International Business

International Business
History of International Business

Early traders (3000+ years ago)
Well before the time of Christ, Phoenician and Greek merchants
Tigris-Euphrates Region
China (Silk Route)
Rome
Egypt
India (Spices and Cotton)
The First Trade Regulations

Free Trade - Romans
Guilds
17th Century mercantilism/colonialism

Portuguese, English, Spanish, French, Dutch (Claimed North &
South American land)
Map of the Ancient Silk Roads
Trade Theory Timeline
Mercantilism
Nations accumulate financial wealth (usually GOLD) by
encouraging exports and discouraging imports
Three pillars:
Maintain trade surplus
Government intervention
Exploit colonies
Flaws:
Zero-Sum Game
Defining mercantilism
Mercantilism
The theory that a country should

accumulate financial wealth by amassing
as many inflows of currency as possible
Mercantilism: 16th late 18th century
A nations wealth depends on accumulated

treasure
Gold and silver are the currency of trade
Two means of increasing a countrys wealth are

colonialism and international trade.
Mercantilism: Policies
Forbidding colonies to trade with other nations

Monopolizing markets with staple ports;
Forbidding trade to be carried in foreign ships;
Maximizing the use of domestic resources;
Also restricting domestic consumption with non-tariff
barriers to trade.
Mercantilism 9-point plan
That every inch of a country's soil be utilized for agriculture, mining or
manufacturing.
That all raw materials found in a country be used in domestic
manufacture, since finished goods have a higher value than raw materials.
That a large, working population be encouraged.
That all export of gold and silver be prohibited and all domestic money be
kept in circulation.
That all imports of foreign goods be discouraged as much as possible.
That where certain imports are indispensable they be obtained at first
hand, in exchange for other domestic goods instead of gold and silver.
That as much as possible, imports be confined to raw materials that can
be finished [in the home country].
That opportunities be constantly sought for selling a country's surplus
manufactures to foreigners, so far as necessary, for gold and silver.
That no importation be allowed if such goods are sufficiently and suitably
supplied at home.
Mercantilism: Flaws
impaired economic growth

Ignores living standards
Ignores human development
Absolute Advantage
Ability of a nation to produce a good more efficiently than any other nation (greater
output using same or fewer resources) Adam Smith
A country should never produce goods at home that it can buy at a lower cost from
other countries
South Korea Sri Lanka

200 Units of 200 Units of
Resource Resource
10 resource unit = 1 ton rice or 10 resource unit = 1/2 ton rice or

1/4 ton tea 1 ton tea
Specialization and trade allows each to

produce and consume more
If a country has absolute advantage in the production of all
goods???
Adam Smith and the
Attack on Mercantilism and Economic
Nationalism
In 1776, Adam Smith published the first modern statement of

economic theory, An Inquiry into the Nature and Causes of the
Wealth of Nations
The Wealth of Nations attacked mercantilismthe system
of which dominated economic thought in the 1700s
Smith proved wrong the belief that trade was a zero sum
gamethat the gain of one nation from trade was the loss
of another
On the other hand Voluntary exchange (trade) is a
positive sum game both nations can gain
Theory of absolute advantage
Adam Smith ideas based on
The capability of one country to produce more

of a product with the same amount of input
than another country
(same thing) The ability of a country to produce
a good using fewer resources than another
country (lower opportunity cost)
Adam Smith argued:
A country should produce only goods where it is

most efficient . and trade for those goods
where it is not efficient
Trade between countries is, therefore, beneficial

destroys the mercantilist idea since there
are gains to be had by both countries party to
an exchange
questions the objective of national
governments to acquire wealth: through
restrictive trade policies
also measures a nations wealth by the living
standards of its people
TRADE BASED ON
ABSOLUTE ADVANTAGE
Consider this simple example involving the EU

and India
Only two products are produced, machines and
cloth
Labor is fixed, homogeneous within a country,
the only factor of production, and is fully utilized
Technology and production costs are constant
Transportation costs are zero and the countries
barter (trade) for goods
TRADE BASED ON
ABSOLUTE ADVANTAGE
One Person Per Day of Labor

Produces
Country Machines Cloth
EU 5 machines 10 yards of
cloth
India 2 machines 15 yards of

cloth
THE PRODUCTION POSSIBILITIES FRONTIER
AND CONSTANT COSTS
The Production Possibilities Frontier (PPF) is a

curve showing the various combinations of two
goods that a country can produce when all of a
countrys resources are fully employed and used in
their most efficient manner
One Person Per Day of Labor Produces
EU 5 machines 10 yards of cloth
India 2 machines 15 yards of cloth

Production Possibilities Curves for the United States and India
Machines
Cloth
10 15
EU
India
Cloth Mach
Cloth Mach
10 0
15 0
8 1
7.5 1
6 2
0 2
4 3
2 4
0 5
Opportunity Cost also known as Relative Price
India - Opportunity Costs EU - Opportunity Costs
Machine = 7.5 cloth Machine = 2 cloth

Cloth = 0.133 machine Cloth = 0.5 machine
Same graph, drawn more to scale!
What Determines the Slope of the PPC?

Slope = Machines/Cloth = Opportunity Cost of Machines
This slope is also known as the Marginal Rate of Transformation
Machines
EU: Slope = Opportunity Cost = -0.5
India: Slope = Opportunity Cost = -0.133

5
2
Cloth
10 15
Absolute Advantage: Production Conditions When
Each Country Is More Efficient in the
Production of One Commodity
EU workers are more productive in producing

machines
The EU has an absolute advantage in
machine production
Indian workers are more productive in

producing cloth
India has an absolute advantage in cloth
production
TRADE BASED ON
ABSOLUTE ADVANTAGE
Yes, maybe that was obvious to you from the
beginning

What does this mean?

What ???
Adam Smith: Wealth of Nations (again)

argued:
A country should produce only goods

where it is most efficient, and trade for
those goods where it is not efficient
Assume TWO Persons per day, so that each product can be fully produced
Two Persons Per Day of Labor Produces

EU 5 machines (and) 10 yards of cloth
India 2 machines (and) 15 yards of cloth
World Output 7 machines (and) 25 yards of cloth
This is a condition under Autarky: (The

complete absence of trade)
Under Autarky all nations can only

consume the goods they produce at
home
Assume TWO Persons per day, so that each product can be fully produced

However, if each country produces to their absolute advantage below

India 0 machines 30 yards of cloth .

.
TRADE BASED ON
ABSOLUTE ADVANTAGE
So there has obviously been an increase in World Output!!
Change in the Production of
EU +5 machines 10 yards of cloth
India 2 machines +15 yards of cloth
Change in World Output +3 machines +5 yards of cloth
.
TRADE BASED ON
ABSOLUTE ADVANTAGE
Both countries can benefit if trade

occurs
EU produces machines and exports them

to India
India produces cloth and exports it to the
EU


Now, suppose that the EU trades 3 machines to India for 12 yards of cloth?
.
India - Opportunity Costs EU - Opportunity Costs
Machine = 7.5 cloth Machine = 2 cloth

Cloth = 0.133 machine Cloth = 0.5 machine
World Price
Back to our opportunity costs (above) Trade will
occur at a trading price World Price which
will occur between these respective Relative
Prices Also called the Terms of Trade
P m
IND (7.5) P P (2)
W
m m
EU
P (0.5) P P
c
EU W
c c
IND (0.133) Look
Remember this graph?
Slope = Machines/Cloth = Opportunity Cost of Machines
This slope is also known as the Marginal Rate of Transformation
P (0.5) P P
c
EU W
c c
IND (0.133)
Machines
EU: Slope = Opportunity Cost = -0.5
India: Slope = Opportunity Cost = -0.133

5
Pw
2
Cloth
10 15
Introduction: The Gains from Trade
The improvement in national welfare (for

both countries) is known as the gains
from trade
One more quick example, just to be sure.
Output per Hour Worked
Output/hour worked
EU Canada
Bread 2 loaves 3 loaves
Steel 3 tons 1 ton
What are the EUs relative prices (opp. cost) Bread? Steel?
What are Canadas relative prices (opp. cost) Bread? Steel?
Who has absolute advantage in Bread?

Who has absolute advantage in Steel?
Given 2 working hours per country what is the maximum world output?
Implications of Adam Smiths Theory
Access to foreign markets helps create wealth

If no nation imports, every company will be limited by
the size of its home country market
Imports enable a country to obtain goods that it cannot

make itself or can make only at very high costs
Trade barriers decrease the size of the potential

market, hampering the prospects of specialization,
technological progress, mutually beneficial exchange,
and, ultimately, wealth creation
Adam Smith and Trade Barriers
Smith was highly critical of trade barriers (Tariffs,

Quotas, Subsidies)
Trade barriers decrease

- Specialization
- Technological progress
- Wealth creation
The modern view of trade shares Smiths dislike for

trade barriers
TRADE BASED ON
ABSOLUTE ADVANTAGE
Labor Theory of Value

Assumes that labor is the only relevant
factor of production
This implies that the pre-trade price of a
good is determined by the amount of labor
it took to produce it.
2-Country Scenario

Produces
U.S. 5 machines 15 yards of cloth
India 1 machine 5 yards of cloth
U.S. has an Absolute Advantage in both goods.

Production Possibilities Curves for the United States and India
Machines
Graphically obvious
U.S. has an Absolute Advantage in both goods.
1
Cloth
5 15
One country has Absolute Advantage
in BOTH goods
In this scenario, there is obviously no

opportunity to trade especially not for U.S.
NO No No!!! This is not correct. We need
to introduce the concept of:
Comparative Advantage
Comparative Advantage
Inability of a nation to produce a good more efficiently than other nations,
but an ability to produce that good more efficiently than it does any other
good David Ricardo
South Korea Sri Lanka
10 resource unit = 1/2 ton rice or 10 resource unit = 10/13.3 ton rice
1/4 ton tea or
1 ton tea
Specialization and trade allow each to
produce and consume more
Assumptions and Limitations
Nations strive only to maximize production and consumption
Only two countries produce and consume just two goods
No transportation costs of traded goods
Labor is the only resource used to produce goods and it cannot
cross borders
Specialization does not create efficiency and improvement gains
No difference in prices of resources in different countries
Theory of Comparative Advantage
David Ricardo: Principles of Political Economy (1817)
Extended free trade argument
Should import even if the country is more efficient in

the products production than country from which it is
buying.
Look to see how much more efficient. If only

comparatively efficient, then import.
TRADE BASED ON
COMPARATIVE ADVANTAGE
Why would trade occur if one country had an

absolute advantage in both goods?
Comparative Advantage is the ability of a country to

produce a good at a lower opportunity cost than
another country
We compare the degree of absolute advantage or

disadvantage in the production of goods
Comparative Advantage: U.S. More Efficient
in the Production of Both Commodities

Produces
U.S. has bigger Absolute Advantage in production of Machines
US - Opportunity Costs India - Opportunity Costs
1 Machine = 3 cloth 1 Machine = 5 cloth

1 Cloth = 0.33 machine 1 Cloth = 0.2 machine
TRADE BASED ON
The U.S. has a greater absolute advantage in

producing machines than is does in
producing cloth (5x more efficient in
machines only 3x more efficient in cloth)
Indias absolute disadvantage is smaller in
producing cloth than in producing machines
Thus the U.S. has a comparative advantage
in machines and India has a comparative
advantage in cloth
TRADE BASED ON
OPPORTUNITY COSTS
Even though U.S. has an absolute

advantage in both goods, India has a
comparative advantage in cloth production
Even if U.S. has an absolute advantage in
both goods, beneficial trade is possible
If both countries specialize according to
their comparative advantage, they both
can gain from this specialization and trade
Since we are dealing with Opp. Costs, we
will compare across 15 yards of cloth
One person Per Day of Labor Produces
Let us allow India to produce cloth up to the level that the U.S. can

U.S. 5 machines -15 yards of cloth
India (3 days) -3 machines (per) 15 yards of cloth
World Output +2 machines 0 cloth
.
TRADE BASED ON
Change in World Output Resulting from Specialization According to Comparative

Advantage
Change in the Production of
U.S. +5 machines 15 yards of cloth
India 3 machines +15 yards of cloth
Change in World Output +2 machines 0 yards of cloth

Trade in the Ricardian Model
(cont.)
A country can be more efficient in
producing both goods, but it will have a
comparative advantage in only one good.
Even if a country is the most (or least)
efficient producer of all goods, it still can
benefit from trade.
TRADE BASED ON
OPPORTUNITY COSTS
Unit Labor Costs in 24 Developing Economies for Selected Sectors,
2000 (Ratios relative to the U.S.)
Food Electrical Transport
Country Products Textiles Clothing Machinery Equipment
Argentina 1.95 1.28 0.64 2.11 1.78
Bolivia 0.61 0.76 0.65 1.00 1.34
Brazil 0.74 0.65 0.47 0.81 0.53
Chile 0.80 0.89 0.51 0.90 0.74
Columbia 0.62 0.66 0.47 1.01 0.97
Cote dIvoire 1.50 1.06 1.02 1.34 1.69
Ecuador 0.88 0.30 0.34 1.20 0.55
Egypt 1.45 1.21 0.38 1.10 0.71
Ghana 0.82 0.96 0.60 0.39 1.63
India 1.29 1.57 0.47 0.98 1.43
Indonesia 1.71 0.42 0.45 0.62 0.26
Kenya 1.31 2.20 0.96 0.74 3.34
TRADE BASED ON
OPPORTUNITY COSTS
Unit Labor Costs in 24 Developing Economies for Selected Sectors,
2000 (Ratios relative to the U.S.)
Food Electrical Transport
Country Products Textiles Clothing Machinery Equipment
Malaysia 1.08 0.59 0.84 1.01 0.69
Mexico 0.90 0.88 0.64 1.06 0.43
Morocco 1.61 1.38 1.05 1.49 0.92
Nigeria 0.29 0.80 0.11 0.56 0.04
Peru 1.02 0.62 0.46 0.95 0.50
Philippines 0.65 0.67 0.59 0.80 0..40
Korea 0.73 0.63 0.62 0.56 0.71
Taiwan 1.93 1.45 0.80 1.81 1.17
Thailand 0.92 0.87 1.07 0.65 0.41
Turkey 1.09 0.96 0.43 0.97 0.65
Uruguay 1.64 0.74 0.69 1.52 1.22
Venezuela 0.93 0.72 0.49 0.68 0.17
DYNAMIC GAINS FROM TRADE
Static Gains from trade are gains in word

output that result from specialization
and trade
Dynamic gains from trade are gains from
trade over time that occur because
trade induces greater efficiency in the
use of existing resources
Assumptions and limitations
Driven only by maximization of production
and consumption
Only 2 countries engaged in production and
consumption of just 2 goods?
What about the transportation costs?
Only resource labor (that too, non-
transferable)
No consideration for learning theory
Factor Proportions Theory
HeckscherOhlin Model Countries will export those goods that
make intensive use of factors that are locally abundant while
importing goods that make intensive use of factors that are locally
scarce
Labor Land and Capital
Two factor types

Leontief Paradox
Research
Researchfound
foundevidence
evidenceopposite
oppositeofofthat
thatpredicted
predictedby
bythe
the
factor
factorproportions
proportionstheory:
theory:
U.S. exports are more labor-intensive than U.S. imports
U.S. exports are more labor-intensive than U.S. imports
Possible explanations:
A country has a special advantage in
producing new goods made with
innovative technologies
Theory assumes nations production
factors to be homogeneous
Theory is better predictor when
expenditures on labor are considered
Product Life Cycle Theory
A company begins by exporting its product and later undertakes foreign
direct investment as a product moves through its life cycle Raymond
Vermon & Louis T. Wells
Source: Raymond Vernon and Louis T. Wells, Jr., The Economic Environment of International Business, 5th ed. (Upper Saddle River, N.J.: Prentice Hall, 1991), p. 85.
New Trade Theory
Fundamentals First-mover advantage
Gains from specialization Economic and strategic

and economies of scale advantage of being first to
Companies first to market enter an industry
create barriers to entry May create a formidable barrier
Government may help by to market entry for potential
assisting home companies rivals
National Competitive Advantage
Nations competitiveness in an industry depends on the industrys capacity to
innovate and upgrade, which in turn depends on four main determinants
(plus Government and Chance)
Factor conditions
Demand conditions
Related and supporting industries
Firm strategy, structure, and rivalry

Does Porters Theory Hold?
Government policy can
affect demand through product standards
influence rivalry through regulation and antitrust laws
impact the availability of highly educated workers and
advanced transportation infrastructure.
The four attributes, government policy, and chance
work as a reinforcing system, complementing each
other and in combination creating the conditions
appropriate for competitive advantage
So far, Porters theory has not been sufficiently tested to
know how well it holds up
What Are The Implications Of
Trade Theory For Managers?
1. Location implications - a firm should disperse its
various productive activities to those countries
where they can be performed most efficiently
2. First-mover implications - a first-mover advantage
can help a firm dominate global trade in that
product
3. Policy implications - firms should work to
encourage governmental policies that support free
trade
Industry Evolution Follows Common
Patterns
How do Industries grow and
become global?
Government Policies
International Trade Policies in the form of Tariffs (Ad valorem or Specific) on
Import, Subsidies to foster export, Quotas (mostly on import), Embargo,
Voluntary export restraint
Fiscal Policies (Tax rates and Government Spending)
Monetary Policies (CRR, SLR, Bank Rate, Credit Ceiling, Repo Rate and
Reverse Repo Rate)
SEZs
Contracting and Licensing
Bilateral Trading relationships and Free Trade Agreements
Entrepreneurs
Research and Consultancy Organizations
Religious Institutions
R&D or manufacturing improvement because of an International
Intelligence System
How do Industries grow and
become global?
Leadership Team (CEO & Board)
Proximity to Resources & Markets
Pursuit of New Technology
Changes in Customer Population, Demographics, Social
Preferences, Income & Consumption levels
Facilitating other Industries
Cultural Proximity
Investors
Telecommunication & Logistics Infrastructure
Growth Rate of Industry and GDP growth rate in domestic market
Herding
Customer adoption
Pankaj Ghemawat's three As of Global Strategy
Difference between Global Strategy and Corporate Strategy
Diversification across boundaries vis-a-vis across industries)
Countries continue to differ significantly in cultural beliefs, languages,
religions, legal institutions, rules of trade, and political systems
Three types of opportunities constitute Pankaj Ghemawat's three As
of Global Strategy: Adaptation, Aggregation, Arbitrage.
Adaptation is about modifying an existing business model to foster success in a foreign
environment. Ex: MTV, Pizza Hut, Kentucky, Fried Chicken
Aggregation is about performing a strategic activity in a centralized location, building
economies of scale, and selling the output of the activity to diverse foreign markets. Ex:
Hyundai Heavy Industries - Ship Building
Arbitrage is about recognizing that market failures occur when different national or
regional markets are connected. Such market failures can be exploited by locating
company activities where costs are lowest and selling the output of those activities
where valuation is highest.
AAA Strategies involve Trade-offs, but are not mutually exclusive
INTERNATIONAL STRATEGY AND THE
STRATEGY DIAMOND
Staging Arenas
When will we go Which geographic areas will we enter?
international? Which channels will we use in those
How quickly will we expand areas?
into international markets? Arenas
In what sequence will we Vehicles
implement our entry tactics?
Which international
Economic market-entry strategies
Staging Vehicles will we use? Alliances?
logic
Acquisitions? Greenfield
investments?
Differentiators
Economic logic Differentiators

How does our international How does being international make our
strategy lower our costs, raise products more attractive to our
the prices we can charge, or customers?
create synergies between our
business? 70
THE CAGE DISTANCE FRAMEWORK
Cultural distance Administrative distance Geography distance Economic distance
Attributes creating distance
Different languages Absence of colonial ties Physical remoteness Differences in consumer
Different ethnicities; lack Absence of shared Lack of a common border incomes
of connective ethnic or monetary or political Lack of sea or river access Differences in costs and
social networks association quality of
Size of country
Different religions Political hostility Natural resources
Weak transportation
Different social norms Government policies Financial resources
or communication links
Human resources
Institutional weakness Differences in climates Infrastructure
Intermediate inputs
Industries or products affected by distance Information or knowledge
Products have high Government involvement is Products have a low value-of- Nature of demand varies with
linguistic content (TV) high weight or bulk ratio (cement) income level (cars)
Products affect cultural in industries that are Products are fragile or Economies of standardization
or national identity of Producers of staple goods perishable (glass, fruit) or scale are important (mobile
consumers (foods) (electricity) phones)
Communications and
Producers of other
Product features vary in connectivity are important Labor and other factor cost
entitlements (drugs)
terms of size (cars), (financial services) differences are salient
Large employers (framing)
standards (electrical Local supervision and (garments)
Large suppliers to
appliances), or operational requirements are Distribution or business
government (mass
packaging high (many services) systems are different
transportation)
Products carry country- National champions (insurance)
specific quality (aerospace) Companies need to be
associations (wines) Vital to national security responsive and agile (home
(telecom) appliances )
Exploiters of natural
resources (oil, mining) 71
Subject to high sunk costs
(infrastructure)
Source: Recreated from www.business-standard.com/general/pdf/113004_01.pdf.
Institutional Voids
Absence of intermediaries to efficiently
connect buyers and sellers
Transaction Costs
Advanced Markets Credible Information Disclosure,
Enforceable Contracts, Market Intermediaries, and Market
Regulation
T. Khanna & K.G. Palepu
Emerging Markets
The term emerging markets was coined by economists at the International Finance Corporation
(IFC) in 1981, when the group was promoting the first mutual fund investments in developing
countries
Frequently used criteria for defining emerging markets

Category Criteria
Poverty Low- or middle-income country
Low average living standards
Not industrialized
Capital markets Low market capitalization relative to GDP

Low stock market turnover and few listed stocks
Low sovereign debt ratings
Growth potential Economic liberalization

Open to foreign investment
Recent economic growth
Source: Standard & Poors; International Finance Corporation; Trade Association for the Emerging Markets; J. Mark Mobius,
Mobius on Emerging Markets (London: Pitman Publishing, 1996), 623
Strategic choices for responding to
institutional voids in emerging markets
Replicate or adapt?
Compete alone or collaborate?
Accept or attempt to change market context?
Enter, wait, or exit?
Taxonomy of Market
Intermediaries
Credibility enhancers
Information analyzers and advisers
Aggregators and distributors
Transaction facilitators
Regulators
Adjudicators
OLI Theory
J.H. Dunning
Ownership (Brand Name, etc), Location (Labour, Raw
Materials, etc), and Internalization (Uppsala Model
Unsolicited Exports, Exports via agents, Opening Overseas
Sales Subsidiaries, Acquiring a Factory abroad, Building a
Greenfield Factory abroad) Advantages
Explains actions of MNCs from Developed
Economies runs into problems in explaining
the actions of firms from transforming
economies
Risks
Six sources Volume

of Profits Competitive
from advantage:
operations in Costs
emerging
markets Differentiation
Margin
Industry
attractiveness/
leverage
Uncertainty/
risk
Knowledge/
resources
5 M Framework
C.F. Fey; A.K.J.R. Nayak; and C. Wu
Motivations (Knowledge Seeking - Learning best practices, efforts to gain
market knowledge, actions to develop social and business networks, and the
applicability of unique home country capabilities - Obtaining Technology and Brands ,
New Market Seeking - Market size, Following the clients, entering adjacent
markets - Diversifying Risks, Efficiency Seeking - Cheaper resources like labor and
raw materials, lower tariffs, tax incentives, worldwide production synergies - Getting
Larger, Obtaining Raw Materials)
Markets (Smaller Cultural, Institutional, and Geographic distance,
Less Competition)
Modes (Modes for Entry leapfrog stages suggested by Uppsala
model)
Methods (Combat Negative Reputation effect, Acquire Foreign
Brands & Technology, Grow Quickly, Invest in R&D)
Management (Cultural Differences, International Staffing, Clear
Vision, Interaction with Subsidiaries)
Challenges of becoming Global
Management problems
Multinational are more complicated than domestic firms. Cross-
fertilization among national operations in product development,
production, and marketing many not materialize if
organizational complexity creates confusion
A firm's managers may not be suited to running a multinational
firm
Transferring intangible assets is often uncertain
Cultural diversity encountered when operating in several
countries may create communication, coordination, and
motivation problems
Inertia - Structural inertia may inhibit attempts to change
Ephemeral advantages
Expected benefits may be less real than apparent
Competitive advantages may erode, leaving a firm with the
costly and difficult to manage shell of a multinational structure.
Trade is enormous...
Trade in goods in 2007
$13,700,000,000,000
or $420,000 per second
Globalization has accelerated over the last 20 years
The volume of trade as a percentage of global GDP has more
than doubled since 1960
Economies by size of merchandize trade in 2013
Source: https://www.wto.org/ accessed on 25.05.2015

Economies by size in trade of Commercial Services in 2013

World merchandise trade and trade in commercial services, 2005-2015

How Do Governments Intervene In Markets?
Governments use various methods to intervene in markets including
(who suffers and who gains)
1. Tariffs
specific tariffs (unit)
ad valorem tariffs (proportion)
2. Subsidies (Cash grants, low-interest rates, tax breaks, and Govt Equity)
3. Import Quotas (US has a quota on cheese imports)
tariff rate quotas
quota rent (profit that suppliers make when supply is artificially limited)
4. Voluntary Export Restraints (US requesting Japan to limit export of cars)
Local Content Requirements (Specific fraction of a good be produced
domestically)
Administrative Polices (Informal Bureaucratic Rules Hollands Tulips to Japan)
Antidumping Policies or countervailing duties
dumping
Why the stress on free world trade?
The world economy went into a deep

depression in the 1930s, as many countries
closed their barriers to trade with other states.
This led to:
Mass unemployment
Social upheaval
Rise of fascism and the Second World War
How to prevent chaos
happening again?
Global powers set up bodies to support
international trade
International Monetary Fund
World Bank
All countries encouraged to join these
organisations, or face exclusion from benefits
of free world trade
Easing Trade Restrictions
Market access
Allows a country to retaliate against protectionism
Export expansion
Easier to gain an export license
Government responsible for exporter needs
Import relief
Offers assistance to companies impacted by
imports
What do the IMF and World Bank do?
IMF:
Lends to countries with balance
of payments problems
Pushes for economic reforms
Reports on policies in member states
World Bank:
Aims to help development by advising and lending
with many conditions
Countries encouraged to lift import and export
barriers, cut subsidies and remove price controls
Criticisms of IMF
IMF only lends money if countries agree to:
Sell their resources cheaply
Cut public spending
Critics say this serves to increase the problems
of poverty in poor member countries
Criticisms of World Bank
Loans depend on countries agreeing a Structural
Adjustment Programme
Leads to rapid increase in price of goods in country
Increases poverty
Lower investment and cut social spending
Little evidence that these policies work
What about the World Trade Organisation (WTO)?
The WTO deals with the rules of trade

between countries
It developed from the General Agreement on
Tariffs and Trade (GATT)
WTO agreements set the ground rules for
international commerce
GATT
The General Agreement on Tariffs and Trade (GATT) is a
multilateral agreement regulating international trade.
According to its preamble, its purpose is the "substantial
reduction of tariffs and other trade barriers and the elimination
of preferences, on a reciprocal and mutually advantageous
basis."
It was negotiated during the UN Conference on Trade and
Employment and was the outcome of the failure of negotiating
governments to create the International Trade Organization
(ITO).
GATT was signed in 1947 and lasted until 1993, when it was
replaced by the World Trade Organization in 1995. The original
GATT text (GATT 1947) is still in effect under the WTO
framework, subject to the modifications of GATT 1994.
WTO
Established : 1 January 1995
Created by : Uruguay Round negotiations (1986-94). Since 1948, the
General Agreement on Tariffs and Trade (GATT) had provided the
rules for the system
Deals with the rules of trade between nations at a global or near-
global level.
Its an organization for liberalizing trade. Its a forum for governments
to negotiate trade agreements. Its a place for them to settle trade
disputes. It operates a system of trade rules.
A total of 161 member countries along with 25 countries currently
negotiating their membership
In 2012, the WTO welcomed 4 new members: Montenegro, Samoa,
Russian Federation and Vanuatu
On 26 May 2015, Seychelles became the newest full member, joining
on 26 April 2015
WTO IS GATT PLUS
WTO covers areas well beyond GATT
Textile and Agriculture

Intellectual Property Rights
Services
Investment
WTOs 2013 Bali summit and India
Indias Public Distribution System and the recently legislated
National Food Security Act emerged as the most
contentious issues .
During his visit just before the Bali ministerial WTOs
Director General made critical comments on the NFSA
Attack also came from the US ambassador to the WTO.
India's concern: two issues
a) food subsidies
b) stockpiling of food grains
G33 proposal (Nov 2012) to amend AoA to support
developing nations
Indias National Food Security Act, 2013 (Right to Food
Act) - reflects the G-33 proposal
Indias stand on WTO
Contradiction between the WTO rule and United Nations
Millennium Development Goals to eradicate poverty and
hunger
In India, public stockholding is a livelihood issue- not a
matter for an external organisation like WTO to interfere
Finally agreed
Following G20 meeting in Brisbane (November 2014), India and
the U.S. reached an agreement on the food-stockpiling program,
enabling India to ratify Trade Facilitation Agreement (TFA)
U.S. agreed to give India more freedom to subsidise and
stockpile food to feed its people and support its farmers
Source: Big emerging countries at the WTO dispute settlement system (DSS): Overview of disputes
concerning BIC (Brazil, India, China), 26 March 2015 accessed on 27.05.2015
Structure of the World Bank
Headquartered in
Washington D.C.
Over 100 offices all over
the world
185 member countries
Membership of the IMF
is required
5 Largest shareholders:
France, Germany, Japan,
UK, and US
International Monetary Fund
Established in December 1946 to regulate the exchange rates and enforce
the rules of an international monetary system.
Initially had 29 members countries but has gone up to 184.
A public institution, established with money provided by taxpayers around
the world but reports to the ministries of finance and the central banks of
the governments of the world.
Lend to countries with persistent balance of payments deficits (or current
account deficits), and to approve of devaluations.
Loans were made from a fund paid for by members in gold and currencies.
Each country had a quota, which determined its contribution to the fund and the
maximum amount it could borrow.
Large loans were made conditional on the supervision of domestic policies by the IMF:
IMF conditionality.
Devaluations could occur if the IMF determined that the economy was experiencing a
fundamental disequilibrium.
Types of Integration
Free Trade Area
Customs Union
Common Market
Economic Union
Economic Integration
Bilateral and Trade Agreements
Trade agreements are either bilateral, involving two countries, or
multilateral. While some believe that bilateral free trade agreements
are a first step towards multilateral free trade, others point out that
bilateral trade agreements are discriminatory and lead to
fragmentation of the world trade system and decline of the
multilateral free trade.
Bilateral Trade is the exchange of goods between two countries.
Bilateral trade agreements give preference to certain countries in
commercial relationships, facilitating trade and investment between
the home country and the foreign country by reducing or eliminating
tariffs, import quotas, export restraints and other trade barriers.
Indias Bilateral Trade Agreements
India has bilateral agreements with the following countries and
blocs:
SAFTA (Bangladesh, Bhutan, the Maldives, Nepal, Pakistan, Sri Lanka
and Afghanistan)
AIFTA (ASEANIndia Free Trade Area)
European Union
Sri Lanka
Singapore
Thailand (separate from FTA agreement with ASEAN)
Malaysia (separate from FTA agreement with ASEAN)
Japan
European Free Trade Association (EFTA) (negotiation ongoing)
Canada (negotiation ongoing)
South Korea
Japan
Multilateral Trade Agreements
A multilateral trade agreement involves three or more
countries who wish to regulate trade between the nations
without discrimination.
They are usually intended to lower trade barriers between
participating countries and, as a consequence, increase the
degree of economic integration between the participants.
Multilateral trade agreements are considered the most
effective way of liberalizing trade in an interdependent global
economy.
World major RTAs
European Union (EU)
North America Free Trade Area (NAFTA)
ASEAN Free Trade Area (AFTA)
South Asian Association for Regional Cooperation (SAARC)
Gulf Cooperation Council (GCC)
MERCOSUR (South American Common Market)
1. To obtain economic benefits.
2. To pursue non-economic objectives
3. To ensure increased security of market access.
4.To improve members bargaining strength.
5.To promote regional infant industries.
6. Trade Diversion.
Different Modes of Entry
Entry strategies into foreign markets include:
Merely exporting a firms products into a foreign market,

possibly with the support of trade brokers
Licensing a firms production and marketing process, or asking

for royalties to be paid for the use of firms assets and resources
Franchising a firms 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
Strategic alliances and joint ventures with foreign firms

Trade-off between Risk and Control
Risk Equity - Based
Modes
International JVs
Wholly owned
subsidiaries
oBrownfield
oGreenfield
Contract Based Modes
Licensing
Franchising
Contract Manufacturing
Turnkey Operations
Management Contracts
Export Based
Modes
Direct Exporting
Indirect Exporting
Control
Forms of FDI: Ownership
Home Country Host Country

Green Field
100% Owned
New Entity
Full Acquisition
(i.e., 100%)
MNE Local Firm

Partial Acquisition
(e.g., 50%) Ownership = (1 - s)%
Ownership = s%
Joint Venture
Complementarity of Resources
Value Chain MNEs
Component Resources Local Firms Resources
R&D Innovative Imitating
capabilities capabilities
Production Advanced Older technology
technology and and know-how
know-how
Marketing & Sales Industry-specific Country-specific
marketing marketing
Organization expertise expertise
structure and Global Best Country specific
systems Practices organization skills
Common Market Entry Modes
HOME COUNTRY HOST COUNTRY
Licensing
Acquisition
MNE Local Firm
Export
Joint Venturing Joint Venture

Company
Green Field Entry
New Subsidiary
Company
CHOICE OF ENTRY MODES
Choice of entry
mode
Equity (FDI)
Non-equity
modes
modes
Contractual Alliances and Wholly owned

Exports
agreements joint ventures (JVs) subsidiaries
Licensing/ Greenfield
Direct exports Minority JVs
franchising investments
Indirect exports Turnkey projects 50/50 JVs Acquisition
Others Contracted R&D Majority JVs Others
Strategic alliances
Comarketing
(within dotted areas)
Source: Adapted from Pan, Y. and D. Tse, The Hierarchical Model of Market Entry Modes, Journal of International Business Studies, 31 (2000),
535-545
Going it Alone: Export
Revenues
MNE Customers
Export of Goods
Going it Alone: Export
Advantages Disadvantages
Low initial investment Potential costs of trade
Reach customers quickly barriers
Transportation cost
Complete control over
Tariffs and quotas
production
Foregoes potential location
Benefit of learning for
future expansion economies
Difficult to respond to
customer needs well
When Is Export Appropriate?

Low trade barriers
Home location has cost advantage
Customization not crucial
A Foreign Target Market
Home country or third Country B
Border C
Produ Sales and
R&D Export
ction service buying Indirect
agent export
A Rider B
C
Product Marketing Sales and Bs international sales
R&D Piggyback
ion service organization
A
B C
Direct
Product
R&D Marketing Sales and Agent, export
ion
service distributor
A1
Producti
R&D
on
B
C
A2
Export Cooperative
Sales and
Product Marketing export
R&D service marketing
ion
group (with
a local agent
A3 of B
Product
R&D
ion
Export Modes
Note: A1, A2, A3, A are n=manufactures of products /services
B: is an independent intermediary/(agent)
C: is the customer
Licensing Agreement
Licensing of Technology
MNE Local Firm
Fees and Royalties

Licensing Agreement
Low initial investment Lack of control over operations
Avoids trade barriers Difficulty in transferring tacit
Potential for utilizing knowledge
location economies Negotiation of a transfer price
Monitoring transfer outcome
Access to local knowledge
Potential for creating a
Easier to respond to
customer needs competitor
When is Licensing Appropriate?

Well codified knowledge
Strong property rights regime
Location advantage
Foreign Acquisition
Investment
MNE Local Firm
Profit
Foreign Acquisition
Access to targets local Uncertainty about targets
knowledge value
Control over foreign Difficulty in absorbing
operations acquired assets
Control over own Infeasible if local market for
technology corporate control is
underdeveloped
When is Acquisition Appropriate?

Developed market for corporate control
Acquirer has high absorptive capacity
High synergy
Going it Alone: Green Field Entry
MNE
Profit
Investment New Subsidiary

Company
Going it Alone: Green Field Entry
Normally feasible Slower startup
Avoids risk of Requires knowledge of
overpayment foreign management
Avoids problem of High risk and high
integration commitment
Still retains full control
When is Green Field Entry Appropriate?

Lack of proper acquisition target
In-house local expertise
Embedded competitive advantage
Management Contract
Management Fees
MNE Local Firm
Managerial
Profit Service
Technological Inputs
Wholly-Owned
Subsidiary
Management Contract
Access to local management Potential incentive problem
skills Potential adverse selection
Avoids buying unwanted problem
assets How do you know the
Retains strategic control competencies of the
manager?
When is a Management Contract Appropriate?

Manager has a reputation to protect
Hotels
Consulting companies
Performance-based contract provides no perverse incentives
Joint Venture
MNE Local Firm

Share of
Inputs
Profit
Inputs Joint Venture
Company
Share of Profit
Joint Venture
Access to partners local Potential loss of proprietary
knowledge knowledge
Reduction of concern about Potential conflicts between
overpayment partners
Both parties have some Neither partner has full
performance incentives performance incentive
Significant control over Neither partner has full
operation control
When is a Joint Venture Appropriate?

Both partners contribute hard-to-measure inputs
Large expected mutual gains in the long-run
Trade secrets can be walled off
Going International
E-commerce: Offering goods and services over the Web:
Corporate websites.
B-to-C and C-to-B forums.
Firms must:
Provide 24-hour order taking and customer support
service (often outsourced)
Have the regulatory and customs-handling expertise to
deliver internationally.
Understand global marketing environments for further
development of business relationships.
Framework for Mode of Entry Decision
Exporting Contractual Joint Acquisition Greenfield
Agreement Venture Investment
Risk Low Low Moderate High High
Return Low Low Moderate High High
Control Moderate Low Moderate High High
Integration Negligible Negligible Low Moderate High
Source: V. Kumar and V. Subramaniam, A Contingency Framework for the Mode of Entry Decision, Journal of World
Business, vol. 32 (1), 1997, pp. 53-72.
Evaluating the Alternate Modes of Entry Decision
Contractual
Agreement
(Licensing or Joint Greenfield
Criteria Weight Exporting Franchising or Acquisition
Venture Investment
Management
Contract or
Turnkey)
Risk
Return
Control
Knowledge
Investment
Ease of
Implementation
Integration
Overall Score 1
Advantages and Disadvantages of Different
Modes of Entry
Entry Mode Advantage Disadvantage
Wholly Enables global strategic High costs and risks
owned coordination Requires overseas
subsidiaries Protects technology management skills
Realizes (potentially) location May be slower to implement
and experience economies
International Gives access to local partner's Loss of control over
Joint knowledge technology and managerial
Ventures Allows sharing of development know-how
costs and risks May impede global
May be more politically coordination
acceptable than 100% foreign May make realization of
ownership location and experience
Allows foreign parent do economies more difficult
deploy resources across more Sharing of profit "pie"
national markets at once
International Similar to international joint May be more difficult to
Strategic ventures manage than international
Alliances joint ventures
Entry Mode Advantage Disadvantage
Franchising Low financial risk Lack of direct control over quality
Relatively low Successful international franchising
development costs requires considerable start-up and
ongoing presence overseas (cost)
Is likely to impede, make global
coordination costlier than ownership
Growth may be slower depending
on franchisee's intentions
Sharing of profit "pie"
Possible loss of know-how to
potential competitor
Licensing Similar to franchising Similar to franchising
Fewer "maintenance"
costs than franchising
Exporting Ability to realize Transport costs
experience curve Trade barriers
economies Motivation of local agents a
challenge
All factors affecting decision
Home country or third Country Foreign target market
Border
B
Prod
A uctio
n
Market Sales and C
Contract
R&D
ing service Manufacturing
A Licensor B Licensee
R&D Produ Mar Sales and

ction ketin service C Licensing
g
A Franchisor B Franchisee
Marke Produ Sales and
R&D ction C Franchising
ting service
A Upstream specialist
R&D Produ A+B (e.g. a joint
ction venture) C
B Downstream specialist Produ Market Sales and X Coalition
R&D
ction ing service
Marke Sales and
ting service
R&D Produ Market Sales and

ction ing service A+B (e.g. a joint venture)
R&D Produ Market Sales and C Y Coalition

B ction ing service

ction ing service Intermediate Modes
Note: A is the manufacture, B: is the partner and C: is the customer

Mode of Entry in international Business
Foreign target market
Home country or third Country Border
Domestic-based sales
Prod Market Sales and
R&D Direct to customer C representatives/
uctio ing service
n manufactures own
Sales force
R&D Produ Marketi Sales and Resident sales
ction ng C
service representatives/ sales
subsidiary/ sales branch
Marke Prod Sales and

R&D uctio C Sales and production
ting service
n subsidiary
R&D Produ Marke Sales and

ction ting service
C Region centre
(two variants
Prod Mark Sales and
R&D
uctio eting service
n
Corporate identity (image), personnel

ction ing service
Prod Market Sales and C Transnational
R&D organization
uctio ing service
n (Globally integrated)
Common R&D, finance Hierarchical modes

Note: C: is the customer
Advantages and Disadvantages of Different Modes of Entry
Mode Primary Advantage Primary Disadvantage
Exporting Relative low financial exposure Vulnerability to tariffs and NTBs
Permit gradual market entry Logistical complexities
Acquire knowledge about local market Potential conflicts with distributors
Avoid restrictions on foreign investment
Licensing Low financial risk Limited market opportunity/profits
Low-cost way to assess market potential Dependence on licensee
Avoid tariffs NTBs restrictions on foreign Potential conflicts with licensee
investment
Licensee provides knowledge of local market Possibility of creating future
competitors
Franchising Low financial risk Limited market opportunity/profits
Maintain more control than with licensing Dependence on franchisee
Franchisee provides knowledge of local May be creating future competitors
market
Low-cost way to assess market potential Potential conflicts with franchisee
Avoid tariffs, NTBs, restrictions on foreign
investment
Advantages and Disadvantages of Different Modes of Entry
Mode Primary Advantage Primary Disadvantage
Contract Low financial risk Reduced control (may affect quality,
Manufacturing delivery schedules, etc.)
Minimize resources devoted to Reduce learning potential
manufacturing
Focus firms resources on other elements of Potential public relationship
the value chain problems-may need more
monitor working conditions, etc.
Management Focus firms resources on its area of expertise Potential return limited by contract
contract conflicts with licensee
Minimal financial exposure May unintentionally transfer
proprietary knowledge and
techniques to contractee
Turnkey project Focus firms resources on its area of expertise Financial risk (cost over runs, etc.)
Avoid all long-term operational risk Construction risks (delays, problems
with supplies, etc.)
Foreign Direct High profit potential High financial and managerial
investment Maintain control over operations investments
Acquire knowledge of local market Higher exposure to political risk
Avoid tariffs, NTBs Vulnerability to restrictions on
foreign investment
Greater managerial complexity

International Business

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International Business

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History of International Business

The First Trade Regulations

17th Century mercantilism/colonialism

The theory that a country should

A nations wealth depends on accumulated

Two means of increasing a countrys wealth are

Forbidding colonies to trade with other nations

impaired economic growth

South Korea Sri Lanka

10 resource unit = 1 ton rice or 10 resource unit = 1/2 ton rice or

Specialization and trade allows each to

In 1776, Adam Smith published the first modern statement of

Adam Smith ideas based on

The capability of one country to produce more

Adam Smith argued:

A country should produce only goods where it is

Trade between countries is, therefore, beneficial

Consider this simple example involving the EU

One Person Per Day of Labor

India 2 machines 15 yards of

The Production Possibilities Frontier (PPF) is a

One Person Per Day of Labor Produces

Country Machines Cloth

EU 5 machines 10 yards of cloth

India 2 machines 15 yards of cloth

Country Machines Cloth

EU 5 machines 10 yards of cloth

India 2 machines 15 yards of cloth

Production Possibilities Curves for the United States and India

Machine = 7.5 cloth Machine = 2 cloth

What Determines the Slope of the PPC?

This slope is also known as the Marginal Rate of Transformation

EU: Slope = Opportunity Cost = -0.5

India: Slope = Opportunity Cost = -0.133

EU workers are more productive in producing

Indian workers are more productive in

One Person Per Day of Labor Produces

What does this mean?

Adam Smith: Wealth of Nations (again)

A country should produce only goods

Two Persons Per Day of Labor Produces

This is a condition under Autarky: (The

Under Autarky all nations can only

Two Persons Per Day of Labor Produces

However, if each country produces to their absolute advantage below

Two Persons Per Day of Labor Produces

India 0 machines 30 yards of cloth .

So there has obviously been an increase in World Output!!

Change in the Production of

Country Machines Cloth

EU +5 machines 10 yards of cloth

India 2 machines +15 yards of cloth

Change in World Output +3 machines +5 yards of cloth

Both countries can benefit if trade

EU produces machines and exports them

Two Persons Per Day of Labor Produces

India 0 machines 30 yards of cloth

Machine = 7.5 cloth Machine = 2 cloth

Slope = Machines/Cloth = Opportunity Cost of Machines

This slope is also known as the Marginal Rate of Transformation

EU: Slope = Opportunity Cost = -0.5

India: Slope = Opportunity Cost = -0.133

The improvement in national welfare (for