ECONOMIC ENVIRONMENT

COMPONENTS OF ECONOMIC ENVIRONMENT INCOME CLASSIFICATION OF COUNTRIES ECONOMIC INSTITUTIONS

ECONOMIC SYSTEM CLASSIFICATION

ECONOMIC ENVIRONMENT
ECONOMIC TRADE POLICIES ECONOMIES IN TRANSITION REGIONWISE CLASSIFICATION OF COUNTRIES

INCOME WISE CLASSIFICATION OF COUNTRIES

WORLD BANK CLASSIFICATION BASED ON 211 COUNTRIES WITH A POPULATION OF ATLEAST 30,000 ARE RANKED BY THEIR GROSS NATIONAL INCOME: LIC (LEAST INCOME): HAVING PER CAPITA GNI IN 2000 OF $735 & LESS LMC (LOWER MIDDLE INCOME): HAVE GNI BETWEEN $736 & $2995 UMC (UPPER MIDDLE INCOME): HAVE GNI BETWEEN $2996 & $9265 HIC (HIGH INCOME COUNTRIES): HAVE GNI OF $9266 AND ABOVE LIC, LMC & UMC ARE CONSIDERED AS DEVELOPING COUNTRIES AND REST AS DEVELOPED COUNTRIES

DEVELOPING COUNTRIES
DVELOPING COUNTRIES SHARE A COMMON AND WELL DEFINED GOALS REDUCTION IN POVERTY, INEQUALITY & UNEMPLOYMENT PROVISION OF MINIMUM LEVEL OF EDUCATION HEALTH, HOUSING AND FOOD FOR EVERY CITIZEN BROADENING OF ECONOMIC AND SOCIAL OPPORTUNITIES FORGING OF COHESIVE NATION STATE RELATED TO THESE GOALS ARE COMMON PROBLEMS SHARED BY MOST DEVELOPING COUNTRIES. DEVELOPING COUNTRIES INCLUDE COUNTRIES IN AFRICA, MIDDLE EAST FORMER COMMUNIST NATIONS IN EUROPE AND ASIA.

DEVELOPED COUNTRIES
HIGHLY INDUSTRIALIZED, HIGHLY EFFICIENT AND PEOPLE ENJOY HIGH QUALITY LIFE DEVELOPED COUNTRIES INCLUDE AUSTRALIA, CANADA, JAPAN, NEWZEALAND, U.S, ALL WESTERN EUROPE NATIONS & GREECE.

ECONOMIC SYSTEM CLASSIFICATION

MARKET ECONOMY ALSO CALLED CAPITALISM, ALL PRODUCTIVE FUNCTIONS ARE PRIVATELY OWNED PRODUCTION IS DETERMINED BY SUPPLY AND DEMAD FORCES. REQUISITES FOR MARKET ECONOMY: TRUST (IN BANKS, INSURANCE COMPANIES, SUPPLIERS ETC.) LAW AND ORDER (ENFORCEMENT OF CONTRACTS) SECURITY OF PERSONS AND PROPERTY BALANCING COMPETITION WITH COOPERATION DIVISION OF RESPONSIBILITY AND DIFFUSION OF POWER COMMUNITY ALTRUISM SOCIAL MOBILITY, LEGITIMATION OF AMBITION, TOLERANCE FOR COMPETITIVENESS MATERIALISTIC VALUE AS A STIMULUS TO GREATER COMPETITION DEFERRING GRATIFICATION TO GENERATE PRIVATE SAVING RATIONALLY UNCONSTRAINED BY TRADITION HONESTY GOVERNMENT EFFICIENT FORM OF COMPETITION, AS OPPOSED TO MONOPOLISTIC CONTROL FREEDOM OF INFORMATION FLOW OF INFORMATION WITHOUT RESTRICTION OR FAVOURITISM

COMMAND ECONOMY
ALSO CALLED SOCIALISM, IN COMMAND ECONOMY PLANNING IS MUST. DECISION RELATING TO ALL ECONOMIC ACTIVITIES ARE DETERMINED BY ECONOMY, A CENTRAL GOVERNMENT PLAN. THE TOOL OF PRODUCTION ARE ORGANIZED, MANAGED AND OWNED BY GOVERNMENT, WITH THE BENEFIT ACCRUING TO PUBLIC OBJECTIVE IS FOR GOVERNMENT TO OWN AND RUN BUSINESS FOR THE GOOD OF SOCIETY

MIXED ECONOMY
FALLS MIDWAY BETWEEN A MARKET ECONOMY AND COMMAND ECONOMY ECONOMIC SETUP IS SPLIT INTO THREE 1. SECTORS IN WHICH BOTH PRODUCTION AND DISTRIBUTION ARE ENTIRELY MANAGED AND CONTROLLED BY THE STATE TO THE COMPLETE EXCLUSION OF PRIVATE ENTERPRISE 2. SECTORS IN WHICH THE STATE AND PRIVATE ENTERPRISE JOINTLY PARTICIPATE IN PRODUCTION AS WELL AS DISTRIBUTION 3. SECTORS IN WHICH THE PRIVATE ENTERPRISE HAS COMPLETE ACCESS SUBJECT ONLY TO GENERAL CONTROL AND REGULATION OF THE STATE

CONTINUUM OF ECONOMIC SYSTEM

PURE MARKET ECONOMY

U.S

CANADA

U.K

FRANCE

BRAZIL

INDIA

CHINA

CUBA NORTH KOREA

PURE CENTRALLY PLANNED ECONOMY

REGIONWISE CLASSIFICATION OF COUNTRIES

EAST ASIA AND PACIFIC EUROPE (EAST AND CENTRAL) AND CENTRAL ASIA LATIN AMERICA AND CARRIBEAN MIDDLE EAST AND NORTH AFRICA SOUTH ASIA SUBSAHARAN AFRICA HIGH INCOME COUNTRIES

ECONOMIES IN TRANSITION
COMMAND ECONOMIES CHANGING INTO MARKET FRIENDLY ECONOMIES. TRANSITION PROCESS INVOLVES FIVE REFORM MEASURES 1) MACRO-ECONOMIC STABILIZATION TO REDUCE BUDGET DEFICIT AND EXPAND CREDIT AVAILABILITY 2) LIBERALISATION OF ECONOMIC ACTIVITY 3) LEGALIZATION OF PRIVATE ENTERPRISES AND PRIVATISATION OF STATE OWNED ENTERPRISES 4) REMOVAL OF TRADE AND INVESTMENT BARRIERS IN GOODS AND SERVICES, REMOVAL OF CONTROLS ON CONVERTIBILITY OF NATIONA CURRENCY 5) DEVELOPMENT OF SOCIAL WELFARE SYSTEM DESIGNED TO EASE THE TRANSITION PROCESS 6) EXAMPLES ARE INDIA, CHINA, VIETNAM, RUSSIA, POLAND, AFRICA, LATIN AMERICA.

TRADE POLICIES
OUTWARD AND INWARD LOOKING POLICIES AN INWARD LOOKING APPROACH SAYS THAT A COUNTRY SHOULD NOT TRADE WITH OTHER NATIONS, WHILE OUTWARDS ADVOCATES FOR THE EASY MOVEMENT OF GOODS AND SERVICES AMONG THE NATIONS.

INTERNATIONAL INSTITUTIONS, TRAETIES AND CONVENTIONS

INSTITUTIONS UNITED NATIONS WORLD BANK INTERNATIONAL MONETARY FUND INTERNATIONAL LABOUR ORGANIZATION TREATIES AND CONVENTIONS THE TREATY OF ROME: GAVE THE BIRTH TO EUROPEAN COMMUNITY, EU. MAASTRICHT TREATY:THE TREATY CALLED FOR COMMON CURRENCY AND POLITICAL UNION OF EU MEMBERS THE VIENNA CONVENTIONS ON THE LAW OF TREATIES: COVERS ISSUES SUCH AS INTERPRETATION, AMENDMENT, TERMINATION AND THE RIGHTS AND DUTIES OF COUNTRIES PARTY TO A TREATY. PARIS CONVENTION: THE FIRST INTERNATIONAL PROPERTY TREATY WAS THE INTERNATIONAL CONVENTION FOR THE PROTECTION OF INDUSTRIAL PROPERTY. IT GUARANTEES THAT FOREIGN TRADEMARK AND PATENT APPLICATION FROM SIGNATORY COUNTRIES RECEIVE THE SAME TREATMENT AND PRIORITY AS DOMESTIC APPLICANTS. THE PATENT COOPERATION TREATY: SUPPLEMENTED THEPARIS CONVENTION BY EASTABLISHING THE CENTRALISED PATENT APPLICATION PROCESS.

LEGAL AND REGULATORY ENVIRONMENT

FOUR FOUNDATIONS ON WHICH LAWS ARE BASED 1. ISLAMIC LAW 2. SOCIALIST LAW 3. COMMON LAW 4. CIVIL OR CODE LAW

BASIC PRINCIPLES OF INTERNATIONAL LAW

1. SOVEREIGNTY AND SOVEREIGN IMMUNITY GOVT. HAS A RIGHT TO RULE THEMSELVES AS THEY FIT IN ONE COUNTRYS COURT SYSTEM CAN NOT BE USED TO RECTIFY OR IMPOSE INJUSTICE ON OTHER COUNTRY UNLESS AGREED 2. INTERNATIONAL JURISDICTION INTERNATIONAL LAW PROVIDES THREE TYPES OF JURISDICTIONAL PRINCIPLE NATIONALITY PRINCIPLE: JURISDICTION OVER CITIZENS NO MATTER WHERE THEY ARE LOCATED TERRITORY PRINCIPLE: RIGHT OF JURISDICTION WITHIN ITS LEGAL TERRITORY PROTECTIVE PRINCIPLE: JURSIDICTION OVER BEHAVIOUR THAT ADVERSELY AFFECTS NATIONAL SECURITY 3. DOCTRINE OF COMITY PART OF INTERNATIONAL CUSTOM AND TRADITION MUTUAL RESPECT FOR LAWS, INSTITUTIONS & GOVERNMENT

CONTD
4. ACT OF STATE DOCTRINE ALL ACTS OF OTHER GOVERNMENT ARE CONSIDERED TO BE VALID UNDER US COURT, EVEN IF SUCH ACTS ARE INAPPROPRIATE IN U.S. 5. TREATMENT AND RIGHTS OF ALIENS RIGHT TO REFUSE ADMISSION OF FOREIGN CITIZENS RIGHT TO IMPOSE SPECIAL RESTRICTIONS ON THEIR CONDUCT, TRAVEL, WHERE THEY STAY & WHAT BUSINESS THEY CONDUCT 6. FORUM FOR HEARING AND SETTLING DISPUTES PRINCIPLE OF US JUSTICE APPLICABLE TO INTERNATIONAL LAW US COURT CAN DISMISS THE CASE BROUGHT FROM THEM BY FOREIGNERS THEY ARE BOUND TO EXAMINE ISSUES SUCH AS WHERE THE PLAINTIFFS ARE LOCATED, WHERE THE EVIDENCE MUST BE GATHERED ETC.

POLITICAL ENVIRONMENT
INFLUENCE OF THE SYSTEM OF GOVERNMENT AND JUDICIARY IN A NATION ON INTERNATIONAL BUSINESS BASIC POLITICAL SYSTEMS: DEMOCRACY:POLITICAL ARRANGEMENT IN WHICH SUPREME POWER IS VESTED IN THE PEOPLE. TWO TYPES PURE DEMOCRACY REPUBLICAN DEMOCRACY TOTALITARIANISM: INDIVIDUAL FREEDOM IS COMPLETELY SUBORDINATED TO THE POWER OF AUTHORITY OF STATE & CONCENTRATED IN THE HAND OF FEW OR SMALL GROUP TYPES OF TOTALIARINISM THEOCRATIC- RELIGIOUS LEADERS ARE POLITICAL LEADERS SECULAR- POLITICAL LEADERS ARE GUIDED BY MILITARY AND BUREAUCRATIC POWER TRIBAL POLITICAL PARTY THAT REPRESENTS THE INTEREST OF PARTICULAR TRIBE MONOPOLISES POWER RIGHT WING TOTALITARIANISM PRIVATE OWNERSHIP OF PROPERTY IS ENDORSED BY GOVERNMENT, MARKET FORCES ARE ALSO ALLOWED TO PLAY FREELY BUT POLITICAL FREEDOMS ARE RARELY GRANTED

POLITICAL RISKS
MACRO-POLITICAL RISKS: AFFECTS ALL INTERNATIONAL BUSINESS IN THE SAME WAY. LIKE BARRIERS TO REPATRIATION OF PROFIT, MANDATORY LABOR LEGISLATION MICRO-POLITICAL RISKS: AFFECTS SPECIFIC FOREIGN BUSINESS. LIKE INCREASED TAXATION, OFFICIAL DISHONESTY. POLITICAL RISKS ASSESSMENTS TWO WAYS 1. THE USE OF EXPERTS OR CONSULTANTS FAMILIAR WITH HOST COUNTRY 2. DEVELOPMENT OF INTERNAL STAFF AND INHOUSE CAPABILITIES

CONTD
CRITERIA FOR EVALUATING POLITICAL RISKS A. POLITICAL ECONOMIC ENVIRONMENT 1. STABILITY OF POLITICAL SYSTEM 2. IMMINENT INTERNAL CONFLICTS 3. EXTERNAL THREATS TO STABILITY 4. DEGREE OF CONTROL OF THE ECONOMIC SYSTEM 5. RELIABILITY OF THE COUNTRY AS TRADING PARTNER 6. CONSTITUTIONAL GUARANTEES 7. EFFECTIVENESS OF PUBLIC ADMINISTRATION 8. LABOUR RELATIONS AND SOCIL PEACE

CONTD.
DOMESTIC-ECONOMIC CONDITION SIZE OF THE POPULATION PER CAPITA INCOME ECONOMIC GROWTH OVER THE LAST 5 YEARS POTENTIAL GROWTH OVER THE NEXT 3 YEARS INFLATION OVER THE PAST 2 YEARS ACCESIBILITY OF THE DOMESTIC CAPITAL MARKET TO OUTSIDERS AVAILABILITY OF HIGH QUALITY LOCAL LABOUR FOCE POSSIBILITY OF EMPLOYING FOREIGN NATIONALS AVAILABILITY OF ENERGY RESOURCES LEGAL REQUIREMENTS REGARDING ENVIRONMENT POLLUTION INFRASTRUCTURE, INCLUDING TRANSPORTATION AND COMMUNICATION SYSTEMS

CONTD
EXTERNAL ECONOMIC RELATIONS
IMPORT RESTRICTIONS EXPORT RESTRICTIONS RESTRICTIONS ON FOREIGN INVESTMENTS FREEDOM TO SETUP OR ENGAGE IN PARTNERSHIPS LEGAL PROTECTION FOR BRANDS AND PRODUCTS RESTRICTION ON MONETARY TRANSFER REVALUATION OF THE CURRENCY DURING THE LAST 5 YEARS BOP SITUATIONS DRAIN ON FOREIGN FUNDS THROUGH OIL & ENERGY IMPORTS INTERNATIONAL FINANCIAL STANDING RESTRICTION ON THE EXCHANGE OF LOCAL MONEY INTO FOREIGN CURRENCIES

MANAGING POLITICAL RISKS

MANAGING RISKS
DIRECT
1. HOST OPERATIONS DEPENDENT ON HOME CONTROL 2. DIVERSIFICATION

INDIRECT

REACTIVE

1. RISK INSURANCE 2. HOME COUNTRY GOVT PRESSURING HOST GOVT

PROACTIVE

1. JOINT VENTURES 1. LOBBYING HOME & HOST GOVT 2. LICENSING AGREEMENT 2. CORPORATE CITIZENSHIP IN 3. PROMOTE HOST GOALS HOST COUNTRY

CONTD
AVOIDING INVESTMENT ADAPTATION LOCAL EQUITY & DEBT DEVELOPMENT ASSISTANCE INSURANCE THREAT LOBBYING TERRORISM CONSULTANTS

CONTD
BARGAINING AND INTEGRATIVE APPROACHES INTEGRATIVE TECHNIQUE - ARE DESIGNED TO HELP THE SUBSIDIARY TO BECOME ONE WITH THE HOST COUNTRYS NEED & CULTURE PROTECTIVE & DEFENSIVE TECHNIQUE - ARE DESIGNED TO DISCOURAGE HOST GOVT TO INTERFERE. EXAMPLE 1. DOING AS LITTLE LOCAL MANUFACTURING AS POSSIBLE 2. LIMITING THE LOCAL PERSONNEL 3. RAISING CAPITAL FROM LOCAL AS WELL AS OUTSIDE SOURCES 4. DISPERSING PRODUCTION OF PRODUCT AMONG NUMBER OF COUNTRIES

SOCIO- CULTURAL ENVIRONMENT

CULTURE INCLUEDS KNOWLEDGE, BELIEF, ART, MORAL,LAWS & OTHER CAPABILITIES AND HABITS ACQUIRED BY AN INDIVIDUAL AS A MEMBER OF SOCIETY CHARACTERISTICS OF CULTURE: LEARNED SHARED TRANSGENERATIONAL SYMBOLIC PATTERNED ADAPTIVE

CULTURAL MATRIX

CONTD
MILDIDIOSYNCRATIC REACTION: THIS TYPE OF BEHAVIOR IS SHOWN WHEN FEW PEOPLE SHARE A PARTICULAR CULTURE AND EXTENT OF SACROSANCT OR EMOTIONAL INVOLVEMENT WITH THAT PARTICULAR CULTURE IS NOT INTENSE. SECOND CHANCE: HERE, NUMBER OF PEOPLE WHO SHARE A PARTICULAR CULTURE IS VERY LARGE BUT THEY ARE NOT EMOTIONALLY INVOLVED WITH THE CULTURE OR BEHAVIOR THAT THEY SHARE. INFORMAL COGNIZANCE: HERE, FEW PEOPLE SHARE A PARTICULAR CULTURE BUT LEVEL OF EMOTIONAL INVOLVEMENT WITH THAT PARTICULAR CULTURE IS QUITE INTENSE. FORMAL COGNIZANCE: HERE, NUMBER OF PEOPLE WHO SHARE A PARTICULAR CULTURE IS VERY LARGE AND INTENSITY OF INVOLVEMENT IS ALSO QUITE HIGH.

LEVELS OF CULTURE
NATIONAL CULTURE: DOMINANT CULTURE WITHIN THE POLITICAL BOUNDARIES OF THE COUNTRY BUSINESS CULTURE: REPRESENTS NORMS, VALUES & BELEIFS THAT PERTAIN TO ALL ASPECTS OF DOING BUSINESS IN A PARTICULAR ENVIRONMENT OCCUPATIONAL & ORGANIZATIONAL CULTURE: PHILOSOPHIES, IDEOLOGIES, VALUES, ASSUMPTIONS ETC. THAT KNIT AN ORGANIZATION TOGETHER AND THAT ARE SHARED BY ITS EMPLOYEES

 Rafael Rodriguez is a stock clerk supervisor at the Target store in Pasadena, California. Supervising people in the fast-paced world of retailing is demanding under any circumstances, and the rich cultural mix of Rodriguez's team makes his job even more challenging. Rodriguez is Hispanic, and his manager is African American. The employees that Rodriguez supervises have cultural backgrounds that are as diverse as the communities served by the nearly 700 Target retail outlets across the United States. Moreover, as in most other Target stores, some of Rodriguez's employees have grown up in the United States, whereas others have recently immigrated and speak English as a second language. The unique combination of influences present in one culture can condition people to think, feel, and behave quite differently from people in another culture. Some of these differences are dramatic, such as in the importance placed on social status. Other differences can be more subtle and more difficult to perceive, such as variations in personal values and decision-making approaches. Rodriguez finds that basic language barriers often prevent employees from understanding each other, but the potential for problems goes beyond differences in language. In one case, a recently immigrated employee was inadvertently making some female co-workers uncomfortable by asking personal questions about hairstyles and nose piercing. His questions were innocent, but because of his cultural background, he couldn't see the invisible boundary that his colleagues had built around their personal lives. Variations in cultureand the misunderstandings that result from themcan affect teamwork, productivity, and job satisfaction. If you were Rafael Rodriguez, what steps would you take to foster a productive and satisfying work environment? How would you make sure your em?ployees improve their intercultural sensitivity so that they can communicate effectively and work together efficiently

TECHNOLOGICAL ENVIRONMENT
TECHNOLOGY & INTERNATIONAL MANAGEMENT RAPID ADVANCES IN BIOTECHNOLOGY REVOLUTIONIZE THE FIELD OF AGRICULTURE,MEDICINE, INDUSTRY. EMERGENCE OF NANOTECHNOLOGY ABILITY TO REMAKE WHOLE PHYSICAL UNIVERSE SATELLITE ROLE IN LEARNING AUTOMATIC TRANSLATION TELEPHONES ARTIFICIAL INTELLIGENCE SUPERCOMPUTERS CAPABLE OF 1 TRRILLION CALCULATIONS/SECOND RESPOND EASILY TO SPOKEN COMMANDS

 E-BUSINESS THE AREA OF E-BUSINESS THAT AFFECT GLOBAL CUSTOMERS: E-RETAILING E- FINANCIAL SERVICES E-CASH TELECOMMUNICATIONS TECHNOLOGY, OUTSOURCING & OFFSHORING FUTURE TECHNOLOGY HAS A POTENTIAL TO DISPLACE EMPLOYEES IN ALL INDUSTRIES MAKES WORK MORE PORTABLE ADVANTAGES COST OF DOING BUSINESS WORLDWIDE WILL DECLINE PRODUCTIVITY GO-UP & COST GO-DOWN DISADVANTEGES LOSS OF JOB / REDUCTION IN SALARY

CONTD

International Trade Theory

International Trade Theory

What is international trade?
Exchange of raw materials and manufactured goods (and services) across national borders

Classical trade theories:

explain national economy conditions--country advantages--that enable such exchange to happen

New trade theories:

explain links among natural country advantages, government action, and industry characteristics that enable such exchange to happen

Implications for International Business

Classical Trade Theories

Mercantilism (pre-16th century)
Takes an us-versus-them view of trade

Other countrys gain is our countrys loss

Free Trade theories

Absolute Advantage (Adam Smith, 1776) Comparative Advantage (David Ricardo, 1817) Specialization of production and free flow of goods benefit all trading partners economies

Free Trade refined

Factor-proportions (Heckscher-Ohlin, 1919)
International product life cycle (Ray Vernon, 1966)

The New Trade Theory

As output expands with specialization, an industrys ability to realize economies of scale increases and unit costs decrease Because of scale economies, world demand supports only a few firms in such industries (e.g., commercial aircraft, automobiles) Countries that had an early entrant to such an industry have an advantage:
Fist-mover advantage
Barrier to entry

New Trade Theory

Global Strategic Rivalry
Firms gain competitive advantage trough: intellectual property, R&D, economies of scale and scope, experience

National Competitive Advantage (Porter, 1990)

Mercantilism/Neomercantilism
Prevailed in 1500 - 1800
Export more to strangers than we import to amass treasure, expand kingdom Zero-sum vs 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

Today neo-mercantilists = protectionists: some segments of society shielded short term

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' G'

Rice

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

Heckscher (1919)-Ohlin (1933)

Differences in factor endowments (not on differences in productivity) determine patterns of trade Absolute amounts of factor endowments matter Leontief paradox:
US has relatively more abundant capital yet imports goods more capital intensive than those it exports Explanation(?): US has special advantage on producing new products made with innovative technologies These may be less capital intensive till they reach massproduction state

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

International Product Life-Cycle (Vernon)

Most new products conceived / produced in the US in 20th century

US firms kept production close to their market initially

Aid decisions; minimize risk of new product introductions Demand not based on price; low product cost not an issue

Limited initial demand in other advanced countries initially

Exports more attractive than overseas production

When demand increases in advanced countries, production follows

With demand expansion in secondary markets

Product becomes standardized production moves to low production cost areas Product now imported to US and to advanced countries

Classic Theory Conclusion

Free Trade expands the world pie for goods/services Theory Limitations:
Simple world (two countries, two products)
no transportation costs no price differences in resources

resources immobile across countries

constant returns to scale each country has a fixed stock of resources and no efficiency gains in resource use from trade full employment

New Trade Theories

Increasing returns of specialization due to economies of scale (unit costs of production decrease) First mover advantages (economies of scale such that barrier to entry crated for second or third company) Luck... first mover may be simply lucky. Government intervention: strategic trade policy

National Competitive Advantage

(Porter, 1990) Factor endowments
land, labor, capital, workforce, infrastructure (some factors can be created...)

Demand conditions
large, sophisticated domestic consumer base: offers an innovation friendly environment and a testing ground

Related and supporting industries

local suppliers cluster around producers and add to innovation

Firm strategy, structure, rivalry

competition good, national governments can create conditions which facilitate and nurture such conditions

Porters Diamond

So What for business?

First mover implications Location Implications

Foreign Investment Decisions

Government Policy implications

BALANCE OF PAYMENT
1. 2. 3. BALANCE OF TRADE MOVEMENT OF GOODS (i.e., VISIBLE ITEMS ONLY) BETWEEN COUNTREIS. BALANCE OF PAYMENT INCLUDES VISIBLE AS WELL AS INVISIBLE ITEMS (VIZ., CHARGES FOR SHIP, BANKING, INSURANCE, INTEREST ON INVESTMENTS, GIFTS ETC. BALANCE OF PAYMENT HAS THREE COMPONENTS CURRENT ACCOUNT CAPITAL TRANSACTIONS OVERALL SURPLUS OR DEFICIT, AND THE METHOD OF USING THE SURPLUS OR FINANCING THE DEFICIT IN THE BALANCE OF PAYMENT

 1. 2.

CONTD
CURRENT ACCOUNT COMPRISES OF MERCHANDISE OR IMPORT/EXPORT OF GOODS (VISIBLE ITEMS) TRADE IN SERVICES TOURIST TRAFFIC, TRANSPORTATION, BANKING & INSURANCE ETC. (INVISIBLE ITEMS) CAPITAL TRANSACTIONS INCLUDES LOANS FROM OR TO FOREIGNERS, CAPITAL REPAYMENT FROM OT TO FOREIGNERS, BORROWINGS FROM OR TO IMF, PURCHASE AND SALE OF CAPITAL ASSETS ETC. DISTINCTION ON CURRENT & CAPITAL ACCOUNT THE CURRENT ACCOUNT DEALS WITH ALL RECEIPT AND PAYMENT FOR CURRENTLY PRODUCED GOODS & SERVICES, ALSO INCLUDES INTEREST EARNED OR PAID ON CLAIMS AND GIFTS AND DONATIONS WHILE CAPITAL ACCOUNT DEALS WITH DEBTS AND CLAIMS OF COUNTRY THE CURRENT OF BOP AFFECTS THE NATIONAL INCOME DIRECTLY WHILE CAPITAL ACCOUNT DOESNT HAVE DIRECT INFLUENCE AS IT ONLY DEALS WITH THE EXTERNAL ASSETS AND CURRENCY RESERVES OF THE COUNTRY

CONTD
1. 2. 3. 1. OVERALL DEFICIT OR SURPLUS METHOD OF SETTLING DEFICIT: EXTERNAL ASSISTANCE IN THE FORM OF LOANS & GRANTS FROM FOREIGN COUNTRIES & FINANCIAL INSTITUTIONS DRAWING FROM IMF USE OF FOREIGN EXCHANGE RESERVES AND GOLD RESERVES IF A COUNTRY HAS DEFICIT IN A PARTICULAR YEAR, IT IS ADJUSTED BY ONE OR MORE OF THE ABOVE THREE METHODS IF COUNTRY SUFFERS FROM PERSISTENT & CHRONIC DEFICIT IN BOP YEAR AFTER YEAR COUNTRY MAY NOT BE ABLE TO BORROW FROM OTHER COUNTRIES BEYOND CERTAIN LIMIT THERE IS A LIMIT TO DRAWING FROM IMF FOREIGN EXCHANGE & GOLD RESERVES COUNTRIES MAY BE EXHAUSTED

2. 3.

 DISEQUILIBRIUM MEANS EITHER THE COUNTRY HAS FAVOURABLE OR UNFAVOURABLE BOP TYPES OF DISEQUILIBRIUM 1. CYCLICAL FAVOURABLE AND ADVERSE BALANCES ALTERNATE DO NOT POSE A PROBLEM TO COUNTRY SO LONG AS MECHANISM OF ADJUSTMENT IS AUTOMATIC 2. STRUCTURAL IS THE RESULT OF TECHNOLOGY, TASTES & ATTITUDE TOWARDS FOREIGN INVESTMENT SUCH DEFICIT IS NOT PERMANENT 3. FUNDAMENTAL REFERS TO THE CAUSES OR SIZE OF DISEQUILIBRIUM OR ITS PERSISTENCE.

DISEQUILIBRIUM IN THE BOP

METHODS OF CORRECTING AN ADVERSE BOP

FIVE METHODS 1. DEFLATION & ADVERSE BALANCE THE FUNDAMENTAL CAUSE IS EXCESSIVE DEMAND FOR FOREIGN GOODS TO CORRECT CURTAIL DEMANDS OF FOREIGN GOODS BY RESTRICTING CONSUMPTIONS DEFLATION (FALL IN PRICES & INCOME) ATTEMPTS TO RESTRICT DEMAND FOR FOREIGN GOODS DEFLATION IS DILIKED FOR TWO REASONS a. REDUCTION IN MONEY INCOME IMPLIES REDUCTION IN WAGES WHICH IS STRONGLY OPPOSED BY TRADE UNIONS b. DEFLATION IMPLIES UNEMPLOYMENT & SUFFERING

CONTD
2. EXCHANGE DEPRECIATION DECLINE IN RATE OF EXCHANGE OF ONE CURRENCY IN TERMS OF OTHER IT IS AUTOMATIC AND CORRECT THE MILD ADVERSE BOP IF INDIA IS FACING ADVERSE BOP IN REGARD TO US THE DEMAND OF DOLLAR WILL RISE AND PRICE OF DOLLAR WILL GO UP THIS WILL RAISE THE PRICE OF AMERICAN GOODS & REDUCE INDIAS DEMANDS FOR AMERICAN GOODS INDIAS IMPORT WILL DECLINE THIS WILL STIMULATE THE EXPORT FROM INDIA FOR 2 REASONS a. AMERICAN WILL FIND INDIAN COMMODITIES CHEAP b. INDIAN EXPORT WILL EXPORT MORE BECAUSE OF LARGER EARNING THAN BEFORE

 EXACHNGE DEPRICIATION IS DEFECTIVE IN MANY WAYS a. NOT SUITABLE FOR COUNTRIES WHICH WANT TO KEEP EXCHANGE RATE FIXED b. MAKES INTERNATIONAL TRADE RISKY AND HENCE REDUCES VOLUME OF TRADE c. THE TERMS OF TRADE WILL GO AGAINST THE COUNTRY WHOSE CURRENCY DEPRECIATES IN VALUE d. MAY RESULT IN INFLATIONARY SITUATION BY MAKING GOODS MORE EXPENSIVE 3. DEVALUATION LOWERING THE VALUE OF CURRENCY IN TERMS OF GOLD OR IN TERMS OF OTHER CURRENCIES IT IS THE PROPER METHOD OF CORRECTING ADVERSE BOP WHICH IS DUE TO OVERVALUATION OF CURRENCY IT MAY ALSO RESORTED BY COUNTRIES IF INTERESTED IN GETTING COMPETITIVE EDGE BY LOWERING COST IN FOREIGN MARKET

CONTD..

CONTD..
CONDITIONS FOR SUCCESS OF DEVALUATION ELASTICITY OF DEMAND COST-PRICE STRUCTURE IT IS POSSIBLE FOR COSTS & PRICES WITHIN A COUNTRY TO CHANGE FOR 2 REASONS RISE IN THE PRICE OF GOODS WHOSE IMPORTS ARE CUT-OFF IMPORTS WHICH HAVE BECOME COSTLY MAY BE A PART OF CONSUMPTION, THUS COST OF LING WILL RISE CO-OPERATION OF OTHER COUNTRIES FOREIGN COUNTRIES WILL EXPERIENCE CONTRACTION IN THE DEMAND FOR THEIR EXPORTS & WHILE EXPANSION IN IMPORT MAY RETALIATE BY KEEPING HIGH TARIFFS TO PREVENT IMPORTS OR GRANT OF SUBSIDIES TO PUSH UP EXPORT

4. EXCHANGE CONTROL GOVT. REGULATION OF EXCHANGE RATES AS WELL AS RESTRICTION ON CONVERSION OF THE LOCAL CURRENCY AGAINST FOREIGN CURRENCY EXCHANGE CONTROL MAY BE ADOPTED BY COUNTRY UNDER FOLLOWING CIRCUMSTANCES a. FREE EXCHANGE MARKET MAY NOT BE DESIRABLE/EFFECTIVE b. MAY BE NECESSARY WHEN THERE IS A HEAVY RUN ON A COUNTRYS FOREIGN RESERVES EITHER DUE TO HEAVY ADVERSE BOP OR MOVEMENT OF CAPITAL OUT OF COUNTRY c. TO PREVENT THE IMPORTS OF FOREIGN GOODS IN TO THE COUNTRY d. TO SECURE AN ADEQUATE AMOUNT OF FOREIGN CURRENCY TO BUY ESSENTIAL FOREIGN GOODS e. TO FREEZE THE ASSETS OF FOREIGN NATIONAL f. TO OVERVALUE OR UNDERVALUE ITS EXCHANGE RATE OR TO AVOID FLUCTUATION IN EXCHANGE RATE g. NECESSARY IN THE PLANNED ECONOMIES

CONTD

 METHODS OF EXCHANGE CONTROL i. INTERVENTIONS PEGGING OPERATIONS GOVT. INTERVENTION IN THE FOREIGN EXCHANGE MARKET TAKE THE FORM OF PEGGING UP /PEGGING DOWN THE CURRENCY OF THE COUNTRY TO A CHOSEN RATE OF EXCHAGE. ii. RESTRICTION A MORE POWERFUL WEAPON GOVT. RESTRICTS THE SUPPLY OF CURRENCY COMING INTO EXCHANGE MARKET. MAY BE OF THREE TYPES: 1. CENTRALIZE ALL TRADING IN FOREIGN EXCHANGE WITH ONE CENTRAL AUTHORITY 2. PREVENT THE EXCHANGE OF NATIONAL CURRENCY AGAINST FOREIGN CURRENCY WITHOUT THE PERMISSION OF GOVT. 3. MAKE ALL FOREIGN EXCHANGE TRANSACTION THROUGH THE AGENCY OF GOVT.

CONTD

CONTD..
iii. EXCHANGE CLEARING ARRANGEMENT TWO COUNTRIES ENGAGED IN TRADE PAY THEIR RESPECTIVE CENTRAL BANKS THE AMOUNTS PAYABLE TO THEIR RESPECTIVE FOREIGN CREDITORS 5. IMPORT DUTIES AND QUOTAS MOST COMMON DEVISE TO RESTRICT FOREIGN TRADE IMPORT DUTIES BETTER THAN OTHER METHOD

INTERNATIONAL MONETARY FUND & WORLD BANK

Purposes of the IMF and The World Bank

The International Monetary Fund (IMF) maintains international monetary cooperation among its members

The World Bank aids in the development and reconstruction of it members

IMF Briefing
Exchange rate stability, balance of payments disequilibrium, and growth of international trade Currently 187 member countries By sharing economic policies the system of buying and selling currencies would be stable

World Bank Briefing

Made up of 5 different organizations
International Bank for Reconstruction and
Development (IBRD) International Development Association (IDA) International Finance Corporation (IFC) Multilateral Investment Guarantee Agency (MIGA) International Center for the Settlement of Investment Disputes (ICSID)

History behind the IMF and World Bank

After the Great Depression in the 1930s there was a need for an organization to create a system for exchange rate stability
Uncertainty of the value of paper money (no longer used the gold standard) Countries began cheating other countries in trade

Countries economies affected by WWII

need for reconstruction in well-developed nations need for development in the lesser developed nations

Bretton Woods Conference

1940s proposals for monetary system by Harry Dexter White (U.S.) and John Keynes (UK)
establish the value of each currency eliminate restrictions and certain practices on trade assistance for post-war reconstruction

Bretton Woods Conference, New Hampshire, July 1944 with delegates of 44 nations
final negotiations of the IMF and the World Bank took place

Purposes of the IMF

Articles of Agreement of the IMF i) promote international monetary cooperation ii) expansion and balanced growth of international trade iii) promote exchange rate stability iv) help establish multilateral system of payments and eliminate foreign exchange restrictions v) make resources of the Fund available to members vi) Shorten the duration and lessen the degree of disequilibrium in international balances of payments

Where the IMF gets its money

Most comes from the quota subscriptions
the money each member contributes when joining the IMF

General Arrangements to Borrow (1962)

line of credit set up with several governments and banks throughout the world

Special Drawing Right (SDRs)

SDR is an invented currency
its value is based on the worth of the worlds five major currencies US Dollar, French Franc, Pound Sterling, Japanese Yen, Deutsche Mark

Countries add SDRs to their holdings of foreign currencies

keep available for need of payments that must be made in foreign exchange

Organization
Board of Governors
Each member country appoints one Governor and and Alternate Governor

Executive Board
24 Executive Directors which are representatives for the members

Managing Director
the chairman of the Executive Board

 Governors spend most of their time dealing with their own countries
report their countries plans to their representatives only meet with entire IMF board once a year

Executive Board oversees the economic policies of the members

holds meetings three times a week Managing Director heads the the IMF staff of about 2,600 people traditionally held by a European

Power among the members

Size of the quotas determine voting power IMF decides on the quota for each member
richer countries have larger quota

US having largest economy provides 18% of the total quota (about $35 billion)
US has largest voting power (18% or 26,5000)

Members with largest quotas

A bit more on quotas

Quotas are reviewed every 5 years by the IMF Quotas also determine how much each member can borrow from the IMF when in need of aid

When is a country in need ?

A country that had not taken in enough foreign currency to pay the other countries for what they have bought
spends more money than it takes in

IMF will lend foreign exchange to that member

hoping to stabilize its currency which will strengthen its trade

How much money a member can borrow from the IMF

25% of the countrys quota may be used If this is not sufficient, then members can borrow up to 3 times the amount of its quota
present plans for reform to Executive Directors

If these plans are sufficient for the Executive Directors, the IMF grants the member a loan

World Bank
Made up of 5 different organizations
International Bank for Reconstruction and
Development (IBRD) International Development Association (IDA) International Finance Corporation (IFC) Multilateral Investment Guarantee Agency (MIGA) International Center for the Settlement of Investment Disputes (ICSID)

International Bank for Reconstruction and Development

Founded in 1944 at the Bretton Woods Conference to finance the reconstruction of countries affected by
WWII help with development of impoverished nations

World Banks central institution 181 member countries

IBRD continued
Lends to countries with relatively high per capita incomes Money is used for:
development projects (i.e. highways, schools) programs to help governments change the way they manage their economies

Provides technical assistance in projects

International Development Association

Established in 1960
assist the poorest developing countries

lends to countries with annual per capita incomes of about $800 or less
Its loans are knows as credits

161 members

International Finance Corporation

Established in 1956 to reduce poverty and improve people's lives in an environmentally and socially responsible manner (174 members)

finances private sector investments, mobilizes capital in international financial markets, and provides technical assistance and advice to governments and businesses
provides both loan and equity finance for business ventures in developing countries

Multilateral Investment Guarantee Agency

Established in 1988 helps developing countries attract foreign investment
provides investment marketing services and legal advisory services to its members

152 members

International Center for the Settlement of Investment Disputes

Established in 1966 to promote increased flow of international investment Provides facilities for the reconciliation of disputes between governments and foreign investors 131 members

Where the IBRD gets its money

through the sale of its bonds in international capital markets Members subscriptions to its capital stock
only 10% of the subscriptions is used by the Bank

Callable Capital
portion of the subscriptions that the Bank borrows the Bank charges a rate of interest rate on its loans to pay this back

Where the IDA gets its money

Mostly from governments voluntary contributions Replenishments
additional contributions which are needed every few years

Differences between the IBRD and the IDA

IBRD charges an interest rate on loans
loans must be repaid within 15-20 years with a 5 year grace period

IDA does not charge an interest rate, only a 0.75% service charge
repayment period is 30-45 years with a 10 grace period

Asian Crisis
Financial crisis broke out in Asia in 1997
large declines in currencies, stock markets, and other asset prices

affected emerging markets outside of Asia

IMF arranged programs of economic stabilization and reform with Indonesia, Korea, and Thailand

IMFs Actions
Temporary tightening of monetary policy correct the weaknesses in the financial system remove features of the economy that were impediments to growth assist in reopening lines of external financing maintaining a sound fiscal policy