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Chapter 1

Globalization

I. What Is Globalization?

The world is moving away from self-contained national economies toward an interdependent, integraeconomic system

Globalization refers to the shift toward a more integrated and interdependent world economy

Globalization has two facets:

1) the globalization of markets

The globalization of markets refers to the merging of historically distinct and separate national markets intglobal marketplace

In many industries, it is no longer meaningful to talk about the German market or the American market

Instead, there is only the global market

Falling trade barriers make it easier to sell internationally The tastes and preferences of consumers are converging on some global norm

Firms help create the global market by offering the same basic products worldwide

2) the globalization of production

The globalization of production refers to the sourcing of goods and services from locations around the gloadvantage of national differences in the cost and quality of factors of production like land, labor, and capital

Companies compete more effectively by lowering their overall cost structure or improving the quality or fu

of their product offeringII. The Emergence Of Global Institutions

Institutions are needed to:

help manage, regulate, and police the global marketplace

promote the establishment of multinational treaties to govern the global business system

Institutions created over the past half century include:

the General Agreement on Tariffs and Trade (GATT)

the World Trade Organization (WTO)

The World Trade Organization (like its predecessor GATT) is primarily responsible for policing the worsystem and making sure that nation-states adhere to the rules laid down in trade treaties signed by WTO mem

In 2007, the 150 nations that accounted for 97% of world trade were WTO members

The WTO promotes lower barriers to trade and investment

the International Monetary Fund (IMF)


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The International Monetary Fund and the World Bank were created in 1944 The IMF was established to maintain order in the international monetary system The World Bank was established to promote economic development

the World Bank

the United Nations (UN)

The United Nations was established in 1945 to:

maintain international peace and security develop friendly relations among nations

cooperate in solving international problems and in promoting respect for human rights

be a center for harmonizing the actions of nations

II. Drivers Of Globalization

Two macro factors underlie the trend toward greater globalization:

the decline in barriers to the free flow of goods, services, and capital that has occurred since the end of WorlDeclining Trade And Investment Barriers

International trade occurs when a firm exports goods or services to consumers in another country

Foreign direct investment (FDI) occurs when a firm invests resources in business activities outside its home

After World War II, advanced countries made a commitment to lower barriers to trade and investment

Since 1950, average tariffs have fallen significantly and are now at about 4%

Countries have also been opening markets to FDI

Lower barriers to trade and investment mean:

that firms can view the world, rather than a single country, as their market

that firms can base production in the optimal location for that activity

technological change

The Role Of Technological Change

Technological change has made the globalization of markets a reality

Important advances have occurred in:

microprocessors and telecommunications

the Internet and World Wide Web

transportation technology

Implications of technological change for the globalization of production include:

lower transportation costs that enable firms to disperse production to economical, geographically separate lo


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lower information processing and communication costs that enable firms to create and manage globallyproduction systems

Implications of technological change for the globalization of markets include:

low cost global communications networks help create electronic global marketplace

low-cost transportation help create global markets

global communication networks and global media are creating a worldwide culture, and a global market foproducts

V. The Changing Demographics Of The Global Economy

There has been a drastic change in the demographics of the world economy in the last 30 years

Four trends are important:

the Changing World Output and World Trade Picture

In 1960, the United States accounted for over 40% of world economic activity

By 2006, the United States accounted for less than 20% of world economic activity A similar trend occurred in other developed countries

The share of world output accounted for by developing nations is rising and is expected to account for morof world economic activity by 2020

the Changing Foreign Direct Investment Picture

In the 1960s, U.S. firms accounted for about two-thirds of worldwide FDI flows

Today, the United States accounts for less than one-fifth of worldwide FDI flows

Other developed countries have followed a similar pattern

In contrast, the share of FDI accounted for by developing countries has risen from less than 2% in 1980 to ain 2005

Developing countries, especially China, have also become popular destinations for FDI

the Changing Nature of the Multinational Enterprise

A multinational enterprise (MNE) is any business that has productive activities in two or more countries

Since the 1960s, there has been a rise in non-U.S. multinationals, and a growth of mini-multinationals

the Changing World Order

Many former Communist nations in Europe and Asia are now committed to democratic politics and freconomies and so, create new opportunities for international businesses

China and Latin America are also moving toward greater free market reforms

V. The Global Economy Of The Twenty-first Century

The world is moving toward a more global economic system, but globalization is not inevitable


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Globalization also brings risks like the financial crisis that swept through South East Asia in the late 1990s

VI. The Globalization Debate

Is the shift toward a more integrated and interdependent global economy a good thing?

Supporters believe that increased trade and cross-border investment mean lower prices for goods and servieconomic growth, higher consumer income, and more jobs

Critics worry that globalization will cause job losses, environmental degradation, and the cultural imperialism of gmedia and MNEs

II. Anti-Globalization Protests

More than 40,000 anti-globalization protesters took to the street at the WTO meeting in Seattle in 1999

Protesters now regularly show up at most major meetings of global institutions

II. Globalization, Jobs, And Income

Globalization critics argue that falling barriers to trade are destroying manufacturing jobs in advanced count

Supporters of globalization contend that the benefits of this trend outweigh the costs that countries will specializewhat they do most efficiently and trade for other goods and all countries will benefit

X. Globalization, Labor Policies, And The Environment

Globalization critics argue that firms avoid costly efforts to adhere to labor and environmental regulations production to countries where such regulations do not exist, or are not enforced

Globalization supporters claim that tougher environmental and labor standards are associated with economso as countries get richer from free trade, they get tougher environmental and labor regulations

X. Globalization And National Sovereignty

Critics of globalization worry that todays interdependent global economy is shifting economic power national governments toward supranational organizations like the WTO, the EU, and the UN

Supporters of globalization contend that the power of these organizations is limited to what nation-states agrand that the power of the organizations lies in their ability to get countries to agree to follow certain actions

XI. Globalization And The Worlds Poor

Critics of globalization argue that the gap between rich nations and poor nations is getting wider

Supporters of globalization claim that the best way for the poor nations to improve their situation is to redu

to trade and investment and implement economic policies based on free market economies, and to reforgiveness for debts incurred under totalitarian regimes

II. Managing In The Global Marketplace

An international business is any firm that engages in international trade or investment

Managing an international business differs from managing a domestic business because:

countries are different


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the range of problems confronted in an international business is wider and the problems more complex thandomestic business

firms have to find ways to work within the limits imposed by government intervention in the internationainvestment system

international transactions involve converting money into different currencies

Chapter 3

Differences in Culture

Introduction

Successful international managers need cross-cultural literacy - an understanding of how cultural differenand within nations can affect the way in which business is practiced

A relationship may exist between culture and the costs of doing business in a country or region

What Is Culture?

Culture is a system of values and norms that are shared among a group of people and that when takeconstitute a design for living where

- Values are abstract ideas about what a group believes to be good, right, and desirable

Values provide the context within which a societys norms are established and justified and form the beculture

- Norms are the social rules and guidelines that prescribe appropriate behavior in particular situations

Norms include folkways (the routine conventions of everyday life) and mores (norms that are seen as cenfunctioning of a society and to its social life)

Society refers to a group of people who share a common set of values and normsCulture, Society, And The Nation-state

There is not a strict one-to-one relationship between a society and a nation state

Nation-states are political creations that can contain one or more cultures

Similarly, a culture can embrace several nations

1) The Determinants Of Culture

The values and norms of a culture are the evolutionary product of a number of factors at work in a societyreligion, political and economic philosophies, education, language, and social structure

2) Social Structure

Social structure refersto a societys basic social organization

Two dimensions to consider:

the degree to which the basic unit of social organization is the individual, as opposed to the group

the degree to which a society is stratified into classes or castes


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Individuals And Groups

A group is an association of two or more people who have a shared sense of identity and who interact with in structured ways on the basis of a common set of expectations about each others behavior

Societies differ in terms of the degree to which the group is viewed as the primary means of social organizat

In many Western societies, there is a focus on the individual, and individual achievement is common

This contributes to the dynamism of the US economy, and high level of entrepreneurship

But, leads to a lack of company loyalty and failure to gain company specific knowledge, competitioindividuals in a company instead of than team building, and less ability to develop a strong network of conta firm

In many Asian societies, the group is the primary unit of social organization

This may discourage job switching between firms, encourage lifetime employment systems, and lead to cin solving business problems

But, might also suppress individual creativity and initiative

Social Stratification All societies are stratified on a hierarchical basis into social categories, orsocial strata

While all societies are stratified to some extent, they differ by:

the degree of mobility between social strata

the significance attached to social strata in business contacts

Social mobilityis the extent to which individuals can move out of the strata into which they are born

A caste systemis a closed system of stratification in which social position is determined by the family intoperson is born, and change in that position is usually not possible during an individual's lifetime

A class systemis a form of open social stratification in which the position a person has by birth can be through his or her achievement or luck

The social stratification of a society is significant if it affects the operation of business organizations

Class consciousnessis a condition where people tend to perceive themselves in terms of their class backgrothis shapes their relationships with others

In cultures where class consciousness is high, the way individuals from different classes work together m

prescribed and strainedReligious And Ethical Systems

Religionis a system of shared beliefs and rituals that are concerned with the realm of the sacred

Christianity

Christianity is the worlds largest religion and is found throughout Europe, the Americas, and other countrieEuropeans

Perhaps the most important economic implication of Christianity is the Protestant work ethic


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In 1804, Max Weber suggested that it was this ethic and its focus on hard work, wealth creation, and frugalithe driving force of capitalism

Islam

Islam, the worlds second largest religion, extends the underlying roots of Christianity to an all-embracing way of lthat governs one's being

In the West, Islamic fundamentalism is associated in the media with militants, terrorists, and violent upheafact Islam teaches peace, justice, and tolerance

Fundamentalists, who demand rigid commitment to religious beliefs and rituals, have gained political powMuslim countries, and blame the West for many social problems

The key economic implication of Islam is that under Islam, people do not own property, but only act as stGod and thus must take care of that which they have been entrusted with, so while Islam is supportive of bway business is practiced is prescribed

Ethical systemsare a set of moral principles, or values, that are used to guide and shape behavior

Religion and ethics are often closely intertwined

Four religions dominate society -Christianity, Islam, Hinduism, and Buddhism

Confucianism is also important in influencing behavior and culture in many parts of Asia

Chapter 5

International Trade Theory

An Overview Of Trade Theory

Free trade refers to a situation where a government does not attempt to influence through quotas or duits citizens can buy from another country or what they can produce and sell to another country

1) The benefits of Trade Smith, Ricardo and Heckscher-Ohlin show why it is beneficial for a country to engage in int

trade even for products it is able to produce for itself

International trade allows a country: to specialize in the manufacture and export of products that it can produce efficiently import products that can be produced more efficiently in other countries

2) The Patterns Of International Trade

Some patterns of trade are fairly easy to explain - it is obvious why Saudi Arabia exports oexports cocoa, and Brazil exports coffee

But, why does Switzerland export chemicals, pharmaceuticals, watches, and jewelry? Why dexport automobiles, consumer electronics, and machine tools?

3) Trade Theory And Government Policy

Mercantilism makes a crude case for government involvement in promoting exports and limiting imports

Smith, Ricardo, and Heckscher-Ohlin promote unrestricted free trade

New trade theory and Porters theory of national competitive advantage justify limited and selective gintervention to support the development of certain export-oriented industries


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. Mercantilism

Mercantilism suggests that it is in a countrys best interest to maintain a trade surplus-- to export mothan it imports

Mercantilism advocates government intervention to achieve a surplus in the balance of trade

It views trade as a zero-sum game - one in which a gain by one country results in a loss by anoth

II. Absolute Advantage

Adam Smith argued that a country has an absolute advantage in the production of a product wmore efficient than any other country in producing it

According to Smith, countries should specialize in the production of goods for which theyabsolute advantage and then trade these goods for the goods produced by other countries

Assume that two countries, Ghana and South Korea, both have 200 units of resources that couldused to produce rice or cocoa

In Ghana, it takes 10 units of resources to produce one ton of cocoa and 20 units of resources tone ton of rice

So, Ghana could produce 20 tons of cocoa and no rice, 10 tons of rice and no cocoa, or some coof rice and cocoa between the two extremes

In South Korea it takes 40 units of resources to produce one ton of cocoa and 10 resources to prton of rice

So, South Korea could produce 5 tons of cocoa and no rice, 20 tons of rice and no cocoa,combination in between

Ghana has an absolute advantage in the production of cocoa

South Korea has an absolute advantage in the production of rice

Without trade:

Ghana would produce 10 tons of cocoa and 5 tons of rice

South Korea would produce 10 tons of rice and 2.5 tons of cocoa

If each country specializes in the product in which it has an absolute advantage and trades for the product:

Ghana would produce 20 tons of cocoa

South Korea would produce 20 tons of rice

Ghana could trade 6 tons of cocoa to South Korea for 6 tons of rice

After trade:

Ghana would have 14 tons of cocoa left, and 6 tons of rice

South Korea would have 14 tons of rice left and 6 tons of cocoa

Both countries gained from trade

V. Comparative Advantage

David Ricardo asked what might happen when one country has an absolute advantage in the proall goods


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Ricardos theory of comparative advantage suggests that countries should specialize in the prothose goods they produce most efficiently and buy goods that they produce less efficiently from other countthis means buying goods from other countries that they could produce more efficiently at home

Assume:

Ghana is more efficient in the production of both cocoa and rice

In Ghana, it takes 10 resources to produce one tone of cocoa, and 13 1/3 resources to produce rice

So, Ghana could produce 20 tons of cocoa and no rice, 15 tons of rice and no cocoa, or some coof the two

In South Korea, it takes 40 resources to produce one ton of cocoa and 20 resources to produce rice

So, South Korea could produce 5 tons of cocoa and no rice, 10 tons of rice and no cocoa,combination of the two

With trade:

Ghana could export 4 tons of cocoa to South Korea in exchange for 4 tons of rice

Ghana will still have 11 tons of cocoa, and 4 additional tons of rice South Korea still has 6 tons of rice and 4 tons of cocoa

If each country specializes in the production of the good in which it has a comparative advatrades for the other, both countries gain

Comparative advantage theory provides a strong rationale for encouraging free trade

1) Qualifications And Assumptions

The simple example of comparative advantage assumes:

only two countries and two goods zero transportation costs

similar prices and values

resources are mobile between goods within countries, but not across countries

constant returns to scale

fixed stocks of resources

no effects on income distribution within countries

2) Extensions Of The Ricardian Model

Resources do not always move freely from one economic activity to another, and job losses may

Unrestricted free trade is beneficial, but because of diminishing returns, the gains may not be athe simple model would suggest

Opening a country to trade:

might increase a country's stock of resources as increased supplies become available from abroa


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might increase the efficiency of resource utilization, and free up resources for other uses

might increase economic growth

The Samuelson Critique

Paul Samuelson argues that dynamic gains from trade may not always be beneficial

The ability to offshore services jobs that were traditionally not internationally mobile may haveof a mass inward migration into the United States, where wages would then fall

Heckscher-Ohlin Theory

Ricardos theory suggests that comparative advantage arises from differences in productivity

Eli Heckscher and Bertil Ohlin argued that comparative advantage arises from differences infactor endowments the extent to which a country is endowed with resources like land, labor, and capital

The Heckscher-Ohlin theory predicts that countries will export goods that make intensive usefactors that are locally abundant, while importing goods that make intensive use of factors that are locally sc

The Leontief Paradox

Wassily Leontief theorized that since the U.S. was relatively abundant in capital comparednations, the U.S. would be an exporter of capital intensive goods and an importer of labor-intensive goods.

However, he found that U.S. exports were less capital intensive than U.S. imports

Since this result was at variance with the predictions of the theory, it became known asthe LeontieParadox

I. The Product Life Cycle Theory

The product life-cycle theory, proposed by Raymond Vernon, suggested that as products maturthe location of sales and the optimal production location will change affecting the flow and direction of trade

Vernon argued that the size and wealth of the U.S. market gave U.S. firms a strong incentive tnew products

Vernon argued that initially, the product would be produced and sold in the U.S., later, as demanother developed countries, U.S. firms would begin to export

Over time, demand for the new product would grow in other advanced countries making it wortforeign producers to begin producing for their home markets

U.S. firms might also set up production facilities in those advanced countries where demand walimiting the exports from the U.S.

As the market in the U.S. and other advanced nations matured, the product would becostandardized, and price the main competitive weapon

Producers based in advanced countries where labor costs were lower than the United States migable to export to the U.S.

If cost pressures became intense, developing countries would begin to acquire a production aover advanced countries

The United States switched from being an exporter of the product to an importer of the pproduction becomes more concentrated in lower-cost foreign locations


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The Product Life Cycle Theory

The product life cycle theory accurately explains what has happened for products like photocopnumber of other high technology products developed in the US in the 1960s and 1970s

But, the increasing globalization and integration of the world economy has made this theory lestoday's world

II. New Trade Theory

New trade theorysuggests that the ability of firms to gaineconomies of scale(unit cost reductioassociated with a large scale of output) can have important implications for international trade

New trade theory suggests that:

through its impact on economies of scale, trade can increase the variety of goods available to cand decrease the average cost of those goods

in those industries when output required to attain economies of scale represents a significant prototal world demand, the global market may only be able to support a small number of enterprises

1) Increasing Product Variety And Reducing Costs

Without trade, nations might not be able to produce those products where economies of important

With trade, markets are large enough to support the production necessary to achieve economies


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So, trade is mutually beneficial because itallows for the specialization of production, the realizationof scale economies, and the production of a greatervariety of products at lower prices

2) Economies Of Scale, First MoverAdvantages, And The Pattern Of Trade

The pattern of trade we observe in the worldeconomy may be the result of first mover advantages (the economic an strategic advantages that accrue to earlyentrants into an industry) and economies of scale

New trade theory suggests that for thoseproducts where economies of scale are significant andrepresent a substantial proportion of world demand, firstmovers can gain a scale based cost advantage that laterentrants find difficult to match

3) Implications Of New Trade Theory

Nations may benefit from trade even when they do not differ in resource endowments or techno

A country may dominate in the export of a good simply because it was lucky enough to have onfirms among the first to produce that good

While this is at variance with the Heckscher-Ohlin theory, it does not contradict comparative atheory, but instead identifies a source of comparative advantage

An extension of the theory is the implication that governments should consider strategic tradthat nurture and protect firms and industries where first mover advantages and economies of scale are impor

III. National Competitive Advantage: Porters Diamond

Michael Porter tried to explain why a nation achieves international success in a particular indidentified four attributes that promote or impede the creation of competitive advantage:

Factor endowments Demand conditions

Relating and supporting industries

Firm strategy, structure, and rivalry

1) Factor Endowments

Factor endowments refer to a nations position in factors of production necessary to compete in industry

A nation's position in factors of production can lead to competitive advantage

These factors can be either basic (natural resources, climate, location) or advanced (skillinfrastructure, technological know-how)

2)

Demand Conditions


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Demand conditions refer to the nature of home demand for the industrys product or service

The nature of home demand for the industrys product or service influences the developcapabilities

Sophisticated and demanding customers pressure firms to be competitive

3) Relating And Supporting Industries

Firm strategy, structure, and rivalryrefers to the conditions governing how companies are crorganized, and managed, and the nature of domestic rivalry

The conditions in the nation governing how companies are created, organized, and managednature of domestic rivalry impacts firm competitiveness

Different management ideologies affect the development of national competitive advantage

Vigorous domestic rivalry creates pressures to innovate, to improve quality, to reduce costs, andin upgrading advanced features

4) Evaluating Porters Theory

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, complemenother and in combination creating the conditions appropriate for competitive advantage

X. Implications For Managers

There are three main implications for international businesses:

location implications first-mover implications

policy implications

1) Location

Different countries have advantages in different productive activities

It makes sense for a firm to disperse its various productive activities to those countries where thperformed most efficiently

International trade theory suggests that firm sthat fail to do this, may be at a competitive disadva

2) First-Mover Advantages

Being a first mover can have important competitive implications, especially if there are econscale and the global industry will only support a few competitors

Firms that establish a first-mover advantage may dominate global trade in that product

3) Government Policy


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Government policies with respect to free trade or protecting domestic industries can significantglobal competitiveness

Businesses should work to encourage governmental policies that support free trade

Firms should also lobby the government to adopt policies that have a favorable impact component of the diamond

Chapter 6The Political Economy of International Trade

Introduction

Free trade occurs when governments do not attempt to restrict what its citizens can buy fromcountry or what they can sell to another country

While many nations are nominally committed to free trade, they tend to intervene in internationprotect the interests of politically important groups

. Instruments of Trade Policy

The main instruments of trade policy are:

Tariffs

Subsides

Import Quotas

Voluntary Export Restraints

Local Content Requirements

Administrative Polices

Antidumping Policies

1) Tariffs

Tariffs are taxes levied on imports that effectively raise the cost of imported products relative toproducts

Specific tariffsare levied as a fixed charge for each unit of a good imported

Ad valorem tariffsare levied as a proportion of the value of the imported good

Tariffs increase government revenues, provide protection to domestic producers againstcompetitors by increasing the cost of imported foreign goods, and force consumers to pay more for certain i

So, tariffs are unambiguously pro-producer and anti-consumer, and tariffs reduce the overall effthe world economy

2) Subsidies

Subsidiesare government payments to domestic producers

Consumers typically absorb the costs of subsidies


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protecting industries deemed important for national security

retaliating to unfair foreign competition

protecting consumers from dangerous products

furthering the goals of foreign policy

protecting the human rights of individuals in exporting countries

a- Protecting Jobs And Industries

Protecting jobs and industries is the most common political reason for trade restrictions

Usually this results from political pressures by unions or industries that are "threatened" by morforeign producers, and have more political clout than the consumers that will eventually pay the costs

b- National Security

Industries such as aerospace or electronics are often protected because they are deemed impnational security

c- Retaliation

When governments take, or threaten to take, specific actions, other countries may remove trade

If threatened governments dont back down, tensions can escalate and new trade barriers may b

d- Protecting Consumers

Governments may intervene in markets to protect consumers

e- Furthering Policy Objectives

Foreign policy objectives can be supported through trade policy

Preferential trade terms can be granted to countries that a government wants to build strong relat

Trade policy can also be used to punish rogue states that do not abide by international laws or no

However, it might cause other countries to undermine unilateral trade sanctions

The Helms-Burton Actand the DAmato Act, have been passed to protect American companiessuch actions

f- Protecting Human Rights

Trade policy can be used to improve the human rights policies of trading partners

However, unless a large number of countries choose to take such action, it is unlikely to be succ

Some critics have argued that the best way to change the internal human rights of a country is toin international trade

The decision to grant China MFN status in 1999 was based on this philosophy

2) Economic Arguments For Intervention


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Economic arguments for intervention include:

the infant industry argument

strategic trade policy

a- The Infant Industry Argument

The infant industry argumentsuggests that an industry should be protected until it can develop viable and competitive internationally

The infant industry argument has been accepted as a justification for temporary trade restrictithe WTO

However, it can be difficult to gauge when an industry has grown up

Critics argue that if a country has the potential to develop a viable competitive position its firmscapable of raising necessary funds without additional support from the government

b- Strategic Trade Policy

Strategic trade policysuggests that in cases where there may be important first mover advagovernments can help firms from their countries attain these advantages

Strategic trade policy also suggests that governments can help firms overcome barriers to eindustries where foreign firms have an initial advantage

V. Revised Case For Free Trade

Restrictions on trade may be inappropriate in the cases of:

Retaliation and Trade War

Domestic Politics

1) Retaliation And Trade War

Paul Krugman argues that strategic trade policies aimed at establishing domestic firms in a position in a global industry are beggar-thy-neighbor policies that boost national income at the expenscountries

Countries that attempt to use such policies will probably provoke retaliation

2) Domestic Policies

Krugman argues that since special interest groups can influence governments, strategic tradealmost certain to be captured by such groups who will distort it to their own ends

Development Of The World Trading System

How has the current world trade system emerged?

1) From Smith To The Great Depression

Until the Great Depression of the 1930s, most countries had some degree of protectionism

The Smoot-Hawley tariff was enacted in 1930 in the U.S creating significant import tariffs ogoods

Other nations took similar steps and as the depression deepened, world trade fell further

2) 1947-79: GATT, Trade Liberalization, And Economic Growth


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After WWII, the U.S. and other nations realized the value of freer trade, and established thAgreement on Tariffs and Trade (GATT)

The approach of GATT (a multilateral agreement to liberalize trade) was to gradually eliminate trade

3) 1980-1993: Protectionist Trends

In the 1980s and early 1990s, the world trading system was strained

Japans economic strength and huge trade surplus stressed what had been more equal trading paJapans perceived protectionist (neo-mercantilist) policies created intense political pressures in other countries

Persistent trade deficits by the U.S., the worlds largest economy, caused significant economicfor some industries and political problems for the government

Many countries found that although limited by GATT from utilizing tariffs, there were many osubtle forms of intervention that had the same effects and did not technically violate GATT

4) The Uruguay Round And The World Trade Organization

The Uruguay Round of GATT negotiations began in 1986

The talks focused on several areas:

Services and Intellectual Property

-going beyond manufactured goods to address trade issues related to services and intellectualand agriculture

The World Trade Organization

-it was hoped that enforcement mechanisms would make the WTO a more effective policemglobal trade rules

The WTO encompassed GATT along with two sisters organizations, the General Agreement onServices (GATS) and the Agreement on Trade Related Aspects of Intellectual Property Rights (TRIPS)

5) WTO: Experience To Date

Since its establishment, the WTO has emerged as an effective advocate and facilitator of futdeals, particularly in such areas as services

So far, the WTOs policing and enforcementmechanisms are having a positive effect

Most countries have adopted WTO recommendations for trade disputes

In 1997, 68 countries that account for more than 90% of world telecommunications revenues popen their markets to foreign competition and to abide by common rules for fair competition in telecommun

102 countries pledged to open to varying degrees their banking, securities, and insurance sforeign competition

The agreement covers not just cross-border trade, but also foreign direct investment

The 1999 meeting of the WTO in Seattle was important not only for what happened between thcountries, but also for what occurred outside the building

Inside, members failed to agree on how to work toward the reduction of barriers to cross-bordagricultural products and cross-border trade and investment in services

Outside, the WTO became a magnet for various groups protesting free trade


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6) The Future Of The WTO: Unresolved Issues And The Doha Round

The current agenda of the WTO focuses on:

the rise of anti-dumping policies

the high level of protectionism in agriculture

the lack of strong protection for intellectual property rights in many nations

continued high tariffs on nonagricultural goods and services in many nations

The WTO is encouraging members to strengthen the regulations governing the imposition of anduties

The WTO is concerned with the high level of tariffs and subsidies in the agricultural sector economies

TRIPS obliges WTO members to grant and enforce patents lasting at least 20 years and copyrig50 years

The WTO would like to bring down tariff rates on nonagricultural goods and services, and rscope for the selective use of high tariff rates

The WTO launched a new round of talks at Doha, Qatar in 2001The agenda includes:

cutting tariffs on industrial goods and services

phasing out subsidies to agricultural producers

reducing barriers to cross-border investment

limiting the use of anti-dumping laws

I. Implications For Managers

Managers need to consider how trade barriers affect the strategy of the firm and the implicgovernment policy on the firm

1) Trade Barriers And Firm Strategy

Trade barriers raise the cost of exporting products to a country

Voluntary exportrestraints (VERs) may limit a firms ability to serve a country from locationsthat country

To conform to local content requirements, a firm may have to locate more production activities market than it would otherwise

All of these can raise the firms costs above the level that could be achieved in a world withobarriers

2) Policy Implications

International firms have an incentive to lobby for free trade, and keep protectionist pressures frothem to have to change strategies

While there may be short run benefits to having governmental protection in some situations, inrun these can backfire and other governments can retaliate


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Chapter 8

Regional Economic Integration

Introduction

Regional economic integrationrefers to agreements between countries in a geographic region to tariff and non-tariff barriers to the free flow of goods, services, and factors of production between each othe

Regional trade agreements are designed to promote free trade, but instead the world may b

toward a situation in which a number of regional trade blocks compete against each other. Levels Of Economic Integration

There are five levels of economic integration:

1. A free trade areaeliminates all barriers to the trade of goods and services among member countmembers determine their own trade policies for nonmembers

the European Free Trade Association (between Norway, Iceland, Liechtenstein, and SwitzerlandNorth American Free Trade Agreement (between the U.S., Canada, and Mexico) are both free trade areas

2. A customs unioneliminates trade barriers between member countries and adopts a common exterpolicy

The Andean Pact (between Bolivia, Columbia, Ecuador and Peru) is an example of a customs un3. A common market has no barriers to trade between member countries, a common external trade po

the free movement of the factors of production MERCOSUR (between Brazil, Argentina, Paraguay, and Uruguay) is aiming for common marke

4. An economic unionhas the free flow of products and factors of production between members, a cexternal trade policy, a common currency, a harmonized tax rates, and a common monetary and fiscal policy

The European Union (EU) is an imperfect economic union5. A political unioninvolves a central political apparatus that coordinates the economic, social, and

policy of member states The EU is headed toward at least partial political union, and the United States is an exampl

closer political unionI. The Case for Regional Integration

1) The Economic Case For Regional Integration

All countries gain from free trade and investment

Regional economic integration is an attempt to exploit the gains from free trade and investment

2) The Political Case For Regional Integration

Linking countries together, making them more dependent on each other:

creates incentives for political cooperation and reduces the likelihood of violent conflict

gives countries greater political clout when dealing with other nations

3) Impediments To Integration

Economic integration can be difficult because:

while a nation as a whole may benefit from a regional free trade agreement, certain groups may

it implies a loss of national sovereignty

V. The Case Against Regional Integration

Regional economic integration is only beneficial if the amount of trade it creates exceeds the diverts


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Trade creation occurs when low cost producers within the free trade area replace high cost dproducers

Trade diversionoccurs when higher cost suppliers within the free trade area replace lower cost suppliers

Regional Economic Integration In Europe

Europe has two trade blocs:

The European Union (EU) with 27 members The European Free Trade Area (EFTA) with 4 members

The EU is seen as the worlds next economic and political superpower

1) Evolution Of The European Union

The EU was formed as a result of the devastation of two world wars on Western Europe and thea lasting peace, and the desire by the European nations to hold their own on the worlds political and econom

The forerunner of the EU was the European Coal and Steel Community, which had the goal of

barriers to trade in coal, iron, steel, and scrap metal formed in 1951 The European Economic Community was formed in 1957 atthe Treaty of Romewith the goal

becoming a common market

2) Political Structure Of The European UnionThere are five main institutions of the EU:

theEuropean Council- resolves major policy issues and sets policy directions the European Commission- responsible for implementing aspects of EU law and monitoring m

states to ensure they are complying with EU laws theCouncil of the European Union- the ultimate controlling authority within the EU the European Parliament - debates legislation proposed by the commission and forwarded to it

council theCourt of Justice- the supreme appeals court for EU law3) The Single European Act ( o lut Chu u thng nht)

The Single European Act: was adopted by the EU in 1987 committed the EC countries to work toward establishment of a single market by December 31, 1 was born out of frustration among EC members that the community was not living up to its prom provided the impetus for the restructuring of substantial sections of European industry allowing

economic growth than would otherwise have been the case4) The Establishment Of The Euro

The Maastricht Treatycommitted the EU to adopt a single currency

By adopting the euro, the EU has created the second largest currency zone in the world after tU.S. dollar

The euro is used by 12 of the 25 member states

For now, three EU countries, Britain, Denmark and Sweden, that are eligible to participate inzone, are opting out

Benefits of the Euro:

There are savings from having to handle one currency, rather than many

A common currency will make it easier to compare prices across Europe


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European producers will be forced to look for ways to reduce their production costs in order totheir profit margins

It should give a strong boost to the development of highly liquid pan-European capital market

A pan-European euro denominated capital market will increase the range of investment optionsto individuals and institutions

Costs of the Euro:

National authorities lose control over the monetary policy

The EU is not anoptimal currency area (an area where similarities in the underlying structueconomic activities make it feasible to adopt a single currency and use a single exchange rate as an insmacro-economic policy)

Since its establishment January 1, 1999, the euro has had a volatile trading history with the U.S.

Initially, the euro fell in value relative to the dollar, but strengthened to a five year high of February 2006

5) Enlargement Of The European Union

Many countries have applied for EU membership

Ten countries joined on May 1, 2004 expanding the EU to 25 states, with population of 45 people, and a single continental economy with a GDP of 11 trillion

In 2007, Bulgaria and Romania joined bring membership to 27 countries

The new countries will not be able to adopt the euro until at least 2007, nor will there be free mof labor between new and existing countries until then

I. Regional Economic Integration In The Americas

There is a move toward greater regional economic integration in the Americas

The biggest effort is the North American Free Trade Area (NAFTA) Other efforts include the Andean Community and MERCOSUR

A hemisphere-wide Free Trade of the Americas is under discussion

1) The North American Free Trade Agreement

The North American Free Trade Area (NAFTA)became law January 1, 1994

NAFTAs participants are the United States, Canada, and Mexico

NAFTA:

abolished tariffs on 99 percent of the goods traded between members

removed most barriers on the cross-border flow of services

protects intellectual property rights

removes most restrictions on FDI between the three member countries

allows each country to apply its own environmental standards, provided such standards have abase


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establishes two commissions to impose fines and remove trade privileges when environmentalor legislation involving health and safety, minimum wages, or child labor are ignored

NAFTAs supporters argue that:

Mexico will benefit from increased jobs as low cost production moves south, and will attain meconomic growth as a result

The U.S. and Canada will benefit from the access to a large and increasingly prosperous marketthe lower prices for consumers from goods produced in Mexico

U.S. and Canadian firms with production sites in Mexico will be more competitive on world ma

Critics of NAFTAs argued that:

that jobs would be lost and wage levels would decline in the U.S. and Canada

Mexican workers would emigrate north

pollution would increase due to Mexico's more lax standards

Mexico would lose its sovereignty

Research indicates that NAFTAs early impact was subtle, and both advocates and detractors been guilty of exaggeration

The agreement has helped to create the background for increased political stability in Mexico

Several other Latin American countries have indicated their desire to eventually join NAFTA

Currently both Canada and the U.S. are adopting a wait and see attitude with regard to most cou

2) The Andean Community

TheAndean Pact:

was formed in 1969 using the EU model

had more or less failed by the mid-1980s

was re-launched in 1990, and now operates as a customs union

signed an agreement in 2003 with MERCOSUR to restart negotiations towards the creation of aarea

3) MERCOSUR

originated in 1988 as a free trade pact between Brazil and Argentina

was expanded in 1990 to include Paraguay and Uruguay

has been making progress on reducing trade barriers between member states may be diverting trade rather than creating trade, and local firms are investing in industries th

competitive on a worldwide basis

4) Central American Common Market And CARICOMThere are two other trade pacts in the Americas:

theCentral American Trade Market (CAFTA) to lower trade barriers between the U.S. and mem CARICOM to establish a customs union Neither pact has achieved its goals yet In 2006, six CARICOM members formed theCaribbean Single Market and Economy (CSME)- to

lower trade barriers and harmonize macro-economic and monetary policy between members


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5) Free Trade Of The Americas

Talks began in April 1998 to establisha Free Trade of The Americas (FTAA)by 2005

The FTAA was not established and now support from the U.S. and Brazil is mixed

If the FTAA is established, it will have major implications for cross-border trade and investmwithin the hemisphere

The FTAA would create a free trade area of nearly 800 million people

II. Regional Economic Integration Elsewhere Several efforts have been made to integrate in Asia and Africa

One of the most successful is the Association of Southeast Asian Nations (ASEAN)

1) Association Of Southeast Asian Nations

TheAssociation of Southeast Asian Nations (ASEAN):

was formed in 1967

currently includes Brunei, Indonesia, Malaysia, the Philippines, Singapore, Thailand, Vietnam, Laos, and Cambodia

wants to foster freer trade between member countries and to achieve some cooperation in theirpolicies

an ASEAN Free Trade Area (AFTA) between the six original members of ASEAN came into ef2003

2) Asia-Pacific Economic Cooperation

The Asia-Pacific Economic Cooperation (APEC):

currently has 21 members including the United States, Japan, and China

wants to increase multilateral cooperation in view of the economic rise of the Pacific nationgrowing interdependence within the region

3) Regional Trade Blocs In Africa Progress toward the establishment of meaningful trade blocs in Africa has been slow Many countries are members of more than one of the nine dormant blocs in the region Kenya, Uganda, and Tanzania committed to re-launching theEast African Community (EAC) in 2001

however so far, the effort appears futileII. Implications For Managers

The EU and NAFTA currently have the most immediate implications for business

1) OpportunitiesRegional economic integration:

opens new markets makes it possible for firms to realize potentially enormous cost economies by centralizing prod

those locations where the mix of factor costs and skills is optimal2) Threats

Within each grouping, the business environment becomes competitive

EU companies are becoming more capable

There is a risk of being shut out of the single market by the creation of a trade fortress


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The EU is becoming more willing to intervene and impose conditions on companies proposingand acquisitions which could limit the ability of firms to follow the strategy of their choice

Chapter 9

The Foreign Exchange Market

Introduction

A firms sales,profits, and strategy are affected by events in the foreign exchange market

Theforeign exchange marketis a market for converting the currency of one country into that of country

Theexchange rateis the rate at which one currency is converted into another

Theforeign exchange marketis the market where currencies are bought and sold and in which cuprices are determined. It is a network of banks, brokers and dealers that exchange currencies 24 hours a day.

. The Functions Of The Foreign Exchange Market

The foreign exchange market:

is used to convert the currency of one country into the currency of another provide some insurance against foreign exchange risk (the adverse consequences of unpredict

changes in exchange rates)

1) Currency Conversion

International companies use the foreign exchange market when:

the payments they receive for exports, the income they receive from foreign investments, or ththey receive from licensing agreements with foreign firms are in foreign currencies

they must pay a foreign company for its products or services in its countrys currency

they have spare cash that they wish to invest for short terms in money markets

they are involved incurrency speculation(the short-term movement of funds from one currenanother in the hopes of profiting from shifts in exchange rates)

2) Insuring Against Foreign Exchange Riska- Spot Exchange Rates ( T gi giao ngay)

The foreign exchange market can be used to provide insurance to protect againstforeign exchange ris(the possibility that unpredicted changes in future exchange rates will have adverse consequences for the firm

A firm that insures itself against foreign exchange risk ishedging

Thespot exchange rateis the rate at which a foreign exchange dealer converts one currency intocurrency on a particular day

Spot rates change continually depending on the supply and demand for that currency and other c

b- Forward Exchange Rates (T gi k hn/ giao sau)

To insure or hedge against a possible adverse foreign exchange rate movement, firms engage iexchanges

A forward exchangeoccurs when two parties agree to exchange currency and execute the deal specific date in the future


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A forward exchange rateis the rate governing such future transactions

Rates for currency exchange are typically quoted for 30, 90, or 180 days into the future

c- Currency Swaps A currency swapis the simultaneous purchase and sale of a given amount of foreign exchange

different value dates Swaps are transacted between international businesses and their banks, between banks, and

governments when it is desirable to move out of one currency into another for a limited period withouforeign exchange rate risk

I. The Nature Of The Foreign Exchange Market The foreign exchange market is a global network of banks, brokers, and foreign exchang

connected by electronic communications systems it is not located in any one place

The most important trading centers are London, New York, Tokyo, and Singapore

The markets is always open somewhere in the world it never sleeps

High-speed computer linkages between trading centers around the globe have effectively createmarket there is no significant difference between exchange rates quotes in the differing trading centers

If exchange rates quoted in different markets were not essentially the same, there would be an o

forarbitrage (the process of buying a currency low and selling it high), and the gap would close Most transactions involve dollars on one side it is a vehicle currency along with the euro, the Jap

yen, and the British pound

V. Economic Theories Of Exchange Rate Determination

Exchange rates are determined by the demand and supply for different currencies.

Three factors impact future exchange rate movements:

a countrys price inflation

a countrys interest rate market psychology

1) Prices And Exchange Rates

The law of one pricestates that in competitive markets free of transportation costs and barriers tidentical products sold in different countries must sell for the same price when their price is expressed in tesame currency

Purchasing power parity (PPP) theory argues that given relativelyefficient markets(markets in whifew impediments to international trade and investment exist) the price of a basket of goods shouldequivalent in each country

PPP theory predicts that changes in relative prices will result in a change in exchange rates

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

Example: US/French exchange rate: $1 = .78Eur

A jacket selling for $50 in New York should retail for 39.24Eur in Paris (50x.78)

A positive relationship between the inflation rate and the level of money supply exists

When the growth in the money supply is greater than the growth in output, inflation will occur


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PPP theory suggests that changes in relative prices between countries will lead to exchange ratat least in the short run

A country with high inflation should see its currency depreciate relative to others

Empirical testing of PPP theory suggests that it is most accurate in the long run, and for counhigh inflation and underdeveloped capital markets

2) Interest Rates And Exchange Rates

There is a link between interest rates and exchange rates

The International Fisher Effect states that for any two countries the spot exchange rate should an equal amount but in the opposite direction to the difference in nominal interest rates between two countri

In other words:

(S1 - S2) / S2 x 100 = i $ - i

where i $ and i are the respective nominal interest rates in two countries (in this case thJapan), S1 is the spot exchange rate at the beginning of the period and S2 is the spot exchange rate at theperiod

3) Investor Psychology And Bandwagon Effects

Investor psychology also affects exchange rates

The bandwagon effectoccurs when expectations on the part of traders can turn into self-fuprophecies, and traders can join the bandwagon and move exchange rates based on group expectations

Governmental intervention can prevent the bandwagon from starting, but is not always effective

Government restrictions can include:

A restriction on residents ability to convert the domestic currency into a for eign currency

Restricting domestic businesses ability to take foreign currency out of the country

Governments will limit or restrict convertibility for a number of reasons that include:

Preserving foreign exchange reserves

A fear that free convertibility will lead to a run on their foreign exchange reserves known as capitflight

4) Summary

Relative monetary growth, relative inflation rates, and nominal interest rate differentialmoderately good predictors of long-run changes in exchange rates

So, international businesses should pay attention to countries differing monetary growth, inflinterest rates

Exchange Rate Forecasting

Should companies use exchange rate forecasting services to aid decision-making?

The efficient market school argues that forward exchange rates do the best possible job of fofuture spot exchange rates, and, therefore, investing in forecasting services would be a waste of money

The inefficient market school argues that companies can improve the foreign exchange markets estimaof future exchange rates by investing in forecasting services


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1) The Efficient Market School

Anefficient marketis one in which prices reflect all available information

If the foreign exchange market is efficient, then forward exchange rates should be unbiased prefuture spot rates

Most empirical tests confirm the efficient market hypothesis suggesting that companies should their money on forecasting services

2) The Inefficient Market School

An inefficient marketis one in which prices do not reflect all available information

So, in an inefficient market, forward exchange rates will not be the best possible predictors of fexchange rates and it may be worthwhile for international businesses to invest in forecasting services

However, the track record of forecasting services is not good

3) Approaches To Forecasting

There are two schools of thought on forecasting:

Fundamental analysisdraw upon economic factors like interest rates, monetary policy, inflation balance of payments information to predict exchange rates

Technical analysischarts trends with the assumption that past trends and waves are reasonable pof future trends and waves

I. Currency Convertibility

A currency isfreely convertiblewhen a government of a country allows both residents and non-reto purchase unlimited amounts of foreign currency with the domestic currency

A currency isexternally convertiblewhen non-residents can convert their holdings of domcurrency into a foreign currency, but when the ability of residents to convert currency is limited in some way

A currency isnonconvertiblewhen both residents and non-residents are prohibited from convertinholdings of domestic currency into a foreign currency

Most countries today practice free convertibility, although many countries impose some restrithe amount of money that can be converted

Countries limit convertibility to preserve foreign exchange reserves and preventcapital flight (wheresidents and nonresidents rush to convert their holdings of domestic currency into a foreign currency)

When a countrys currency is nonconvertible, firms may turn tocountertrade (barter like agreements which goods and services can be traded for other goods and services) to facilitate international trade

II. Implications For Managers Firms need to understand the influence of exchange rates on the profitability of trade and invest

There are three types of foreign exchange risk:

1. Transaction exposure

2. Translation exposure

3. Economic exposure

1) Transaction Exposure


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Transaction exposure is the extent to which the income from individual transactions is affecfluctuations in foreign exchange values

It includes obligations for the purchase or sale of goods and services at previously agreed pricborrowing or lending o funds in foreign currencies

2) Translation exposure

Translation exposure is the impact of currency exchange rate changes on the reported fistatements of a company

It is concerned with the present measurement of past events

Gains or losses are paper losses theyre unrealized

3) Economic Exposure

Economic exposure is the extent to which a firms future international earning power is affected by cexchange rates

Economic exposure is concerned with the long-term effect of changes in exchange rates on future pricescosts

4) Reducing Translation And Transaction ExposureTo minimize transaction and translation exposure, firms can:

buy forward

use swaps

leading and lagging payables and receivables (paying suppliers and collecting payment from early or late depending on expected exchange rate movements)

A lead strategyinvolves attempting to collect foreign currency receivables early when a foreign is expected to depreciate and paying foreign currency payables before they are due when a currency is eappreciate

A lag strategy involves delaying collection of foreign currency receivables if that currency is expappreciate and delaying payables if the currency is expected to depreciate

Lead and lag strategies can be difficult to implement

To reduce economic exposure, firms need to:

distribute productive assets to various locations so the firms long-term financial well-being is severely affected by changes in exchange rates

ensure assets are not too concentrated in countries where likely rises in currency values widamaging increases in the foreign prices of the goods and services the firm produces

5) Other Steps For Managing Foreign Exchange Risk

In general, firms should:

have central control of exposure to protect resources efficiently and ensure that each subunit acorrect mix of tactics and strategies

distinguish between transaction and translation exposure on the one hand, and economic exposuother hand

attempt to forecast future exchange rates


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establish good reportingsystems so the central finance function can regularly monitor the firms eposition

produce monthly foreign exchange exposure reports

Chapter 10

The International Monetary System

Introduction

The institutional arrangements that countries adopt togovern exchange ratesare known as thinternational monetary system

When a country allows the foreign exchange market to determine the relative value of a cufloating exchange rate systemexists

When a country fixes the value of its currency relative to a reference currency, apegged exchange rasystem exists

When a country tried to hold the value of its currency within some range of a reference curredirty

floatexists Countries that adopt afixed exchange ratesystem fix their currencies against each other

Prior to the introduction of the euro, some European Union countries operated with fixed exchwithin the context of theEuropean Monetary System (EMS)

. The Gold Standard (Ch bng v vng) The gold standard dates back to ancient times when gold coins were a medium of exchang

account, and store of value Payment for imports was made in gold or silver Later, as trade grew, payment was made in paper currency which was linked to gold at a fixed ra A key problem with the gold standardwas that there was no multinational institution that coul

countries from engaging in competitive devaluations.1) Mechanics Of The Gold Standard

Pegging currencies to gold and guaranteeing convertibility is known as thegold standard

In the 1880s, most of the worlds trading nations followed the gold standard

Under the gold standard one U.S. dollar was defined as equivalent to 23.22 grains of "fine (pure

The amount of a currency needed to purchase one ounce of gold was called thegold par value

2) Strength Of The Gold Standard

The great strength of the gold standard was that it contained a powerful mechanism for abalance-of-trade equilibrium (when the income a countrys residents earn from its exports is equal to the mresidents pay for imports) by all countries

3) The Period Between The Wars: 1918-1939

The gold standard worked fairly well from the 1870s until the start of World War I in 1914

During the war, many governments financed their war expenditures by printing money, and in created inflation


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People lost confidence in the system and started to demand gold for their currency putting prcountries' gold reserves, and forcing them to suspend gold convertibility

By 1939, the gold standard was dead

I. The Bretton Woods System

In 1944, representatives from 44 countries met at Bretton Woods, New Hampshire, to desiginternational monetary system that would facilitate postwar economic growth

Under the new agreement:

a fixed exchange rate system was established

all currencies were fixed to gold, but only the U.S. dollar was directly convertible to gold

devaluations could not to be used for competitive purposes

a country could not devalue its currency by more than 10% without IMF approval

The Bretton Woods agreement also established two multinational institutions:

the International Monetary Fund (IMF)to maintain order in the international monetary system

theWorld Bank to promote general economic development1) The Role Of The IMF

The IMF was charged with executing the main goal of the Bretton Woods agreement - avrepetition of the chaos that occurred between the wars through a combination of disciplineandflexibility

Discipline mean that:

the need to maintain a fixed exchange rate put a brake on competitive devaluations and broughto the world trade environment

a fixed exchange rate regime imposed monetary discipline on countries, thereby curtailing price

Flexibility meant that:

while monetary discipline was a central objective of the agreement, a rigid policy of fixed exchwould be too inflexible

the IMF was ready to lend foreign currencies to members to tide them over during short pbalance-of-payments deficit, when a rapid tightening of monetary or fiscal policy would hurt domestic empl

The International Monetary Fund (IMF) Articles of Agreement were heavily influenced by the wfinancial collapse, competitive devaluations, trade wars, high unemployment, hyperinflation in Germany anand general economic disintegration that occurred between the two world wars.

The aim of the IMF was to try to avoid a repetition of that chaos through a combination of disciflexibility.

2) The Role Of The World Bank

The World Bank is also called theInternational Bank for Reconstruction and Development (IBRD)

There aretwo ways to borrowfrom the World Bank:

1. Under the IBRD scheme, money is raised through bond sales in the international capital market

Borrowers pay what the bank calls a market rate of interest - the bank's cost of funds plus a mexpenses.


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2. Through the International Development Agency, an arm of the bank created in 1960

IDA loans go only to the poorest countries

V. The Collapse Of The Fixed Exchange Rate System

Bretton Woods worked well until the late 1960s

It collapsed when huge increases in welfare programs and the Vietnam War were financed by ithe money supply and causing significant inflation

Other countries increased the value of their currencies relative to the dollar in response to specudollar would be devalued

However, because the system relied on an economically well managed U.S., when the U.S. begmoney, run high trade deficits, and experience high inflation, the system was strained to the breaking point

The system of fixed exchange rates established at Bretton Woods worked well until the late 1960

The US dollar was the only currency that could be converted into gold

The US dollar served as the reference point for all other currencies

Any pressure to devalue the dollar would cause problems through out the world

Factors that led to the collapse of the fixed exchange system include:

President Johnson financed both the Great Society and Vietnam by printing money

High inflation and high spending on imports

On August 8, 1971, President Nixon announces dollar no longer convertible into gold

Countries agreed to revalue their currencies against the dollar

On March 19, 1972, Japan and most of Europe floated their currencies

In 1973, Bretton Woods fails because the key currency (dollar) is under speculative attack The Floating Exchange Rate Regime.

In 1976, following the collapse of Bretton Woods, IMF members formalized a new exchange raat a meeting in Jamaica

The rules that were agreed on then, are still in place today

1) The Jamaica Agreement

Under the Jamaican agreement:

floating rates were declared acceptable gold was abandoned as a reserve asset

total annual IMF quotas - the amount member countries contribute to the IMF - were increasbillion

2) Exchange Rates Since 1973 Since 1973, exchange rates have become more volatile and less predictable than they were betw

and 1973 Volatility has increased because of: The 1971 oil crisis The loss of confidence in the dollar that followed the rise of U.S. inflation in 1977 and 1978


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The 1979 oil crisis The unexpected rise in the dollar between 1980 and 1985 The partial collapse of the European Monetary System in 1992 The 1997 Asian currency crisis

I. Fixed Versus Floating Exchange Rates

The merit of a fixed exchange rate versus a floating exchange rate system continues to be debate

Many countries today are disappointed with the floating exchange rate system

1) The Case For Floating Exchange Rates

The case for floating exchange rates has two main elements:

1. Monetary policy autonomy

2. Automatic trade balance adjustments

Supporters of floating exchange rates argue that removing the obligation to maintain exchange restores monetary control to a government

Under a fixed system, a country's ability to expand or contract its money supply as it sees fit is

the need to maintain exchange rate parity So, under the Bretton Woods system, if a country developed a permanent deficit in its balanc

that could not be corrected by domestic policy, the IMF would have to agree to a currency devaluation

2) The Case For Fixed Exchange Rates Supporters of fixed exchange rates focus on monetary discipline, uncertainty, and the lack of c

between the trade balance and exchange rates Having to maintain a fixed exchange rate parity ensures that governments do not expand the

supplies at inflationary rates They also claim that speculation that is associated with floating exchange rates can cause uncert Advocates of floating exchange rates also argue that floating rates help adjust trade imbalances

3) Who Is Right?

There is no real agreement as to which system is better

We know that a fixed exchange rate regime modeled along the lines of the Bretton Woods systework

A different kind of fixed exchange rate system might be more enduring and might foster thstability that would facilitate more rapid growth in international trade and investment

II. Exchange Rate Regimes In Practice

Various exchange rate regimes are followed today

Currently:

14% of IMF members follow a free float policy

26% of IMF members follow a managed float system

28% of IMF members have no legal tender of their own

the remaining countries use less flexible systems such as pegged arrangements, or adjustable pe

1) Pegged Exchange Rates


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A country following apegged exchange rate system, pegs the value of its currency to that of anmajor currency

Pegged exchange rates are popular among the worlds smaller nations There is some evidence that adopting a pegged exchange rate regime does moderate inflationary

in a country2) Currency Boards

Countries using acurrency boardcommit to converting their domestic currency on demand into acurrency at a fixed exchange rate

To make this commitment credible, the currency board holds reserves of foreign currency eqfixed exchange rate to at least 100% of the domestic currency issued

III. Crisis Management By The IMF Since many of the original reasons for the IMF no longer exist, the organization has redefined it

The IMF now focuses on lending money to countries experiencing financial crises

However, critics claim that IMF policies in these countries have actually made the situation wor

1) Financial Crises In The Post-Bretton Woods Era

A currency crisisoccurs when a speculative attack on the exchange value of a currency results indepreciation in the value of the currency, or forces authorities to expend large volumes of internationa

reserves and sharply increase interest rates in order to defend prevailing exchange rates A banking crisisrefers to a situation in which a loss of confidence in the banking system leads

on the banks, as individuals and companies withdraw their deposits

A foreign debt crisisis a situation in which a country cannot service its foreign debt obligations, private sector or government debt

2) Mexican Currency Crisis Of 1995

The Mexican currency crisis of 1995 was a result of:

high Mexican debts

a pegged exchange rate that did not allow for a natural adjustment of prices

To keep Mexico from defaulting on its debt, a $50 billion aid package was created

3) The Asian CrisisThe 1997 Southeast Asian financial crisis was caused by a series of events that took place in the previous de

huge increases in exports that helped fuel a boom in commercial and residential property, industand infrastructure

investments that were made on the basis of projections about future demand conditions tunrealistic and created significant excess capacity Investments made on the basis of unrealistic projections ademand conditions created significant excess capacity

investments were often supported by dollar-based debts when inflation and increasing imports put pressure on the currencies, the resulting devaluatiodefault on dollar denominated debts

by the mid 1990s, imports were expanding across the region by mid-1997, it became clear that several key Thai financial institutions were on the verge of de foreign exchange dealers and hedge funds started to speculate against the Baht, selling it short after struggling to defend the peg, the Thai government abandoned its defense and announce

Baht would float freely against the dollar With its foreign exchange rates depleted, Thailand lacked the foreign currency needed to fi

international trade and service debt commitments, and was in desperate need of the capital the IMF could pr Following the devaluation of the Baht, speculation caused other Asian currencies including the

Ringgit, the Indonesian Rupaih and the Singapore Dollar to fall


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These devaluations were mainly driven by similar factors to those that led to the earlier devaluaBaht--excess investment, high borrowings, much of it in dollar denominated debt, and a deteriorating payments position

4) Evaluating The IMFs Policy Prescriptions

By 2006, the IMF was committing loans to some 59 countries in economic and currency crisis

All IMF loan packages require a combination of tight macroeconomic policy and tight monetary

However, critics worry:

the one-size-fits-all approach to macroeconomic policy is inappropriate for many countries

the IMF is exacerbating moral hazard (when people behave recklessly because they know thesaved if things go wrong)

The IMF has become too powerful for an institution without any real mechanism for accountabi

As with many debates about international economics, it is not clear who is right

X. Implications For Managers

For managers, understanding the international monetary system is important for:

currency management business strategy corporate-government relations

1) Currency Management Managers must recognize that the current international monetary system is a managed float

which government intervention can help drive the foreign exchange market Under the present system, speculative buying and selling of currencies can create volatile mov

exchange rates2) Business Strategy

Managers need to recognize that while exchange rate movements are difficult to predict, their m

can have a major impact on the competitive position of businesses To contend with this situation, managers need strategic flexibility

3) Corporate-Government Relations

Managers need to recognize that businesses can influence government policy towards the intmonetary system

So, companies should promote an international monetary system that facilitates international gdevelopment

Chapter 12


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The Strategy of International Business

Strategy And The Firm

A firms strategyrefers to the actions that managers take to attain the goals of the firm

Profitabilitycan be defined as the rate of return the firm makes on its invested capital

Profit growthis the percentage increase in net profits over time

Expanding internationally can boost profitability and profit growth

Managers can increase the profitability of the firm by pursuing strategies that lower costs or bystrategies that add value to the firms products, which enables the firm to raise prices. Managers can increaswhich the firms profitsgrow over time by pursuing strategies to sell more products in existing markets or by strategies to enter new markets. As we shall see, expanding internationally can help managers boost profitabilityand increase the rate of profit growth over time.

1) Value Creation

Thevalue createdby a firm is measured by the difference between V (the price that the firm cafor that product given competitive pressures) and C (the costs of producing that product)

The higher the value customers place on a firms products, the higher the price the firm can chathose products, and the greater the profitability of the firm

Profits can be increased by:

adding value to a product so that customers are willing to pay more for it a differentiation strategy

lowering costs a low cost strategy

Michael Porter argues that superior profitability goes to firms that create superior value by lowcost structure of the business and/or differentiating the product so that a premium price can be charged

2) Strategic Positioning

Michael Porter argues that firms need to choose either differentiation or low cost, and then internal operations to support the choice

To maximize long run return on invested capital, firms must:

pick a viable position on the efficiency frontier

configure internal operations to support that position

have the right organization structure in place to execute the strategy

The strategy, operations, and organization of the firm must all be consistent with each other if it is tcompetitive advantage and garner superior profitability. Operations refers to the different value creation firm undertakes

3) Operations: The Firm As A Value Chain

A firmsoperations can be thought of a value chain composed of a series of distinct value cactivities, including production, marketing, materials management, R&D, human resources, information sythe firm infrastructure


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Value creation activities can be categorized asprimary activities(R&D, production, marketing and scustomer service) andsupport activities(information systems, logistics, human resources

. Global Expansion, Profitability, And Profit Growth

International firms can:

expand the market for their domestic product offerings by selling those products in international

realize location economies by dispersing individual value creation activities to locations aroundwhere they can be performed most efficiently and effectively

realize greater cost economies from experience effects by serving an expanded global markcentral location, thereby reducing the costs of value creation

earn a greater return by leveraging any valuable skills developed in foreign operations and trthem to other entities within the firms global network of operations

1) Expanding The Market: Leveraging Products And Competencies

Firms can increase growth by selling goods or services developed at home internationally

The success of firms that expand internationally depends on the goods or services they sell, ancore competencies(skills within the firm that competitors cannot easily match or imitate)

Core competencies enable the firm to reduce the costs of value creation and/or to create perceiin such a way that premium pricing is possible

2) Location Economies

When firms base each value creation activity at that location where economic, political, andconditions, including relative factor costs, are most conducive to the performance of that activity, they realilocatioeconomies(the economies that arise from performing a value creation activity in the optimal location for thwherever in the world that might be)

By achieving location economies, firms can:

lower the costs of value creation and achieve a low cost position

differentiate their product offering

Firms that take advantage of location economies in different parts of the world, create aglobal webovalue creation activities

Under this strategy, different stages of the value chain are dispersed to those locations around where perceived value is maximized or where the costs of value creation are minimized

A caveat:

transportation costs, trade barriers, and political risks complicate this picture

3) Experience Effects Theexperience curverefers to the systematic reductions in production costs that have been obse

occur over the life of a product

Learning effectsare cost savings that come from learning by doing

So, when labor productivity increases, individuals learn the most efficient ways to perform tasks, and management learns how to manage the new operation more efficiently

Economies of scalerefer to the reductions in unit cost achieved by producing a large volume of a

Sources of economies of scale include:


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spreading fixed costs over a large volume

utilizing production facilities more intensively

increasing bargaining power with suppliers

By moving down theexperience curve, firms reduce the cost of creating value

To get down the experience curve quickly, firms can use a single plant to serve global markets

4) Leveraging Subsidiary SkillsIt is important for managers to:

recognize that valuable skills that could be applied elsewhere in the firm can arise anywhere wfirms global network (not just at the corporate center)

establish an incentive system that encourages local employees to acquir

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