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What is International Business? Any Commercial transaction between two or more countries is known as International Business. The parties of the transaction could be either companies or Governments. Necessity of International Business:
• • • •
Raw Materials required from abroad Processes acquired from abroad. Eg-WalMart Advanced technologies required from abroad Competition-There will always be competition. Even if the company does not enter into foreign territory, foreign companies will enter into the host country.
So baring some very local businesses, it is not possible to stay insulated from international business because of the above mentioned reasons. Features of International Business (Distinction b/w Domestic and IB):
• • • • • •
World is the Market Global scale of operation Ample number of opportunities World class products/services International level of productivity Efficient/Productive value chain
International Business by its very nature is a primary determinant of International Trade. One of the reasons of the increasing success of international business ventures is globalization. Competitions due to global Opportunities There are four level of competitions due to global opportunities 1. From host country suppliers- If a company from india wants to manufacture or export its products to US then the existing US suppliers will have advantage over the indian company in terms of zero custom tax, minimum transportation cost and a popular brand name. 2. From domestic players of home countries - In home country multiple companies with similar products having same pricing start competing. 3. Free trade agreements/ trade blocks - The advantages of Manufacturers belonging to a trade block is they don't have to pay any custom duty. The only cost incurred by them is the transportation cost. Eg-NAFTA.
4. International Players - apart from the company from home country, a number of other companies across the world would also like to sell their product in a particular host country. So there exists competition from international players. Why Companies engage in International Business? The following are the factors for companies engaging in International Business 1. To increase sales / Sales Expansion
Larger canvas + convention of Scale Economy Companies Leverage International Product Life Cycle— as stage in product PLC changes around the world the place of production changes. IPLC stages followed by a product are different in different countries. These differences provide different market opportunities in different countries. Lead Market--companies want to be leaders in some market and just want to present in some other lead markets. If a company wants to be global, then it has to know what is happening in the lead market for its product. For this the compny needs to have a presence in the lead market. Following the Customer -- Every company has some core customers. Companies follow their core customers where ever they go in the international arena.
2. To acquire resources
Better quality or competitive resources at lower cost Global sourcing-- not to depend on a few countries. Companies want to spread risks in acquiring resources. low cost , quality of resources , technology, hr
3. Reducing Risk -- companies try to reduce risk by spreading operations around the world. Simple geographic risk , Industry cycle ,Cross patrolling Modes of International Business There are basically two aspects of international business 1. Supplying to host country 2. Manufacturing in host country 1. Supplying to host country -- In this case the products are manufactured in home country and then exported to host country. It is feasible when the labor costs are low in
home country, transportation costs are not high and no tariff barriers to exports. The advantage of this method is scale economy and excess capacity utilization. 2. Manufacturing in host country -- The manufacturing in the host country can be done either by contract manufacturing or by licensing.
contract Manufacturing-- In contract manufacturing the company gives a contract to local manufacturers instead of setting up a factory. The advantage is the companies will have low level of involvement and in turn get a taste of the market first. The disadvantages being sharing of profits and the manufacturers might take over the market. Licensing-- In licensing the licensor permits the use of technology for a certain period of time to the licenseefor the manufacturing of licensed products and sale in the licensed territories. Here the licensor owns the technology. The licensee is permitted to use the technology. For this the licensee pays down payment as well as royalty to the licensor.
FDI BASED and non FDI BASED Non FDI----- exports, contract manufacturing/ licensing, management contract, R+D turkey projects, Contract R+ D : Critical part of R+D at home . no technology diffusion. Stand alone modules ==== r+d contract. Country should be compliant with IPR Turnkey projects : Client in host country. Entire responsibility from concept to commission is given to the expert company. Eg design, global procurement, testing ,stage upto product being switched ON. Global bidding. Client is normally in the host country. Public private partnerships come under this! FDI based --- local assembly, JV, wholly owned subsidiary, acquisition, merger. In order of risk
Foreign Country Entry Strategies 1. 2. 3. 4. 5. 6. 7. Exports Contract Manufacturing Licensing Assembly Joint Venture Wholly owned subsidiary Acquisition
1.Exports The company goes for exports because it has higher competitive advantage. The transportation costs are low. The tariff rates are also low. 2. Contract Manufacturing no marketing s done In contract manufacturing the parent/hiring company approaches a firm known as contract manufacturer with a design/formula. Once the contract is finalised then the contract manufacturer manufactures the components/products for the hiring company. Freedom frm managing the labour , tech/design diffusion wil occur but only for manufacturing part! 3. Licensing In licensing, first the licensor searches for a potential licensee. Then the licensor permits the use of technology for manufacturing a component/product to the licensee for a definite period at a certain location. Role = manufacture + market A contract manufacturer only produces products where as a licensee produces as well as sells for the licensor. The advantage in licensing being the licensor gets tie ups with best distributors, knows local market and has cost advantage.Can cover many countries in the world at faster speed and lesser investment. The disadvantage is diffusion of technology & loosing the market to liscensee. Also at the expiry of the licensing agreement the licensee will become the competitor to the licensor. So the market presence increases with licensing. Franchising (services) trademark being used
4.Assembly In case of assembly, different parts of the product are manufactured in different countries. The assembly of the parts takes place in the host country. Over a period of time the product becomes local to the host country. Local labour Becoz in other country when u start business customization becomes expensive 5.Joint Venture In a Joint Venture, both the parties contribute a certain amount of equity and form a new company. Main::::Risk cost sharing with local partner
Wholly Owned Subsidiary A wholly owned subsidiary is a subsidiary whose parent company owns 100 percent of its common stock and there are no minority owners. 6. Risk involved as no local partner and political risk is high Advantages • • • • • • Freedom in designing the plant No dilution of brand image No dilution of profits Total control over operations No dilution of system processes Processes are standardised . distributors and established channel partners Cultural bridge Unable to get 100% FDI since government restrictions Joint ventures are a necessity by government Profit sharing/market sharing Why Joint Ventures Fail • • • • • • Change in external environment Conflict of vision/interest Both parties not contributing equally sharing of market. JV might be due to govt. 100% control . guard technology MIXED VENTURE : when one partner is government Reasons for forming Joint Venture: • • • • • • • • To enter into a foreign country Sharing risks as well as costs Good brand name and relations Suppliers. labor management . host country relation / relation with banks. no local partners. reduces risk as sharing risk in unknown market Disadvantage : cultural differences due to environmental changes . which is not entirely present with either party. regulations so might be a compulsion. there by Market contraction Global competitiveness requires control.Advantage : local market familiarity .
u choose only the time of it Expropriation vs. then it is known as expropriation where as if the government takes over any localised company. Acquisition Acquisition may be defined as a corporate action in which a company buys most. then it is known as Nationalisation. of the target company’s ownership stakes in order to assume the control of the target firm. No risk sharing Less knowledge of the market Degree of competition increases 7.Disadvantages • • • Total risk ownership. Advantages • • • • Acquiring the entire target company Saves time/ quicker to market Quick to the market-due to well established distribution and sales channel The competition in the market remains unchanged Suppliers inherit Disadvantages • • • Obsolete technology Resources might not be best in class Processes and practices might not be world class In JV ---choose ur location Merger---. Nationalisation If the government of any country takes over any foreign company. Wholly owned subsidiaries are exposed to expropriation where as joint venture agreements protect firms from expropriation. if not all. .
MNEs include MNCs but not viceversa. Types of MNEs • • • Global Multi-domestic Transnational Global Company • • • • • • • Integrates its operations around the world Produces for the world market Utilises best resrouces Operates on scale economies It has a global brand The dark side is. Multinational company (MNC) A MNC is a company which has its own presence in at least two countries. economical and currency risks Uncontrollability-The degree of Uncontrollability is higher in host countries Competitions Competence-people in different countries are at different levels of competence. .no customization of global brands so might lose some segment of the market Eg-Mc Donalds. an MNE is a company that owns (a significant part of) and operates facilities in nations other than the one in which it is based. Multinational Enterprises (MNE) Multinational Enterprise is a firm that has engaged in foreign direct investment (FDI). MNEs are partnerships. intel Multi Domestic Company • • • • Operates in different countries Customises its product for different countries Better customer loyalty Larger scales and better margins/profitability. Domestic Business The following factors distinguish International business from domestic business • • • • • • • • • • • World market Political environment Legal system Cultural difference Communication Distance are higher Diversity Uncertainty-Political. Equivalently.International Business vs.
better margins Eg-Unilever. values and beliefs of a group of people. lower the cost of customization Eg-Caterpillar. GE Chapter 2 Culture Culture refers to the shared behaviour patterns based on attitudes. . client loyalty.• • • • Takes into account cultural differences. temperature variations Products are customized to the extent necessary Advantages are. P&G Transnational Company • • • • • • World is the market Learns the best practices from anywhere in the worldwide operations Leverages learning Integrates operations worldwide to reduce cost.greater market share. long term market share.
the more it is adaptable to change. Language Language is a factor that greatly affects cultural stability. Religion Religion is a major aspect of consumer behaviour. Religion has also influence on practices. There are many aspects from business point of view • • • • • Design : how you make your product Color : Packaging Music : Advertising Product Policy Consumer preferences. For advertising the language has a greater impact e. 3. the kind and type of products/services the country is offering. 6. When people from different areas speak the same language. 4. culture spreads more easily. products/services has to be in sync with religion. The governance of a country becomes simple with education. 8. Within religion there are many many factions whose specific beliefs may affect business. 5. The more the education level of a country. Business can be done more easily with other nations that share the same language. . Mandarin. 4. Education is being given the paramount importance. The largest religion is christianity.Elements /Determinants of Culture The following are the determinants of culture 1. 3.g. 2. 7. Education broadens the perspectives. 2. Education Religion Language Aesthetics Attitudes and Beliefs Technology and material culture Social Unit (family/tribe) Opinion Leaders 1.Education The education level of a country is one of the determinants of its culture. From business point of view it shapes the kind of market we are operating. From business perspective. they sometimes regulate their languages. Because countries see language is an integral part of their cultures.In india. It is a strong shaper of values. Aesthetics Sensory perceptions play a major role.
7. Beliefs are related to education also. caste. for employee engagement we need to know the family values and the priority of work-life balance. Beliefs are derived from values and history. A person's importance/ranking depends upon both kinds of affiliations. Relationship Preferences There are basically three aspects . political and professional associations. Ascribed group affiliations include gender. There is tremendous respect for elders in certain countries. From company perspective understanding belief is very important. Eg. 1. not in family but in work place also. in certain countries ladies are not allowed to choose their profession. family. By discovering the local channels of influence an international company may locate opinion leaders. However barriers to employment based on gender are easing substantially in many parts of the world. Opinion Leaders Opinion Leaders help in speeding up the acceptance of change. However countries differ in their degree of materialism. Attitudes and Beliefs Changing behaviour is easier but changing attitude is difficult. Social Unit In Some societies the family is the most important group membership. 3. Acquired group affiliations include religion. age. Technology and Material Culture It determines how much the culture has adopted technology.• Brand Name Customization 5. In workplaces males are generally preferred. small family run companies are quite successful. but age does not matter in some other countries. Opinion leaders may emerge in unexpected places. 2. 6. Characteristics of opinion leaders vary from country to country. Role of Ladies in Society and Respect for elders There are strong country specific differences in attitudes toward males and females. From company perspective predispositions i. Ascribed Vs Acquired group affiliations Affiliations determined by birth are known as ascribed group affiliations where as affiliations not determined by birth are known as acquired group affiliations. They go by meritocracy. Attitudes are inherent in us. ethnic.e. But these companies have difficulty in growing because of their reluctance to share responsibility with professional managers. risk taking ability. creativity demands compliance are important. In societies in which there is low trust outside the family. racial and national origin. 8. Robotics is being used in US for certain kind of jobs.
Authoritative Vs Particiapative In authoritative societies people prefer being instructed. The attributes of Collectivism are dependence on the organization. The needs from lowest to highest level being physiological. esteem and self actualization. Where power distance is high. Low context Vs High context . people prefer little consulation between superiors and subordinates. Individualism Vs Collectivism some societies are individualistic ( american society) where the effort is sinlge handed and group effort is to the extent necessary. some cultures tend to focus first on the whole and then on the parts where as others do the opposite. freedom and challenge. affiliation. where as in collective societies (japanese society) people prefer to work in teams but take a longer time to come up with a consensus. 7. where as in Participative societies people work in consent with each other. subordinates and peers varies substantially internationally. perople prefer and usually have consultative styles. Attributes of Invidualism are low dependence on the organization and a desire for personal time. security. In certain countries people like to take decisions where as it is exactly opposite in some other countries. 6. They like authoritative decision. Maslow's hierarchy of needs varies across countries According to this theory there are five levels of needs. So this theory is helpful for differentiating the reward preferences of employees in different countries. 5. good physical conditions and benefits. Cultures such as those in northern europe are called monochronic where as cultures in southern europe are polychronic. People try to fulfill lower level needs sufficiently before moving on to higher ones. Monochronic Vs Polychronic In monochronic culture people are used to perform tasks sequentially where as in polychronic culture people are comfortable in doing the tasks simultaneously. desire for training. But different countries have different levels of needs. Employee preferences in how to interact with their bosses. Similarly where power distance is low.• • • • Power distance Individualism Vs Collectivism Authoritative Vs Participative Centralization and decentralization Power Distance Power distance is a term describing the relationship between superiors and subordinates.
High fatalistic people are less swayed by bosses’ pursuasive logic. Future Orientation Countries differ in the extent to which individuals live for present rather than for future. Trust The level of trust among people varies across countries. Fatalism In countries with high degree of fatalism. people plan less for contingencies. Risk taking behaviours. Risk taking behaviours are basically categorized into four categories • • • • Uncertainty avoidance Trust Future Orientation Fatalism Uncertainty Avoidance In countries with high uncertainty avoidance. companies motivate workers through delayed compensation like retirement programs where as it is exactly opposite in low future orientation countries. 8. They like to try new products/services. When managers from both types of cultures deal with each other. People are reluctant to take insurance schemes. low context individuals believe that the high context individuals are inefficient and waste much time where as high context individuals believe that low context individuals are too aggressive to be trusted. In these countries people prioritize job security and spend a longer time in a particular company. In countries with high trust level the cost of doing business is low because costs incurred in supervision and contingency can be lowered. They believe unfortunate events are acts of god. employees prefer set rules that are not to be broken even if it is for company's best interest. Idealism Vs Pragmatism . where as companies have to be more cautious in doing business in low trust level countries. Where as in high context cultures people consider peripheral information to be valuable in decision making and infer meaning from things said indirectly. In countries with high future orientation.In low context cultures people consider firsthand information that helps directly in decision making are only relevant. Where as in countries with low uncertainty avoidance people are adaptable to change easily. 9.
Some people also encounter culture shock while returning to home country because they have learned a different culture abroad. Timing--Many good business decisions fall flat because they are ill timed. This is known as reverse culture shock. the more difficult it becomes to accept. The principal reason being business. so in this scenario the profits generated due to the proposed change has to be shared among the people who must support it. so accordingly the attitudes or orientations can be broadly classified into three categories • • • Polycentrism Ethnocentrism Geocentrism . 11. Culture Shock Vs Reverse Culture Shock Culture shock is the frustration that results when a person moves to another country and has to learn and cope with a vast array of cultural cues and expectations. 13. However the local citizens treat local people and foreigners differently. By this method the company may learn how strong the resistance will be if changes are made. Cost of change--Some changes to foreign culture increases the productivity and sales greatly where as some other changes to foreign culture increases the productivity marginally. So we have to consider the cost in changes to some foreign culture and the benefits associated with the change.Idealism cultures first determine principle before resolving small issues where as pragmatism cultures focus more on details of the issue rather on principles for resolution. Participation in change decision--To avoid problems arising from a proposed change. By discovering the local channels of influence. so the changes in products/services have to be made in a phased manner. Accomodation of foreigners Every country does accomodate foreigners. a company might locate an opinion leader. 10. 12. Implementation of cultural change The various aspects of implementation of cultural change are as follows • • • • • • • Value Systems--The more something counters our value system. all the stakeholders are made to participate in change decison. In many countries foreign women are easily accepted as managers as compared to local women. Opinion leaders--Sometimes opinion leaders greatly help to speed up the acceptance of change. Too much change too soon--People are generally reluctant to accept too much changes too soon. So changes should be implemented at the right time so that it can be easily accepted. Reward sharing--sometimes a proposed change may have no foreseeable benefit to the people who must support it. Company Mindsets The adaptation of a foreign culture by a company not only depends upon the conditions of the foreign culture but also depends upon the attitudes of managers of the company. FDI and inturn the country will emerge in the world map.
Ethnocentrism In ethnocentrism the company believes. Excessive polycentrism may lead to such extensive imitation of proven host-country practices that the company loses its innovative superiority. Political risk is the chance that political . Geocentrism exists when a company bases its operations on an informed knowledge of its organization culture along with home and host country needs. Geocentrism Geocentrism is a judicial process. The organization believes that business units in different countries should act very much like local companies. It gives better foothold in the market but the downside is the company has to give up its core business practices. Notes Contributed By Rashi Political Risk it is the risk that political decisions or events in a country negatively affect the profitability or sustainability of an investment.Polycentrism A polycentric organization customizes business practices/processes for different countries. In ethnocentrism managers overlook important cultural factors abroad because they have become accustomed to certain cause and effect relationships in the home country. capabilities and constraints. It might be business practices or retention of employees. Since cultures and people are different. Here the management recognizes the environmental differences but still focuses on achieving home country objectivees. what worked well in the home country will work well in the host country. Chapter 3 Chapter 3 : Political Risk. Here a model is being created taking into consideration the host country needs and own company practices. so ethnocentrism does not necessarily work.
To prohibit monopolistic and restrictive trade. 2. It affects company’s operations and profits. People unrest can also happen because people are unhappy with the present govt. they consider political risk to be very important. When companies choose among the 200 countries. Harmful actions against people. To provide for the control of monopolies. • • • Political risk matters most to any MNE in the world. Actions. Civil Strife/Unrest/Disorder • • • It Could be due to economic unrest. Govt Actions Govt.decisions. FERA Act (Foreign Exchange Regulation Act)-1973 An act to consolidate and amend the law regulating certain payments. Civil Strife/Unrest/Disorder. Govt. the better the business opportunity and in turn higher the country attractiveness. events or conditions in a country will affect the business environment in ways that may adversely affect the business of MNEs. Change in political ideology 1. dealings in foreign exchange and securities. The lower the political risk. 3. 4. Causes of Political Risk 1. Govt puts many acts to impose restrictions on the sectors like FERA and MRTP Act. Governments can put restrictions to the sectors in which business can be done. MRTP (Monopolistic and Restrictive Trade Practices Act)-1969 MRTP was enacted • • • To ensure that the operation of the economic system does not result in the concentration of economic power in hands of few. 2. . for the conservation of the foreign exchange resources of the country and the proper utilisation theory in the interests of the economic development of the country. action can change the country's attractiveness. International War. 5. transactions indirectly affecting foreign exchange and the import and export of currency.
Compensation to the company. Chile. 2. Zambia. 6. In case of Monarchy. Venezuela. Many Indian companies were also operating. However in any event the losses are immense. It generally happens in developing countries for natural resources like oil. It is generally a hostile takeover. Uganda. Change in Political Ideology • • • Political ideology can change with the change in political government. Discriminatory taxation policies. Harmful actions against people • • Injurious actions that target the local staff of the company. Eg. Unilateral breach of contract. 1. Every government has a different perception about the MNEs. Expropriation or Nationalization. diamond when the host country feels that there is no value addition. 5. MNEs are bound to leave the country during war. Differing points of view. 5. Disruption of property. extortion and terrorism. like saudi arabia. 4. Generally seen in lesser developed countries. This event was common in the 1960s and 1970. International War • • • Damages or destroys the company’s local assets.when a new prince comes in .• • It can lead to damage of company’s property. 3. Uthopia. Eg: French Revolution 3. Iran 2. Disruption of property . a mandate and not a choice which is given to the company. if at all forthcoming is generally a trivial percent of the asset’s value. there were many MNEs by virtue of management contracts. When Iraq invaded Kuwait. chances are there will be changes in political environement. Restrictions on repatriation of profit. Impact of Political Risk 1. Sometimes the company’s assets are taken over by the host country with or without adequate compensation. Expropriation or Nationalization • • • A govt or political faction unilaterally takes ownership of the company’s local assets. Cuba. 4. Eg. but is rare today. often involves kidnapping.
Differing points of view Differing interpretation of labour rights and environmental obligations create backlash problems in the foreign company’s home market.• • Kidnapping. 4. 2. Taking expert opinion. Strikes happen resulting loss of profit (opportunity loss) in addition to property getting damaged. or in some cases. 6. 3. due to its nationality. thefts occur. The revision penalizes the firm and rewards the nation by reallocating the profits of the local operations. In addition this extends to government approval of a local company’s choice to breach its contracts with its foreign partner. Discriminatory taxation policies A foreign company bears a higher tax burden than the local firm. 3. Examples : . 5. the more favoured foreign company. Restrictions on repatriation of profit The govt arbitrarily set limits on the gross amount of profits a foreign company can remit from its local operation. Analyzing past trends. Examining the social and economic conditions that might lead to such political risk 1. Unilateral breach of contract • • • Decision of a government to repudiate the original contract that it had negotiated with the foreign company. Analyzing past trends Companies cannot help but get influenced by past patterns of political risk. In some countries the new govt might not honour the previous management contracts / leases. Predicting risk using past trends holds many dangers. How to access political risk Managers use 3 approaches to predict political risk : 1. Management can make predictions based on past patterns. However political situations may change rapidly for better or worse as far as foreign companies are concerned.
TV. which often reflect changing political conditions that may affect the business sector. Systematic.e. In this method companies should examine views of govt decision makers and then get a cross-section of opinions and use expert analysts. Managers visit the country and listen to a cross section of opinions.. In Pakistan. Expropriation of property occurred frequently in the 1970s and early 1980s. 3. Higher the frustration level. Journalists. aspiration level and achievement level. such as those published by Business International. middle level local govt authorities and labor leaders usually reveal their own attitudes. Expert Opinions Companies may rely on experts’ opinion about a country’s political situation. but it has been less important in recent years. If there is a great deal of frustration in a country. 2. Economist Intelligence Unit. Companies may examine country’s social and economic conditions that could lead to the peoples’ level of aspirations and the country’s level of welfare and expectations. These analysts might rate a country on specific political conditions that could lead to problems for foreign businesses. Differences in aspiration level and achievement level leads to frustration. Companies read the statements made by political leaders both in and out of office to determine their philosophies on business in general. Types of Political Risk There are four types of political risk 1. Companies may determine opinions more systematically by relying on analysts with experience in a country. .• • • FDI into US fell sharply after 2001 terrorist attack in NY because foreign firms saw the US as less safe than before. groups may disrupt business by calling general strikes and destroying property and supply lines. A company also may rely on commercial risk assessment services. foreign input to business. Internet where as the achievement level increases with income level. with the purpose of ascertaining how influential people may sway future political events affecting business. initially democracy ruled and then dictatorship where as in India it has always been democratic in spite of change in governments. Economic and Social Perspective (Semantec Technique) There are two economic parameters i. Euro money. higher the political risk in terms of unrest. Aspiration level of people spreads with education. Embassy officials and foreign and local business people are useful sources of opinions about the probability and direction of change. academicians. then the frustration level increases. the means of affecting economic changes and their feelings toward given foreign countries. If disparity between the two is very high year after year.
Shortest time. MNE is doing a business in host country and thus generating employment. labour disputes and a partisan judicial system can significantly raise the cost of getting things done. 3. Quality and reliability. Each move creates a procedural transaction between units. Then again. Catastrophic 1. Countries then aim to claim a greater . As foreign investors achieve greater success. some countries question the distributive justice of the rewards. Every day people. Thus taxation changes can come in. Systematic Political Risk These kinds of risks are inherent in system. Some countries are more corrupt and the company faces many hurdles. Eg. Distributive 4. The three main objectives of supply chain are • • • Lowest cost. if it wants to clear goods through customs. As we get raw materials from across the world. Normally supply chain is never short term until there is a war situation. a government may target its public policy initiatives toward a specific economic sector that it believes foreign companies unduly dominate. so the company faces different levels of risk. In 1990. Procedural 3. whether within a company or country. it has to cross borders. Globally competent supply chain is required from most competitive/best sources. Many countries see foreign investors as agents of prosperity. Political actions sometimes create frictions that interfere with these transactions. Systemic changes do not necessarily create political risks that reduce potential profits. Corruption among custom officials can push a foreign firm to agree to pay for special assistance. products and funds move to different locations in the global market. These regulations alter the business system for all companies. wondering whether they are getting their fair share. newly elected Argentina govt. Procedural political risk Companies procure from best sources from different countries to have comparative advantage. Distributive Political Risk MNE and host country cannot do without each other. 2. Government corruption.2. so not necessarily meant for only foreign companies. But if the host country feels that the MNE is capable of doing much more than at present and mostly much of it is going currently to other countries then host country wants to have a larger share from the MNEs economic gain for its own people and their economic growth. Domestic and International companies face political risks created by shifts in public policy or change in political ideology. began a radical program of deregulation and privatization of the state centred economy. The risks are higher in less developed countries.
While uncommon. US has highest degree of political risk in world of cigarette companies on matters of taxation. Interest Aggregation: Putting it all together in the form of budget. Chapter 4 Chapter-4-Economic Environment of a Country The following are some of the key macro economic parameters. . Eg. Prior to budget government talks in a structured form to various groups. their impact disrupts the business environment for all firms. regulatory structure and monetary policy to capture greater benefits from foreign companies. Ultimate test of a political system is its ability to unite a society in the face of divisive pressures of competing ideas and outlooks. is more transparent and predictable about its policies. Role of Government • • • • • • • Interest Articulation: Understand the interests of all stakeholders. They do so by revising their tax codes.share of rewards but in ways that do not provoke the company to leave. The purpose of a political system must agree. the relationships between those institutions and the political norms and rules that govern their functions. Catastrophic Political Risk These types of risks arise from flash points like ethnic discord. regulation. A political system is the complete set of institutions. should look for the proper functioning of foreign companies. is that it integrates different groups into a functioning. self sustaining and self governing society. political organizations. A company which has more membership internationally. interest groups. Implementation+Adjudication : Should look forward for the economic cooperation of other countries. Those random political developments adversely affect the operations of all companies in a country. Should look for groups which the country joins. business practice and liability. local companies and small scale industries. 4. A country’s political environment has enormous implications to managers and companies. civil disorder or war. Policy Making : Legislature.
Interest Rate 10. GDP/GNI 2. Also the growth rate of the sector from where the resources are obtained is to be considered. Debt 1. ForEx Reserves 8. Population and Demographics 4. 2. then developed countries have a stable growth rate but not growing rapidly where as the developing countries are growing at a rapid rate although their economic base is smaller. GDP Per Capita : Managers divide the GDP to the number of people who live in a country. FDI 6. This ratio leads to a per capita estimator that measures the relative performance of a country’s economy. Income Distribution and Poverty 15. the sectoral break up and growth rate also needs to be known for a country. In addition to the GDP. So compared to absolute growth rate. manufacturing and services. For country’s attractiveness GDP is a more important factor. sectoral break up is more important. It determines which kinds of products will be bought by the people of that country. PPP 3.1. Exports/Imports (Trade Gap) 5. It is a good indicator for consumer goods where as for industrial goods sectoral break up is a good indicator. Unemployment 14. The three major sectors of India are Agriculture. From an organization point of view. no matter whether domestic or foreign owned companies make the product. FPI 7. Purchasing Power Parity (PPP) . If we take the growth rate. the growth rate of the relevant market’s sector needs to be considered. Services sector is the major sector. Balance of Payment (BOP) 12. GDP GDP is the total value of all goods and services produced within a nation’s borders over one year. It signifies the average income level of the country. Inflation 9. Human Development Index (HDI) 13. Exchange Rate 11.
and consumer groups based on age. literacy. level of education. Exports/Imports (Trade Gap) The companies opt for exports when the cost of labor in home country is low. 4. gender. Gender : Certain professions are restricted to gents only. Trade gap: The difference between the exports and imports of a country is known as trade gap. FDI . When a country is in disadvantage regarding some specific goods and services. There are several parameters like age. (Eg: Saudi Arabia) Education: The reach of advertisements will be determined by the literacy and education level of the country. A country can export goods when it has comparative advantage as compared to the host country. transportation costs and tariff barriers are also low. 3. The most common PPP exchange rate comes from comparing a basket of goods and services in a country with an equivalent basket in the United States. it opts for imports. If exports is greater than imports then the country is said to have trade surplus where as if the imports are greater than exports then the country is said to have trade deficit. Age : Population of the working class workforce.The Purchasing power parity is the number of units of a country’s currency required to buy the same amounts of goods and services in the domestic market that one unit of income would buy in the other country. Urban/Rural Population: the nature of market is different whether it is urban populated or rural populated. Population and Demographics India and China are countries with 1 billion plus population where as the average population of a country is 10 million. 5. It is useful to compare the purchasing power of different countries. urban/rural distribution.
the country has certain strengths of world class level (technology. It can also be a part of the overall supply chain. when there is market opportunity or staying closer to the customer as required by the customer. how the country is being perceived by other countries and MNEs. FPI Foreign portfolio investments are meant for only short term purpose. Countries go for outward FDI. 7. 6. ForEx reserves are required for payment of interests. 8. Inflation . FDI helps the home country to a great extent in terms of controlling other markets. debts for imports. It might not be only for manufacturing. The Inward FDI tells about the competitive sectors of the country. Inward FDI : FDI. Outward FDI : FDI what goes out of home country is known as outward FDI. what comes to home country is known as inward FDI. It indicates the economic development of the host country.companies adopt FDI route in order to get a controlling stake in a host country for a long term purpose. For outward FDI. ForEx Reserves It indicates the economic health and sustainability of the country. Outward FDI indicates that. Here the main motive is to get a good return at a moderate risk with high liquidity. Inward FDI indicates. skills) in certain sectors for which they are venturing outside. the country should have economic strength as well as domain knowledge and capabilities. The forEx reserve of a country should be high. Countries can’t get any controlling stake by investing through FPI. The inward FDI for India is 15 Billion dollars.
Inflation is the pervasive and sustained rise in the aggregate level of prices measured by an index of the cost of various goods and services. The stability in these rates helps in predicting the uncertainty in the business. Inflation results when aggregate demand grows faster than aggregate supply. Both interest rates and inflation move in the same direction. It is a measure of the government’s success in the economy. When inflation goes up. The daily transactions in foreign exchange market is about $3. It is a large measure of MNE’s confidence. interest rate and exchange rate are the factors which attract other companies to invest in the country. The foreign exchange market is one of the largest markets of the world. the interest rates also go up to adjust the return for the lender. export competitiveness go down and exchange rates also go down. Exchange Rate Exchange rates between two currencies specifies how much one currency is worth as compared to other. Balance of Payment (BOP) . For a country. 10. 11. Inflation also puts great pressure on governments to control it. Ideally interest rates should be low and stable. From MNE’s perspective it determines the pricing and long term strategy. having stability in inflation. When inflation is high. 9.2 trillion dollars. Often governments try to reduce inflation by raising interest rates and imposing protectionist trade policies and currency controls. Countries try to have interest rates which is close to LIBOR (London Inter Bank Offer Rate). Interest Rate Interest rate is the indicator of cost of raising capital. A moderate rate of inflation brings stability which is attractive to the MNEs.
From 0. The components of Current account are a.8 to 1 have high HDI. Investments. BOP is an important measure for long term stability of a country. secondary and tertiary gross enrolment ratio. Longevity : as measured by life expectancy at birth Knowledge : as measured by the adult literacy rate and the combined primary. dividends. Countries scoring less than 0. BOP has two main accounts namely current account and capital account.5 are having low HDI. governments or individuals. It indicates a country’s long term potential. Capital Account : It tracks both loans given to foreigners and loans received by citizens. repayments. Receipts and payments for services and intangible goods c. Value of exports and imports of physical goods. Current accounts indicate trade balance. loans. The BOP should be moderate. . HDI is scaled in between 0 and 1.It records a country’s international transactions that take place between companies. The components of capital account are a. 12. Gender : a gender related development index that adjusts for gender inequalities. Human Development Index (HDI) HDI measures the average achievements in a country on three dimensions. unilateral transfers where as Capital accounts indicate FII. Official transfers. Long term capital flows. real estate. HDI aims to capture long-term progress in human development rather than short term changes.HDI measures both economic and social parameters to estimate its current and future economic activity. Private transfers such as money sent home by expatriate workers d. United Nations refined the HDI by adding two more dimensions i. Short term capital flows. Standard of living : as measured by GNI per capita expressed in PPP for US dollars. interests for investments. b. b.5 to 0. Current Account: It tracks all trade activity in merchandise.8 are having moderate and from 0. Poverty : a measure of poverty to adjust for human deprivations and the denial of choices and opportunities.e. In doing so the BOP reports the total of all the money that comes into a country from abroad less all the money going out of the country to any other country during the same period. BOP is also officially known as the statement of International transactions.
If income distribution is unequal. Internal Debt : Internal debt results when the government spends more than it collects in revenues. External Debt: External debt results when a government borrows money from foreign . The higher the misery. foreign organization. The proportion of unemployed workers in a country shows how well a nation’s human resources are used and serves as a measure of economic activity. Debt It is the sum total of government’s financial obligations. Unemployment If the country has high level of unemployment. The larger the total debt. The skewness of the income distribution is very high in India as well as Asian countries. the lower are the chances that foreign companies will invest in the country. 15. In countries with high poverty levels customary market systems may not exist. Misery Index is the sum of country’s inflation and unemployment rates. Therefore managers look for the economic potential of a country by adjusting their analyses to reflect the actual distribution of income.Managers access the situation of a country by checking the misery Index. then it triggers political risk. So only a part of the population will be relevant. 14. state owned enterprises run deficits. So companies have to deal with all such situations. then it will lead to poverty. Poverty impacts the economic environment and analyses to a huge extent. In India 80 percent of the population earn less than $2 a day and 40 percent of the population earn $1 a day. Income distribution and Poverty The top 20% of the world population account for the 86% of the income where as the bottom 20% account for only 1%.13. national infrastructure may not work. It measure the state’s borrowing from its population. Internal deficit occurs due to imperfect taxing system. criminal behaviours may be pervasive. the more unstable the country’s economy becomes. International companies facing such situations must deal with their implications to virtually every feature of the economic environment. foreign governments and international institutions.A country’s debt has two parts : Internal and External debt.
Foreign investors monitor debt levels to gauge debt pressures on the government to revise its economic policies. Here the government decides the type. banks. price. stores and are managed by the employees of the state. On one end there is capitalism and on the other hand there is communism. Canada. quantity. the government owns the means of production i. However for some public goods like traffic systems or national defence. Great Britain. production and distribution of goods. make the majority of economic decisions. Here the government owns and controls all resources. In market economy individuals. Types of Economic Systems An economic system is the set of structures and processes that guides the allocation of resources and shapes the conduct of business activities. This principle is credited to Adam Smith and his proposition that a market economy has two general features • • Producers efficiently make products that consumers want in a profit making motive. Here the price of the goods and .e. A market is very less dependent upon government rules and restrictions. factories. So basically there are three types of economic systems.lenders. rather than government. Command Economy Also known as centrally planned economy. Capitalism is a free market system built on private ownership and control. Communism is a centrally planned system built on state ownership of all economic factors of production and control of economic activity. The theoretical principles that define free-market economies are based on the principle of laissez-faire (non-intervention by government in economic matters). • • • Market Economy Command Economy Mixed Economy Market Economy It is basically a capitalist economy. United States are major market economies. government intervenes to enforce contracts. Eg: Hong Kong. It is the exact opposite of market economy. quantity. where by consumers influence the allocation of resources through their demand of products is the essence of market economy. land. So the consumer sovereignty. supply and demand so that capital and labor are allocated productively. Consumers determine the relationships among price. farms. In a centrally planned economy. property rights to ensure fair and free competition and to regulate certain economic activities and provide general security.
services usually remains constant however the quality deteriorates over a time period because • • • Whatever product is made is usually in short supply. regional. In a mixed economy the public sector. Command economies are traditionally found in communist countries. cultural and institutional traditions and trends. steady economic growth and an equitable distribution of wealth. Many Countries are transiting from command economies to market economies. Consumers typically have few to no other choices. thereby creating business opportunities. local governments may actually own some means of production. Mixed Economy Most of the economies are neither purely market nor command economies. The government can influence private production or consumption decisions. The proponents of mixed economies concede that an economic system should aspire to achieve the efficiencies endemic to free markets. There is not much incentive for companies to innovate and little profits to invest. Currently very fewer countries are practicing command economies like North Korea and Cuba. But an economic system must also protect the society from the excesses of individualism and greed and ideally apply policies needed to achieve low employment. Operationally government intervention in the economy takes various forms. Here the government owns key factors of production. low poverty. yet consumers and private producers still influence price and quantity. often achieved marginal rates of efficiency while making acceptable products. private sector and private sector co-exist simultaneously. However centrally planned economies sometimes allowed free market forces to play in the informal gray markets where scarce consumer goods are exchanged at market determined rates. However the products produced are not competitive with global standards. Most of them fall in the midway of the capitalism-communism spectrum. The extent and nature of government intervention varies from country to country and changes over time based on a country’s political. . • • • Central. The government can redistribute income and wealth in pursuit of some equity objective. Command economies can perform well in terms of growth rates for short periods of time by mobilizing unemployed or underemployed resources to generate growth. A mixed economy is a system where economic decisions are largely market driven and ownership is largely private. In communist countries. the state economic planners give highest priority to industrial investments and military spending where as consumer goods and food products are given little or no priority. social. but the government intervenes in many private economic decisions.
The disadvantage in deregulation is. improvisation of business practices and creation of innovations. Privatization reduces govt debt by eliminating the need to subsidize typically inefficient. money loosing state owned enterprises. knowledge growth. and indirect taxes). deregulating the economy. Privatization leads to up gradation of technologies. therefore it is apparent that government ownership and control of the factors of production constrained growth and prosperity due to operational inefficiency and strategic ineffectiveness. Property Rights Protection of property rights means that entrepreneurs who come up with an innovation can legally claim the present and future rewards of their idea. It largely depends on how well the country’s government can dismantle its central planning system and consumer sovereignty in its economic environment. Deregulation Deregulation involves relaxing or removing restrictions on the free operation of markets and business practices. exports. reforming fiscal and monetary policies and applying antitrust regulation. The protection also supports a competitive economic environment by assuring investors and entrepreneurs that they will prosper from their hard work. effort and risk. It will lead to a certain level of unemployment. Fiscal and Monetary Reform . Therefore the resulting freedom and savings encourage managers to make the investments into the innovations that then lead to economic growth. The country. The process of transition to a market economy varies from country to country. It increases the productivity due to less regulation compliance. Also due to globalization. there is free flow of products. the control remains elsewhere instead of the host country.Transition to a market economy Since the market economies outperformed command and mixed economies. Market economies create powerful individual incentives that stimulate innovation. The success of transition appears to be intricately linked to how well the government deals with privatizing the means of production. The govt gains taxes in the form of (income taxes. infrastructure development. protecting property rights. Privatization improves general market efficiency and shapes the relationship between supply and demand. The result will be employee generation. sectoral growth. makes it more attractive for MNEs. company taxes. by deregulating. people and ideas among nations. whereas mixed and command economies seemed to create weak or no incentives. Together these developments aggravate a fundamental limitation of mixed and command economies. Privatization It is the process of transfer of ownership and control of factors of production from government to private owners.
and use market based policies to manage the supply. set strict budget limits. companies and capital needed to start and finance growth. prices are kept low by the forces of competition. The government’s intent on liberalizing its economic system must legislate antitrust laws that encourage the development of industries with as many competing businesses as the market will sustain. governments can prevent monopolies from exploiting consumers and restraining market growth. Chapter 6-International Trade and Factor Mobility Theory . In such industries. Antitrust Laws By enforcing antitrust laws.Adopting free market principles requires a government to rely on market-oriented instruments for macroeconomic stabilization. Using the market to enforce fiscal and monetary discipline leads to stable economic environments that attract the investors.
the second reason being sourcing i. specifying trade blocks etc. Trade theories tell countries about what products should be exported and imported or what should be the total foreign trade as a percentage of the GDP.e. Trade theories tell how or whether governments should intervene directly to affect their countries’ trade with other countries.Once countries make decisions about what. The decisions taken by countries in this matter greatly affect their business because they affect which countries can produce given products more efficiently and whether countries will permit imports to compete against their own domestically produced goods and services. where to import from .Utility of International Trade Theories for countries and companies Trade theory in India comes from the ministry of commerce. There are two aspects of trade policies. how much and with whom to trade. officials enact trade policies to achieve the desired results. Companies need to understand trade theories so that they can find where to locate the production/distribution unit. ♦ Policy book which specifies the policies ♦ Handbook of proceedings which specifies as an exporter or importer what should be your duties. other countries wrestle with the questions of what. Like India. how much and with whom their country should import and export. It is based on the factors basically framed by WTO like who should be your trading partners.
Developed countries do this to developing countries. However it is not necessarily beneficial to run a trade surplus or disadvantageous to run a trade deficit.e. The objective is not purely economical. These different trade theories provide insights about favourable locales as well as potentially successful export products. So employment will be there and excess production will occur in the country. . imports goods and services of less value than those it is exporting. In mercantilist period the difference in trade was made up by a transfer of gold. The theories also increase understanding about government trade policies and predict how those policies might affect companies’ competitiveness. According to this theory a country should export more than it imports and if successful. the governments of colonial powers seldom aimed directly to limit the development of the industrial capabilities within their colonies. Theories of Specialization The theory of specialization states that nations should neither artificially limit imports nor promote exports. receive gold from countries that run deficits. governments imposed restriction on most imports and they subsidized production of many products that could otherwise not complete in domestic or export markets. In addition by doing excessive production and export. they generate employment in the home country and increase the sphere of influence among the host countries. A favourable balance of trade indicates that a country is exporting more than it is importing. where as an unfavourable balance of trade indicates the opposite. It says all theories are related to countries not companies. In this process the country will become stronger and popular. export more than they import. To export more than import. There are three theories of specialization. Prescriptive Theory There are two prescriptive theories namely Mercantilism and Neomercantilism Mercantilism It is a trade theory which formed the foundation of economic thought from about 1500 to 1800. According to this theory the countries try to run a favourable balance of trade i. rather social and political. A country that is running a surplus for the time being. As the influence of the mercantilist philosophy weakened after 1800. Neomercantilism It is an extension of Merck theory.and where to export. By exporting they acquire political good will of the countries to whom they export. but today it is made up by holding the deficit country’s currency or investments denominated in that currency.
Theory of comparative advantage In 1817. So most countries import ores. the goods that could not be produced competitively should be obtained from other countries that have competitive advantage over the same. This theory says . Long production runs would provide incentives for the development of more effective working methods A country can have either natural advantage or acquired advantage. Based on this theory. These countries should produce these goods and export it to countries having less or no advantage of these goods. Acquired Advantage: Countries that produce manufactured goods and services competitively have an acquired advantage. It will lead to the optimal utilisation of resources throughout the world. Through specialization. access to certain natural resources. Natural advantage: A country may have a natural advantage in producing a product because of climatic conditions. or availability of certain labor forces. An advantage of product technology is that it enables a country to produce a unique product or one that is easily distinguished from those of competitors. David Ricardo developed the theory of comparative advantage. Labor would not loose time in switching from the production of one kind of product to another. According to him some countries can produce certain goods more efficiently (competitively) because of their natural advantage (natural resources). By doing this countries will have large production units for certain products. An advantage in process technology is a country’s ability to produce a homogeneous product (one not easily distinguished from that of competitors) efficiently. usually either in product or process technology. • Comparative advantage.• Theory of absolute advantage. • • • Labor could become more skilled by repeating the same tasks. he questioned why the citizens of any country should have to buy domestically produced goods when they could buy these goods more cheaply abroad. Theory of absolute advantage In 1776 Adam smith said the wealth of the country depend on its goods and services. No country is sufficiently rich in natural resources to be independent of the rest of the world. He first talked about free trade. metals and fuels from other countries. countries could increase their efficiency because of three reasons. • Factor proportions theory. On the contrary.
In countries where there is little capital available for investment per worker is low. Two Countries. Economic Efficiency Objective: Countries also often pursue objectives other than output efficiency. So a country will gain if it concentrates its resources on producing the commodities it can produce most efficiently. These relative factor costs lead countries to excel in the production and export of products that used their abundant production factors. Labor skills in fact vary within and among countries because people have different training and education. then the advantages of trade are negated. Transportation costs: If transportation costs more than what is saved through specialization. International Product Life Cycle . because the factor-proportions theory assumes production factors to be homogeneous. This theory is based on countries’ production factors like land. labor and capital. then labor cost would be low. They may avoid overspecialization because of the vulnerability created by changes in technology and by price fluctuations. However the relative conditions that give countries advantages or disadvantages in the production of given products are dynamic. Services: The theories of absolute and comparative advantage deal with commodities rather than services. However when countries have many unemployed or unused resources. Statics and Dynamics: The theories view the advantages statically. Two Commodities: the theory assumes a simple world composed of only two countries and two commodities. However. Mobility: The theory assumes that resources can move domestically from the production of one good to another and at no cost. Division of Gains: Although specialization brings potential benefits to all countries that trade. This theory is accepted by most economists and is influential in promoting policies for free trade. This theory says that differences in countries’ endowments of labor compared to their endowments of land or capital explained the differences in the cost of production of factors. Factor Proportions Theory Heckscher and ohlin developed factor proportions theory. However an increasing portion of world trade is in services. managers might expect to find cheap labor rates and export competitiveness in products that require large amounts of labor relative to capital. tests to substantiate the theory have been mixed. Assumptions and Limitations of Theories of Specialization Full employment: The specialization theories assume that resources are fully employed.that global efficiency gains may still result from trade if a country specializes in those products that it can produce more efficiently than other products—regardless of whether other countries can produce those same products even more efficiently. they may seek to restrict imports to employ or use idle resources. But this assumption is not completely valid. the earlier discussion did not indicate how countries will divide increased output. It will then trade some of those commodities for those commodities it has relinquished. If labor were abundant in comparison to land and capital.
which in turn reduce per unit cost. maturity and decline. In this stage. Decline Phase In this phase the markets in high income countries decline more rapidly than those in low-income economies as affluent customers demand ever newer products. So the production process may still be labor intensive during this stage. inexpensive labor efficiently for standardized production.Although the early production is most apt to occur in high income countries. theoretically it can manufacture that product anywhere in the world. which export to the declining or small niche markets in high income countries. although it is becoming less so. Producers have incentives to shift production to emerging economies where they can employ unskilled. this labor tends to be highly educated and skilled so that it is adept and efficient when production is not yet standardized. which consist of four stages namely introduction. Introductory phase Once a company has created a new product. Because sales are growing rapidly at home and abroad. Growth Phase In this phase. the early production generally occurs in domestic location so that the company can obtain rapid market feedback as well as save on transport costs. the production process is more labor intensive because the product is not yet standardized and its production process must permit rapid changes in product characteristics as market feedback dictates. market and cost factors have dictated that almost all production is in emerging economies. Because markets and technologies are widespread. competitors enter the market and demand grows substantially in foreign markets. However product technology may not yet be well developed because of the number of product variations introduced by competitors that are also trying to gain market share. By this time. making cost an important competitive weapon. there are incentives for companies to develop process technology. Maturity phase In this stage the overall worldwide demand begins to level off. There is often a shakeout of products such that product models become highly standardized. companies can often pass costs onto consumers who are unwilling to wait for possible price reductions later. . although it may be growing in some countries and declining in some countries. thus creating more demand in emerging economies. growth.The international product life cycle theory of trade states that the location of production of certain kinds of products shifts as they go through their life cycles. as the sales of new product grow. In practice. Even if production costs are high because of expensive labor. particularly in other high income countries. Longer production runs become possible for foreign plants. the innovating country no longer commands a production advantage. which have high labor rates. however.
making them more self sufficient than smaller countries. needs Ease and comfort of operations Porter’s diamond theory For diagram please refer at the top of this post. Companies come up with new products only when they observe a need or demand for the same in the market. It is possible due to international trade. companies’ development of internationally competitive products and for being supremacy depends on four domestic factors namely • • • • Demand conditions Factor conditions Related and supporting industries Firm strategy. Countries with large land areas are apt to have varied climates and an assortment of natural resources. The distances for neighbouring countries for small countries are less and hence less transportation cost. Companies then start up production near the observed market. capital. According to porter’s diamond theory. If certain factor conditions are not available then the companies refer the host country diamond. The third condition is the existence of related and supporting . then industry players try to outperform each other and this leads to more competition and thus better products. Further transport costs in trade affect large and small countries differently. the smaller country tends to depend more on trade than the larger country because of transportation costs. The demand conditions look for the quality of people i.e.Theory of Country size The theory of country size holds that large countries usually depend less on trade than small countries. structure and rivalry Demand conditions are the first condition in the theory. Here the companies look for the natural advantage available in the domestic market in terms of skilled labor. Country similarity Similar countries engage in trade among themselves because • • • Requirements are similar Similar income levels. If the customers are more demanding. The second condition is the Factor conditions. how demanding the customers are. Among countries that border each other. technology and equipment.
firm strategy. Utilize the specialized factor conditions and enhance/compliment them with their own capabilities. At the same time the absence of any of the four onditions from the diamond domestically may not inhibit companies and industries from becoming globally competitive. For Companies • • • Select and tap the host country diamond.industries. If alliance is to take place. may not get resources. All earlier theories looked at comparative advantage while porter’s diamond focuses on competitive advantage. The sectors are competitive across the world and are not restricted to a single country. then it has to take place with foreign players. . The ability of the companies to develop and sustain a competitive advantage requires favourable circumstances for the fourth condition i. committed R&D Limitations of porter’s diamond • • • • • Resources may be channelled to sectors where there is comparative advantage based industries and in turn those industries where innovation is due. Rivalry brings out the best in the companies. These industries are required in the country for the components of the main product. materials and components are now more easily brought in from abroad due to advancement in transportation and relaxation of import restrictions. Government should not allow companies to have strategic alliance between companies of the same country because it will reduce competition. If related and supporting industries are not available locally. structure and rivalry.e. Governments should be open for foreign country market through negotiation with other countries. Implications of Porter’s diamond For country government • • • Government should focus on “specialized factor conditions” eg-education for growth of IT. The existence of four favourable conditions does not guarantee that an industry will develop in a given locale. Focus on innovation i.e. What is comparative advantage today may not be there tomorrow due to the ongoing globalization.
Another reason for capital mobility is because governments give foreign aid and loans. People are also internationally mobile. At the same time the mobility of capital. technology and people affect trade and relative competitive positions. Non profit organizations donate money abroad to relieve worrisome economic and social conditions. Why production factors move Capital. largely work in another country for economic reasons. People move from the area of abundance to area of scarcity. People who travel to another country as tourists. or overseas positions. People move for short term when they are allocated in turnkey onsite projects. About 2 percent of the world’s population has migrated to another country. Factor Mobility Factor conditions change in both quality and quantity. However people move for long term through migration and take citizenship. is the most internationally mobile production factor.• Companies react not only to domestic rivals but also to foreign based rivals with whom they compete at home and abroad. Individuals remit funds to help their families and friends in foreign countries. especially short term capital. Short term capital is more mobile than long term capital because there is more likely to be an active market through which investors can quickly buy foreign holdings and sell them if they want to transfer capital back home or to another country. Companies and private individuals primarily transfer capital because of differences in expected return. Effects of factor movements . students and retirees do not constitute labor mobility unless they work there. The relative capabilities of countries also change. People also move for political reasons also like persecution or war dangers. However companies invest in long-term abroad to tap markets and lower operating costs. The changes are important in understanding and predicting changes in export production and import market locations. People whether professionals or unskilled workers.
The inability to gain sufficient access to foreign production factors may stimulate efficient methods of substitution. Substitution When the factor proportions vary widely among countries. import goods and may also export in the long run. thus adding to the base of skills that enabled countries to be newly competitive in an array of products they might otherwise have imported. Countries lose potentially productive resources when educated people leave. the comparative costs of transferring goods and factors would determine the location of production. improve technology.where they can command a better return. subsidiary to subsidiary of . subsidiary to parent. such as development of alternatives for traditional production methods. Complementarity Trade and investments are complementary. About a third of world trade (exports) is among controlled entities such as from parent to subsidiary. which further altered their competitive structures and international trade.• • • Immigrants bring human capital with them. However there are restrictions on factor movements that make them only partially mobile internationally. but they may gain from the foreign earnings on those factors. a situation known as a brain drain. Any investment in terms of trade made by a foreign country leads to import of capital equipment. When companies invest abroad. import of components. Countries receive foreign capital to develop infrastructure and natural resources. If finished goods and production factors were both free to move internationally. Relationship of trade and Factor mobility Free trade when coupled with freedom of factor mobility internationally will usually result in the most efficient allocation of resources. pressures exist for the most abundant factors to move to countries with greater scarcity. local players also reduce cost. the investments often stimulate exports from their home countries.
social or political objectives. Retaliation that decreases employment in a capital-intensive industry may not affect employment as much as the value of the trade loss would imply. All nations interfere with international trade to varying degrees. Governments intervene in trade to attain economic. The government can do that through import restriction. India changed from Import substitution to export oriented. Another reason might be domestic operating units may export materials and components to their foreign facilities for use in a finished product. One difficulty with restricting imports to create jobs is that other countries normally retaliate with their own restrictions. Governmental officials apply trade policies that they reason have the best chance to benefit the nation and its citizen and in some case their personal political longevity. Governments pursue political rationality when trying to regulate trade. Role of Government • • • • Interest articulation: since different interest groups co-exist. Interest aggregation: take all stakeholders view into account Policy making Implementation and adjudication The Economic Rationales for governmental intervention 1. so different interests need to be put forward. Many of the exports would not occur if overseas investments did not exist. Governments want to protect their own industries.Unemployment One of the social objectives of government is to prevent unemployment. Two factors can ease the effects of retaliation • • Small trading countries are less important in the retaliation process. Governments routinely influence the flow of imports and exports. Chapter 7. Governmental measures may limit your ability to sell abroad. such as by prohibiting the export of certain products to certain countries. Also governments directly or indirectly subsidize domestic industries to help them engage foreign producers at home or challenge them abroad. . or by making it difficult for you to buy what you need from foreign suppliers. Governments also want to promote exports at the same time.the same company. After 70s.Governmental Influence on Trade Protectionism The governmental restrictions and incentives to trade are known as protectionism.
So persistent unemployment pushes many groups to call for protectionism. Unemployment. It is reasonable to expect production costs to decrease over time. Typically either consumers or tax payers take the burden. 2. Ultimately the validity of the infant industry argument rests on the expectation that the future benefits of an internationally competitive industry will exceed the costs of the associated protectionism. Government officials should compare the costs of higher prices with the costs of unemployment and displaced production that would result from freer trade. So there are two risks for protecting an infant industry. However. the government can then recoup the costs of trade protection through benefits like higher domestic employment.If import restrictions do increase domestic employment. lower social costs and higher tax revenues. In addition.Infant industry protection In 1792. They become strong in the home market also. but they may never fall enough to create internationally competitive products. Promote Industrialization Countries with a large manufacturing base generally have higher per capita incomes than those that do not. Infant industry protection requires some segment of the economy to incur the higher cost of inefficient local production. Hence many emerging economies try to develop an industrial base by . • • Governments must identify those industries that have a high probability of success. it does not necessarily follow that companies in those industries should receive governmental assistance. The govt protects infant industries where the country has either comparative or competitive advantage. Government protects these industries through subsidies. The employment issue can slow trade liberalization because displaced workers are often the ones who are least able to find alternative work at a comparable salary. Once the infant industry becomes globally competitive. they must consider the costs of policies to ease the plight of displaced employees. in and of itself. So the companies of those industries will become major exporters. This theory holds that a government should shield an emerging industry from foreign competition by guaranteeing it a large share of the domestic market until it is able to compete on its own. Alexander Hamilton presented infant industry argument. The infant industry argument presumes that the initial output costs for a small scale industry in given country may be so high as to make its output non competitive in world markets. Govt needs to protect its potential stars. such as for unemployment benefits or retraining. is better dealt with through fiscal and monetary policies. Even if policy makers can determine those infant industries likely to succeed. 3. then fellow citizens will have to bear the cost of higher prices or higher taxes. evidence suggests that efforts to reduce unemployment through import restrictions are usually ineffective.
Foreign investment inflows may also add to local employment. Greater growth of manufactured products Markets for industrial products grow faster than markets for agricultural products. Hence. which is a detriment to economies that depend on few of them. Diversification Prices and sales of agricultural products and raw materials fluctuate very much. such as weather affecting supply or business cycles abroad affecting demand. However the industrialization rationale asserts that the industrial output will increase. Import restrictions. The following are the effects of promoting industrialization • • • • • • Use of surplus workers. emerging nations that depend on primary products have become increasingly poorer relative to industrial countries. The industrialization argument presumes that the unregulated importation of lower priced products prevents the development of a domestic industry. can wreak havoc on economies that depend on the export of primary products. . Promoting investment inflows Inflows of foreign investment in the industrial area promote sustainable growth. even if the prices are not globally competitive. so many people can migrate from agricultural sectors to industrial sectors and in turn increase industrial output. Price variations due to uncontrollable factors. The prices of raw materials and agricultural commodities do not rise as fast as the prices of finished products. A greater dependence on manufacturing does not either guarantee diversification of export earnings. Since agricultural output per person is low. Promoting investment inflows. applied to spur industrialization. which is attractive to policymakers. The terms of trade are the quantity of imports that a given quantity of a country’s exports can buy. may also increase foreign direct investment. Diversification Greater growth for manufactured products Import substitution versus export promotion Nation building Use of surplus workers Surplus workers can more easily increase manufacturing output than agricultural output. because local consumers must buy local goods from local producers.largely regulating imports from foreign producers using trade protection to spur local industrialization. overtime it takes more low priced primary products to buy the same amount of high priced manufactured goods. So.
Basically the restrictions need to be believable and important to the influential parties in the other country. To remain competitive and perform better economically. which makes all the products cheaper in relation to foreign products. One way to do this is to devalue the currency of the country. 4. yet export development of the same products may be feasible later. The performance of free markets suggests a strong relationship between industrialization and aspects of the nation building process. To successfully use restriction as a bargaining tool required careful consideration of what products to target. Restrictions as a Negotiating tool The imposition of import restriction may be used as a means to persuade other countries to lower their import barriers.Import substitution versus export promotion Traditionally emerging economies promoted industrialization by restricting imports in order to boost local production for local consumption. Nation Building Industrial activity helps the nation building process. Increasing country’s economic power relative to other countries Countries monitor their absolute economic welfare as well as track how their performance compares to other countries. the countries adopt the following five methods. They also try to charge higher export and lower import prices. If BOP difficulties arise and persist. Industrialization helps countries to build infrastructure. Governments impose trade restrictions to improve their relative trade positions. a government may restrict imports or encourage exports to balance its trade account. Industrialization may result initially in import substitution. • • • • • Improving Balance of payments (BOP) through Balance of Trade Restrictions as a Negotiating tool Price control on exports Fair access/Reciprocity Optimal tariff theory Improving Balance of payments through BOT Governments can improve BOP by improving their balance of trade. . Some countries have achieved rapid economic growth by promoting the development of industries that export their output. Believable implies that there are either alternative sources to buy the same product or that consumers are willing to do without it. advance rural development. enhance rural proples’ social life and boost the skills of the workforce. This approach is known as export led development.
Governments apply trade restriction to protect essential domestic industries during peacetime so that a country is not dependent on foreign sources of supply during war.Price control on exports Countries sometimes withhold goods from international markets in an effort to raise prices abroad. Economic theory supports this idea. • • • • Maintenance of essential industries Prevention of shipment to unfriendly countries Maintenance or extension of spheres of influence Protecting activities that help preserve the national identity Maintenance of essential industries The essential industries include defence. This policy may also encourage other countries to develop technology that will provide either substitute products or different ways of producing the same product. This is called the essential industry argument. Fair access/Reciprocity Companies and industries often argue that they are entitled to the same access to foreign markets as foreign industries and companies have to their markets. Optimal tariff theory This theory states that a foreign producer will lower its prices if the importing country places a tax on its products. Noneconomic rationales for government intervention Governments are involved in the following noneconomic rationales. If this occurs. a practice called dumping. but which lack equal access to a competitor’s market will struggle to gain enough sales to be cost competitive. the essential industry argument should not be accepted without a careful evaluation of costs. Companies do dumping to build a market abroad. education. Once an industry receives protection. benefits shift to the importing country because the foreign producer lowers its profits on the export sales. Because of the high cost of protecting an inefficient industry or a higher cost domestic substitute. Prevention of shipment to unfriendly countries . A country may limit exports of a product that is in short supply worldwide in order to favour domestic consumers. real needs and alternatives. it is difficult to remove the protection. Companies sometimes export below cost or below their home country price. Some of these industries need to be controlled through government. reasoning that producers operating in industries where increased production leads to steep cost decreases.
even to friendly countries. “Buy Local” Legislation 8. Countries also start blacklisting other countries who supply to their rival countries. Countries are held together partially through a unifying sense of identity that sets their citizens apart from those in other nations. Trade controls on nondefense goods also may be used as a weapon of foreign policy to try to prevent another country from meeting its political objectives. of strategic goods that might fall into the hands of potential enemies or that might be in short supply domestically. Restrictions on services 1. To sustain this collective identity.e. trade controls. Subsidies 3. For this the country requires national identity and a sense of belongingness. Instruments of Trade Control The following are some of the instruments of trade control 1. Countries achieve these political goals using economic means i.Here the government’s is not to supply goods to rival countries. Maintenance or extension of spheres of influence Governments give aid and credits to. countries limit foreign products and services in certain sectors. Export constraints may be valid if the exporting country assumes there will be no retaliation that prevents it from securing even more essential goods from the potential importing country. Tariffs 2. Protecting activities that help preserve the national identity Govt's role is not only to govern the country but also to protect the country and put it together. Quotas 7. and encourage imports from countries that join a political alliance or vote a preferred way within international bodies. Consular fees 6. Countries concerned about security often use national defence arguments to prevent the export. A country’s trade restrictions may coerce governments to follow certain political actions or punish companies whose governments do not. Reciprocal Requirements 12. Specific permission requirements 10. Tariffs . Tied Aid to countries 4. Administrative delays 11. It is about exporting to another country and in turn generating employment and BOP. Custom valuation 5. Standards and Labels 9.
electric power projects etc. many countries that export raw materials charge export tariffs. Import tariffs raise the price of imported goods. Export tariffs are imposed because these items going out would affect local industries.A tariff (duty) is the most common type of trade control and is a tax that governments levy on a good shipped internationally. then it is called compound duty. then it is called ad valorem duty. Trade blocks also charge common tariff rates to non member countries. then it is called specific duty. 2. • • • Export Tariff: Tariffs collected by the exporting country are called an export tariff. Ultimately public pays for these subsidies in terms of taxes subsidizing less efficient/less competitive industries. Subsidies Govt pays in various ways to local players in order to make them competitive globally and in turn expect them to become exporters. Tariffs also serve as a source of governmental revenue. . Subsidies make local players compete domestically as well as in foreign markets. thereby giving domestically produced goods a relative price advantage. When the government assesses a tariff based on both specific and ad valorem duty. such as telecommunications. Import tariffs are imposed to make local production more attractive and competitive. Tied aid helps win large contracts for infrastructure. • • • When the government assess a tariff on a per unit basis. Governments charge a tariff when a good crosses its official boundary. then it is known as tied aid or tied loan. However trade frictions result from disagreement on the definition of a subsidy. ad valorem duty and compound duty. Tariffs are basically three types namely specific duty. 3. Tied Aid to countries When governments give aid and loans to other countries with precondition that the recipient is required to spend the funds in the donor country. When the government assesses a tariff as a percentage of the value of the item. Export tariffs put essential items useful locally. Import Tariff: Tariffs collected by an importing country are called import tariff. trade expositions and foreign contacts) to make it cheaper or more profitable to sell overseas. Transit Tariff: Tariffs collected by a country through which the goods have passed are called a transit tariff. Tied aid can slow the development of local suppliers in developing countries and shield suppliers in the donor countries from competition. Although. Governments sometimes also provide other types of assistance like business development services (market information. revenue tariffs are most commonly collected on imports.
It is a very high amount and delays the proceedings. Quotas The quota is the most common type of quantitative import or export restriction. Quotas usually increase the consumer price because there is little incentive to use price competition to increase sales. Advantages of VER • • A VER is much easier to switch off than an import quota. An import quota prohibits or limits the quantity of a product that can be imported in a given year. Tariffs generate revenue for the government. There are different variations of quotas. Export Quotas A country may establish export quotas to assure domestic consumers of a sufficient supply of goods at a low price to attempt to raise export prices by restricting supply in foreign markets. then officials may compute a value based on final sales value or on reasonable cost. 6. The appearance of “voluntary” choice by a country. then they impose tariff on the basis of the value of identical goods. custom officials first use the declared invoice price. Governments impose embargoes in the effort to use economic means to achieve political goals. . Consular Fees Some countries require consular fees. Voluntary export restraint (VER) Here the government of country A asks the government of country B to reduce its companies’ exports to country A voluntarily. BY implementing quotas the countries increase BOP and BOT by decreasing imports and increasing exports. The typical goal of an export quota is to raise prices to importing countries.4. Sometimes officials use their discretionary power to assess the value too high. It makes the import to the country less attractive. 5. Embargo It is a specific type of quota that prohibits all forms of trade between the countries. If not possible. Custom valuation While imposing tariffs on exports or imports. does not damage the political relations between those countries as much as an import quota does. If officials doubt the authenticity. Countries or group of countries may place embargoes on either imports or exports. on whole categories of products or specific products with specific countries. However quotas generate revenues for the companies that are able to obtain and sell the intentionally limited supply. Here either country B volunteers to reduce its exports or country A may impose tougher trade regulations. thereby preventing the importation of foreign made products.
These sorts of barter transactions are called countertrade or offsets. So by buying locally. Technology up gradation happens in the local market. More frequently. Reciprocal Requirements Governments sometimes require that exporters take merchandise in lieu of money or they promise to buy merchandise or services. 9. labelling and testing standards to allow the sale of domestic products but obstruct that of foreign made ones. Labels provide information to consumers who may prefer to buy products from certain nations. Administrative delays International administrative delays create uncertainty and raise the cost of carrying inventory.7. in the country to which they export. By doing this the local market develops. Sometimes they favour domestic producers through price mechanisms. however. A foreign exchange control is a similar type of control. 10. “Buy Local” Legislation Sometimes governments specify a domestic content restriction-that is . Restrictions on services . Competitive pressure. Many nations prescribe a minimum percentage of domestic content that a given product must have for it to be sold legally in their country. the companies have to indicate on a product where it is made. Specific permission requirements Some countries require that potential importers or exporters secure permission from governmental authorities before conducting trade transactions. However some foreign companies argue that standards are just another means to protect domestic producers. however. 12. In case of labels. Exports also happen on the component parts. The purpose of standards is to protect the safety or health of the domestic population. This procedure can restrict imports or exports directly by denying permission or indirectly because of the cost. a certain percentage of the product must be of local origin. time and uncertainty involved in the process. This requirement is known as import license. Standards and Labels Countries devise classification. 11. the govt gives protection to the local players. reciprocal requirements are made between countries with ample access to foreign currency that want to secure jobs or technology as part of the transaction. moves countries to improve their administrative systems. 8. in place of cash payment. Govt has the option of buying locally as well as internationally.
Mail. . hiring a foreigner is still difficult. media are often not for profit sectors. domestic or foreign. Even if no one is available. foreign or domestic. Immigration Governmental regulations often require that an organization. search extensively for qualified personnel locally before it can even apply for work permits for personnel it would like to bring in from abroad. education.Services are the fastest growing sector in international trade. Standards Governments limit foreign entry into many service professions to ensure practice by qualified personnel. Countries restrict trade in services for three reasons Essentiality Countries sometimes prohibit private companies. In other cases they set price controls for private competitors or subsidize government owned service organizations. creating disincentives for foreign private participation. in some sectors because they feel the services should not be sold for profit. hospital.
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