ch 8 and 9 Introduction to International Business - Regional Economic Integration & Foreign Exchange Markets

A set of 50 vocabulary flashcards encompassing key concepts and terms related to regional economic integration and foreign exchange markets.

Regional Economic Integration

The process of reducing trade barriers and increasing economic cooperation among countries in a specific region.

past 2 decades- proliferation of regional trade blocs

BRICS

an association of five major emerging economies: Brazil, Russia, India, China, and South Africa, aimed at promoting peace, security, and development.

CARICOM

The Caribbean Community, a regional organization comprising Caribbean nations aimed at promoting economic integration, cooperation, and common policies.

central americs

ASEAN

The Association of Southeast Asian Nations, a regional organization that promotes political and economic cooperation and regional stability among its member states.

AFCFTA

the African Continental Free Trade Area, an agreement to create a single market for goods and services across Africa to enhance intra-African trade and economic integration.

EAC

The East African Community, a regional intergovernmental organization that promotes economic integration, cooperation, and political stability among its member countries in East Africa.

NAFTA

North American Free Trade Agreement, a trade agreement between the U.S., Canada, and Mexico established to promote free trade.

• free trade agreement jan 1 1989

• taks to establish formal FTA

• NAFTA- jan 1 1994

contents:

Abolition by 2004 of tariffs on 99 percent of the goods traded among the three;

• Removal of most barriers on the cross-border flow of services, allowing financial

institutions, for example, unrestricted access to the Mexican market by 2000;

• Protection of intellectual property rights;

• Removal of most restrictions on FDI among the three member countries;

• But special treatment (protection) was given to Mexican energy and railway industries,

American airline and radio communications industries, and Canadian culture;

• Application of national environmental standards;

• Establishment of two commissions with the power to impose fines and remove

trade privileges when environmental standards or legislation involving health

and safety, minimum wages, or child labour are ignored.

Now CUSMA

pros of NAFTA

• opportunity to create an enlarged and more efficient productive base for the entire region

• mexico benefiting from inward investment

• mexicans increasingly importing can and us goods

• lower costs of production inmexico

NAfta results

In 1990, U.S. trade with Canada and Mexico accounted for about 30

percent of total U.S. trade. By 2017, the figure was over 40 percent.

● Canada and Mexico are now among the top three trading partners of

the United States (the other is China), accounting for 46 percent of the

recorded total trade.

● All three countries also experienced strong productivity growth in the

first 10 years NAFTA was in place.

● Estimates suggest that employment effects of NAFTA have been

moderate to small.

● A study of the welfare effects of NAFTA suggests that Mexico and the

U.S. saw small welfare gains of 1.31 percent and 0.08 percent,

respectively, while Canada suffered a welfare loss of 0.06 percent.

CUSMA

Canada-United States-Mexico Agreement, which replaced NAFTA and introduced new provisions for trade.

• July 1 2020

• raised threshold from 62.5 to 75% of a vehicles content to be produced in NA to qualify for 0 tariffs- discourage sourcing auto parts from germany, japan, south korea, or china, resulting in trade diversion

• mandated that by 2023, 40% of all parts for any tariff free wehichle must come from a high wage factory

• canadian dairy market

• intellectual property

• 16 year sunset clause- expire after 16 years

levels of economic integration

free trade area

customs union

common market

economic union

political union

Political Union

The highest level of economic integration, where countries establish a central political authority.

central political apparatus that coordinates economic, social, an foreign policy

US is a political union of states

Economic Union

A level of integration where countries remove barriers to trade and implement a common currency.

• harmonization of tax rates

• common monetary and fiscal policy

• need to sacrifice significant amounts of national sovereignty

• common external trade policy

Common Market

A group of countries that allows free movement of goods, services, and factors of production among members.

-labour and capital are free to move, no restriction on cross border flows of capital

-common external trade policy

MERCOSUR- aiming to become a common market

Customs Union

A type of trade bloc that allows free trade between member countries and applies a common external tariff.

pursuit of common external trade policy- takes heavy administrative machinery

ex. Andean community

Andean community

A customs union in South America formed by countries such as Colombia, Peru, Ecuador, and Bolivia, which facilitates trade and economic integration among member states.

Free Trade Area

A group of countries that eliminates tariffs and trade barriers among themselves but retains independent external trade policies.

committed to a free flow of goods

ex. EFTA

EFTA

The European Free Trade Association, a regional trade agreement between European countries that promotes free trade and economic cooperation among its member states.

economic case FOR integration

• attempt to achieve additional gains from free flow of trade and investment to achieve additional gains from free flow of trade and investment between countries

• easier for small group of local countries than world wide

political case For integration

reducing potential for violent conflict- due to local countries being increasingly dependent on each other

promotes democracy

Costs of integration

• certain groups will lose

  • ex. workers in textile in Canada and US due to nafta

• loss of national sovereignty

  • ex. mexico concerns of maintaining control over oil interests- mexico oil was exempted from any liberalization of foreign investments regulation achieved under CUSMA

• trade creation

• trade diversion

Trade Creation

The increase in trade that occurs when high-cost domestic producers are replaced by low-cost producers within a free trade area.

Trade Diversion

The shift of trade from a more efficient producer to a less efficient / higher cost producer as a result of a regional trade agreement.

How to combat Costs of integration

• WTO should increase scope so it covers non-tariff barriers

• allow free trade areas be formed only of members set tariffs that are not higher or more restrictive to outsiders than ones previously set

Criticism of nafta

taking away jobs

bad environmental standards

and potential negative impacts on small businesses and agriculture.

mexico exposed to aggressive competition

national sovereignty

European Union (EU)

A political and economic union of member states located primarily in Europe, which has its own institutions and policies.

product of 2 world wars and desire for peace and the European’s desire to hold their own

political structures of EU

• European commission

• council of EU

• European Parliament

• court of justice

Economic Integration

The process by which countries reduce barriers to trade and increase economic cooperation.

Andean Community

A regional trade bloc in South America consisting of countries such as Bolivia, Colombia, Ecuador, and Peru.

MERCOSUR

A South American trade bloc that promotes free trade and economic integration among its member states.

EFTA

European Free Trade Association, a regional trade agreement among European states that are not part of the EU.

European Commission

The executive body of the EU responsible for proposing legislation and implementing decisions.

Responsible for monitoring compliance, ran by group of commissioners appointed by each member country- 27

handles competition policy- anti monopoly

imposed 4.3 mill fine to google, 1.06 bill fine to intel

Council of EU

ultimate controlling authority

• composed of 1 rep from gov of each member state

  • varies for what type of issues are discussed - ex. agriculture

• Draft legislation from commission can become EU law only if council agrees- must be unanimous agreement

European Parliament

• Primarily consultive rather than a legislative body

• can make suggestions , power has been increasing

• can vet some laws

• 705 members directly elected by the populations of the member states

Court of Justice

The highest court in the EU that ensures EU law is interpreted and applied uniformly across member states.

composed of one judge from each country- serving as the supreme appeals court for EU law

judges act as independent officials, not reps of their own country- not acting in their country’s interest

Single European Act

from EC to EU: A significant legislative act aimed at creating a single market within the EU by removing barriers to trade.

• born out of frustration among member that the community was not living up to it’s promises- it was clear that the EC had fallen short of objectives to remove barriers to free flow of trade

objective: crate one marketplace by1992

became law in 1987

proposed changes of Single European act

• remove frontier controls- abolishing delays- complying with trade bureaucracy

• mutual recognition- product standards

• institute open public procurement to non-national suppliers- allowing lower cost suppliers to compete with national suppliers

• lifting barriers to competition

• removing restrictions on foreign exchange transactions between members by the end of 1992

• abolish restrictions on cabotage- the right of foreign truckers to pickup and deliver goods within another members state orders

• changes are expected to lower cost of doing business

• complicated supply effects

• restructuring substantial sections of euro mail industries

Euro

The common currency used by 19 of the 27 EU member states.

pros of establishing euro

• savings - lower foreign exchange and hedging costs

• easily compare prices across Europe- good for customers

• PRODUCERS ARE FORCED TO LOOK FOR WAYS TO REDUCe their production costs to maintain profit margins

• supports the development of the pan-European capital market

• highly liquid increases investment efficiency

cons of establishing euro

• lost control over monetary policy

• Maastricht treaty called for the establishment of an independent European central bank

• ECB has responsibility to set interest rates and determine monetary polices- political pressure

• loss of national sovereignty

• optimal currency area

optimal currency area

A region where multiple countries use a single currency effectively due to similar economic conditions, which minimizes negative impacts of external shocks and facilitates trade.

if the interest rate is high

EURO trend

since 2008 the euro has weakened- persistent concerns over slow economic growth and budget deficits

110 bill to bail out Greece

85 bill to Ireland

78 bill to Portugal

Purchasing Power Parity (PPP)

An economic theory that states that exchange rates should adjust to equalize the purchasing power of different currencies.

enlargement of EU

to qualify for membership applicants must privatize state assets, deregulate markets, restructure industries and tame inflation

enshrine eU laws, have stable democratic gov and respect human rights

examples of countries who are candidates for EU

Countries like Albania, North Macedonia, and Serbia turkey,bosnia, serbis, ukraine gergia, kosovo

foreign exchange Market

a market for converting the currency of one country into that of another country

2 functions

Exchange Rate

The rate at which one currency can be exchanged for another.

direct quotation: E= hoe much of the local currency is needed to buy one unit of foreign currency

Foreign Exchange Risk

The risk of financial loss due to unpredictable changes in exchange rates.

Business main uses for currency conversion

• Payments a company receives from it’s exports: income it recieves from foreign investments and licencing agreements

• paying foreign companies for products or services in thier currency

• investing spare monay for short terms in foreign financial markets to enjoy higher foreign interest rates

• Currency speculation

• Carry trade

currency speculation

The practice of buying and selling currencies with the aim of profiting from fluctuations in exchange rates.

short term movement of funds from one currency to another to profit from shifts in exchange rate

Carry trade

A trading strategy where an investor borrows funds in a currency with a low interest rate and invests them in a currency with a higher interest rate to profit from the interest rate differential.

also an example of speculation

investor borrows money in a low interest rate currency and invests it in a higher yielding currency to earn the difference.

the canadian dollar

• currency linked to the raw materials that Canada exports, including oil and natural gas

• various factors can make firms thrive even under a string domestic currency, making the fact that a rise in the Canadian dollar will increase cost to US and damage export no-longer absolute.

Spot Exchange Rate

The current exchange rate at which a currency can be exchanged for another currency immediately.

• reported in real time

• value is determined by the interaction between demand and supply of other currencies

• deals executed immediately

Forward Exchange Rate

The agreed exchange rate for currency transactions that will occur at a future date.

• usually 30, 90, 180 days into the future, taking out insurance against the possibllity that future exchange rate movements will make a transactionunoprfitable by the tume the transaction occurs

currency swaps

the simultaneous purchase and sale of a given amount of foreign exchange for two different value dates\

Countertrade

Trade in which goods and services are exchanged for other goods and services rather than for cash.

Transaction Exposure

The risk that a firm's cash flow will be affected by fluctuations in exchange rates.

Translation Exposure

The impact of currency exchange rate changes on a company's financial statements.

Interest Rate Parity Theory

A theory that explains the relationship between interest rates and exchange rates.

Investor Psychology

Behavioral factors that influence the decisions of investors in the foreign exchange market.

Hedging

A risk management strategy used to offset potential losses in foreign exchange transactions.

Insuring itself against foreign exchange risk

nature of foreign exchange market

US, UK, SING, HK, JAP→ accounted for 78% of foreign exchange trading

LONDON→38% dominance

• central position, link between east asian and NY markets

• first major industrial trading nation

2 features:

• market never sleeps

• US$ is used in almost every transaction

Arbitrage

The practice of taking advantage of price differences in different markets to generate profit.

buy low sell high

Economic Case for Integration

Arguments that highlight the benefits of increased trade and investment flows among integrated economies.

Political Case for Integration

Arguments that emphasize the geopolitical advantages of closer economic ties among neighboring countries.

Maastricht Treaty

The treaty that established the European Union and set the stage for the creation of the Euro.

Fiscal Transfers

Financial support provided by one level of government to another to help manage economic challenges.

Common External Trade Policy

A policy that sets common tariffs and trade practices for all member states in a customs union.

Enlargement of the EU

The process of adding new member states to the European Union.

Investor Expectations

Future market behaviors based on traders' psychological outlooks on economic conditions.

Cross-Border Flows

Movement of goods, services, and capital across international borders.

Foreign Direct Investment (FDI)

Investment by a firm in one country in production or business in another country.

Global Trade Agreements

Trade treaties that govern commercial relationships among multiple countries.

Non-Tariff Barriers

Trade barriers that restrict imports or exports of goods through mechanisms other than the usual tariffs.

theories of exchange rate determination

• law of one price

• PPP

• money supply and price inflation

• interest and exchange rates

• investor psychology

Purchasing Power Parity

derived from law of one price

model assumptions:

1. No transportation costs

2. The basket is identical (comparable) between the

economies

3. No differences in taxation

4. No trade barriers

5. Perfect information

PPP and Law of one price

if law of one price is true, PPP exchange rate could be found from any individual set of prices

given relatively efficient markets, the price of a basket of goods should be roughly equivalent in each country

the exchange rate will change if relative prices change

a country with a high inflation rate will see depreciation in its currency exchange rate

problem with PPP and Law of One price

Not a strong predictor of short-run movements in exchange rates covering

time spans of five years or less.

• Transportation costs and trade barriers such as import tariffs

• Taxes

• Non-traded services

• Market competition

• Inflation

• Government intervention

Law of one price

to avoid arbitrage, products must be sold at the same price in different countries when their price is expressed i the same currency.

Money supply and inflation

• the growth rate of a country’s money supply is faster than the growth on its output price, inflation is fulled

Inflation

Occurs when the quantity of money in circulation rises faster than the stock of goods and services

GOV Policy

• determines whether the rate of growth in output

• gov can increase money supply y issuing it

• usually do it to fund public expenditure

• Excessive growth+ inflation

• high control over money supply= future inflation rate = low

Empirical tests of PPP theory

• Yielded mixed results

• may not holD iF many national markets are dominated by MNEs that have influence over prices

• price discrimination

• arbitrage must be limited

The fisher effect

The Fisher Effect describes the relationship between inflation and interest rates, stating that the real interest rate is equal to the nominal interest rate minus the expected inflation rate. It suggests that as inflation rises, nominal interest rates will also rise to maintain real returns.

i=r+I where i is nominal interest rate, r is real interest rate, and I is inflation rate.

International fisher effect

states for any 2 countries , the spot exchange rate should change in an equal amount, but in opposite directions to the difference in nominal interest rates btwn the 2 countries

moderately good predictors of long run changes in exchange rates

relative monetary growth, relative inflation rates, nominal interest rate differentials

long run predictors are Poor predictors of short run changes in exchange rates

because of the impact of psychological behaviours ,

investor expectations, bandwagon effects, shortterm currency movements

Investor Psychology and Bandwagon Effects

Expectations on the part of traders can turn into self-fulfilling

prophecies, and traders can joint the bandwagon and move exchange

rate based on group expectations.

• While such changes can be important in explaining some short-term

exchange rate movements, they are very difficult to predict.

exchange rate forecasting

efficient market school,

Inefficient market school

efficient market school,

“cannot beat the market”

Many economists believe the foreign exchange market is efficient at

setting forward rates.

● View that prices reflect all available public information.

● Forward exchange rates should be unbiased predictors of future spot

rates.

Inefficient market school

View that prices do not reflect all available information.

● Forward exchange rates are not the best possible predictors of future

spot exchange rates.

● Professional exchange rate forecasts might better predict future spot

rates than forward exchange rates do … but the track record of

professional forecasting services is not that good.

not useing private info+not allowed

approaches to forecasting

fundamental analysis

technical analysis

fundamental analysis

draws on economic theory to

construct sophisticated econometric models for predicting

exchange rate movements.

may include variable related to balance of payments of current accounts positions

if CA goes down, may result in depreciation of a county’s currency for foreign exchange market

hinges on whether people are willing to hold dollars

technical analysis

uses price and volume data to

determine past trends, which are expected to continue into

the future.

based on premise that there are analyzable market friends ad waves can be used to predict future trends and waves

Gained favour

Currency convertibility

freely convertible, externally convertible , nonconvertible

freely convertible

country’s gov allows both non residents and residents to purchase unlimited amounts of forien currency with it

externally convertible

only non residents may convert it into foreign currency without any limitations

nonconvertible

neither residents non non residents are allowed to convert it into a foreign currency

why do govs restrict convertability?

to. preserve foreign exchange reserves

a country needs an adequate supply of these reserves to service it’s international debt commitments and to purchase imports

problems under non-convertability

• although a us company may be able to generate significant profits in another country, it may not ba able to take that money back home

• govs impose restrictions when they fear that free convertibility will lead to a run on their foreign exchange reserves, avoiding capital flight