International Business 200 - Exam 1

National Differences in Political Economy

- Political, economic, and legal systems differ greatly

- Political systems are moving towards individualism

- Economic systems are moving towards market-based approaches

Economic Systems

Market, command, and mixed

Market (Economic System)

- Productive activities are privately owned

- Supply and demand focused

Command (Economic System)

- Goods and services, as well as their prices, are controlled by the government

Mixed (Economic System)

- Reflective of most, government takes some control if/as needed

Legal Systems

Common law, civil (code) law, and theocratic law

Common Law

Derived from custom judicial precedent rather than statute

EX: Marriage in a common law system is done by a mutual relationship and understanding, rather than a civil or traditional ceremony

Civil (Code) Law

Legal system with a prevalent feature of having it's core principles codified into a referable system, serving as the primary source of 'law'

Theocratic Law

The God's or deity's laws being interpreted by the ecclesiastical authorities, or people appointed due to their divine nature, such as priests

Legal Barriers

- Many exist in international business

- Pricing, distribution, promotion, financing, and labeling restrictions

- How much pepperoni has to be on a 'pepperoni' pizza?

- English words are restricted in French Marketing

- Islamic nations don't allow for traditional financing because interest is seen as evil

Contract Law

- Specifies conditions under which an exchange will happen, as well as rights and obligations

- Disputes that can't be resolved between parties on their own need to be resolved based on one of their legal systems, but which one? By who? Traditional, mediated, or arbitrated? Find a 3rd country?

Property Rights

- Resources, including land, buildings, intellectual property

- Use of resources, use of income from said resources

- Enforcement issues with property rights

1.) You can sell or transfer

2.) You can hide or destroy it

3.) You can use it/the resource for pleasure, income

Intellectual Property

Patent: inventors' exclusive rights to manufacture, use, sell an invention

Copyright: same for authors, composers, artists, publishers

Trademark: unique design, name, officially registered

- Even though patented in one country, may not be in another

Public Action and Corruption

- US Foreign Corrupt Practices Act (FCPA) covers accounting transparencies and bribery of foreign officials. Controversial because:

1.) Limits competitiveness in forcing countries if they don't have the same laws

2.) Broad definition of 'US Company'

3.) Describes bribes a certain way but allows other things that are bribery but not defined as such (allows for 'small and infrequent payments' to push things through customs)

- Public actions that violate property rights: Legally (eminent domain) and illegally (corruption)

Education (Driver of Globalization)

- Drives income up, interest in more expensive products and a greater amount of them increases as well

Political Economy (Driver of Globalization)

- Privatization

- Growth in property rights, including intellectual property protection

- Growth of multinational trading frameworks and diminishing restrictions on trade and investment flows (lower tariffs lead to lower prices)

- 'Open economies' allow businesses and trade to expand

Shrinking Globe: Complex Webs and Consequences

- Cocoa farmers haven't tasted chocolate, chocolate producing countries don't recognize cocoa

- Workers assembling iPhones can't afford the product

- 'Dry' states in India produce wine

(Globalization 1.0) Thomas Friedman, The World is Flat

1492-1800

- 'Countries and muscles' drove globalization

- Military force drove global integration (often inspired by religion or imperialism, or a combination of both)

Globalization 2.0

1800-2000 (interrupted by Great Depression)

- Multinational corporations drove global integration

- Technology innovation in hardware enabled pursuit of new markets (steamships, railroads, telephones)

- Breakdown of Soviet system symbolized the end of this period of globalization as the 'walls fell down'

Globalization 3.0

2000-present

- Shrinking the world from a small size to TINY size

- Individuals (not countries or corporations) are primary force driving globalization

- Software (not hardware or muscles) facilitate new power of individual entrepreneurship

- Global fiber-optic network allows individuals to connect seamlessly (call centers, radiologists, accountants)

3 BILLION New capitalists

- 1.0 and 2.0 driven primarily by European and Americans

- 3.0 driven by non-westerners

- Globalization is the primary force shaping the 21st century

- Nations, companies, and individuals need to adapt to these new realities if they want to prosper

If the world is flat.. then who is 'us'?

- What does it mean to be 'American'?

- Should US jobs be protected over those in other countries?

- Should US companies receive benefits that foreign companies do not?

-Should consumers favor US products?

Globalization and Firm Strategy

- Profit determined by the amount of value customers place on firm's goods or services and the firm's cost of production

- Firm creates profit by increasing value or lowering cost

- 2 basic strategies to create value and attain competitive advantage are LOW COST and DIFFERENTIATION strategies

Location Economies

- Realized by performing a value creation activity in an optimal location anywhere around the globe (rather than being popular because it is made somewhere, popular because a country's name is on it)

- Often arise due to differences in costs and endowments

- Can lower costs of value creation to enable low cost strategy and/or help in differentiation of products from competitors

- Global Web: different stages of value chain are dispersed to those locations where perceived value is maximized or costs of value creation are minimized

Global Integration of Fragmentation?

Getting flatter... (growing integration and technology) ...but still quite bumpy (community, culture, security, and non-market forces keep us apart).

Mercantilism (Trade Theory)

1500-1800

- A country will gain wealth when exports>imports

- Goals to earn gold and silver, to have a trade surplus, maximize exports through subsidies, and limit imports through tariffs and quotas

- 'Zero-sum game'

David Hume on Mercantilism

Is maintaining a trade surplus feasible?

- Increased wealth (gold) and increased exports ultimately leads to growth, inflation

-Imports keep inflation low

- Results in an exporter becoming an importer because of changes in relative prices

- NO one can keep a trade surplus

Comparative Advantage (Ricardo)

Problems with assumptions: the world does not consist of two countries and two goods; no transportation costs assumed; resources are mobile between goods and countries, but not across countries; constant returns to scale

New Trade Theory

1970s

- Deals with the returns on specialization where substantial economies of scale are present

- Specialization increases output and ability to enhance economies of scale increase

- Typically requires industries with high, fixed costs

- World demand supports few competitors

Today's Thinking (Trade Theory)

- Competition on cost and value basis - What macro level factors help countries compete on a cost and value basis?

- Importance of location for strategic positioning

Innovation is key, especially as technological change in countries like China and India is happening faster than developed economies can cope with

- The role of the government once again seems important for governance, infrastructure, policies

Renewing the Case for trade

- Trade is a general win-win, but there are losers in the short term

- Benefits from trade come down to a gain in annual income per household of $10,000, higher wages, lower prices, and better choices.

- but, technologies are replacing human jobs and once production jobs are extinguished, they aren't replaced

Challenging Popular Nations

'We should take care of our own before helping people elsewhere'

- But US is a leading recipient of FDI

'Globalization is a race to the bottom for wages'

- Why aren't these economies already rich, and do we want to prevent them from growing themselves wealthy?

Why is free trade not completely free?

- Taxation, national defense, retaliation, infant industry, unemployment, corporate lobbying

- Strategic trade: desire for industrialization/agriculture, balance of payments, diversification, foreign policy

Costs of Protectionism

- Consumers: higher cost and less choices

- Workers: in the short term can help, but in the long term can effect their insulation from foreign businesses

- Government: makes government look 'good' for protecting jobs and business, but in the long term it can deflate economic growth

- Foreign Business: meant to hurt foreign business and help domestic

Tariffs (1/7 Instruments of Trade Policy)

Specific: fixed charge per unit

Ad Valorem: charge is proportion of the goods value

Compound: combines the two

Oldest form of protection

+ Good for government and producers

- Bad for consumers, leads to inefficiency

Subsidies (1/7 Instruments of Trade Policy)

- 'To level the playing field'

- Direct: payments to reduce costs

- Indirect: tax breaks, loans, public/private partnership, insurance

Import Quotas/Voluntary Export Restraints (1/7 Instruments of Trade Policy)

Quotas: direct restriction on the quantity of a good that can be imported into a country

VERs: quota on trade imposed by the exporting country at the request of the importing country's government

Hurts consumers, helps producers by raising domestic prices of imported goods (and possibly domestic goods)

Local Content Requirements (1/7 Instruments of Trade Policy)

- Requires a fraction of a good to be produced domestically in exchange of lowering trade barriers (% of components or value)

- Initially used by developing countries to help shift from assembly to production of goods

- US beginning to implement

"Buy Local" Legislation (1/7 Instruments of Trade Policy)

- Government purchased or influenced bodies give preference to domestically made goods or services (EX: Fly America Act)

- Sometimes legislate preferences for domestic goods

-EX: requiring fuel to be blended with ethanol and requiring a tariff on imported ethanol, encouraging local production

Administrative Policies (1/7 Instruments of Trade Policy)

- Legal and procedural barrier designed to make it difficult for imports to enter a country

-EX: Customs formalities: 1.) tulip bulbs in Japan (there was an environmental 'scare' for imported tulips, had to cut them open and check for bugs). 2.) Japan wanted to 'protect culture' so had to open ever package from FedEx to make sure there wasn't porn

Antidumping Policies (1/7 Instruments of Trade Policy)

Dumping: selling goods into a foreign market below production cost or below 'fair market value'

- Used to unload excess production or institute predatory pricing

- Used to protect local industry from 'unfair practices'

How US Trade Policy is Established

- President: US Trade Representative, Department of Commerce

- Congress: Trade Promotion Authority

Balance of Payments

- BOP accounts for a country's international transactions for a calendar year, includes Current and Financial Accounts

BOP Accounting

- Double Entry system

- Positive (+) transactions on the CURRENT account are results of payments FROM FOREIGNERS (incoming money)

- Merchandise exports

- Service Exports

- Transportation and travel receipts from foreigners

- Income received from investments abroad

- Gifts received from foreign residents

- Aid received from foreign governments

- Positive (+) transactions on CURRENT account reflected oppositely on FINANCIAL account

Current Account Surplus

- Exports > Imports

- Unsustainable because high export volume brings you a high influx of cash which diffuses the power of your dollar in the market place, prices within your country rise, causing your stock to rise, causing your economic productivity to increase. Your currency becomes worth more, making it harder to export because your prices climb higher, so other countries tend not to look to you for products. You become wealthier and wealthier, desiring more lavish goods from foreigners, causing you to import more and export less, and consequently closing your surplus gap.

Current Account Deficit

- Imports > Exports

- Unsustainable because you are spending more money than you have (on imports), so you are borrowing from other countries to fund your debt. The next year, you accrue a percentage of interest on that loan, and so on and so on. Eventually, you become too risky of an investment for other countries because your debt keeps climbing, so they are less likely to lend to you, or they will do so at a higher interested rate. The value of your currency then falls, you import less because it is more expensive to do so, you export more because your prices are attractive to foreign countries, and your deficit balances out.

Would a government rather have a current account deficit or surplus?

- Surplus

- Deficit is more worrisome because you owe interest each year on your payments

Federal Direct Investment (FDI)

- Involves ownership of entity abroad for production, marketing, service, or raw materials

- Parent has managerial control, depending on the extent of ownership and contractual terms

- At least 10% ownership

Merger and Acquisition (Type of FDI)

- Purchasing of a competitor's existing assets

- Quick entry, local market know how, local financing possible, and eliminate competitor

- Can inherit problems

- EX: Tata Motors buying Land Rover and Jaguar

New Interest/Greenfield (Type of FDI)

- No local entity exists or is available for sale, so you develop your own

- Local financing incentives may encourage, no inherited problems, long lead time to generation of sales or any outcomes

Horizontal FDI

- FDI in the same industry as the firm that currently operates in said industry at home

EX: Automaker in one country buys out an automaker in another

Vertical FDI

Forward: Acquiring a distributer that distributes your products abroad (though made domestically)

EX: Nutella buys a warehouse within the US to distribute their Nutella product, even though it is produced outside of the US

Backward: Acquiring a manufacturer that provides inputs for a firm's domestic production process from outside of the host country

EX: Nutella buys a Hazelnut farm in another country and imports the harvested nuts solely for the use of Nutella production

FDI Pros and Cons

- Circumvents potential future trade barriers and transportation costs

- Keeps up with competition

- Closer to customers

- Control of industry

... but expensive and risky compared to exporting or licensing

Host Country Effects of FDI (Thailand hosting John Deer Plant)

Benefits: resource transfer (brings the brands and knowledge, equipment practice, analytics), employment, BOP increases exports (due to the price being lowered so far)

Costs: capital inflow followed by capital outflow + profits, potential production input importation, threat to national sovereignty and autonomy, loss of economic independence

Home Country Effects of FDI

Benefits: adverse BOP current accounts effects mitigated by inward flow of foreign earnings, positive employment effect from increased exports of raw materials or assemblies to the overseas subsidiary

Costs: BOP trade position is negatively affected, loss of employment to overseas market

Government Policy for FDI

Radical: inbound FDI is harmful, instrument of imperial domination, exploit host to the advantage of home country, extract profits from host country and give nothing back

Free market: FDI is encouraged, increases economic efficiency because its brings to bear unique ownership advantages on the local economy's comparative advantages and resource transfers, increases purchasing power,

Regional Economic Integration

- Agreements among nations to reduce tariff and non-tariff barriers to free flow of goods, services, and factors of production

- Economic and political arguments for and against

Reasons For/Against Regional Integration

- Economic enhancement of the member states through free trade and more attractive FDI

- Politically link economies to each other and create interdependencies that reduce the potential for violent conflict or instability, grouping gives countries more political clout world-wide

- Impediments: painful adjustments in certain segments of economy, threats to national sovereignty

Levels of Regional Economic Integration

- The level that follows the past combines all of the past steps as well

Free Trade Area: removes trade barriers among members, but members retain own trade policies towards others (different outgoing and incoming tariffs)

Customs Union: allows common trade policy toward others (same tariffs between countries)

Common Market: factors of production can move freely between members

Economic Union: allows full integration of member economies (common currency, common monetary and fiscal policy, harmonization of taxes)

Political Union: coordinates integration of economic, social, and foreign policy

Is NAFTA working?

- Positive increase in trade (300% since inception)

- Shift in some jobs in Mexico (maquiladoras generate significant employment and tax earnings for Mexico, significant increase of US FDI in Canada and Mexico)