International Business (Mod 1 & 2)

AMITY GLOBALBUSINESS SCHOOL

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Let Us First Answer…..


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What is the Logic of Business?


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What is Business? An organization engaged in the trade of goods, services, or both to consumers (Sullivan & Sheffrin, 2003).

An economic system in which goods and services are exchanged for one another or money, on the basis of their perceived worth. Every business requires some form of investment and a sufficient number of customers to whom its output can be sold at profit on a consistent basis (http://www.businessdictionary.com/definition/business.html)


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Some of Those Changes…Evolution of human needs…

Transaction to Selling to Marketing

And now from Marketing to Relationships and Partnerships!

The emergence of institutions of business…

Increased complexity and competitiveness…

Technology…… Movement of goods and people…. Movement of Information!


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One Such Change


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Discuss….


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What Then is International Business?

International business consists of transactions

that are devised and carried out across national

borders to satisfy the objectives of individuals,

companies, and organizations


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Effects of International BusinessCreates NEW: Markets, customers, products, opportunities

Creates FLOW: Of Capital, Of Ideas, Of Technology, Of Knowledge, Of Labor, Of Employment

Theoretically, international business is supposed to enable all round development by removing scarcities and inefficiencies, providing employment, better earning potential, better products.


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Then “International Business” is a subset of “International Economics”


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How Does Int. Eco Come Into the Picture?International Business (IB) entails interaction between sovereign states through trade of goods and services, through flows of money and through investment.

International Economics (IE) is devoted to the study of such interactions

The need for appreciation of IE in the study of IB has increased with the increased quantum of IB and the consequent increase in interdependence of national economies


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Int. Trade as a % of US National Income


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India’s International Trade


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What Forms Can IB Take?

Export – Import

Licensing

Franchising

Joint Ventures

Ownership

Strategic Alliance

Management Contract


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Issues Arising Out of Int. BusinessGains From Trade

Pattern of Trade

Volume of Trade

Balance of Payments

Exchange Rate Determination

International Policy Coordination

International Capital Market


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Gains From Trade

1. When a buyer and a seller engage in a voluntary

transaction, both receive something that they want and

both can be made better off.

• Norwegian consumers could buy oranges through international trade that they otherwise would have a difficult time producing.

• The producer of the oranges receives income that it can use to buy the things that it desires.


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Gains From Trade2. How could a country that is the most or least efficient

producer of everything gain from trade?With a finite amount of resources, countries can use those resources to produce what they are most productive at, then trade those products for goods and services that they want to consume.

Countries can specialize in production, while consuming many goods and services through trade.

3. Trade is predicted to benefit a country by making it more efficient when it exports goods which use abundant resources and imports goods which use scarce resources.


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Gains From Trade4. When countries specialize, they may also be more

efficient due to large scale production

Trade is predicted to benefit countries as a whole in several ways, but trade may harm particular groups within a country. International trade can adversely affect the owners of resources that are used intensively in industries that compete with imports.

Trade may therefore have effects on the distribution of income within a country.

Conflicts about trade should occur between groups within countries rather than between countries.


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Patterns of TradeDifferences in climate and resources can explain why Brazil exports coffee and Australia exports iron ore.

But why does Japan export automobiles, while the U.S. exports aircraft?

Differences in labor productivity may explain why some countries export certain products.

How relative supplies of capital, labor and land are used in the production of different goods and services may also explain why some countries export certain products.


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Coordinating Govt. PoliciesPolicy makers affect the amount of trade through

Tariffs: A tax on imports or exports,

Quotas: A quantity restriction on imports or exports,

Export Subsidies: A payment to producers that export,

Or through other regulations (ex., product specifications) that exclude foreign products from the market, but still allow domestic products.

What are the costs and benefits of these policies?


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Coordinating Govt. PoliciesEconomists design models that try to measure the effects of different trade policies.

If a government must restrict trade, which policy should it use?

If a government must restrict trade, how much should it restrict trade?

If a government restricts trade, what are the costs if foreign governments respond likewise?


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Balance of PaymentsGovernments measure the value of exports and imports, as well as the value of financial assets that flow into and out of their countries.

Related to these two measures is the measure of official settlements balance, or the balance of payments: the balance of funds that central banks use for official international payments.

All three values are measured in the government’s national income accounts.


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Exchange Rate DeterminationBesides financial asset flows and the official settlements balance, exchange rates are also an important financial issue for most governments.

Exchange rates measure how much domestic currency can be exchanged for foreign currency.

They also affect how much goods that are denominated in foreign currency (imports) cost.

And they affect how much goods denominated in domestic currency (exports) cost in foreign markets.


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International Capital MarketsInternational trade focuses on transactions of goods and services across nations.

These transactions usually involve a physical movement of goods or a commitment of tangible resources like labor services.

International finance focuses on financial or monetary transactions across nations.

For example, purchases of U.S. dollars or financial assets by Europeans.


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Theory Of Mercantilism

The economic doctrine in which government control

of foreign trade is of paramount importance for

ensuring the prosperity and military security of the

state


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Theory Of MercantilismStates that nations should accumulate financial wealth, usually in the form of gold, by encouraging exports and discouraging imports.

Other measures of a nation’s well-being, such as living standards or human development, are irrelevant.

Practiced from around 1500 to the late 1700s by European nations, including Britain, France, the Netherlands, Portugal, and Spain.


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Theory Of MercantilismTrade was to benefit mother countries, colonies like India were sources of exploitable resources.

Nations increased wealth through a trade surplus

Trade deficits were to be avoided at all costs

Governments intervened in international trade to maintain a trade surplus


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Absolute AdvantageThe ability of a nation to produce a good more efficiently than any other nation

Adam Smith claimed that market forces, not government controls should determine the direction, volume, and composition of international trade.

Each nation should specialize in producing goods it could produce most efficiently

In absolute advantage, both nations would gain from trade.


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Theory of Comparative AdvantageThe ability of a person, company or country to produce a particular good or service at a lower marginal and opportunity cost

Comparative advantage is the 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

Trade is still beneficial even if one country is less efficient in the production of two goods, as long as it is less inefficient in the production of one of the goods.


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Theory of Comparative AdvantageA country has a comparative advantage in producing a good if the opportunity cost of producing that good is lower in the country than it is in other countries.

A country with a comparative advantage in producing a good uses its resources most efficiently when it produces that good compared to producing other goods.

Country has a comparative advantage in producing the good in which its absolute disadvantage is less.


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Why Do US Companies Outsource to India?Approximately 1.2 Billion people

Comparative advantage in production of goods or services that require large amounts of labor

Indians speak English, don’t we??

Low labor costs due to large workforce

Internet and telephone communications much less expensive

Industries off-shoring include software engineering, telemarketing, banking, medical services, claims processing, IT jobs, financial services, insurance

Jobs created in India should help generate jobs in USA


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Theory of Comparative AdvantageThe U.S. has a comparative advantage in computer production: it uses its resources more efficiently in producing computers compared to other uses.

Ecuador has a comparative advantage in rose production: it uses its resources more efficiently in producing roses compared to other uses.

Suppose initially that Ecuador produces computers and the U.S. produces roses, and that both countries want to consume computers and roses.

Can both countries be made better off?


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The Heckscher Ohlin ModelThe model says that countries will export products that use their abundant and cheap factors) of production and import products that use the countries' scarce factors

Relative endowments of the factors of production (land, labour, and capital) determine a country's comparative advantage

Aka 2X2X2 model as it considers 2 countries, 2 products & 2 factors of production


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Assumptions of H-O ModelThe preferences of all consumers in the world are identical. The preferences of any individual are such that the Marginal Rate of Substitution is independent of the scale of consumption.

The MRS of Wine for Cheese is the additional amount of Wine that would keep the individual's level of happiness unchanged even after the consumption of Cheese is reduced by one unit. Under this assumption, if the amounts of Cheese and Wine being consumed are, say, doubled, then the MRS remains unchanged. In other words, the MRS does not change if the ratio of the amounts of Cheese and Wine consumed, Cheese/ Wine, does not change.


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Assumptions of H-O ModelIndividuals make decisions so as to maximize happiness, whereas

Firms make decisions so as to maximize profits

All markets are perfectly competitiveGovernments do not interfere with the smooth functioning of markets

There are no taxes, subsidies, tariffs, quotas, etc.

However, although there is free trade in goods and services, there is no cross-border movement of resources, such as labor


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HO Model & The Outsourcing ExampleThe HO Theory states that international and interregional differences in production costs occur because of differences in the supply of production factors. Therefore,

India should export labor intensive goods.

USA with relatively more capital than labor should specialize in capital intensive products


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Empirical Evidence of the HO ModelTests on US data

Leontief found that U.S. exports were less capital-intensive than U.S. imports, even though the U.S. is the most capital-abundant country in the world: Leontief paradox.

Tests on global dataBowen, Leamer, and Sveikauskas tested the Heckscher-Ohlin model on data from 27 countries and confirmed the Leontief paradox on an international level.

Tests on manufacturing data between low/middle income countries and high income countries.

This data lends more support to the theory.


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Porter’s Diamond

FactorConditions

DemandConditions

Firm Structure &

Rivalry

Related & Supporting Industries


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Porter’s Diamond


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Porter’s DiamondPorter claims that four kinds of variables will impact a local firm’s ability to use a country’s resources to gain a competitive advantage.

Demand conditions

Factor conditions

Related and supporting industries

Firm strategy, structure, rivalry


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Porter’s Diamond

Demand ConditionsIf customers are demanding, firms will produce high-quality and innovative products gaining competitive advantage

Factor ConditionsLevel and consumption of factors of productionLack of natural endowments has caused nations to invest in the creation of advanced factors


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Porter’s Diamond

Related & Supporting IndustriesSuppliers and industry support services tend to form a cluster in a given location

Firm Structure & RivalryExtent of domestic competition,The existence of barriers to entryThe firm’s management style and organization.


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Instruments of International Trade Policy


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Instruments of Int. Trade PolicyTariffs

Subsidies

Local content requirements

Administrative policies

Anti dumping policies

Political and economic arguments for intervention


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TariffsTariff is the fixed monetary tax per physical unit of the good imported

The biggest advantage of tariffs are that they are easy to administer as they are easy to calculate

Problems arise when the cost of the good being imported rises….. Then the tariff’s effectiveness in protecting domestic industry falls as price of imported good rises…… Because the proportion of tariff in the total cost keeps reducing.


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TariffsA specific tariff is levied as a fixed charge for each unit of imported goods.For example, $1 per kg of cheese

An ad valorem tariff is levied as a fraction of the value of imported goods.For example, 25% tariff on the value of imported cars.


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Supply, Demand, and Trade

Let’s construct a model measuring how a tariff

affects a single market, say that of wheat.

Suppose that in the absence of trade the price of

wheat in the foreign country is lower than that in the

domestic country.


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Supply, Demand, and Trade

An export supply curve is the difference between the

quantity that foreign producers supply minus the

quantity that foreign consumers demand, at each price.

An import demand curve is the difference between the

quantity that domestic consumers demand minus the

quantity that domestic producers supply, at each price.


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The Home Import Demand Curve


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Foreign Export Supply Curve


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Supply, Demand, and Trade In equilibrium, the quantities ofImport demand = Export supplyDomestic demand – Domestic supply = Foreign supply – Foreign demand

In equilibrium, the quantities ofWorld demand = World supply


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World Equilibrium


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International Trade Can Occur When…Production of Wheat in country A is more than the domestic demand.

Production in Country B is less than the domestic demand.

In the absence of trade the price of wheat in country A is lower than that in country B


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Effects of TariffsA tariff can be viewed as an added cost of transportation, making sellers unwilling to ship goods unless the price difference between the domestic and foreign markets exceeds the tariff.

If sellers in Country A are unwilling to export wheat, there is excess demand for wheat in the domestic market and excess supply in country A. And when traded…

The price of wheat will tend to rise in A.

The price of wheat will tend to fall in B.


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Effects of Tariff “t”


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Effects of Tariff “t”Because the price in domestic markets rises (to PT), domestic producers should supply more and domestic consumers should demand less.

The quantity of imports falls from QW to QT

Because the price in foreign markets falls (to P*T),

foreign producers should supply less and foreign consumers should demand more.

The quantity of exports falls from QW to QT


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Effects of Tariff “t”The quantity of domestic import demand equals the quantity of foreign export supply when PT – P*

T = t

In this case, the increase in the price of the good in the domestic country is less than the amount of the tariff.

Part of the effect of the tariff causes the foreign country’s export price to decline, and thus is not passed on to domestic consumers.

But this effect is sometimes not very significant:


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Costs and Benefits of TariffsA tariff raises the price of a good in the importing country, so we expect it to hurt consumers and benefit producers there.

In addition, the government gains tariff revenue from a tariff.


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Export SubsidyAn export subsidy can also be specific or ad valorem

A specific subsidy is a payment per unit exported.

An ad valorem subsidy is a payment as a proportion of the value exported.


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Export Subsidy

An export subsidy raises the price of a good in the

exporting country, while lowering it in foreign countries.

In contrast to a tariff, an export subsidy worsens the

terms of trade by lowering the price of domestic

products in world markets.


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Import QuotaAn import quota is a restriction on the quantity of a good that may be imported.

This restriction is usually enforced by issuing licenses to domestic firms that import, or in some cases to foreign governments of exporting countries.

A binding import quota will push up the price of the import because the quantity demanded will exceed the quantity supplied by domestic producers and from imports.


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Import QuotaWhen a quota instead of a tariff is used to restrict imports, the government receives no revenue.

Instead, the revenue from selling imports at high prices goes to quota license holders: either domestic firms or foreign governments.

These extra revenues are called quota rents.


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Export RestraintA voluntary export restraint works like an import quota, except that the quota is imposed by the exporting country rather than the importing country.

However, these restraints are usually requested by the importing country.

The profits or rents from this policy are earned by foreign governments or foreign producers.

Foreigners sell a restricted quantity at an increased price.


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Local Content Requirement

A local content requirement is a regulation that requires a

specified fraction of a final good to be produced

domestically.

It may be specified in value terms, by requiring that some

minimum share of the value of a good represent domestic

valued added, or in physical units.


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From the viewpoint of domestic producers of inputs, a local

content requirement provides protection in the same way

that an import quota would.

From the viewpoint of firms that must buy domestic inputs,

however, the requirement does not place a strict limit on

imports, but allows firms to import more if they also use

more domestic parts.


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Local content requirement provides neither government

revenue (as a tariff would) nor quota rents.

Instead the difference between the prices of domestic

goods and imports is averaged into the price of the final

good and is passed on to consumers.


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Administrative PoliciesExport credit subsidies

A subsidized loan to exportersSIDBI provides subsidized loans to exporters.

Government procurementGovernment agencies are obligated to purchase from domestic suppliers, even when they charge higher prices (or have inferior quality) compared to foreign suppliers.

Bureaucratic regulationsSafety, health, quality, or customs regulations can act as a form of protection and trade restriction.


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Anti Dumping PoliciesDumping is said to have taken place when an exporter sells a product to a country at a price less than the price prevailing in its domestic market.

The price at which like articles are sold in the domestic market of the exporter is referred to as the “normal value” of those articles.

So…. If export price is less than normal value, then it is dumping!


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Instruments of International Trade Policy


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How is International Business Different?Markets and customers are different – So experiences in the domestic industry may be rendered irrelevant

International business climate is much more complex with different currencies, regulatory systems, cultures and risks

Often extremely large, multi-market and multi-product, and must be managed across vast distances and time differences.

Globalization and Glocalization – Think Global, Act Local


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Management Orientations

Ethnocentric

GeocentricPolycentric

Regiocentric


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Ethnocentric OrientationAssumes home country is superior to the rest of the world; associated with attitudes of national arrogance and supremacy

Management focus is to do in host countries what is done in the home countrySometimes called an international company

Products and processes used at home are used abroad without adaptation


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Regiocentric OrientationRegion becomes the relevant geographic unit (rather than by country)

Management orientation is geared to developing an integrated regional strategy

European Union NAFTA


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Polycentric OrientationManagement operates under the assumption that every country is different; the company develops country-specific strategiesSometimes called a multinational company

Company operates differently in each host country based on that situation

Opposite of ethnocentrism


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Geocentric OrientationEntire world is a potential market

Managerial goal is to develop integrated world market strategies

Global companies serve world markets from a single country and tend to retain association with a headquarters countryTransnational companies serve global markets and acquire resources globally; blurring of national identity


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What Then is a Multinational?Has polycentric orientation

A corporation that has its management headquarters in one country, known as the home country, and operates in several other countries, known as host countries.

A Transnational Corporation (TNC) differs from a traditional MNC in that it does not identify itself with one national home.

Traditional MNCs are national companies with foreign subsidiaries