International Trade - Unit 1

What is International Business? International Business consists of transactions that are devised and carried out across national borders to satisfy the objectives of individuals, companies and country…

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INTRODUCTION • IB field is concerned with the issues facing international companies and governments in dealing with all types of cross border transactions. • IB involves all business transactions that involve two or more countries. • IB consists of those activities private and public enterprises that involve the movement across national boundaries of goods and services, resources, knowledge or skills. 2

Need for International Business • International business: – causes the flow of ideas, services, and capital across the world – offers consumers new choices – permits the acquisition of a wider variety of products – facilitates the mobility of labor and technology – provides challenging employment opportunities – reallocates resources, makes preferential choices and shifts activities to a global level 3

Reasons for International Business Expansion • Market-Seeking Motives – Marketing opportunities due to life cycles – Uniqueness of product or service

• Economic Motives – Profitability – Achieving economies of scale – Spreading R&D costs

• Strategic Motives – Growth – Risk spread

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Concept of International Business • International Trade: Exports of goods and services by a firm to a foreign-based buyer (importer)

• International Marketing: It focuses on the firm-level marketing practices across the border, including market identification and targeting, entry mode selection, and marketing mix and strategic decisions to compete in international markets.

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• International

Investments:

Cross-border

transfer

of

resources to carry out business activities.

• International Management: Application of management

concepts and techniques in a cross-country environment and adaptation to different social-cultural, economic, legal, political and technological environments.

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• International Business: All those business activities which involves cross border transactions of goods, services, and resources between two or more nations

• Global Business: Conduct of business activities in several countries using a highly co-ordinated and single strategy across the world.

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Reasons for International Business Expansion • Market-Seeking Motives – Marketing opportunities due to life cycles – Uniqueness of product or service

• Economic Motives – Profitability – Achieving economies of scale – Spreading R&D costs

• Strategic Motives – Growth – Risk spread

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International Trade Theory

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Mercantilism: mid-16th century • • • • •

Emerged in England in mid -16th century. A nation’s wealth depends on accumulated treasure Gold and silver are the currency of trade. Could earn gold / silver by exporting export Theory says you should have a trade surplus. – Maximize exports through subsidies. – Minimize imports through tariffs and quotas. – Zero-sum v/s positive-sum game view of trade • Government intervenes to achieve a surplus in exports – King, exporters, domestic producers: happy – Subjects: unhappy because domestic goods stay expensive and of limited variety 10

 Problem with this theory is that it excludes the fact that sometime it is good to import & if you completely refuse to import population will have live without certain consumer items.

 David Hume highlight its shortcoming in 1752 If England’s BOP IS IN SURPLUS i.e. export more than import more gold/ silver will flow in England which increases money supply and inflation.

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Absolute Advantage  Adam Smith: The Wealth of Nations, 1776  Mercantilism weakens country in long run; enriches only a few  A country – Should specialize in production of and export products for which it has absolute advantage; import other products – Has absolute advantage when it is more productive than another country in producing a particular product

G

Cocoa

G: Ghana K: S. Korea

K K'

Rice

G' 12

• • • •

•

Suppose both countries have 200 resources Suppose Ghana needs 10 resources to produce 1ton of cocoa / 20 resources to produce 1 ton of rice. Thus Ghana can produce 20 tons of cocoa or no rice or 10 tone of rice or no cocoa Similarly S. Korea needs 40 RESOURCES TO produce one tone of cocoa&/ 10 resources to produce 1 tone of rice as a result S. Korea can produce 5 tone of cocoa no rice or 20 rice or no cocoa Suppose neither countries trade with each other thus each countries devotes its half resources to the production of rice & half to the cocoa & each countries consume what it produces.

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The Theory of Absolute Advantage and the Gains from Trade Resources Required to Produce 1 Ton of Cocoa and Rice

Ghana S. Korea

Cocoa

10 40

Rice

20 10

Production and Consumption without Trade

Ghana 10.0 S. Korea 2.5 Total production 12.5

5.0 10.0 15.0

Ghana S. Korea Total production

20 0 20

0 20 20

Ghana S. Korea

14.0 6.0

6.0 14.0

Ghana S. Korea

4.0 3.5

1.0 4.0

Production with Specialization

Consumption after Ghana Trades 6T of Cocoa for 6TSouth Korean Rice

Increase in Consumption as a Result of Specialization and Trade

Table 4.1

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Comparative Advantage  David Ricardo: Principles of Political Economy, 1817  Country should specialize in the production of those goods in which it is relatively more productive... even if it has absolute advantage in all goods it produces  Absolute Advantage is a special case of Comparative Advantage G

Cocoa

G: Ghana K: S. Korea

K K'

G'

Rice 15

•

•

•

Ghana needs 10 resources to produce 1 tone of cocoa &13.33 resources to produce 1 tone of rice thus it can produce 20 tons of cocoa & no rice or 15 tone of rice or no cocoa S.Korea needs 40 resources to produce one tone of cocoa& 20 resources to produce 1 tone of rice. Thus S.Korea can produce 5tone of cocoa& no rice or 10 tone rice & no cocoa Suppose neither countries trade with each other thus each countries devotes its half resources to the production of rice & half to the cocoa & each countries consume what it produces.

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Comparative Advantage and the Gains from Trade Resources Required to Produce 1 Ton of Cocoa and Rice

Ghana S. Korea

Cocoa

10 40

Rice

13.33 20

Production and Consumption without Trade

Ghana 10.0 S. Korea 2.5 Total production 12.5

7.5 5.0 12.5

Ghana 15 S. Korea 0.0 Total production 15

3.75 10.0 13.75

Ghana S. Korea

11 4

7.75 6

Ghana S. Korea

1.0 1.5

0.25 1.0

Production with Specialization

Consumption after Ghana Trades 4T of Cocoa for 4TSouth Korean Rice

Increase in Consumption as a Result of Specialization and Trade

Table 4.2

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Assumptions • Resources can move freely. • Constant return to scale i.e. specialization will have no effect on the amount of resources required to produce cocoa /rice. • Country is having fixed amount of resources and free trade does not change efficiency with which resources is used • There is only two goods & two countries. • No transportation cost b/w two countries • No difference in the prices of resources of two countries i.e. exchange on one to one basis.

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Extensions of the Ricardian Model • Immobile resources: – Resources do not always move easily from one economic activity to another.(Immobile resources: eg , easy to convert land from production of cocoa to rice can be true for agricultural land but not always , shift from labour intensive to knowledge based may not benefit all)

• Diminishing returns: (Fig. A) – More a country produces, at some point, will require more resources (diminishing returns to specialization). – Not all the resources are of same quality (more use of marginal land) – Different goods use resources in different proportions.(rice requires more labour than capital compare to cocoa)

• However(Fig. B) – Free trade might increase a country’s stock of resources (as labor and capital arrives from abroad), and – Increase the efficiency of resource utilization.(better tech. ,green revolution) .

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Ghana’s PPF under Diminishing Returns Fig. A

Cocoa

G

Figure 4.3

G’ 0

Rice 20

The Influence of Free Trade on the PPF Fig. B PPF2

Cocoa

PPF1

G’

Figure 4.4

0

Rice 21

Heckscher (1919)-Ohlin (1933) Differences in factor endowments not on differences in productivity determine patterns of trade (as Ricardo stress)  Labor is not the only Factor of production. We need to account for land, capital, and technology.  Factor endowments: extent to which a country is endowed with such resources as land, labor, and capital.  Export goods that intensively use factor endowments which are locally abundant & import goods made from locally scarce factors.  Patterns of trade are determined by differences in factor endowments - not productivity.  Remember, focus on relative advantage, not absolute advantage. 22

Theory of Relative Factor Endowments (Heckscher-Ohlin)  Factor endowments vary among countries  Products differ according to the types of factors that they need as inputs  A country has a comparative advantage in producing products that intensively use factors of production (resources) it has in abundance  Factors of production: labor, capital, land, human resources, technology 23

Location theory

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Location theory Alfred Weber (1909): 1. A part of the costs are stable 2. To gain as much as possible 3. Cost depending of the geography 4. Transportation costs 5. Agglomeration

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Location factors 1. raw materials 2. energy 3. working force 4.size of the market 5. transportation

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Location economy 1. How important is the place? 2. Why do some regions do better than the others? 3. One sector and one place - why? 4. Why is one place/region specialised?

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Competitive advantage of nations Michael Porter:

Firm strategy, structure and rivalry Demand conditions

Factor conditions

Related and supporting industries

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Competitive advantages of nations Factor conditions: • capital, land, jobs and raw material Demand conditions: • not the size of the market but the quality of the demand

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Competitive advantages of nations Related and supporting industries • distribution  co-operation - cluster Firm strategy, structure and rivalry • many companies, same branch, same region  competition  innovation

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What is internationalization? Internationalization is the process through which a firm expands its business outside the national (domestic) market Firms go international:  to enter new output markets

 to reduce costs and enhance competitiveness  to exploit their own core competences in new markets  to share risks over a larger market  to take advantage of lower labor cost, lower taxation, cheaper natural resources (sometimes, because the domestic market is just too small for company growth) 31

What is internationalization? Firms generally go international by exporting their products first, then by establishing sale representatives in the foreign countries, and then possibly setting up production facilities Eventually, international firms may develop into:

Multinational corporations (MNC): a firm that carries out its value chains in more than one country. It is generally headquartered in one home country while it also operates in one or more host countries. Trans-national corporations (TNC): a MNC that does not identify itself with any specific nation, but acquires truly international (i.e., not country-dependent) features and

high local responsiveness

British East India Company, est. 1600

Siemens, Berlin, est. 1847

Royal Dutch Shell, est. 1907

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What is internationalization? Example: Cobra beer

Subsidiaries Licensed and brewed in the UK by Wells & Young's

First brewed in Bangalore, India, by Mysore Breweries

Majority of the firm acquired by a US-Canada brewer

Exported to the UK Est. Fulham, London 1989

1990

1997

Exported to about 45 countries 2009

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How do firms go international? Entry strategies into foreign markets include: Merely exporting a firm's products into a foreign market, possibly with the support of trade brokers Licensing a firm's production and marketing process, or asking for royalties to be paid for the use of firm's assets and resources Franchising a firm's business Directly undertaking production and selling in a foreign country a) through a 'multinational approach' by adapting to local markets b) through a 'global approach' by mass-marketing the same product

Foreign direct investment (FDI) Strategic alliances and joint ventures with foreign firms 34

How do firms go international? Entry strategies into foreign markets include: Merely exporting

Licensing or asking for royalties

Franchising a firm's business

“Multinational approach”

“Global approach” 35

Strategic alliances and joint ventures

What issues do international firms face? Internationalization strategy brings about some issues, for example:

Managing cultural differences

Facing risk of exchange rate fluctuation (e.g., €/US$)

Coping with unwelcoming host government policies

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Differences Between Domestic and International Business • Economic Environment • Socio-Cultural Environment

• Legal Environment • Political Environment • Competition

• Infrastructure • Technology 37

4 DRIVERS OF INTERNATIONAL BUSINESS • •

•

Different companies have different reasons for growing their business and these are summarized below: I. Cost a. Export i. Some companies require large capital investments in plants and machinery. ii. Strong incentive to spread the costs of these fixed costs over a large number of units. b. Import / Outsourcing i. Some companies, in response to consumer demands, attempt to offer goods at the lowest possible price, moving manufacturing overseas (such as in China or Mexico). ii. Strong incentive to lower production costs II. Competition a. Companies follow their domestic competitors abroad to maintain their world-wide market share. b. Companies retaliate against foreign competitors entering their home market by going to these competitors’ home markets. c. Companies counter a competitor’s new product entry by offering a similar product, often produced abroad. III. Market factors a. Consumers’ tastes and preferences have become increasingly uniform worldwide. b. Consumers have become increasingly knowledgeable about products and willing to try new foreign alternatives. IV. Technology a. Diffusion of information is universal b. Competition for products is worldwide: the Internet allows people to trade with one another. 38

Elements and Drivers of International Trade and Business Globalization of Markets: • It refers to the merging of national markets into one huge global marketplace. Now selling internationally is easier due to falling barriers to cross-border trade. A company doesn’t have to be the size of these multinational giants to facilitate and benefit from the globalization of markets. It is important to offer a standard product to the worldwide. But very significant differences still exist between national markets like consumer tastes, preferences, legal regulations, cultural systems. These differences require that marketing strategies in order to match the conditions in a country. To illustrate, Wal-Mart may still need to vary their product from country depending on local tastes and preferences. Globalization of Production: • It refers to the sourcing of goods and services from locations around the world to take advantage of national differences in the cost and quality of factors of production. The idea is to compete more effectively offering a product with good quality and low cost. For example, Nike is considerate one of the leading marketers of athletic shoes and apparel on the world. The company has some overseas factories where has achieved a super production with low cost. Unfortunately Nike has been a target of protest and persistent accusations that its products are made in sweatshops with poor working conditions. The company has signaled a commitment to improving working conditions, but in spite of the fact, the attacks continue.

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Elements and Drivers of International Trade and Business Falling Barriers to Trade and Investment: • The falling of barriers to international trade enables firms to view the world as their market. The lowering of barrier to trade and investments also allows firms to base production at the optimal location for that activity. Thus, a firm might design a product in one country, produce a component parts in two other countries, assemble the product in another country and then export the finished product around the world. The lowering of trade barriers has facilitated the globalization of production. The evidence also suggests that foreign direct investment is playing an increasing role in the global economy. Technological Innovation: • Technological changes have achieved advances in communication, information processing, and transportation technology, including the Internet and the World Wide Web (www). The most important innovation has been development in the microprocessors after that global communications have been revolutionized by developments in satellite, optical fiber, and wireless technologies, and now the Internet and the www. The rapid growth of the internet and the associated www is the latest expression of this development. Besides, innovations have occurred in the field of the transportation technology. The development of commercial jet aircraft has reduced the time needed to get from one location to another. 40

Barriers to International Trade •

•

•

•

Cultural and social barriers: A nation’s cultural and social forces can restrict international business. Culture consists of a country’s general concept and values and tangible items such as food, clothing, building etc. Social forces include family, education, religion and custom. Selling products from one country to another country is sometimes difficult when the culture of two countries differ significantly. Political barriers: The political climate of a country plays a major impact on international trade. Political violence may change the attitudes towards the foreign firms at any time. And this impact can create an unfavorable atmosphere for international business. Tariffs and trade restrictions: Tariffs and trade restrictions are also the barriers to international trade. They are discussed below: – Tariffs: A duty or tax, levied on goods brought into a country. Tariffs can be used to discourage foreign competitors from entering a digestive market. Import tariffs are two types-protective tariffs and revenue Tariffs. – Quotas: A limit on the amount of a product that can leave or enter a country. – Embargoes: A total ban on certain imports or exports. Boycotts: A government boycott is an absolute prohibition on the purchase and importation of certain goods from other countries. For example: Nestle products were boycotted y a certain group that considered the way nestle promoted baby milk formula to be misleading to mothers and harmful to their babies in less development counties. 41

Barriers to international trade • • •

Standards: Non-tariff barriers of this category include standers to protect health, safety and product quality. The standards are sometimes used in an unduly stringent or discriminating way to restrict trade. Anti dumping Penalties: It is one kind of practice whereby a producer intentionally sells its products for less than the cost of product in order to undermine the competition and take control of the market. Monetary Barriers: There are three such barriers to consider: – Blocked currency: Blocked currency is used as a political weapon is response to difficult balance payments situation. Blockage is accomplished by refusing to allow importers to exchange their national currency for the seller’s currency. – Differential exchange rate: The differential exchange rate is a particularly ingenious method of controlling imports. It encourages the importance of goods the government deems desirable and discourage importation of goods the government does not want. The essential mechanism requires the importer to pay varying amount of domestic currency for foreign currency with which to purchase products indifferent categories. Such as desirable and less desirable products. – Government approval for securing foreign exchange: Countries experiencing severe shortages of foreign exchange often use it. At one time or another, most Latin American and East European countries have required all foreign exchange transactions to be approved by central bank. Thus importers who want to by foreign goods must apply of ran exchange permit that is permission to exchange an amount of local currency for foreign currency

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Major current trends in foreign trade • • •

•

Major current trends in foreign trade are as follows: Intense competition among countries, industries, and firms on a global level is a recent development owed to the confluence of several major trends. Among these trends are: 1) Forced Dynamism: International trade is forced to succumb to trends that shape the global political, cultural, and economic environment. International trade is a complex topic, because the environment it operates in is constantly changing. First, businesses are constantly pushing the frontiers of economic growth, technology, culture, and politics which also change the surrounding global society and global economic context. Secondly, factors external to international trade (e.g., developments in science and information technology) are constantly forcing international trade to change how they operate. 2) Cooperation among Countries: Countries cooperate with each other in thousands of ways through international organizations, treaties, and consultations. Such cooperation generally encourages the globalization of business by eliminating restrictions on it and by outlining frameworks that reduce uncertainties about what companies will and will not be allowed to do. Countries cooperate: i) To gain reciprocal advantages, ii) To attack problems they cannot solve alone, and iii) To deal with concerns that lie outside anyone’s territory.

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•

•

•

3) Liberalization of Cross-border Movements: Every country restricts the movement across its borders of goods and services as well as of the resources, such as workers and capital, to produce them. Such restrictions make international trade cumbersome; further, because the restrictions may change at any time, the ability to sustain international trade is always uncertain. However, governments today impose fewer restrictions on cross-border movements than they did a decade or two ago, allowing companies to better take advantage of international opportunities. Governments have decreased restrictions because they believe that: i) So-called open economies (having very few international restrictions) will give consumers better access to a greater variety of goods and services at lower prices, ii) Producers will become more efficient by competing against foreign companies, and iii) If they reduce their own restrictions, other countries will do the same. 4) Transfer of Technology: Technology transfer is the process by which commercial technology is disseminated. This will take the form of a technology transfer transaction, which may or may not be a legally binding contract, but which will involve the communication, by the transferor, of the relevant knowledge to the recipient. It also includes non-commercial technology transfers, such as those found in international cooperation agreements between developed and developing states. Such agreements may relate to infrastructure or agricultural development, or to international; cooperation in the fields of research, education, employment or transport. 5) Growth in Emerging Markets: The growth of emerging markets (e.g., India, China, Brazil, and other parts of Asia and South America especially) has impacted international trade in every way. The emerging markets have simultaneously increased the potential size and worth of current major international trade while also facilitating the emergence of a whole new generation of innovative companies. According to “A special report on innovation in emerging markets” by The Economist magazine, “The emerging world, long a source of cheap la, now rivals the rich countries for business innovation”.

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