
beyond its means, it is risking insolvency, but if the country is using debt to finance investments
that have a higher rate of return than the cost of the debt, it can run a current account deficit and
remain solvent.
A country can attempt to reduce its current account deficit by increasing the value of its exports
relative to the value of imports. It can do this by placing restrictions on imports, promoting exports
or seeking to improve the global competitiveness of its exporters. It can also use devaluation of its
currency to make its exports less expensive.
The UK is an example of a country that runs a current account deficit. It has high levels of imports
financed by borrowings and much of what it exports are commodities that have declined in value,
resulting in lower earnings for UK companies.
The UK currency declined in value dramatically after the Brexit vote in 2016. UK firms that sold goods
priced in US dollars, or held cash reserves in the USA, were suddenly much more wealthy in UK
pounds and the devaluation also meant that the UK’s current account deficit unexpectedly decreased.
OVER TO YOU
Activity 2: What about your country?
Does your country run a current account deficit? How big is it and what do politicians
say about it? Go online and see what you can find out.
© ABE 61
NEED TO KNOW
Current account deficit

When the value of the goods and services a country imports exceeds the value of
the goods and services it exports, this creates a deficit in the current account of
the balance of payments. REVISION
on the go
READING LIST

• http://www.bankofengland.co.uk
• http://www.mckinsey.com
• http://knowledge.wharton.upenn.edu
• https://www2.deloitte.com/global/en.html?icid=site_selector_global
• https://dupress.deloitte.com
• https://www.accenture.com/gb-en
• https://home.kpmg.com/uk/en/home.html
• http://www.economist.com REVISION
on the go
Summary
This final chapter has covered the key aspects of international finance and has provided you with
an understanding of the aims and roles of key international institutions in the financial aspects of
world trade. You should now have an insight into the impact of foreign currency exchange and
interest rates on international business, and can understand how the trading position of countries is
measured by balance of trade and balance of payments.
62 © ABE
Glossary
Glossary
Absolute advantage A trade theory which Economic integration The establishment of
holds that nations can increase their economic transnational rules and regulations that enhance
well-being by specialising in goods that they economic trade and cooperation among
can produce more efficiently than anyone else. countries.
Born global firms Business organisations Economic union A form of economic
that, from inception, seek to derive significant
integration characterised by free movement
competitive advantage from the use of
of goods, services, and factors of production
resources and the sale of outputs in multiple
among member countries, and full integration
countries.
of economic policies.
BRICS Five countries considered the world’s Embargo A quota set at zero, thus
main emerging economies: Brazil, Russia, India,
preventing the importation of those products
China and South Africa.
that are involved.
Common market A form of economic European Coal and Steel Community
integration characterised by the elimination
(ECSC) A community formed in 1952 by
of trade barriers among member nations, a
Belgium, France, Italy, Luxembourg, the
common external trade policy, and mobility of
Netherlands and West Germany for the purpose
factors of production among member countries.
of creating a common market that would
revitalise the efficiency and competitiveness of
Comparative advantage A trade theory
the coal and steel industries in those countries.
which holds that nations should produce those
goods for which they have the greatest relative
European Economic and Monetary Union
advantage.
(EMU) The agreement among, initially, 11 of
the European Union countries to eliminate their
Containerisation The use of standardised
currencies and create the euro. European Union
shipping containers that can be simply loaded
countries do not necessarily have to join the EMU.
onto a carrier and then unloaded at their
destination without any repackaging of the
European Free Trade Association
contents of the containers.
(EFTA) A free trade area currently
consisting of Iceland, Liechtenstein, Norway
Currency diversification An exchange risk
and Switzerland – past members included the
management technique through which the firm
UK (before it joined the EU).
places activities or assets and liabilities into
multiple currencies, thus reducing the impact of
European Union (EU) A treaty-based
exchange rate change for any one of them.
institutional framework that manages economic
and political co-operation among its 27 member
Customs union A form of economic
states: Austria, Belgium, Bulgaria, Cyprus, Czech
integration in which all tariffs between member
Republic, Denmark, Estonia, Finland, France,
countries are eliminated and a common
Germany, Greece, Hungary, Ireland, Italy, Latvia,
trade policy toward non-member countries is
Lithuania, Luxembourg, Malta, the Netherlands,
established.
Poland, Portugal, Romania, Slovakia, Slovenia,
Decision-making The process of choosing Spain, Sweden, and the United Kingdom.
from alternatives.
Exchange rates The value of one currency in
Distribution The course that goods take terms of another. For example, $US 2.00/€1.
between production and the final consumer.
Exchange risk The risk of financial loss
Dumping The selling of imported goods at or gain due to an unexpected change in a
a price below cost or below that in the home currency’s value.
country.
© ABE 63
Glossary
Exchange risk adaptation An exchange countries with relatively more capital than labour
risk management technique through which a will specialise in capital-intensive goods.
company adjusts its business activities to try to
balance foreign-currency assets and liabilities, Hedging A strategy to protect the firm against
and inflows and outflows. risk, in this case against exchange rate risk.
Exchange risk transfer An exchange risk Imports Goods and services produced in one
management technique through which the firm country and brought in by another country.
contracts with a third party to pass exchange
risk onto that party, via such instruments as
Import tariff A tax levied on goods shipped
into a country.
forward contracts, futures and options.
Exports Goods and services produced by a firm Industry clusters Geographic concentrations
of interconnected businesses, including
in one country and then sent to another country.
suppliers, specialist contractors and associated
Factor conditions Land, labour and capital. institutions.
Factor endowment theory A trade theory Innovation The renewal and enlargement
which holds that nations will produce and export of the range of products and services and the
products that use large amounts of production associated markets; the establishment of new
factors that they have in abundance and will methods of production, supply and distribution;
import products requiring a large amount of the introduction of changes in management,
production factors that they lack. work organisation, and the working conditions
and skills of the workforce.
Foreign direct investment (FDI) Equity
funds invested in other nations. International Monetary Fund (IMF) The
international organisation that includes most
Foreign exchange Foreign-currency- countries of the world and offers balance of
denominated financial instruments, ranging payments support to countries in crisis along
from cash-to-bank deposits to other financial with financial advising to Central Banks.
contracts payable or receivable in foreign
currency. International trade The exchange of goods
and services across international borders.
Free trade area An economic integration
arrangement in which barriers to trade (such as Licence A contractual arrangement in which
tariffs) among member countries are removed. one firm (the licensor) provides access to some
of its patents, trademarks or technology to
Globalisation The production and distribution another firm in exchange for a fee or royalty.
of products and services of a homogeneous type
and quality on a worldwide basis. Mercantilism A trade theory which holds that
a government can improve the economic well-
Gross domestic product (GDP) A being of the country by encouraging exports
monetary measure of the market value of all and stifling imports to accumulate wealth in the
final goods and services produced in a period form of precious metals.
(quarterly or yearly). Nominal GDP estimates
are commonly used to determine the economic MERCOSUR A sub-regional free trade group
performance of a country. formed to promote economic cooperation; the
group consists of Argentina, Brazil, Paraguay
Heckscher–Ohlin theory A trade theory and Uruguay.
that extends the concept of comparative
advantage by bringing into consideration the MINT countries Mexico, Indonesia, Nigeria
endowment and cost of factors of production, and Turkey.
and helps to explain why nations with relatively
large labour forces will concentrate on
MIST countries Mexico, Indonesia, South
Korea and Turkey.
producing labour-intensive goods, whereas
64 © ABE
Glossary
Multinational enterprises (MNEs) A Promotion The process of stimulating

company headquartered in one country but demand for a company’s goods and services.
having operations in other countries.
Quota A quantity limit on imported goods.
Non-tariff barriers Rules, regulations and
bureaucratic red tape that delay or preclude the SWOT analysis An analysis of strengths,
purchase of foreign goods. weaknesses, opportunities and threats.
North American Free Trade Agreement World Bank The world’s largest development
(NAFTA) A very large free trade area, covering bank, formed along with the IMF at Bretton
450 million people, formed by the USA, Canada Woods in 1944. Its original name was the
and Mexico. International Bank for Reconstruction and
Development (IBRD). The World Bank assists
Organisation for Economic Co-operation developing countries with loans and economic
and Development (OECD) A group of advising for economic development.
30 relatively wealthy member countries that
facilitates a forum for the discussion of economic, World Trade Organisation (WTO) An
social and governance issues across the world. international organisation that deals with the
rules of trade among member countries. One
PESTLE analysis A market analysis that of its most important functions is to act as a
covers political, economic, social, technological, dispute-settlement mechanism.
environment and legal factors.
Political union An economic union in which

there is full economic integration, unification of
economic policies and a single government.
© ABE 65

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Yo u r road to success

Your road to success

Copyright © ABE 2017

All facts are correct at time of publication.

Author: Dr Bruce Johnstone

Editorial and project management by Haremi Ltd.

The rights of Dr Bruce Johnstone to be identified as the author of this work

Chapter 1 Economic Principles 2

1.1 Why organisations engage in international trade 3

Chapter 2 International Markets 20

2.1 How markets are selected 21

Chapter 3 International Trading Blocs 40

3.1 Different types of economic co-operation and preferential trade arrangements  41

Chapter 4 International Finance 54

4.1 Key international financial institutions in world trade  55

Element of learning Key capabilities

Analysis, justification, presenting reasoned arguments,

Commercial awareness of cultural aspects and the direct

Analysis, commercial awareness, cultural awareness,

Global perspective, relationships, communication

Financial awareness, analysis

The study guide includes a number of features to enhance your studies:

Website addresses current as of August 2017.

1.1 Explain the reasons why organisations engage in international trade

1.3 Demonstrate an awareness of the impact of international issues such as globalisation on

1.1 Why organisations engage in international

CASE STUDY: COMPARATIVE ADVANTAGE

Name Abeke Barika

Occupation Lawyer Typist

Typing speed 100 wpm 50 wpm

Hourly rate $100/hour as a lawyer $20/hour as a typist

Value to Abeke of doing own

Value created by hiring Barika $100 − $40 = $60/hour $20/hour

The factor endowment theory

New trade theory

Porter’s five factors

What can governments do in the role of a catalyst and challenger to support

1.2 Arguments for and against free trade

Import tariffs or duty

Protecting emerging industries

Trade strategy reasons

Protecting essential industries

Losers and winners of free trade

Read these articles online:

1.3 The impacts of globalisation

Key drivers of globalisation

How does globalisation affect organisations trading internationally?

What drives globalisation?

2.4 Recommend appropriate marketing mix strategies for different contexts

2.1 How markets are selected

Less developed countries (LDCs)

Researching markets – sources of information

2.2 Assessing the main market entry methods

Agents and distributors

Foreign direct investment

2.3 Conducting a structured analysis of a market

Technological – for example, how good is information communication technology infrastructure

Figure 1: The PESTLE model used to review the macro factors in an

CASE STUDY: A PESTLE ANALYSIS OF SOMALIA

Porter’s Five Forces

Threat of new entrants Rivalry among existing competitors

Rivalry among Bargaining power

Bargaining power of suppliers Bargaining power of buyers

Chapter 1 Economic Principles 2

1.1 Why organisations engage in international trade 3

Chapter 2 International Markets 20

2.1 How markets are selected 21

Chapter 3 International Trading Blocs 40

3.1 Different types of economic co-operation and preferential trade arrangements 41

Chapter 4 International Finance 54

4.1 Key international financial institutions in world trade 55