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III. The Global Trade

and Investment
Environment
GROUP 3

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Introduction
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 Fundamental questions in International Trade

• Why does international trade take place?
• What determines which country should export a
particular good and which country should import
it?
• Who gains from such trade?

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Why do Nations Trade?
i. Nations are different
• Unequal distribution of natural resources
• Difference in technology Supply
• Cost Advantages: conditions
(production
Cost of production for the same product differs among different possibilities
locations. )

Better explained by the Theories of Absolute Advantage and

Comparative Advantage
• Difference Preferences
American prefer Basmati rice grown in India (taste difference) Demand
conditions
Due to different income levels
ii. To achieve economies of scale in production
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• The New Trade Theory
Whytostudy
Click trade
edit Master theory?
title style
i. Talks about benefits od international trade
 theories show why countries should trade for
product/services even when they can produce them
domestically

ii. Talks about patterns of international trade

 theories show why countries specialize the way they do.

iii. Talks about the role of interventions

 theories help articulate the role of government policy
(tariffs, qoutas, etc.)
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AN OVERVIEW OF TRADE THEORY

o Early thinking: Theory of Mercantilism

o Adam Smith: The theory of absolute advantage, 1776
o Ricardo: The theory of comparative advantage, 1817
o Heckscher-Ohlin theory: 20th century
o “New” trade theory
o Product Life Cycle Theory
o Porter’s Competitive Advantage Theory
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Click to edit
Theory of Master title style
Mercantilism

• A trade theory prevailed during 16th to 19th

centuries
•The wealth of a nation is measured based on its
accumulated wealth in terms of gold and silver
•Nations should accumulate wealth by encouraging
exports and discouraging imports
•Theory of mercantilism aims at creating trade
surplus and in turn accumulate nation’s wealth

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Absolute Advantage Theory

• Adam Smith, ‘An Enquiry into the Nature and

Causes of the Wealth of Nations’,1776
• There is international benefit from trade
- Everyone better off without making anyone worse
off
• When one country can produce a unit of good with
less cost than another country, the first country has
an absolute cost advantage in producing that good.
• Cost is considered based on number of labour units
used
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Click to editAdvantage
Absolute Master title style
Theory
Assumptions:
•Two countries (a&b), both producing two products
(x&y)
•Labour is the only factor of production and its
productivity remains the same
•Perfect mobility of labour between the sectors within
a country
•No mobility of labour between the countries
•Assumes perfect competition
- No transportation cost
- No restriction on the movement of goods between
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Theory of Absolute Advantage
Limitations:
• Explains the causes of trade only when both the countries
enjoy absolute advantage in the production of at least one
product.
• Assumes the transportation costs are either non-existent or
insignificant, which may not always hold good.
• Assumes that prices are comparable across countries,
implying stability of exchange rate.
• Perfect mobility of labour between sectors- labour may be
mobile but an extent.
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Comparative Advantage Theory
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David Ricardo, ‘The Principles of Political Economy &
Taxation’ 1817
• Nations can still gain from trade even without an absolute
advantage.
• Facilitator – Difference in opportunity cost
• A country has a Comparative Advantage in producing a
good if the opportunity cost of producing that good in terms
of other goods is lower in that country compared to other
countries.
The Comparative Advantage Theory
 Even if countries do not have an absolute advantage, they
can gain from trade by allocating resources based on their 10
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 Click
The to edit Master
Heckscher- title style
Ohlin Model
Cause of trade
- International differences in labour productivity - Ricardian View
- Differences in countries resources – H.O model
• Developed by Eli Heckscher and Bertil Ohlin
• Also called Factor – proportions Theory – because it discusses:
- The proportions in which different factors of production are
available in different countries, and
- The proportion in which they are used in producing different
goods

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Assumptions:
- Two factors of production – capital and labour
- Two countries (India & Japan), differ in factor
abundance/endowments
- Two commodities – steel and cloth
- Steel is more capital intensive and Cloth is more
labour intensive in both countries
- Both goods uses both factors and the relative factor
intensities are the same for each good in the two
countries.

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• Based on these pospulates, the H-O model predicts
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that the capital surplus specializes in the
production and export of capital – intensive goods
and the labour surplus country specializes in the
production and export of labour – intensive goods.

The H-O Theorem

Countries tend to export goods whose production
is intensive in factors with which they are
abundantly endowed
Gains from trade
trade leads to convergence of relative places,
which in turn has strong effect on the relative
earnings of the factors of production. 13
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THE NEW TRADE THEORIES
The New Trade Theory (NTT) is an international trade theory
developed by Paul Krugman, a Nobel prize winner that explains the two
main points economies of scale and first-mover advantage.
NTT emerged in the late 1970s, and a number of economists pointed
out the ability of firms to attain economies of scale that focuses on the
role of increasing constant returns to scale and network effects.
New trade theory aimed to explain international trade differently than
old trade theory (such as comparative advantage, factor endowment,
etc.) which relies on productivity, factor endowments, and structure.
But, NTT explained without differences in factor endowments also
international trade occurs because of economies of scale between
similar countries. This argues countries should specialize in specific
niches to reduce per-unit cost and achieve economies of scale and
such specialization will let countries trade with each other. 14
 Click to edit Master title style

Economies of Scale
Economies of scale are unit cost reductions
associated with a large volume of output. The major
source of cost reduction in many industries may
include computer software, automobiles, advanced
machines, etc.

In a simple sense, economies of scale mean the

minimum per-unit cost of production that results
from large production due to which fixed costs
remain constant.
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In the domestic market economies of scale may not be attained
because the demand and area are limited as such unit costs are
higher without it. But, in the international market, the demand
is very high and firms are forced to produce goods in huge
quantities.
As such, domestic firms may be able to better attain economies
of scale. Each country may be able to specialize in producing a
narrower range of products than it would be in the absence of
trade.
Each country can simultaneously increase the variety of goods
lowering the costs of those goods. Opportunities for mutual
gains may be attained even when countries don’t differ in their
resource endowments or technology. 16
Assumptions of New
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style Theory
• Specialization increases output, and the ability of firms to enhance
economies of scale increases.
• Learning effects are high, in cost savings that come from “Learning
by doing”.
• Competitors may emerge because of “First-mover advantages”.
• The role of government becomes significant (Subsidies to firms).
• Economies of scale may make it possible to stop new entrants.

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First Mover Advantage
First-mover advantages are the economic and strategic
advantages that a firm gets from rising early into an industry.
May dominate the global market and trade.
The first mover industry can get benefit from a lower cost
structure. Economies of scale are significant and represent a
substantial proportion of world demand, firms export more
quantity and become first movers, which could increase the
ability to capture the international market.
For example, Nokia (Home Country – Finland, products –
Electrical and electronic equipment) dominated the production
and marketing of mobile phone sets.

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The first-mover
Click implications
to edit Master title style depend on consideration of
product life-cycle and market imperfection, and ownership
advantages.

Thus, a first-mover company has various advantages. It will get

subsided by the government, conducts economic
rationalization, and may get a monopoly within the industry.

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PRODUCT CYCLE THEORIES
• Introduced by Raymond Vernon in 1966
• Differs from previous trade theories
• Focus on the product, not its factor proportions
• Puts lees emphasis on comparative cost doctrine
• Increased emphasis on technology’s impct on
production cost
- the innovation
- the effects of scale economies
• Explain international investment
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PRODUCT
Click CYCLEtitle
to edit Master THEORY:
style VERNON’S
PREMISES

Vernon uses two technology-based proportions:

- Technical innovations, leading to new and

profitable products, require large of quantities of
capital and skilled labor

- The product and the methods manufacture go

through different stages of maturation

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STAGES OF THE PRODUCT CYCLE
Most manufactured products have a kind of life cycles, similarly to
the human beings: New-product phase (I), Growth phase (II),
Maturity phase (III), Decline phase (IV) (V)
PHASE I: Product is produced and consumed only in the
innovating country.
PHASE II: Production is perfected in the innovating country and
increases rapidly to accommodate rising demand at home and
abroad. The innovating nation has a monopoly in both the home
and export markets.
PHASE III: The product become more or less standardized and
the innovating firm may find it profitable to license other domestic
and foreign firms to manufacture the products. Thus the imitating
country starts producing the product for domestic consumption. 22
 PHASE IV: The imitating country begins to undersell
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the innovating country in third markets, and
production of product in the innovating country
declines

PHASE V: The imitating country start underselling the

innovating country in the latter’s markets as well, and
production of the product in the innovating country
declines rapidly or collapses. Production moves to low
cost production locations

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 NATIONAL COMPETITIVE ADVANTAGE
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(PORTER,1990)

• Why does a nation achieve success internationally in a

particular industry?
• Why are firms based in a particular nation able to create and
sustain competitive advantage against its global competitors in
a particular field?

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COMPETITIVE ADVANTAGE
Overview
• Introduced by Michael Porter, a famous Harvard business
professor in 1990
• Conducted a comprehensive study of 100 industries in 10 nations
to learn ‘what leads to success’
• Believes the standard classical theories on comparative
advantage provides only a partial explanation- They do not say
why these countries are more productive compared to others
• A nation attains competitive advantage if its firm are
competitive
• And, firms became competitive through innovations
• Innovation- either technical improvements to the product or to
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THE POLITICAL
ECONOMY OF
INTERNATIONAL
TRADE
WHAT IS THE POLITICAL REALITY OF
INTERNATIONAL TRADE?
FREE TRADE occurs when governments do not attempt to restrict what
citizens can buy from another country or what they can sell to another
country.
While many nations are nominally committed to free trade, they tend to
intervene in international trade to protect the interests of politically
important groups.

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INSTRUMENT OF TRADE
POLICY
• Tariff
• Subsidies
• Import quotas
• Voluntary export restraints
• Local content requirements
• Antidumping policies
• Administrative policies

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TARIFF
The oldest form of trade policy
Two categories:
Specific tariff are levied as a fixed charge for each unit
Ad valorem tariffs are levied as a proportion of the value
of the imported goods
Increase government revenues
Force consumers to pay more for certain imports
Are pro-producer and anti-consumer
Reduce the overall efficiency of the world economy

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SUBSIDIES
Government payment to a domestic producer in order
to encourage the production of goods and services
It can take many forms: Cash grants, low-interest loan,
tax breaks, equity participation, government purchases
Aim to achieve lower cost to
 Compete against cheaper imports
 Gain export markets
 Increase domestic employment
 Help local producers achieve first-mover advantage in
emerging industries

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IMPORT QUOTA
It restrict the quantity of some goods
that may be imported into a country
Tariff rate quotas – a hybrid of a
quota and a tariff where a lower tariff
is applied to imports within the quota
than to those over the quota
A quota rent- the extra profit that
producers make when supply is
artificially limited by an import quota

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VOLUNTARY EXPORT
RESTRAINTS
The quotas on trade imposed by the
exporting country, typically at the
request of the importing county’s
government
Important quotas and voluntary
export restraints
• Benefit domestic producers
• Raise the prices of import goods

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LOCAL CONTENT
REQUIREMENTS

Demand that some specific fraction

of a good be produced domestically
• Benefit domestic producers
• Consumers face higher prices

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ANTIDUMPING POLICIES
Dumping
• Selling goods in a foreign market
below their costs of production, or
selling goods in a foreign market
below their “fair” market value
• Enables firms to unload excess
production in foreign markets
Government use countervailing
duties to punish foreign firms that
engage in dumping and protect
domestic producers from “unfair”
foreign competition
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ADMINISTRATIVE
POLICIES
Bureaucratic rules designed to make
it difficult for imports to enter a
country
• Policies hurt consumers by limiting
choice

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WHY DO GOVERNMENT
INTERVENE IN MARKETS?
There are two main arguments for
government intervention in the
market
• Political arguments - concerned with
protecting the interests of certain
groups within a nation (normally
producers), often at the expense of
other groups (normally consumers).
• Economic arguments - typically
concerned with boosting the overall
wealth of a nation

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POLITICAL ARGUMENTS
FOR INTERVENTION
Protecting jobs
Protecting industries deemed
important for national security
Retaliating to unfair foreign
competition
Protecting consumers from
“dangerous” products
Furthering the goals of foreign policy
Protecting the human rights of
individuals in exporting countries

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ECONOMIC ARGUMENTS FOR INTERVENTION
INFANT INDUSTRY
ARGUMENT
 An industry should be
protected until it can develop
and be viable and competitive
icon
STRATEGIC TRADE POLICY
 In cases where there may be
important first mover advantages,
government can help firms from
their countries attain these
advantages
 Government can help firms
overcome barriers to entry into
industries where foreign firms
have an initial advantage
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THE REVISED CASE FOR FREE TRADE

RETALIATION AND TRADE WAR

 Since special interest groups can

 Krugman argues that strategic trade
policies aimed at establishing
domestic firms in a dominant
position in a global industry are
beggar-thy-neighbor policies that
boost national income at the
expense of other countries
 A country that attempts to used
such policies will probably provoke
retaliation
influence governments, Krugman
argues that the strategic trade policy
is almost certain to be captured by
special interest groups within an
economy, who will distort it to their
own ends
DOMESTIC POLITICS

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DEVELOPMENT OF THE GLOBAL TRADING
SYSTEM

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 HOW HAS THE CURRENT WORLD TRADING
SYSTEM EMERGED?
 Until the Great Depression of the 1930s, most countries had some degree of protectionism

 After WWII, the U.S. and other nations realized the value of freer trade
 Established the General Agreement on Tariffs and Trade (GATT) – a multilateral agreement to
liberalize trade

 In the 1980s early 1990s protectionist trends emerged

 Japan’s perceived protectionist (neo-mercantilist) policies created intense political pressures in
other countries
 Persistent trade deficits by the U.S.
 Use of non-tariff barriers increased

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 HOW HAS THE CURRENT WORLD TRADING
SYSTEM EMERGED?
 The Uruguay Round of GATT negotiations began in 1986 focusing on
1. Services and intellectual property
2. The World Trade organization
 The WTO encompassed GATT along with two sisters organization
 The General Agreement on Trade in services (GATT)
 The Agreement on Trade Related Aspects on Intellectual Property Rights
 The WTO has emerged as an effective advocate and facilitator of future trade deals, particular in
such areas as services
 So far, the WTO’s policing and enforcement mechanism are having a positive effect
 Most countries have adopted WTO recommendations for trade disputes

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WHAT IS THE FUTURE OF THE WORLD TRADE
ORGANIZATION
 The WTO has become a magnet for various groups protesting free trade
 The current agenda of the WTO focuses on;
 The rise of anti-dumping policies
 The high level of protectionism in agriculture
 The lack of strong protection for intellectual property rights in many nations
 Continued high tariffs on nonagricultural goods and services in many nations

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WHAT IS THE FUTURE OF THE WORLD TRADE
ORGANIZATION?
 The WTO launched a new round of talks at Doha, Qatar in 2001
 The agenda includes
 Cutting tariffs on industrial goods and services
 Phasing out subsidies to agricultural producers
 Reducing barriers to cross-border investment
 Limiting the use of anti-dumping laws

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 WHAT DO TRADE BARRIERS MEAN FOR
MANAGERS
1. The trade barriers raise the cost of exporting products to a country
2. Voluntary export restraints (VERs) may limit a firm’s ability to serve a country
from locations outside that country
3. To conform to local content requirements, a firm may have to locate more
production activities in a given market than it would otherwise

45
Foreign Direct
Investment (FDI)
REPORTER:
RONY TABLATE
JERICHO BUENAVISTA
WHAT IS FDI?
 It is define as an investment made by an investor of one country to acquire an
asset in another country with the intent to manage that asset.

 Foreign investment and technology play an important role in the economic

development of a nation and have been exploited by a number of developing
countries.

 FDI takes on two main forms; the first is a green field investment, which
involves the establishment of a wholly new operation in a foreign country.
The second involves acquiring or merging with an existing firm in a foreign
country.
 HOW DOES FDI WORKS?
 Foreign Direct Investment is a long-term strategy. Through this a firm invests
directly in facilities to produce and/or market a product in a foreign country.

 Companies can make an FDI in several ways, including purchasing the asset of a
foreign company, investing in the company or in new property, plants, or
equipment; or participating in a joint venture with a foreign company.

 A country’s FDI can be both inward and outward. As the terms would suggest,
inward FDI refers to investment coming into the country and outward FDI are
investments made by companies from that country into foreign companies in
other countries . The difference between inward and outward called the net FDI
inflow, which can be either positive or negative.
TYPES OF FOREIGN DIRECT
INVESTMENT
Foreign direct investments are commonly categorized as horizontal, vertical, or
conglomerate.

 With a horizontal FDI, a company establishes the same type of business operation
in a foreign country as it operates in its home country. A U.S.-based cellphone provider
buying a chain of phone stores in China is an example. 
 In a vertical FDI, a business acquires a complementary business in another
country. For example, a U.S. manufacturer might acquire an interest in a foreign
company that supplies it with the raw materials it needs.

 In a conglomerate FDI, a company invests in a foreign business that is unrelated to

its core business. Because the investing company has no prior experience in the foreign
company’s area of expertise, this often takes the form of a joint venture.
 FDI IN THE WORLD ECONOMY
 Foreign direct investment flow is, by definition, an increase in the book value of the
net worth of investments in one country held by investors of another country, where the
investments are under the managerial control of the investors. Most of these investments
are, in fact, subsidiaries of multinational corporations, and the investors are the parent
organizations of these firms. Thus, foreign direct investment flows mainly represent the
expansion of the international activities of multinational corporations. The surge of foreign
direct investment that began in the mid-1980s therefore is largely a manifestation of the
much discussed "globalization" of business that has taken place during the past ten years.
 THEORIES OF FDI
 Capital Market Theory

The capital market theory is a part of portfolio investment theory and is considered one of the oldest
theories that explain the idea behind expansion of firms abroad. According to this approach, FDI is
determined mainly by interest rate and the value of host country’s currency. Aliber (1971) argued that
firms are more likely to expand abroad when their currency value in the home country is strong.

 Product Life Cycle Theory

The theory of product life cycle was established by Vernon (1966), and it provided a rational
framework to explain the reasons behind the establishment of operations in a foreign country. This theory
employs the theory of comparative advantage, and it analyzes the relationship between product lifecycle
and possible FDI flows. Vernon in this theory explained certain types of FDI for US companies in Western
Europe after the World War II in manufacturing industry,
 Internationalization Theory

It is an extension of the market imperfection theory. By investing in a foreign subsidiary rather than
licensing, the company is able to send the knowledge across borders while maintaining it within the firm,
where it presumably yields a better return on the investment made to produce it.

 Industrial Organization Theory

The industrial organization theory of Hymer (1976) is seen as a core to provide sufficient explanation
for the motivations of an active multinational corporation. Hymer was one of the most famous economists
who established an organized approach towards understanding the motives of domestic firms to extend their
activities internationally. Hymer's theory is based on the idea that firms extend their operations abroad to
compete with local companies and to capitalize on specific capabilities and advantageous position regarding
consumer’s preference, the legal system, and culture that are not shared by other competitors in foreign
countries, which is called “monopolistic advantage.” However, expanding abroad exposes foreign firms to
various risks originating from market imperfection (market failure) (Rugman et al., 2011).
BENEFITS AND COST OF FDI
COST OF FDI TO THE NATION STATE
HOST COUNTRY HOME COUNTRY
 Adverse effects on competition.  Balance of payment from outward FDI
Foreign subsidiaries have strong economic  Employment effect from outward FDI
power to put local competitors out of market
 Adverse effects on the balance of payment.
Against the initial capital inflow that comes
with FDI must be the outflow of earnings to be
repatriated
 Perceived Loss of National Sovereignty and
Autonomy.
BENEFITS OF FDI TO THE NATION STATE

HOST COUNTRY HOME COUNTRY

 Resource-transfer effects  Balance of payment from inward flow of
foreign earnings
 Employment effects- FDI brings jobs to a
host country  Positive employment effects when a
subsidiary demands home country exports
 Balance of payment effects
of capital equipment
 FDI is a substitute for imports of goods
 Home country MNE learns skills
and services
transferable in technologies for use in the
 MNE uses the subsidiary in the host home country
country to export goods and services to
other countries
Political Ideology and FDI

What is Political
Ideology?

In social studies, a political ideology is a certain set of ethical ideals, principles, doctrines,
myths or symbols of a social movement, institution, class or large group that explains how society
should work and offers some political and cultural blueprint for a certain social order.
 RADICAL VIEW

 The radical view traces its roots to Marxist political and economic theory.
Radical writers argue that the multinational enterprise (MNE) is an instrument of
imperialist domination. They see the MNE as a tool for exploiting host countries
to the exclusive benefit of their capitalist-imperialist home countries.
THE FREE MARKET VIEW
 argues the international production should be distributed among countries
according to the theory of comparative advantage.
 That is, countries should specialize in the production of those goods and
services that they can produce most efficiently.

PRAGMATIC NATIONALISM
 In practice, many countries have adopted neither a radical policy
nor a free market policy toward FDI, but instead a policy that can
best be described as pragmatic nationalism.
 FDI can benefit a host country by bringing capital, skills,
technology, and jobs, but those benefits often come at a cost.
 The pragmatic nationalism view is that FDI has both benefits and
cost
 GOVERNMENT POLICY
INSTRUMENT OF FDI
o HOME COUNTRY POLICIES to ENCOURAGE OUTWARD FDI

Many investor nation have government backed insurance programs to cover major types of foreign
investment risk. The types of risk insurable through these programs include risk of expropriation
(nationalization), war losses and the inability to transfer profit back home. Such programs are particularly
useful in encouraging firms to undertake investments in politically unstable countries.

o HOME COUNTRIES POLICIES to RESTRICT OUTWARD FDI

Virtually all investor countries, including the US, have tried to exercise some control over outward FDI
from time to time. One common policy has been to limit the capital outflows out of certain concern for the
country’s balance of payment. From the early 1960s until 1979, for example, Britain had exchange control
regulations that limited the amount of capital a firm could take out of the country.
o HOST COUNTRY POLICIES to ENCOURAGE INWARD FDI

It is increasingly common for governments to offer incentives to foreign firms to invest to

their countries. Such incentives take many forms, but the most common are tax concessions, low
interest loans, grants or subsidies. Incentives are motivated by desire to gain from the resource-transfer
and employment effects of FDI. They are also motivated by desire to capture FDI away from other
potential host countries. Not only do countries compete with each other to attract FDI, but so do regions
of countries.

o HOST COUNTRY POLICIES to RESTRICT IINWARD FDI

Host government use a range of controls to restrict FD. The most common are ownership
limitations and performance requirements. Ownership restraints can take several forms. In some
countries foreign companies are excluded from certain businesses. For example, they are excluded from
tobacco and mining in Sweden and from the development of certain natural resources in Brazil, Finland
and Morocco. In other countries, foreign firms may only own up to a certain percentage of the shares in
the local company.
 REGIONAL
ECONOMIC
INTEGRATION
01
What is regional economic INTEGRATIOn?

○ Refers to agreements between countries in a

geographic region to reduce tariff and notariff
barriers to the free flow of:
■ Goods
■ services, and
■ factors of production between each other.

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Five Levels Of Regional Economic Integration

62
Free trade union
o all barriers to trade among members, but each country determines its own barriers against
nonmembers.
Examples: European Free Trade Association (between Norway, Iceland, Liechtenstein, and
Switzerland), and the North American Free Trade Agreement (between the U.S., Canada, and
Mexico
Custom union
o is one step further along the road to full economic and political integration, and eliminates trade
barriers between member countries and adopts a common external trade policy.
Example: The Andean Pact (between Bolivia, Columbia, Ecuador and Peru)
Common market
o has no barriers to trade between member countries, a common external trade policy, and the
free movement of thee factors of production.

Example: MERCOSUR (between Brazil, Argentina, Paraguay, and Uruguay) 63

Economic Union
o Involves the free flow of products and factor of production between members, the adoption
of a common external trade policy, and in addition, a common currency, harmonization of the
member countries’ tax rates, and a common monetary and fiscal policy.

Example: The European Union (EU) is an economic union, although an imperfect one since not all
members of the EU have adopted the euro, and differences in tax rates across countries still
remain.

Political Union
o Represents the potentially most advanced form of intregation with a common government and
where the sovereighnty of a member country is significantly reduced.

THE CASE FOR REGIONAL INTEGRATION

The Economic Case for Integration
o Regional economic integration is an attempt to achieve additional gains from the free flow of
trade and investment between countries beyond those attainable under international
agreements such as the WTO.
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 THE CASE FOR REGIONAL INTEGRATION
The Political Case for Integration
o It has two main points;
o by linking countries together, making them more dependent on each other, and
forming a structure where they regularly have to interact, the likelihood of violent
conflict and war.
o by linking countries together, they have greater clout and are politically much
stronger in dealing with other nations.
Impediments to Integration
o There are two main impediments to integration;
o While a nation as a whole may benefit from a regional free trade agreement, certain
groups may lose.
o Concerns over the loss of national sovereignty
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 THE CASE AGAINST REGIONAL INTEGRATION

o Regional economic integration only makes sense when the amount of trade
it creates exceeds the amount it diverts.
o Trade creation – occurs when low cost procedures within the free
trade area replace high cost domestic producers.
o Trade diversion – occurs when higher cost suppliers within the free
trade area replace lower cost external suppliers.

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INTEGRATION IN EUROPE
o European efforts at integration began shortly after the Second World War among a
small group of countries and involved a few select industries. Regional integration now
encompasses practically all of Western Europe and all industries.

European Union 
1. The Early Years
Europe in 1945 faced two challenges:
(1) To rebuild itself and avoid further conflict; and
(2) To increase its industrial strength to stay competitive with the US

 Belgium, France, West Germany, Italy, Luxembourg, and the Netherlands signed the
Treaty of Paris in 1951, creating the European Coal and Steel Community to remove
barriers to trade in coal, iron, steel, and scrap metal.

 Members of the European Coal and Steel Community signed the Treaty of Rome in
1957, creating the European Economic Community (EEC),which outlined a future
common market. 67
 In 1967 the Community’s scope was broadened to include additional industries, notably
atomic energy, and changed its name to the European Community Enlargement
continued and in 1994 the bloc changed its name to the European Union (EU).
 
 Today the 27-member European Union has a population of about 485 million people
and a GDP of over $9.5 trillion.

a. Single European ACT (SEA)

The SEA of 1987 proposed removal of remaining barriers, increased harmonization,
and enhanced competitiveness of European companies. M&As swept Europe: Large firms
combined their understanding of European needs, capabilities, and cultures with
economies of scale.

b. Maastricht Treaty
The 1991 Maastricht Treaty (effective in 1993):

(1) created single, common currency; 68

 (2) set monetary and fiscal targets for countries taking part in monetary union; and

(3) Proposed eventual political union—including a common foreign and defense policy
and common citizenship

2. European Monetary Union
Countries opting out of the euro are Britain, Denmark, and Sweden.
a. Management Implications of the Euro Eliminates exchange-rate risk for business
deals between member nations using the euro. Transparency in prices harmonizes
prices across markets.

3. Enlargement of the European Union
a. Expanded in 2004 to include ten new countries: Cyprus (south),Czech Republic,
Estonia, Hungary, Latvia, Lithuania, Malta, Poland, Slovakia, and Slovenia. Expanded
again in 2007 to include Bulgaria and Romania.
b. Candidates for future membership are Croatia and Turkey.
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c. New members must meet the Copenhagen Criteria
4. Structure of the European Union
a. European Parliament
i. More than 700 members who are elected by popular vote within each member nation
every five years.

ii.Parliament acts as a consultative rather than a legislative body by debating and

amending legislation proposed by the European Commission.

b. Council of the European Union

iii. The legislative body of the EU. Council members change depending on the topic
under discussion (e.g., For agriculture, the Council is comprised of agriculture
ministers of each member).
iv. No proposed legislation becomes EU law unless the Council votes it into law.
Some legislation today requires only a simple majority to win approval.

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c. European Commission
i. The executive body of the EU whose commissioners are appointed by each
country—larger nations get two commissioners, smaller countries one.
ii. Drafts legislation, manages and implements policy, and monitors compliance
with EU law.
d. Court of Justice
iii. The EU court of appeals includes one justice from each member country.
iv. One type of case heard is when a member nation is accused of not meeting its
treaty obligations.
v. Justices are required to act in the interest of the EU as a whole, not in the
interest of their own countries.
e. Court of Auditors
vi. Composed of 27 members (one from each member nation) appointed for six-
year terms.
vii. Duty is to audit EU accounts and implement EU budget, improve EU financial
management, and report to member nations’ citizens on the use of public funds.
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B. European Free Trade Association 
1.Some nations wanted the benefits of a free trade area but wary of a full common
market. In 1960, they formed the European Free Trade Association (EFTA) to focus on
trade in industrial goods. Today members are Iceland, Liechtenstein, Norway,
and Switzerland.

2.EFTA has about 12 million people and a combined GDP of $620 billion

3.The EFTA and EU cooperate on the free movement of goods, person, services,
and capital. They also cooperate in other areas, including the environment, social
policy, and education.

INTEGRATION IN THE AMERICAS
• Latin American countries began forming regional trading arrangements in the early
1960sbut made substantial progress only in the 1980s and 1990s. North America is
taking major steps toward economic integration.

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A. North American Free Trade Agreement 
•NAFTA (January 1994) seeks to eliminate most tariffs and non-tariff trade barriers on
most goods originating from North America.
•Calls for liberalized rules regarding government procurement practices, the granting of
subsidies, and the imposition of countervailing duties.
•Other provisions deal with trade in services, intellectual property rights, and standards of
health, safety, and the environment.

1. Local Content Requirements and Rules of Origin
a. Producers and distributors must determine if their products meet NAFTA rules to
qualify for tariff-free status. The producer or distributor must also provide a NAFTA
“certificate of origin” to an importer to claim an exemption from tariffs.

b. Four criteria to meet NAFTA rules of origin: 
1.goods wholly produced or obtained in the NAFTA region;
2.goods containing non originating inputs but meeting origin rules;
3.goods produced in the NAFTA region wholly from originating materials;
and
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4.unassembled goods with sufficient North American regional value content.
2. Effects of NAFTA
a. Mexico’s exports to the United States jumped an astonishing275%, from under $40
billion to more than $150 billion.
b. Canada’s exports to the United States more than doubled, from almost $117 billion
to $287 billion, while US exports to Canada grew 76%, from $100 billion to
$176 billion.
c. Canada’s exports to Mexico grew more than threefold from $640million to nearly
$2.7 billion.
d. The agreement’s effect on employment and wages is not easy to determine. The US
Trade Representative Office and the AFL-CIO group of unions debate NAFTA’s
effect on jobs.

3. Expansion of NAFTA
e. Continued ambivalence about NAFTA delays its expansion.
f. A boost would be if the US Congress grants trade promotion authority to successive
U.S. presidents.
g. c. The Americas will experience further integration and North American economies
could even adopt a single currency.
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B. Central American Free Trade Agreement

1. Established in 2006 between U.S. and Costa Rica, El Salvador, Guatemala,

Honduras, Nicaragua, and the Dominican Republic.
2. CAFTA nations represent a U.S. export market larger than India, Indonesia, and
Russia combined. And nearly 80 percent of exports from the Central American
nations and the Dominican Republic already enter the United States tariff-free.
3. In 2003, the combined value of goods traded between the United States and the
six CAFTA countries was around $32 billion.
4. Benefits to U.S.:
1. Lower tariff and non-tariff barriers;
2. Ensures U.S. companies are not disadvantaged by Central American nations’
trade agreements with other countries;
3. Requires Central American nations and Dominican Republic to encourage
competition and investment, protect intellectual property rights, and promote
transparency and the rule of law;
4. Supports U.S. national security interests by advancing regional integration,
peace, and stability. 75
C. Andean Community

1. Formed in 1969 and today includes Bolivia, Columbia, Ecuador, and Peru. It
comprises a market of more than 97 million consumers and a combined GDP of
about $216 billion.
2. Objectives include tariff reduction, a common external tariff, and common policies
in both transportation and certain industries.

D. Latin American Integration Association

3. Formed in 1980, called for preferential tariff agreements between pairs of members
(reflecting their economic development levels).
4. ALADI did not significantly increase cross-border trade despite 24 bilateral
agreements and 5 sub regional pacts.

E. Southern Common Market

5. MERCOSUR members: Argentina, Brazil, Paraguay, Uruguay, and Venezuela
(Bolivia, Chile, and Peru are associate members).
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 2. Acts as customs union and liberalizing trade and investment emerging as
the most powerful trading bloc throughout Latin America.
3. May incorporate all of South America into a South American Free Trade
Agreement and link up with NAFTA.
4. Different trade agendas, various macroeconomic policy frameworks, and
economic problems of Argentina and Brazil hamper integration.

F. Central America and the Caribbean 
Integration efforts here have been modest.
5. Caribbean Community and Common Market (CARICOM)
a. Formed in 1973. Bahamas is a member of the Community but does
not belong to the Common Market. Has combined GDP of nearly $30
billion and a market of almost 6 million people.
b. In 2000, CARICOM members called for the establishment of a single
market, but the problem is that members trade more with
nonmembers than with each other.

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 2. Central American Common Market (CACM)
a. Intended to create a common market between Costa Rica, El Salvador,
Guatemala, Honduras, and Nicaragua. Progress was constrained by civil
wars and wars among members. Comprises a market of 33 million and
combined GDP of $120 billion
b. Not yet a customs union, but officials say goal is integration, closer political
ties, and a single currency likely the dollar. El Salvador adopted the dollar as
its official currency in 2000.

G. Free Trade Area of the Americas 

1. Intends to create a trading bloc stretching from Alaska to Tierra del Fuego in South

America. Would comprise 34 nations and 800 million consumers and have a
collective GDP of more than $12 trillion. Cuba is the only Western Hemisphere
nation excluded.

2. Would remove tariffs and non-tariff barriers between members, but continues to
face opposition from labor organizations, environmentalists, and others against
globalization. 78
INTEGRATION IN ASIA
A. Association of Southeast Asian Nations 
1. Market of 500 million consumers and a GDP of $740 billion.
2. Objectives: (1) promote economic, cultural, and social development:
(2)safeguard economic and political stability; and (3) serve as a forum in which
differences can be resolved fairly and peacefully.
3. Adding Cambodia, Laos, and Myanmar, may help counter China’s strength
and resources of cheap labor and abundant raw materials.

B. Asian Pacific Economic Cooperation 
4. Comprise over half of world trade and a GDP of over $16 trillion.
5. Aims to strengthen the multilateral trading system and expand the global
economy by simplifying and liberalizing trade/investment procedures.
6. Hopes to have free trade and investment throughout the region by  2010 for
developed nations, 2020 for developing ones

79
4. Record of APEC
a. Succeeded in halving members’ tariff rates from an average of15 to 7.5%.
Liberalization hampered more recently.
b. Is a political body as much as it is a movement toward free trade. Open
dialogue and cooperation should encourage progress toward APEC goals,
however slowly.
c. Grants region-wide business visas without requiring multiple visas, and
recommends regional recognition of national qualifications for professionals.

INTEGRATION IN THE MIDDLE EAST AND AFRICA

A. Gulf Cooperation Council (GCC)
1. Members are Bahrain, Kuwait, Oman, Qatar, Saudi Arabia, and the United Arab
Emirates. Formed to cooperate with the increasingly powerful trading blocs in
Europe.
2. Main achievements: allowing citizens to travel freely among member nations,
and allowing citizens to own land, businesses, and other property in fellow
member nations without the need for local partners. 80
B. Economic Community of West African States (ECOWAS)
1. Intends to form a customs union and an eventual common market  and monetary union
among its members. The ECOWAS nations comprise a large portion of the economic
activity in sub-Saharan Africa.
2. Progress on market integration is almost nonexistent, but ECOWAS has made progress
in the free movement of people, construction of international roads, and development
of telecommunication links.
3. Problems for ECOWAS arise because of political instability, poor governance, weak
national economies, poor infrastructure, and poor economic policies

C. African Union (AU)
4. Group of 53 nations joined forces in 2002 to create the African Union.
5. Aims: 
6. rid vestiges of colonialism and apartheid; 
7. promote unity and solidarity;
8. coordinate and intensify cooperation for development;
9. safeguard members’ sovereignty and territorial integrity;
10. promote international cooperation within the United Nations.
3. But problems abound (e.g., ethnic violence in Darfur region of Sudan despite heavy
AU involvement).
81
THANK YOU! SUPER!
References:
:https://www.google.com/search?q=Foreign+Direct+Investment+(FDI)&rlz=1C1UEAD_enPH1031PH10
31&oq=Foreign+Direct+Investment+(FDI)&aqs=chrome..69i57.1932j0j15&sourceid=chrome&ie=UTF-
8https://www.google.com/search?
q=theories+of+FDI&rlz=1C1UEAD_enPH1031PH1031&sxsrf=AJOqlzXa4ePXQa9q0w4gNxHzlZ9NerIdaw
%3A1677507595511&ei=C7z8Y6foHtq12roPpe-

MkAY&ved=0ahUKEwjnmdri8rX9AhXamlYBHaU3A2IQ4dUDCA8&uact=5&oq=theories+of+FDI&gs_lcp=Cgxnd3Mtd2l6LXN
lcnAQAzIE
CCMQJzIFCAAQkQIyBQgAEIAEMgUIABCABDIFCAAQgAQyBQgAEIAEMgoIABAWEB4QDxAKMgkIABAWEB4Q8QQyCQg
AEBYQHhDxBDIJCAAQFhAeEPEEOgcIIxDqAhAnOg0IABCPARDqAhC0AhgBOgQIABBDOgsIABCABBCxAxCDAToKCAAQ
sQMQgwEQQzoRCC4QgAQQsQMQgwEQxwEQ0QM6CgguEMcBENEDEEM6BAguEEM6CAguEIAEELEDOgsIABCxAxCD
ARCRAjoNCAAQgAQQsQMQgwEQCjoHCAAQgAQQCkoECEEYAFCwI1jHXmC7bWgDcAF4AYABpAWIAbotkgELMC4xLjQ
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https://www.researchgate.net/publication/342529872_MAIN_THEORIES_OF_FOREIGN_DIRECT_INVESTMENT/link/
5ef9f44545851550507b289d/download

https://www.mbaknol.com/managerial-economics/government-policy-instruments-for-managing-foreign-direct-investment-fdi/

Hill, C. W. (2012). International business. New York, NY: McGraw-Hill Education

 Thank you!
“Integration is the end of the zero sum game”
–Teal Swan .

84