Trade Policies and Foreign Direct Investment Overview

Free trade

The absence of barriers to the free flow of goods and services between countries.

General Agreement on Tariffs and Trade (GATT)

International treaty that committed signatories to lowering barriers to the free flow of goods across national borders and led to the WTO.

Trade policy instruments

Uses 8 main instruments: tariffs, bans, subsidies, import quotas, voluntary export restraints, local content requirements, administrative policies, and antidumping duties.

Import tariffs

A tax levied on imports of goods or services. Pro-producer and anti-consumer. Reduce the efficiency of the world economy because it encourages firms to produce at home.

Specific tariffs

A tariff levied as a fixed charge for each unit of good imported.

Ad valorem tariffs

A tariff levied as a proportion of the value of an imported good.

Export tariff

A tax placed on the export of a good. Discriminate against exporting in order to ensure there is sufficient supply of a good within a country.

Export ban

A policy that partially or entirely restricts the export of a good.

Subsidy

Government financial assistance to a domestic producer. Take many forms like cash grants, low-interest loans, tax breaks, and government equity participation.

Import quota

A direct restriction on the quantity of a good that can be imported into a country.

Tariff rate quota

Lower tariff rates applied to imports within the quota than those over the quota.

Voluntary export restraint (VER)

A quota on trade imposed from the exporting country's side, instead of the importer's; usually imposed at the request of the importing country's government.

Quota rent

Extra profit producers make when supply is artificially limited by an import quota. Supply goes down, price goes up.

Local content requirement (LCR)

A requirement that some specific fraction of a good be produced domestically.

Administrative trade policies

Administrative policies, typically adopted by government bureaucracies, that can be used to restrict imports or boost exports.

Dumping

Selling goods in a foreign market for less than their cost of production or below their 'fair' market value.

Antidumping policies

Designed to punish foreign firms that engage in dumping and thus protect domestic producers from unfair foreign competition.

Countervailing duties

Antidumping duties.

Austerity

Cutting government spending.

Infant industry argument

New industries in developing countries must be temporarily protected from international competition to help them reach a position where they can compete on world markets with the firms of developed nations.

Strategic trade policy

Government policy aimed at improving the competitive position of a domestic industry and/or domestic firm in the world market.

Reasons for government intervention

Political or economic reasons including protecting jobs and industries, national security, retaliating, consumer safety, furthering foreign policy objectives, and human rights.

Smoot-Hawley Act

Enacted in 1930 by the U.S. Congress, this act erected a wall of tariff barriers against imports into the United States.

WTO

Where we go to settle disputes with trade.

Antidumping Policies

Policies aimed at preventing the sale of products at prices lower than their normal value.

Protectionism in Agriculture

Government actions and policies that restrict international trade to support domestic industries.

Protection of Intellectual Property

Legal rights that provide creators protection for their inventions, designs, and artistic works.

Market Access for Nonagricultural products

Tariff reduction aimed at improving the ability of nonagricultural products to enter a market.

Bilateral or Multilateral Trade Agreements

Reciprocal trade agreements between two or more partners.

Foreign Direct Investment (FDI)

When a firm invests directly in facilities to produce or market a good or service in a foreign country.

Multinational Enterprise

An entity that has 10% or more in a foreign investment.

Flow of FDI

The amount of foreign direct investment undertaken over a given time period (normally one year).

Stock of FDI

Total accumulated value of assets owned by firms domiciled in a nation outside of that nation's borders at a given time.

Outflows of FDI

Flow of foreign direct investment out of a country.

Inflows of FDI

Flow of foreign direct investment into a country.

Reasons for Growth of FDI

Decline of trade barriers, political and economic changes in developing nations, globalization of the world economy, and desire to have production facilities near major customers.

Greenfield Investment

Establishing a new operation in a foreign country.

Acquiring and Merging

Acquiring and merging with an existing firm in the foreign country.

Platform FDI

Buying a Japanese restaurant for a company owned by Japan that wants to leave the US because it doesn't like US food.

Eclectic Paradigm

Argument that combining location-specific assets or resource endowments and the firm's own unique assets often requires FDI.

Exporting

Sale of products produced in one country to residents of another country.

Licensing

Occurs when a firm (the licensor) licenses the right to produce its product, use its production processes, or use its brand name or trademark to another firm (the licensee).

Royalty Fee

Fee collected by the licensor on every unit the licensee sells.

Internalization Theory

Marketing imperfection approach to foreign direct investment.

Lean Production

Producing higher quality products at a lower cost than global rivals.

Market Imperfections

Imperfections in the operation of the market mechanism.

Market Failure

Occurs when one or more of the following conditions holds: when the firm has valuable know-how that a licensing contract cannot adequately protect, when the firm needs tight control over a foreign entity to maximize its market share and earnings in that country, or when a firm's skills and know-how are not amenable to licensing.

Oligopoly

An industry composed of a limited number of large firms.

Multipoint Competition

When two or more enterprises encounter each other in different regional markets, national markets, or industries.

Location-specific Advantages

Advantages that arise from using resource endowments or assets that are tied to a particular foreign location and that a firm finds valuable to combine with its own unique assets.

Externalities

Knowledge spillovers.

Pragmatic Nationalism

A stance between a radical position that is hostile toward all inward FDI and a noninterventionist principle of free market, where policy is based on cost vs benefits.

Radical View (Marx)

The perspective that multi-national enterprises exploit host nations for the benefits of the home nation, viewing FDI by MNE as an instrument of imperialism.

Free Market View

The belief that international production among countries should be based on comparative advantage, increasing overall efficiency of the world economy.

Foreign Exchange Market

A market for converting the currency of one country into that of another country.

Exchange Rate

The rate at which one currency is converted into another.

Foreign Exchange Risk

The risk that changes in exchange rates will hurt the profitability of a business deal.

Currency Speculation

Involves short-term movement of funds from one currency to another in hopes of profiting from shifts in exchange rates.

Carry Trade

A kind of speculation that involves borrowing in one currency where interest rates are low and then using the proceeds to invest in another currency where interest rates are high.

Hedging

When a firm insures itself against all foreign exchange risk.

Spot Exchange Rate

The exchange rate at which a foreign exchange dealer will convert one currency into another that particular day.

Forward Exchange

When two parties agree to exchange currency and execute a deal at some specific date in the future.

String of Pearls

A strategy involving buying ports.

Belt and Road Initiative (BRI)

A global development strategy adopted by China involving infrastructure development and investments in countries across Europe, Asia, and Africa.

First Criteria for FDI

Political, economic, and legal stability.

High Tech Industries

Industries that tend to cluster firms that have valuable know-how not amenable to licensing.

Global Oligopolies

Industries characterized by a limited number of firms competing globally.

Intense Cost Pressure Industries

Industries where firms face significant pressure to minimize costs.

Coal Network (Ramish)

A system involving buying coal, selling coal, and hiding coal.

Forward exchange rates

The exchange rate governing a forward exchange transaction.

Currency swap

Simultaneous purchase and sale of a given amount of foreign exchange for two different value dates.

Arbitrage

The purchase of securities in one market for immediate resale in another to profit from a price discrepancy.

Law of one price

In competitive markets free of transportation costs and barriers to trade, identical products sold in different countries must sell for the same price when their price is expressed in the same currency.

PPP

Basket of goods should cost roughly the same in every country when adjusted by exchange rate. Measured by US dollar.

Efficient market

A market where prices reflect all available information.

Fisher effect

Nominal interest rates (i) in each country equal the required real rate of interest (r) and the expected rate of inflation over the period of time for which the funds are to be lent (l). That is, i = r + I.

International fisher effect (IFE)

For any two countries, the spot exchange rate should change in an equal amount but in the opposite direction to the difference in nominal interest rates between countries.

Bandwagon effect

Movement of traders like a herd, all in the same direction and at the same time, in response to each other's perceived actions.

Inefficient market school

Argues that companies can improve the foreign exchange markets estimate of future exchange rates by investing in forecasting services.

Inefficient market

One in which prices do not reflect all available information.

Freely convertible

A country's currency is freely convertible when the government of that country allows both residents and nonresidents to purchase unlimited amounts of foreign currency with the domestic currency.

Externally convertible

Limitations on the ability of residents to convert domestic currency, though nonresidents can convert their holdings of domestic currency into foreign currency.

Nonconvertible

A currency is not convertible when both residents and nonresidents are prohibited from converting their holdings of that currency into another currency.

Capital flight

Converting domestic currency into a foreign currency; everyone converts out of a failing currency.

Countertrade

The trade of goods and services for other goods and services.

Transaction exposure

The extent to which income from individual transactions is affected by fluctuations in foreign exchange values.

Translation exposure

The extent to which the reported consolidated results and balance sheets of a corporation are affected by fluctuations in foreign exchange values.

Economic exposure

The extent to which a firm's future international earning power is affected by changes in exchange rates.

Lead strategy

Collecting foreign currency receivables early when a foreign currency is expected to depreciate and paying foreign currency payables before they are due when a currency is expected to appreciate.

Lag strategy

Delaying the collection of foreign currency receivables if that currency is expected to appreciate and delaying payables if that currency is expected to depreciate.