Postgraduate Course

Paper MCCC202 : International Business Study Material : (1–10)

Contents

Lesson-1 : International Business – Definition, Importance, Nature

Lesson-2 : Scope of International Business

Lesson-3 : IT and International Business

Lesson-4 : Political Systems, Economic Systems, Legal Systems, Cultural Environment and Associated Risks

Lesson-5 : Framework for Analyzing International Business Environment

Lesson-6 : Theories of Trade

Lesson-7 : Government Intervention in International Trade

Lesson-8 : World Trading Systems

Lesson-9 : World Trade Organization

Lesson-10 : India and World Trade Organization

Edited by Written by

K.B. Gupta Sonam Datta

SCHOOL OF OPEN LEARNING UNIVERSITY OF DELHI

5, Cavalry Lane, Delhi-110007

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LESSON – 1

Contents

International business- definition, importance, nature

Different entry modes in international business

Globalisation, Drivers of globalization

International business consists of transactions that are devised and carried out across national borders to satisfy the objectives of individuals, companies, and organizations.

International Business is the process of focusing on the resources of the globe and objectives of the organisations on global business opportunities and threats.

International business defined as global trade of goods/services or investment. More comprehensive view does not focus on the “firm” but on the exchange process Free Trade occurs when a government does not attempt to influence, through quotas or duties, what its citizens can buy from another country or what they can produce and sell to another country. The Benefits of Trade allow a country to specialize in the manufacture and export of products that can be produced most efficiently in that country.

Importance of international business

1. To achieve higher rate of profits

2. Expanding the production capacity beyond the demand of the domestic country

3. Severe competition in the home country

4. Limited home market

5. Political conditions

6. Availability of technology and managerial competence

7. Cost of manpower, transportation

8. Nearness to raw material

9. Liberalisation, Privatisation and Globalisation (LPG)

10. To increase market share

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11. Increase in cross border business is due to falling trade barriers (WTO), decreasing costs in telecommunications and transportation; and freer capital markets

Different countries and companies are given the chance to expand and to share their products and services to others beyond their own territory.

In fact, there is an actual give and take scenario between two or more nations that sign a mutual agreement of trading. Below are the lists on what make international business important.

1. It acquires more sales

Businessmen will have the chance to expand their companies and to be known to other countries. Undoubtedly, this will increase their profits rather than restricting their business within their own borders. Our local country will also benefit from this since new products, technologies, and services are being offered for us to use. And, because we allow them to export their goods and services to us, we are also given the chance to export our own products to them. In this way, both our local businessmen and government will also earn.

2. It opens new opportunities If there are increasing numbers of foreign companies in our country, they will need more manpower to help them in running the business. We will be given the chance to use and to share our skills and knowledge, once we are hired. In return, we will gain income to provide the needs of our family. The agreement also implies that we can go to their country to work, to study, or to live.

3. It gives new technologies Other countries have invented different technologies which can help us in our daily living like modern appliances and computers. For those countries that lack the means to create new high quality technologies can also have an access to enjoy the benefits once these technologies are exported to them. Another example is the invention of rear projection screens. These will help us in disseminating and advertising in our country.

4. It utilizes the resources Countries that are rich in fuel, minerals, and many more can utilize their resources by sharing these to others. Instead of keeping these resources, they can share these to other countries so that others will also have the benefits. In return of their resources, they can have more income for their government.

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5. It provides quality products Different countries have their own unique and useful products and services that they can offer to us. In this way, we can choose the best ones that are helpful to us. There are wide varieties of choices when it comes to brands, prices, designs, and features. 6. It helps in earning foreign exchange Investors are welcomed to invest from both local and international. More investors mean that the economic status of our country will become stable. This helps a lot, especially those fellow citizens that need assistance from the local government. 7. It acquires investment in infrastructure Countries that deal with international business need to invest in infrastructure. This will help them in transporting and communicating with other business partners and customers. This will also help the people since these infrastructural developments are open to be used by the public. Nature of International Business 1. Accurate Information 2. Information not only accurate but should be timely 3. The size of the international business should be large 4. Market segmentation based on geographic segmentation 5. International markets have more potential than domestic markets Expansion of International trade

In the past 30 years, the volume of international trade has expanded from $200 billion to over $7.5 trillion.

The sales of foreign affiliates of multinational corporations are now twice as high as global exports

RECENT CHANGES IN INTERNATIONAL BUSINESS

Total world trade declined dramatically after 2000, but is again on the rise.

The rate of globalization is accelerating.

Regionalization is taking place, resulting in trading blocs.

The participation of countries in world trade is shifting.

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DIFFERENT MODES OF ENTRY IN INTERNATIONAL BUSINESS

1. Exports

Export deals with physical movement of goods and services from one place to another through a customs port followings the rules of both the country of origin and country of destination. Depending upon the involvement of the exporter, exports can be classified as direct or indirect. Direct exporters export their goods and services in their own name and the buyer directly remits proceeds, in a proper manner and through a proper channel. The proper channel means that the remittance is made through the banking channel in the currency, which is quoted in the invoice, and the proper channel means that the goods are legally exported through a customs port. Indirect exporters supply goods to direct exporters. Lack of expertise, international contacts and manpower cause them to depend upon direct exporters. Farmers rarely export grains on their own. Artisans cannot develop international contacts to clinch business deals. Therefore, they become indirect exporters. Their products are to other countries but not in their names. Exporters can be classified in several ways:

1. Depending upon the size of business, they are classified as small and large exporters. Current national trade policy provides incentives and facilities to promote both small & large exporters in different ways that are status holders due to their performance in earning foreign exchange.

2. Depending upon the product lines exported, they are classified as single product and multiple product line

3. Depending upon their legal status, they are classified as proprietary, partnership, private limited and public limited companies.

4. Depending upon the destination of their exports, they are classified as single destinations or multi destination exporters. Nowadays, the majority of the companies adopt the philosophy of multi product, multi location, multi strategic, and multi dimensional operations.

5. Depending upon the frequency of their exports, they are classified as occasional exporters and dynamic exporters.

2. International licensing International licensing is an agreement between the licensor and the licensee over a period of time for the use of brand name, marketing, know-how, copyright, work method and trade mark by paying a license fee. For example, British American Tobacco Company (BATS) has given licenses in many countries for the manufacture of their brand of cigarettes “555”. In India, ITC is the licensed producer of “555”. Pepsi cola licensed to Heineken of the Netherlands giving them the exclusive right to produce and sell Pepsi cola in Netherlands. The licensor has minimum involvement in day-to-day functions. Therefore the returns are also comparatively low.

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Licensing specifies the territory as well as period. The licensor gives such permission after establishing such a command-able position globally. It has a brand command.

3. Franchising Franchising is a form of licensing wherein the franchiser exercises more control over franchisee. The franchiser supplies the main part of the product, and provides the following services to the franchisee: 1. TRADEMARKS 2. OPERATING SYSTEMS 3. PRODUCT, & 4. BRAND NAME.

Company support systems like advertising, training of employees, quality assurance are also involved in franchising. McDonald, Dairy Queen, Domino’s Pizza and KFC are the known franchise brands. NIIT & Aptech have appointed franchisees in Africa, south East Asia, Gulf countries and China. Hotels like The Hilton and Marriott are well known operators in hotel sector. Jatia’s in India are the national franchisees of McDonalds. All the investments on premises, HR, operations and promotions are totally borne by the franchisees. In practice the franchiser is determined to maintain a standard throughout the world in terms of quality brand logo and symbol. But the product is adaptable depending on the socio-cultural background of the country. McDonalds sells BEEF BURGERS in Russia & VEG BURGERS in India.

Sometimes the franchisers initiate the process where the economy is on boom. In many developing nations, franchisees initiate the process and they are forced to bear all the expenses.

4. Contract manufacturing Many companies outsource their products and concentrate mainly on marketing operations. Contract manufacturing is the strategy of identifying a manufacturing unit to produce items at a competitive price in any part of the world. Nike is procuring its athletic footwear in a number of factories in South East Asia. Mega Toys is sourcing from China. Hundreds of international companies with their origin in European countries have selected manufacturing centers in India, China and South East Asia. Mark and Spencer, J.C. penny, Target and H & M have contract manufacturing arrangements in many parts of the world. Contract manufacturing with a dimension in the service sector offer ample opportunities for Indian companies in the form of BUSINESS PROCESS OUTSOURCING (BPO) and KNOWLEDGE PROCESS OUTSOURCING (KPO). All the developed nations are becoming end user of outsourced products and services of developing nations.

5. Contract marketing All the companies, which are strong in production, may not have equal marketing strengths. However, they may be comfortable dealing with marketing outlets around the world such as TESCO, Maeys, ‘K’ Mart, Wal-Mart and Spinneys. Such manufacturing units enter in to a marketing agreement and concentrate more on production at lower costs. Thermax, Ion Exchange and Supreme industries have selected marketing firms in other countries, which have a

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good background with technology support. Majority of technology-based companies essentially have to identify competent organizations with marketing infrastructure to aggressively promote their products or projects. Many Indian companies are contract marketers for Germany based medical equipments, dental care items and hearing aids. Their contractual obligations include TARGETS & TERRITORIES.

6. Management contracts Companies with a low level of technology and managerial expertise may seek the assistance of foreign countries. A management contract is an agreement between two companies whereby one company provides managerial and technical assistance for which proper monetary compensation is given, either as a flat lump sum fee or a percentage on the sales or a share in the profits. Delta airlines, Air France and KLM offer such services in developing countries. Exxon is a major operator in Gulf region in the field of oil exploration.

7. Joint venture VENTURE ORIGINATES FROM ADVENTURE which means NEW, either market or technology or environment. A joint venture is a binding contract between two venture partners to set up a project either in home country or host country or a third country. In this case both parties are committed to joint risk taking and joint profit sharing. For example, The Taj group of hotels has a joint venture in Russia for setting up Five Star Hotels. Mahindra & Mahindra has recently entered in to a joint venture with Renault to manufacture cars. A large number of joint ventures have been miserable failures in the past. In the initial stage every venture promises excellent opportunities to both the venture partners. However, when the operation actually starts, certain functional level grievances and issues become inevitable. Therefore, it is absolutely necessary for both the venture partners to understand all the aspects of management, investment and regulations of the countries where they operate. The business units should have clear guidelines and operation manuals wherein the role of every one should be clearly defined. Hence, a joint venture is nothing but a “marriage binding” between two partners from different backgrounds with an understanding, commitment and mutually rewarding experience to work together.

8. Collaboration While a joint venture deals with the project in totality, in financial terms and the proportionate partnership commitments, Collaboration deals with only a part of the functions. For example Bajaj Auto has technological collaboration with Kawasaki of Japan, who offers the technology for two wheelers. Others well known technological collaborations are Ind-Suzuki, Kinetic-Honda and Hero-Honda. All the developing countries encourage technology collaborations. The investors in the US, Japan, Germany and UK enjoyed the fruits by offering technical expertise to the developing nations. The world famous Kellogg Business School has collaborated with the Indian school of business (ISB) in Hyderabad, by offering teaching methodology. Likewise, there may be financial collaborations, HR collaborations, systems collaborations and strategic collaborations. The common term used for collaboration is TIE-UP.

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9. Foreign direct investment

The flow of funds from one destination to another is called investment. Companies, which are constantly involved in international business, invest their money in manufacturing and marketing bases through ownership and control. Kellogg, Pepsi, Coca Cola and the Hyatt group of hotels are willing to invest even if the profits are expected after a long gestation period. Currently every developing country is formulating strategies by offering ample amount of incentives to attract investments. Foreign firms adopt certain methods as mentioned below: a. They control the operations through subsidiaries to achieve strategic synergies. b. They have control through technology, manufacturing expertise, intellectual property rights and brand name. c. One permanent person or a team in the country of operation is appointed to monitor day to day operations. The most attractive part of the operation is the direct investment, which contributes to optimization of resources in the host country, generating employment opportunities and enhancing the standard of living in the host country. The other major developments, which have taken place during the past two decades, are exposure of the host countries to advance technology and quality products. It is boon to the host country since capital is great resource it is coming through investment. The main disadvantages are lack of clarity of repatriation of profits, imposition of restrictions by host countries and elimination of small and medium industries due to the financial power of the investor. A number of South American countries like Argentina and few South East Asian nations like Indonesia fell pray to the dominant forces of overseas investors. They feel that the old colonialism may re-emerge through investments. Generally, a foreign investment takes place on full swing in developing countries only in the past two decades. China, Taiwan, India, Brazil, Argentina and other developing countries have started attracting huge foreign investments. If it takes place in specific sectors like infrastructure, mining, marine technology and agro processing, it is highly beneficial to both the host country and investor.

10. Mergers and acquisitions

In this case the company in the host country selects a foreign company merges itself with it. The foreign company acquires the control of ownership. This mode of entry gives an outstanding competitive edge over others. Such companies strengthen their international manufacturing facilities and marketing network. Proctor & Gamble entered Mexico and became leaders in five years by acquiring Loreto. Tata bearing acquired Metal Box in India. It is an easy and fast method since the cost of acquisition is comparatively low. At the same time the disadvantages are: a. It is a complex task involving banks, lawyers, bureaucrats and obviously politicians. b. The host countries may impose restrictions on acquisitions. c. The labour problem is a big challenge to acquisitions specially in developing countries where unemployment is a critical issue. The global STEEL-KING L.N.Mittal was successful right from the first acquisition of steel mill in Indonesia. Many other acquisitions followed in Trinidad, Kazakhstan, Hungary and

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others. The recent Aditya Birla Group Company Hindalco acquisition of Novelis has strengthened its production synergy and market access for non-ferrous category in the international market.

11. Take-overs

This is a strategy whereby a company identifies a healthy unit with strong brand name and network and brings it under the management of another unit in order to become a leader in the field and guarantee success. Since there may be many parties wanting to takeover a well-known company, competition becomes inevitable. It is obvious that only one entity will win and the winner has to withstand hostilities. Therefore, the process is called a “hostile take over” and the winner is called the “take over tycoon”. Wellknown examples are the Hindujas who took over Ashok Leyland and Uniliver who took over Brook Bond and Lipton. Take-over is also on different levels, such as company takeover, business takeover, product takeover and brand takeover. Some takeovers in the past have made many corporate success stories. For example, Uniliver’s take over of Brook Bond and Lipton enhanced its position as a leader in the tea industry in India. Always takeovers cost more as compared to acquisition but probability of success is high.

12. Turnkey projects A turnkey project is a contract under which a company is fully involved from concept to completion. It covers right from supply of manpower, capital, and erection of plant, installation and commissioning up to the trial operation of a project. The turnkey project contractors either get a fixed fee or the cost plus profits are collected over a period of time. Today, infrastructure projects like power plants, airports, refineries, railway lines, highways and dams are undertaken on a turnkey basis. Bechtel, Brown Bovery, Hyundai, Mitsubishi, L&T and Daewoo are turnkey contractors for international projects. They use terms like BOT (Build, Operate and Transfer) and BOOT (Build, Own, Operate and Transfer) depending upon the level of involvement and obligations. Whenever turnkey project contractor is capable of cutting costs on material and manpower or finances or speed of completion: every component increases profitability.

13. Counter trade In all the above operations, foreign exchange is necessary for transactions. For exports, the supplier gets the proceeds in foreign exchange. For joint ventures, profits are shared in foreign exchange. For international licensing, the license fee is paid in foreign exchange. The current challenge to many international business organizations is to get payments in foreign currency. A vast majority of the countries in the world do not have the necessary reserves of foreign exchange to remit. However they can still be actively involved in international business, by using COUNTER TRADE mechanism. Counter trade came in to existence in the absence of foreign exchange reserves in a country. Sometimes the country is not willing to pay, though foreign exchange reserves are with it. Such unwillingness will lead to non-repatriation of payment.

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Ultimate solution is to enter in to counter trade practices. Counter trade can be classified in to three categories: 1. Pure Barter 2. Buy Back 3. Counter Purchase

Pure Barter In this system goods and services are mutually exchanged between two countries depending upon their bargaining strength. A country with surplus products can finalize deals with another country that has a shortage of the same range of products. At the same time, the second country may have a surplus of a different range of products, which are in short supply in the first country. Hence, both countries can exchange their products by fixing a price in advance for a given period of time. This age old system that was prevalent during the era of ancient civilizations is being practiced currently. The Indus Valley supplied timber for maritime activities to Mohenjadaro and Harappa. The same practice has re-emerged with sophisticated pre fixation of value. Pure barter is defined as “the mutual exchange of goods and services between two countries depending upon their bargaining strength, in order that both the countries enjoy the benefits”.

A buy back is an arrangement by which the home country representative sets up a project in the host country, which does have sufficient foreign exchange reserves to fully pay for the project to the supplier. The project amount is partially paid in foreign exchange and the remaining amount is paid in kind. Usually, the home country representative comparatively at low price purchases the end product of the same project. This can be marketed in the home country or it could even be diverted to a third country in order to maximize the profit margin. Buy back arrangements have become popular since many turnkey project contractors get greater benefits by marketing the end product in any part of the world at a higher margin. Bharat Heavy Electricals (BHEL) sets up projects in other countries. Partially it gets the payment in foreign exchange. For the balance amount it takes back tankers from the host country and markets them in any other country and also brings them back to India to sell at a higher price. Such deals enable the home country businesses to get international exposure very fast. The host country is an ultimate beneficiary since the project is locate in and owned by it.

Counter purchase is a method, wherein company A from country A supplies product X to country B. Country B, which has a surplus of product Y, compensates by supplying it to company A, which finds a market for e product Y, say country C. Country C sells a product Z to a country D, which has sufficient foreign exchange to pay for it. Country D can then pay country C, and finally country A collects payment routed through company B and C. Thus purchasing takes place against supply until a country, which has sufficient foreign exchange reserves is found. He transaction. Many multinationals use this system to make large amounts of money at every stage of For example, Pepsi International supplies rice to South Africa from India. From South Africa it procures steel equivalent to the amount of rice collects and supplies it to Ghana. From Ghana, it procures coffee and cocoa equivalent to the steel imports and sells them to Canada, which has sufficient foreign exchange reserves to pay for them. By appointing one representative or employee the company can carry out routine functions deals in the Far East are Marubeni Corporation, Mitsubishi and Majuko. The age-old economic theory of inter-

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dependency of nations has been redefined with the counter purchase mechanism. Today, to trade with other countries, it is not necessary that the country in question has to have sufficient foreign exchange reserves. Without foreign exchange reserve one can continue trade. The model on the next page shows the benefits that both the home country and the host country enjoy on successful completion of the transactions undertaken. Today, anyone can do business with any country. Foreign exchange as a medium of transaction had a dominant role in all the countries in the past. Due to counter purchase mechanism very few countries with foreign exchange reserve can comfortably contribute to international business.

GLOBALISATION

Globalization (or globalisation) is the process of international integration arising from the interchange of world views, products, ideas and mutual sharing, and other aspects of culture. Advances in transportation, such as the steam locomotive, steamship, jet engine, container ships, and in telecommunications infrastructure, including the rise of the telegraph and its modern offspring, the Internet, and mobile phones, have been major factors in globalization, generating further interdependence of economic and cultural activities. Though scholars place the origins of globalization in modern times, others trace its history long before the European Age of Discovery and voyages to the New World. Some even trace the origins to the third millennium BCE. Large-scale globalization began in the 19th century. In the late 19th century and early 20th century,

Economic globalization is the increasing economic interdependence of national economies across the world through a rapid increase in cross-border movement of goods, service, technology and capital. Whereas the globalization of business is centered around the diminution of international trade regulations as well as tariffs, taxes, and other impediments that suppresses global trade, economic globalization is the process of increasing economic integration between countries, leading to the emergence of a global marketplace or a single world market.] Depending on the paradigm, economic globalization can be viewed as either a positive or a negative phenomenon. Economic globalization comprises the globalization of production markets, competition, technology, and corporations and industries. Current globalization trends can be largely accounted for by developed economies integrating with less developed economies by means of foreign direct investment, the reduction of trade barriers as well as other economic reforms and, in many cases, immigration

Because of globalization, for the first time in history, the availability of international products and services can be accessed by individuals in many countries, from diverse economic backgrounds.

Globalization refers to the shift toward a more integrated and interdependent world economy. Globalization has several facets, including the globalization of markets and the globalization of production.

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The globalization of markets refers to the merging of historically distinct and separate national markets into one huge global marketplace. Falling barriers to cross-border trade have made it easier to sell internationally. It has been argued for some time that the tastes and preferences of consumers in different nations are beginning to converge on some global norm, thereby helping to create a global market.5 Consumer products such as Citigroup credit cards, Coca-Cola soft drinks, Sony PlayStation video games, McDonald's hamburgers, Starbucks coffee, and IKEA furniture are frequently held up as prototypical examples of this trend. Firms such as those just cited are more than just benefactors of this trend; they are also facilitators of it. By offering the same basic product worldwide, they help to create a global market.

The globalization of production refers to the sourcing of goods and services from locations around the globe to take advantage of national differences in the cost and quality of factors of production (such as labor, energy, land, and capital). By doing this, companies hope to lower their overall cost structure or improve the quality or functionality of their product offering, thereby allowing them to compete more effectively. Consider Boeing's 777, a commercial jet airliner. Eight Japanese suppliers make parts for the fuselage, doors, and wings; a supplier in Singapore makes the doors for the nose landing gear; three suppliers in Italy manufacture wing flaps; and so on.11 In total, some 30 percent of the 777, by value, is built by foreign companies. For its most recent jet airliner, the 787, Boeing has pushed this trend even further; some 65 percent of the total value of the aircraft is outsourced to foreign companies, 35 percent of which goes to three major Japanese companies.

DRIVERS OF GLOBALIZATION

Drivers of Globalization

Two macro factors underlie the trend toward greater globalization.17 The first is the decline in barriers to the free flow of goods, services, and capital that has occurred since the end of World War II. The second factor is technological change, particularly the dramatic developments in recent decades in communication, information processing, and transportation technologies.

Declining trade and investment barriers - During the 1920s and 30s many of the world's nation-states erected formidable barriers to international trade and foreign direct investment. 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 country. Many of the barriers to international trade took the form of high tariffs on imports of manufactured goods. The typical aim of such tariffs was to protect domestic industries from foreign competition. One consequence, however, was "beggar thy neighbor" retaliatory trade policies, with countries progressively raising trade barriers against each other.

Having learned from this experience, the advanced industrial nations of the West committed themselves after World War II to removing barriers to the free flow of goods, services, and

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capital between nations.18 This goal was enshrined in the General Agreement on Tariffs and Trade. Under the umbrella of GATT, eight rounds of negotiations among member states worked to lower barriers to the free flow of goods and services. The most recent negotiations to be completed, known as the Uruguay Round, were finalized in December 1993. The Uruguay Round further reduced trade barriers; extended GATT to cover services as well as manufactured goods; provided enhanced protection for patents, trademarks, and copyrights; and established the World Trade Organization to police the international trading system.19 Table 1.1 summarizes the impact of GATT agreements on average tariff rates for manufactured goods. As can be seen, average tariff rates have fallen significantly since 1950 and now stand at about 4 percent.

The globalization of markets and production and the resulting growth of world trade, foreign direct investment, and imports all imply that firms are finding their home markets under attack from foreign competitors.

The role of technological change

The lowering of trade barriers made globalization of markets and production a theoretical possibility. Technological change has made it a tangible reality. Since the end of World War II, the world has seen major advances in communication, information processing, and transportation technology, including the explosive emergence of the Internet and World Wide Web. Telecommunications is creating a global audience. Transportation is creating a global village. From Buenos Aires to Boston, and from Birmingham to Beijing, ordinary people are watching MTV, they're wearing blue jeans, and they're listening to iPods as they commute to work.

In addition to the globalization of production, technological innovations have facilitated the globalization of markets. Low-cost global communications networks such as the World Wide Web are helping to create electronic global marketplaces. Low-cost transportation has made it more economical to ship products around the world, thereby helping to create global markets. For example, due to the tumbling costs of shipping goods by air, roses grown in Ecuador can be cut and two days later sold in New York. This has given rise to an industry in Ecuador that did not exist 20 years ago and now supplies a global market for roses. In addition, low-cost jet travel has resulted in the mass movement of people between countries. This has reduced the cultural distance between countries and is bringing about some convergence of consumer tastes and preferences. At the same time, global communication networks and global media are creating a worldwide culture.

Despite these trends, we must be careful not to overemphasize their importance. While modem communication and transportation technologies are ushering in the "global village," significant national differences remain in culture, consumer preferences, and business practices. A firm that ignores differences between countries does so at its peril.

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LESSON - 2

Contents

Scope of international business, Selecting an entry strategy, India’s involvement in international business. One of the most dramatic and significant world trends in the past two decades has been the rapid, sustained growth of international business. Markets have become truly global for most goods, many services, and especially for financial instruments of all types. World product trade has expanded by more than 6 percent a year since 1950, which is more than 50 percent faster than growth of output the most dramatic increase in globalization, has occurred in financial markets. In the global forex markets, billions of dollars are transacted each day, of which more than 90 percent represent financial transactions unrelated to trade or investment. Much of this activity takes place in the so-called Euromarkets, markets outside the country whose currency is used.

This pervasive growth in market interpenetration makes it increasingly difficult for any country to avoid substantial external impacts on its economy. In particular massive capital flows can push exchange rates away from levels that accurately reflect competitive relationships among nations if national economic policies or performances diverse in short run. The rapid dissemination rate of new technologies speeds the pace at which countries must adjust to external events. Smaller, more open countries, long ago gave up illusion of domestic policy autonomy. But even the largest and most apparently self-contained economies, including the US, are now significantly affected by the global economy. Global integration in trade, investment, and factor flows, technology, and communication has been tying economies together. Why then are these changes coming about, and what exactly are they? It is in practice, easier to identify the former than interpret the latter. The reason is that during the past few decades, the emergence of corporate empires in the world economy, based on the contemporary scientific and technological developments, has led to globalization of production. As a result of international production, co-operation among global productive units, the large-scale capital exports, ―the export of production‖ or ―production abroad‖ has come into prominence as against commodity export in world economy in recent years. Global corporations consider the whole of the world their production place, as well as their market and move factors of production to wherever they can optimally be combined. They avail fully of the revolution that has brought about instant worldwide communication, and near instant-transformation. Their ownership is transnational; their management is transnational. Their freely mobile management, technology and capital, the modern agent for stepped-up economic growth, transcend individual national boundaries. They are domestic in every place, foreign in none-a true corporate citizen of the world. The greater interdependence among nations has already reduced economic insularity of the peoples of the world, as well as their social and political insularity.

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Scope of international business activities

The study of international business focus on the particular problems and opportunities that emerge because a firm is operating in more than one country. In a very real sense, international business involves the broadest and most generalized study of the field of business, adapted to a fairly unique across the border environment. Many of the parameters and environmental variables that are very important in international business( such as foreign legal systems , foreign exchange markets, cultural differences, and different rates of inflation) are either largely irrelevant to domestic business or are so reduced in range and complexity as to be of greatly diminished significance. Thus, it might be said that domestic business is a special limited case of international business. The distinguishing feature of international business is that international firms operate in environments that are highly uncertain and where the rules of the game are often ambiguous, contradictory, and subject to rapid change, as compared to the domestic environment. In fact, conducting international business is really not like playing a whole new ball game, however, it is like playing in a different ballpark, where international managers have to learn the factors unique to the playing field. Managers who are astute in identifying new ways of doing business that satisfy the changing priorities of foreign governments have an obvious and major competitive advantage over their competitors who cannot or will not adapt to these changing priorities. The guiding principles of a firm engaged in (or commencing) international business activities should incorporate a global perspective. A firm‘s guiding principles can be defined in terms of three board categories products offered/market served, capabilities, and results. However, their perspective of the international business is critical to understand the full meaning of international business. That is, the firm‘s senior management should explicitly define the firm‘s guiding principles in terms of an international mandate rather than allow the firm‘s guiding principles in terms as an incidental adjunct to its domestic activities. Incorporating an international outlook into the firm‘s basic statement of purpose will help focus the attention of managers (at all levels of the organization) on the opportunities (and hazards) outside the domestic economy. It must be stressed that the impacts of the dynamic factors unique to the playing field for international business are felt in all relevant stages of evolving and implementing business plans. The first broad stage of the process is to formulate corporate guiding principles. As outlined below the first step in formulating and implementing a set of business plans is to define the firm‘s guiding principles in the market place. The guiding principles should, among other things, provide a long-term view of what the firm is striving to become and provide direction to divisional and subsidiary managers vehicle, some firms use ―the decision circle‖ which is simply an interrelated set of strategic choices forced upon any firm faced with the internationalization of its markets. These choices have to do with marketing, sourcing, labor, management, ownership, finance, law, control, and public affairs. Here the first two marketing and sourcing-constitute the basic strategies that encompass a firm‘s initial considerations. Essentially, management is answering two questions: to whom are we going to sell what, and from where and how will we supply that market? We then have a series of input strategies-labor, management, ownership, and financial. They are in their efforts to develop their

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own business plans. As an obligation addressed essentially to the query, with what resources are we going to implement the basic strategies? That is, where will we find the right people, willingness to carry the risk, and the necessary funds? A third set of strategies legal and control-respond to the problem of how the firm is to structure itself of implement the basic strategies, given the resources it can muster. A final strategic area, public affairs, is shown as a basic strategy simply because it places a restraint on all other strategy choices. Each strategy area contains a number of subsidiary strategy options. The decision process that normally starts in the marketing strategy area is an iterative one. As the decision maker proceeds around the decision circle, previous selected strategies must be readjusted. Only a portion of the possible feedback adjustment loops is shown here. Although these strategy areas are shown separately but they obviously do not stand-alone. There must be constant reiteration as one moves around the decision circle. The sourcing obviously influences marketing strategy, as well as the reverse. The target market may enjoy certain preferential relationships with other markets. That is, everything influences everything else. Inasmuch as the number of options a firm faces is multiplied as it moves into international market, decision-making becomes increasingly complex the deeper the firm becomes involved internationally. One is dealing with multiple currency, legal, marketing, economic, political, and cultural systems. Geographic and demographic factors differ widely. In fact, as one moves geographically, virtually everything becomes a variable: there are few fixed factors. For our purposes here, a strategy is defined as an element in a consciously devised overall plan of corporate development that, once made and implemented, is difficult (i.e. costly) to change in the short run. By way of contrast, an operational or tactical decision is one that sets up little or no institutionalized resistance to making a different decision in the near future. Some theorists have differentiated among strategic, tactical, and operational, with the first being defined as those decisions, that imply multi-year commitments; a tactical decision, one that can be shifted in roughly a year‘s time; an operational decision, one subject to change in less that a year. In the international context, we suggest that the tactical decision, as the phrase is used here, is elevated to the strategic level because of the rigidities in the international environment not present in the purely domestic-for example, work force planning and overall distribution decisions. Changes may be implemented domestically in a few months, but if one is operating internationally, law, contract, and custom may intervene to render change difficult unless implemented over several years.

A mode of entry into an international market is the channel which your organization employs to gain entry to a new international market. This lesson considers a number of key alternatives, but recognizes that alteratives are many and diverse. Here you will be consider modes of entry into international markets such as the Internet, Exporting, Licensing, International Agents, International Distributors, Strategic Alliances, Joint Ventures, Overseas Manufacture and International Sales Subsidiaries. Finally we consider the Stages of Internationalization.

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Licensing includes franchising, Turnkey contracts and contract manufacturing. Licensing is where your own organization charges a fee and/or royalty for the use of its

technology, brand and/or expertise.

Franchising involves the organization (franchiser) providing branding, concepts, expertise, and infact most facets that are needed to operate in an overseas market, to the franchisee. Management tends to be controlled by the franchiser. Examples include Dominos Pizza, Coffee Republic and McDonald’s Restaurants.

Turnkey contracts are major strategies to build large plants. They often include a the training and development of key employees where skills are sparse – for example, Toyota’s car plant in Adapazari, Turkey. You would not own the plant once it is handed over.

International Agents and International Distributors

Agents are often an early step into international marketing. Put simply, agents are individuals or organizations that are contracted to your business, and market on your behalf in a particular country. They rarely take ownership of products, and more commonly take a commission on goods sold. Agents usually represent more than one organization. Agents are a low-cost, but low-control option. If you intend to globalize, make sure that your contract allows you to regain direct control of product. Of course you need to set targets since you never know the level of commitment of your agent. Agents might also represent your competitors – so beware conflicts of interest. They tend to be expensive to recruit, retain and train. Distributors are similar to agents, with the main difference that distributors take ownership of the goods. Therefore they have an incentive to market products and to make a profit from them. Otherwise pros and cons are similar to those of international agents.

Strategic alliances Strategic alliances is a term that describes a whole series of different relationships between companies that market internationally. Sometimes the relationships are between competitors. There are many examples including:

Shared manufacturing e.g. Toyota Ayago is also marketed as a Citroen and a Peugeot. Research and Development (R&D) arrangements. Distribution alliances e.g. iPhone was initially marketed by O2 in the United Kingdom. Marketing agreements.

Essentially, Strategic Alliances are non-equity based agreements i.e. companies remain independent and separate.

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Joint Ventures (JV)

Joint Ventures tend to be equity-based i.e. a new company is set up with parties owning a proportion of the new business. There are many reasons why companies set up Joint Ventures to assist them to enter a new international market:

Access to technology, core competences or management skills. For example, Honda’s relationship with Rover in the 1980’s.

To gain entry to a foreign market. For example, any business wishing to enter China needs to source local Chinese partners.

Access to distribution channels, manufacturing and R&D are most common forms of Joint Venture.

Overseas Manufacture or International Sales Subsidiary

A business may decide that none of the other options are as viable as actually owning an overseas manufacturing plant i.e. the organization invests in plant, machinery and labor in the overseas market. This is also known as Foreign Direct Investment (FDI). This can be a new-build, or the company might acquire a current business that has suitable plant etc. Of course you could assemble products in the new plant, and simply export components from the home market (or another country). The key benefit is that your business becomes localized – you manufacture for customers in the market in which you are trading. You also will gain local market knowledge and be able to adapt products and services to the needs of local consumers. The downside is that you take on the risk associated with the local domestic market. An International Sales Subsidiary would be similar, reducing the element of risk, and have the same key benefit of course. However, it acts more like a distributor that is owned by your own company.

Internationalization Stages

So having considered the key modes of entry into international markets, we conclude by considering the Stages of Internationalization. Some companies will never trade overseas and so do not go through a single stage. Others will start at a later or even final stage. Of course some will go through each stage as summarized now:

Indirect exporting or licensing Direct exporting via a local distributor Your own foreign presences Home manufacture, and foreign assembly Foreign manufacture

It is worth noting that not all authorities on international marketing agree as to which mode of entry sits where. For example, some see franchising as a stand alone mode, whilst others

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see franchising as part of licensing. In reality, the most important point is that you consider all useful modes of entry into international markets – over and above which pigeon-hole it fits into. If in doubt, always clarify your tutor’s preferred view.

Exporting

There are direct and indirect approaches to exporting to other nations. Direct exporting is straightforward. Essentially the organization makes a commitment to market overseas on its own behalf. This gives it greater control over its brand and operations overseas, over an above indirect exporting. On the other hand, if you were to employ a home country agency (i.e. an exporting company from your country – which handles exporting on your behalf) to get your product into an overseas market then you would be exporting indirectly. Examples of indirect exporting include:

Piggybacking whereby your new product uses the existing distribution and logistics of another business.

Export Management Houses (EMHs) that act as a bolt on export department for your company. They offer a whole range of bespoke or a la carte services to exporting organizations.

Consortia are groups of small or medium-sized organizations that group together to market related, or sometimes unrelated products in international markets.

Trading companies were started when some nations decided that they wished to have overseas colonies. They date back to an imperialist past that some nations might prefer to forget e.g. the British, French, Spanish and Portuguese colonies. Today they exist as mainstream businesses that use traditional business relationships as part of their competitive advantage.

India’s involvement in international business

IN order to successfully navigate the international trade arena, India’s new government will be tasked with lever-aging India’s growing role within the international trading system to achieve both its domestic and international objectives. As the geo-economic landscape has seen a shift in recent years, emerging economies have increasingly begun to play a more pronounced role in a number of global economic issues, and as the world’s fourth largest economy, India’s role in this system has become more prominent.

At the most recent ministerial conference of the WTO in Bali, Indonesia in early December 2013, India’s growing role as a voice for the poor was amplified as it fought to ensure that the outcome would favour not only the poor within its own borders, but those of the developing countries as well. While the members did indeed arrive at a consensus after a protracted week of negotiations, the sheer effort reflected the much larger problem of not only divergent interests between different groups of countries but that of aligning domestic development objectives with international trade commitments. While the first challenge will require the combined political

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will of all WTO members, the second will have to be addressed by country leaders within their own borders. It is in tackling this second challenge that India’s new government will need to think strategically to leverage the benefits of the international trading system in order to achieve its national objectives.

India’s approach to trade promotion has followed a two-pronged approach, dealing with both supply-side and demand-side constraints. It aimed to first implement domestic policies to enhance its supply capacity and second, address the demand-side of trade promotion by engaging in international trade negotiations to secure better market access. While the latter was achieved by India’s engagement in multilateral as well as plurilateral trade negotiations, the former was accomplished through India’s National Foreign Trade Policy (NFTP) which is adopted every five years, and augmented with annual supplements in order to streamline policy and thereby develop a more comprehensive and better trade capacity

A complementarity between these two aspects is, therefore, imperative. However, in the past, planning and administration of policy instruments under the NFTP has often taken its own course without thorough consideration of the sectoral needs that get preferential market access through trade agreements. Recent studies undertaken by CUTS International indicate that India has immense trading potential with its neighbouring countries in many sectors and products. However, most of these products are not included in the list of focus markets and focus products selected under India’s current NFTP.1 Indeed, in order to strengthen the functioning of the NFTP, there is a need for better coordination between the NFTP and other domestic policies, including with state governments.

More attention needs to be focused on the interface between trade and other policies such as competition, standards, government procurement, and manufacturing to ensure policy coherence. Incidents such as when products with a high import demand in countries with which India has formal trading agreements fail to receive assistance as focus products are reflective of a lack of policy coherence with other government strategies. Herein lies one of the major challenges and opportunities that India’s new government must tackle.

Instruments that impact trade performance can be divided into three categories: (a) schemes which pertain to the development of production capacities within countries; (b) the reduction of trade costs facilitating the movement of the outputs of these productive operations across borders;2 and (c) export promotion activities which include identifying the formal export process, identifying potential markets abroad after concluding free trade agreements, studying their specific demand profile and finding specific business partners.3 A strategic and comprehensive foreign trade policy that incorporates these three features will play a crucial role in achieving India’s national objectives over the next five years.

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In recent years CUTS International has been engaged in research that has afforded an opportunity to act as a conduit linking those who frame the NFTP to those affected by it. India’s current national trade policymaking process tends to be centralized and as yet there are no established channels of communication between the grassroots beneficiaries and policymakers. During our research we identified five priority areas that the incoming government will need to address in order to maximize benefits from India’s NFTP in the coming years: (i) inclusiveness with respect to SMEs (small and medium enterprises) as major beneficiaries; (ii) coordination with external trade negotiations; (iii) linkages between NFTP and FDI policy; (iv) role of the NFTP in exploring and strengthening participation of Indian business units in regional/global value chains; and (v) the role of NFTP in domestic policy and regulatory reforms for better economic governance.4

India’s Foreign Trade Policy 2009-14 was formulated with an objective to double India’s exports of goods and services by 2014, while simultaneously aiming at doubling India’s share in global trade by 2020.5 NFTP 2009-14 and its annual supplements contain several such specifically targeted schemes, tailor-made to use trade expansion in the labour-intensive goods sector as an instrument for employment generation. These objectives were envisaged to be achieved through the use of fiscal incentives, providing full refund of indirect taxes and levies, institutional measures, change in procedures, increased market access around the world, diversifying export markets and improving infrastructure in order to reduce transaction costs. However, the policy lacked certain supportive features that would have facilitated inclusiveness and access to a larger set of stakeholders.

The implementation of such schemes often lacked inclusiveness, resulting in small and medium scale operators and enterprises (SMEs) often unable access the benefits. One of the major challenges faced by SMEs, particularly those in the informal sector, is a lack of both awareness and understanding of how to operate in the international business environment. In developing countries like India, stakeholders at the grassroots are often unaware of the various support schemes that are offered by their own governments. Hence, in order to create a more inclusive NFTP, measures need to be put in place to ensure increased awareness of the NFTP’s schemes and policy instruments by local level stakeholders.

Acknowledging and, in certain cases, addressing the conflict of interest faced by certain stakeholders is imperative to ensuring an inclusive NFTP. The interests of different parties must be taken into consideration while evaluating the NFTP and suggesting changes. This requires greater effort to increase interaction with sub-national actors, such as the state governments, in implementing India’s NFTP. The Inter-State Trade Council, among others, can play a key role in ensuring a continuous dialogue between state governments and union territories. Revitalizing such groups could play a necessary and key role in advising the Government of India on measures for providing an enabling international trade environment within the states themselves. This would provide a framework for the states to be partners in international trade and export

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efforts.6 State WTO cells could also be strengthened in order to generate awareness of sub-national actors on India’s trade policy and other related matters.

Second, an examination of recent trends towards what are commonly known as mega-regional trade agreements shows that emerging countries, including India, find themselves excluded from these negotiations. While there has been much speculation regarding why members were left out, these countries, none the less, need to adopt a proactive approach to managing this current shift in order to avoid the backlash of exclusion such as trade diversion, as well as the establishment of international trade rules outside the WTO. Keeping in mind its national interests, it is imperative for India to continue with the mandate of negotiating trade agreements at the multilateral as well as bilateral and regional levels.

There is a need to resuscitate and broaden the mandate of bodies such as the (now defunct) National Advisory Committee on International Trade, to help conduct periodic reviews of the impact of trading agreements on the Indian economy. There is enough evidence to show that India’s current trade agreements fail to take advantage of its core competencies. Therefore, going forward, mechanisms to conduct sustainability impact assessments in order to understand economic, social and environmental sustainability of future trade agreements are necessary in order to develop India’s negotiating positions.

Third, it is important to align India’s foreign trade policy with its FDI policy in light of significant backward and forward linkages that exist between trade related sectors and FDI. Given India’s position along its development trajectory, she is poised to benefit not only from efficiency-seeking FDI that seeks to locate production process in low cost regions, but also market seeking FDI. While the NFTP has indeed opened up certain sectors, this objective has not been similarly reflected in India’s FDI policy and has thus resulted in sub-optimal utilization of this policy. Owing to the fact that companies are off-shoring not only their manufacturing processes but also their business functions, there is an increase in FDI flows which are aimed at tertiary sectors rather than only secondary sectors. Given India’s strength in this sector, an FDI policy that incorporates India’s comparative advantage in this area could enhance export competitiveness. Attracting FDI into cluster development or economic corridors could also work to further align India’s NFTP and FDI policy.

Fourth, global value chains (GVCs) remain an area that India has not adequately explored. There has been little deliberation on how policies and instruments as contained in the NFTP can be used to facilitate the participation of business units into both regional value chains and GVCs. GVCs first emerged as regional supply chains in East Asia, with Japanese investors taking the lead. This fragmentation of production improved the cost competitiveness of the final products which were then able to compete with products from other developed countries. Over time, multinationals from other developed countries moved to the region for improving their cost competitiveness. What emerged from this phenomenon were GVCs with production spread

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across countries, regions and continents, gathering cost advantages to become globally competitive.7 While India is one of the top 25 exporting countries in the world, it has one of the lowest foreign value added trade share at only ten per cent and the lowest rate of GVC participation.8 The NFTP could play a key role in exploring and strengthening participation of Indian business units in both regional and global value chains to enable it to leverage the large potential for growth in this area.

Last, the NFTP needs to play a role in domestic policy and regulatory reforms for better economic governance. While a number of developed countries have successfully used their foreign trade policy instruments for improving overall domestic economic governance, in India the NFTP is often approached as a stand alone-policy. Coherence between the NFTP and other major macroeconomic policies is crucial for domestic policy and regulatory reforms to ensure complementarity between all major macro-economic policies.

India’s manufacturing policy is an example of a macroeconomic initiative that was undertaken by the government to increase the percentage of manufacturing from the current level of 15 per cent to 25 per cent of GDP by 2025. However, better coherence with the NFTP will help enhance the sector’s contribution to GDP growth which has remained stagnant in recent years. Similarly, although the extant public procurement rules follow the principle of non-discrimination which is in line with India’s commitment at the WTO, a transparent, competitive and fair public procurement policy would ensure better market accessibility as well as reciprocity for domestic suppliers to venture into other government procurement markets. Institutional and macroeconomic reforms, which seek to improve the business climate and provide a better foundation for the economy to generate growth and competitiveness, must ensure that companies are able to take advantage of aligning trade opportunities.9

The second of India’s two-pronged approach to trade promotion is achieved by its engagement in multilateral as well as preferential and plurilateral trade negotiations. The effectiveness of a sound domestic policy improves if it is accompanied by a coherent external strategy that enables it to leverage the benefits of the international trading system. While India initially followed a closed economic policy, post economic reforms, India’s participation in the global economic arena has hugely increased. After liberalizing its economy and joining the WTO in 1994, India is a protagonist of the multilateral trading system. However, as the global landscape has changed with a proliferation of preferential trading agreements, India too has increasingly begun to participate in these preferential trading agreements. In part this was mirroring a global trend post the problems with the Doha Round. But equally, the success of India’s first FTA with Sri Lanka in 1999 ushered in a new attitude towards interaction with its trading partners and the global trading system as a whole. Today, India has signed about 15 PTAs and many more are in the pipeline.

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Nonetheless, India remains excluded from the major mega-regional trade agreements that are becoming a prominent feature of today’s trading environment. These FTAs could pose a threat to its economic security. India’s pursuit of its own mega-regional trading agreement, namely the Regional Comprehensive Economic Partnership (RCEP) Agreement, is a unique move on its part to counter the negative impacts that could stem from these FTAs as well as establish it as a regional power. The benefits of this trading agreement are immense. It provides an opportunity for India to further integrate into regional production networks, consolidate overlapping FTAs within the region and thus increase trade and development opportunities in the region and enable congruence with its Look East foreign policy.

India’s foreign trade policy also needs to keep in mind its strategic and security interests. In order to play a role commensurate to its size and potential, India needs to reinforce all elements of its state power, not only economic but military as well. India must also ensure that it follows a strategic trade policy in respect to providing sector-specific market access to some of its critical trading partners from whom it can secure new and possibly dual technologies for indigenous defence production. Over a period of time, such a strategic trade policy could help the country develop a military-industrial complex, generating employment opportunities and ensuring a better balance of trade.

While India remains one of the highest end users of defence equipment, a country with the world’s third largest pool of technical manpower and scientific talent, and with a track record of indigenously excelling in high-end technologies of space, nuclear, information technology, it is still dependent on foreign sources to meet 70 per cent of its defence requirements.10 Simultaneously, it has to get its act together on a National Offset Authority under a whole-of-government approach to be able to capture cross-sectoral deals when negotiating with foreign defence equipment suppliers.

In order to effectively tackle specific issues of development, India’s NFTP requires a whole-of-government approach. In pursuit of a country’s overall national interest, government agencies cannot function as separate entities. A whole-of-government approach requires complex coordination for optimum outcomes. This method is designed to establish a common approach and understanding to problem solving in what is commonly referred to as policy coherence.

In order to ensure this coordinated approach in forming and implementing India’s trade policy, including negotiating trade agreements, the Department of Commerce, the Department of Revenue, and the Ministry of External Affairs need to work in tandem. The Inter-State Trade Council and State WTO cells would also need to be effectively integrated into policy formulation to ensure increased engagement with state governments, and better political buy-in for India’s trade policy.

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To successfully navigate the international trade arena, India’s new government will need to pointedly address the five gaps as outlined above. An inclusive NFTP that is not designed as a stand-alone policy, but is strategically integrated into all aspects of Indian foreign policy, has the potential to help India achieve both its domestic and international objectives. As India’s role within the global economy continues to grow, the possibility of garnering more benefits from the international arena to help achieve its domestic objectives is increasing and a well-balanced NFTP could help achieve this goal. It is imperative that the next Foreign Trade Policy (2014-19) include not only a gamut of policy instruments which are capable of being adjusted to macroeconomic shocks and ripple effects from the outside economies, but also instruments which operate seamlessly with other domestic macroeconomic policies to function as a welfare-inducing policy instrument.11

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LESSON-3

Contents

IT and international business

Difficulties and benefits of international business

Globalization and international business

International versus domestic business. IT and International Business

Computerization has changed the way business is conducted the world over. No aspect of business has remained untouched by the information technology (IT) revolution. This is especially true of international business where people located in different parts of the world conduct transactions with each other. The activities of international business include manufacturing, in-land transportation, customs and excise matters, port operation, shipping, clearing and forwarding, etc. During the course of these transactions, a large number of documents are created and exchanged, many of these documents or the information contained therein is repeated, while creating and mailing these documents before the advent of IT., hundreds of man-hours would be lost in repetitive operation, innovations in IT have revolutionized international business; the use of technology in managing and processing information. Especially in large organizations helps save time, bring down costs, and reduce manpower, manual data input and transfer has now become not only obsolete, but also irrational.

Areas

In international business today, IT finds maximum utility in the following areas:

1. Electronic procurement

2. Electronic marketing

3. Electronic logistics

A modern competitive enterprise seeks to hold an edge over the market. IT helps provide this competitive advantage through its various applications tools. By adapting these tools in various areas of business, the organization can gain many advantages in terms of accessibility to a customer or supplier in any part of the world, speed of operations, reduction in man power, etc. due to the reach of the internet it is possible to conduct buying and selling transactions irrespective of geographical location. Internet banking helps in the speedy execution of payments and settlement of accounts. A website can be a virtual showroom, where products can be displayed, demonstrated, and sold. Such a website can also provide various after- sales service tips and suggestions, launch discussions forums, ask for customer feedback, and educate the

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customer. IT application such as electronic data interchange (EDI) has also enabled logistics operations to be paperless.

1. Electronic Procurement

E-procurement essentially comprises a number of inter-related methods for improving the procurement process through the use of electronic systems and processes. The need for e-procurement stems from the fact that in today's globalized world, a manufacturer can source inputs such as raw materials, components, machinery and consumables from any part of the world. The manufacturer is constantly looking for suppliers who can offer quality materials at the most competitive rates. The internet has become a favourite hunting ground for the best bargains. Small companies can purchase their inputs through various websites, which sell a variety of items. However, for the larger organizations, electronic procurement is a systematically outlined process. Here, enterprises use automated applications to streamline buying both production and non-production goods and services.

The entire electronic procurement process can be divided into three major components: pre-purchase, purchase, and payment activities. Pre-purchase activity can begin with a Request For Purchase (RFP) generated by the user department and sent to the purchase department. The electronic platform helps to plan pre-purchase activities starting with the vendor pre-qualification process. Vendors are invited to register their interest in a prescribed application form. They are asked to provide information about their organization, availability of resources, such as manpower, machinery, and monetary resources. Reference letters from their bankers help establish their standing in the market. A list of their present customers is also sought to gauge their market base. The short-listed vendors are registered and whenever there is a requirement of their services, a Request For Quote (RFQ) is sent to them. In case of very large purchase orders, venders are invited to bid in a competitive bidding process. Tender evaluations tools help identify the most suitable bid. A number of companies resort to reverse auctions, whereby, they announce the auction process on their website and ask the vendors to make their bids before the deadline. The bids are then opened and evaluated, before the contract is awarded to the selected vendor with the most suitable offer. This process is called a reverse auction because in this case the auction is for procurement instead of a sale.

2. Electronic Marketing

Internet has changed the way we exchange goods for money. It has broken geographical barriers between buyers and sellers. The internet enables a manufacturer in India to sell his/her goods to a customer in any part of the world through the World Wide Web. It is necessary, however, that the buyer has access to internet and has the necessary know-how and desire to make online purchases.

The internet has provided a very effective platform for electronic marketing or e-marketing. E-marketing means using digital technologies to help sell your goods or services. This is different

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from a conventional market place, where sellers display their goods and buyers can touch and feel the goods and bargain with sellers. In case of e-marketing, sellers can display photographs, video films and specifications of their products. In most cases, the prices are also displayed so that buyers have a clear idea about the product and price.

3. Electronic Logistics

Electronic logistics is use of web –based technologies to support warehousing and transportation management processes. E-logistics enables distribution to couple routing optimization with inventory tracking and tracking information.

In international trade and distribution, computerization is slowly but surely tacking hold of every aspect of business.

Electronic logistics is use of web –based technologies to support warehousing and transportation management processes. E-logistics enables distribution to couple routing optimization with inventory tracking and tracking information.

In international trade and distribution, computerization is slowly but surely tacking hold of every aspect of business. From ability to transmit huge amount of data speedily, or make global data available to expedite the decision making process.

Due to the advantages offered by IT, many logistics providers are planning to handle majority of their commercial transactions electronically. Also, exporters are already using IT for various activities ranging from e-procurement of goods to availing transportation services on the net.

Important Electronic Tools

Shipping lines are keen to encourage their customers to use the internet and have developed a number of attractive tools. The biggest benefit of these tools is that both shippers as well as shipping lines gain by using them. Following are some of the important tools:

Electronic receipt of vessel schedule information

Tracking and tracing of cargo

Remote bill of lading (B/L) printing Single data entry reporting Exception reporting Online tendering, etc.

1. Electronic Receipt of Vessel Schedule Information

Shippers can visit a logistics portal to check the schedule of different shipping lines and choose what suits their supply chains the best. This saves shippers time and effort. The shipping lines, too, benefit as they do not have to inform individual shippers about their voyage

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schedules. At present, the only limitation to this system is that not every portal maintains information about every shipping line, nor does every shipping line provide updated information on their sites or related portals.

2. Tracking and Tracing of Cargo

The biggest benefit shippers enjoy as far as e-logistics is concerned, is tracking and tracing the cargo. With e-connectivity they need to spend less time per enquiry with shipping lines about the status of their cargo and significantly improve their supply chain visibility.

However, different portals offer different services.

3. Remote Bill of Lading Printing

The main benefits of this facility are reduced production and distribution costs for the carriers. The shipper's gain is fast and error-free receipt of documents. More and more shippers are using this facility and are demanding simplified transmission of transport documents. One of the reasons for this is error-free transmission of Bill of Lading. Shipping lines normally dispatch the Bill of Lading within 48 hours of vessel sailing.

4. Single Data Entry Reporting

With the aligned system of documentation, the format of various shipping documents is now standardized. Information once keyed in any document will automatically appear in all aligned documents. This system saves repetitive data entries and also saves substantial time and cost.

5. Exception Reporting

Shippers across the world, who work tirelessly towards manufacture of quality products, also want reliable delivery schedules. Exception reporting by the shipping line helps the shipper to know if there are any deviations from the instructions, which he/she has given to the shipping line.

6. Online Tendering

To find out the ocean freight rates from various shipping lines, the shipper has to send an enquiry separately to each shipper. Online tendering helps the shipper to send out rate enquiries to as many shipping lines as desired by merely pressing a button. Today, in the era of rationalization, mergers and acquisitions, the shipper's global requirements are getting increasingly complex. Online tendering helps them get competitive quotations from shipping lines operating on various routes. These multinationals maintain databases of such quotations in order to choose the most competitive rates on various routes.

Conclusion

Technology is changing at a very fast pace. Various aspects of electronic business such as e-procurement, e-marketing, e-logistics use a number of technology products. The life cycle of technology products is very short. We are living in a knowledge-driven era, where everyone has

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access to information thanks to internet and a variety of other sources of information. However, the market is dominated by those, who translate information into knowledge and use the knowledge to improve productivity and efficiency of their enterprises. India is enjoying an enviable position because of its leadership in the area of information technology. A number of business solutions are developed in India for world wide applications. However, such applications take a long time to be implemented in India itself.

One of the most dramatic and significant world trends in the past two decades has been the rapid, sustained growth of international business. Markets have become truly global for most goods, many services, and especially for financial instruments of all types. World product trade has expanded by more than 6 percent a year since 1950, which is more than 50 percent faster than growth of output the most dramatic increase in globalization, has occurred in financial markets. In the global forex markets, billions of dollars are transacted each day, of which more than 90 percent represent financial transactions unrelated to trade or investment. Much of this activity takes place in the so-called Euromarkets, markets outside the country whose currency is used. This pervasive growth in market interpenetration makes it increasingly difficult for any country to avoid substantial external impacts on its economy. In particular massive capital flows can push exchange rates away from levels that accurately reflect competitive relationships among nations if national economic policies or performances diverse in short run. The rapid dissemination rate of new technologies speeds the pace at which countries must adjust to external events. Smaller, more open countries, long ago gave up illusion of domestic policy autonomy. But even the largest and most apparently self-contained economies, including the US, are now significantly affected by the global economy. Global integration in trade, investment, and factor flows, technology, and communication has been tying economies together. Why then are these changes coming about, and what exactly are they? It is in practice, easier to identify the former than interpret the latter. The reason is that during the past few decades, the emergence of corporate empires in the world economy, based on the contemporary scientific and technological developments, has led to globalization of production. As a result of international production, co-operation among global productive units, the large-scale capital exports, ―the export of production‖ or ―production abroad‖ has come into prominence as against commodity export in world economy in recent years. Global corporations consider the whole of the world their production place, as well as their market and move factors of production to wherever they can optimally be combined. They avail fully of the revolution that has brought about instant worldwide communication, and near instant-transformation. Their ownership is transnational; their management is transnational. Their freely mobile management, technology and capital, the modern agent for stepped-up economic growth, transcend individual national boundaries. They are domestic in every place, foreign in none-a true corporate citizen of the world. The greater interdependence among nations has already reduced economic insularity of the peoples of the world, as well as their social and political insularity. International business includes any type of business activity that crosses national borders. Though a number of definitions in the business literature can be found but no simple or universally accepted definition exists for the term

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international business. At one end of the definitional spectrum, international business is defined as organization that buys and/or sells goods and services across two or more national boundaries, even if management is located in a single country. At the other end of the spectrum, international business is equated only with those big enterprises, which have operating units outside their own country. In the middle are institutional arrangements that provide for some managerial direction of economic activity taking place abroad but stop short of controlling ownership of the business carrying on the activity, for example joint ventures with locally owned business or with foreign governments. In its traditional form of international trade and finance as well as its newest form of multinational business operations, international business has become massive in scale and has come to exercise a major influence over political, economic and social from many types of comparative business studies and from a knowledge of many aspects of foreign business operations. In fact, sometimes the foreign operations and the comparative business are used as synonymous for international business. Foreign business refers to domestic opperations within a foreign country. Comparative business focuses on similarities and differences among countries and business systems for focuses on similarities and differences among countries and business operations and comparative business as fields of enquiry do not have as their major point of interest the special problems that arise when business activities cross national boundaries. For example, the vital question of potential conflicts between the nation-state and the multinational firm, which receives major attention is international business, is not like to be centered or even peripheral in foreign operations and comparative business.

DIFFICULTIES IN INTERNATIONAL BUSINESS

What make international business strategy different from the domestic are the differences in the marketing environment. The important special problems in international marketing are given below:

1. Political and legal differences- The political and legal environment of foreign markets is different from that of the domestic. The complexity generally increases as the number of countries in which a company does business increases. It should also be noted that the political and legal environment is not the same in all provinces of many home markets. For example, the political and legal environment is not exactly the same in all the states of India.

2. Cultural differences- The cultural differences, is one of the most difficult problems in international marketing. Many domestic markets, however, are also not free from cultural diversity.

3. Economic differences- The economic environment may vary from country to country.

4. Differences in the currency unit- The currency unit varies from nation to nation. This may sometimes cause problems of currency convertibility, besides the problems of exchange rate fluctuations. The monetary system and regulations may also vary.

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5. Differences in the language- An international marketer often encounters problems arising out of the differences in the language. Even when the same language is used in different countries, the same words of terms may have different meanings. The language problem, however, is not something peculiar to the international marketing. For example: the multiplicity of languages in India.

6. Differences in the marketing infrastructure- The availability and nature of the marketing facilities available in different countries may vary widely. For example, an advertising medium very effective in one market may not be available or may be underdeveloped in another market.

7. Trade restrictions- A trade restriction, particularly import controls, is a very important problem, which an international marketer faces.

8. High costs of distance- When the markets are far removed by distance, the transport cost becomes high and the time required for affecting the delivery tends to become longer. Distance tends to increase certain other costs also.

9. Differences in trade practices- Trade practices and customs may differ between two countries.

BENEFITS OF INTERNATIONAL BUSINESS

Survival- Because most of the countries are not as fortunate as the United States in terms of market size, resources, and opportunities, they must trade with others to survive; Hong Kong, has historically underscored this point well, for without food and water from china proper, the British colony would not have survived along. The countries of Europe have had similar experience, since most European nations are relatively small in size. Without foreign markets, European firms would not have sufficient economies of scale to allow them to be competitive with US firms. Nestle mentions in one of its advertisements that its own country, Switzerland, lacks natural resources, forcing it to depend on trade and adopt the geocentric perspective. International competition may not be matter of choice when survival is at stake. However, only firms with previously substantial market share and international experience could expand successfully.

Growth of overseas markets - Developing countries, in spite of economic and marketing problems, are excellent markets. According to a report prepared for the U.S. CONGRESS by the U.S. trade representative, Latin America and Asia/Pacific are experiencing the strongest economic growth. American markets cannot ignore the vast potential of international markets. The world is more than four times larger than the U.S. market. In the case of Amway corps., a privately held U.S. manufacturer of cosmetics, soaps and vitamins, Japan represents a larger market than the United States.

Sales and profit - Foreign markets constitute a larger share of the total business of many firms that have wisely cultivated markets aboard. Many large U.S. companies have done well because

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of their overseas customers. IBM and Compaq, foe ex, sell more computers aboard than at home. According to the US dept of commerce, foreign profits of American firms rose at a compound annual rate of 10% between 1982 and 1991, almost twice as fast as domestic profits of the same companies.

Diversification- Demand for mast products is affected by such cyclical factors as recession and such seasonal factors as climate. The unfortunate consequence of these variables is sales fluctuation, which can frequently be substantial enough to cause lay offs of personnel. One way to diversify a companies‘ risk is to consider foreign markets as a solution for variable demand. Such markets, even out fluctuations by providing outlets for excess production capacity. Cold weather, for instance may depress soft drink consumption. Yet not all countries enter the winter season at the same time, and some countries are relatively warm year round. Bird, USA, inc., a Nebraska manufacturer of go carts, and mini cars, for promotional purposes has found that global selling has enabled the company to have year round production. It may be winter in Nebraska but its summer in the southern hemisphere-somewhere there is a demand and that stabilizes the business.

Inflation and price moderation- The benefits of export are readily self-evident. Imports can also be highly beneficial to a country because they constitute reserve capacity for the local economy. Without imports, there is no incentive for domestic firms to moderate their prices. The lack of imported product alternatives forces consumers to pay more, resulting in inflation and excessive profits for local firms. This development usually acts a s prelude to workers demand for higher wages, further exacerbating the problem of inflation. Import quotas imposed on Japanese automobiles in the 1980‘s saved 46200 US production jobs but at a cost of $160,000 per job per year. This cost was a result of the addition of $400 to the prices of US cars, and $1000 to the prices of Japanese imports. This windfall for Detroit resulted in record high profits for US automakers. Not only do trade restrictions depress price competition in the short run, but they also can adversely affect demand for year to come.

Employment - Trade restrictions, such as high tariffs caused by the 1930‘s smoot-hawley bill, which forced the average tariff rates across the board to climb above 60%, contributed significantly to the great depression and have the potential to cause wide spread unemployment again. Unrestricted trade on the other hand improves the world‘s GNP and enhances employment generally for all nations. Importing products and foreign ownership can provide benefits to a nation. According to the institute for international Economics-a private, non- profit research institute – the growth of foreign ownership has not resulted in a loss of jobs for Americans; and foreign firms have paid their American workers the same, as have domestic firms.

Standards of living- Trade affords countries and their citizen‘s higher standards of living than other wise possible. Without trade, product shortages force people to pay more for less, products taken for granted, such as coffee and bananas may become unavailable overnight. Life in most

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countries would be much more difficult were it not for the many strategic metals that must be imported. Trade also makes it easier for industries to specialize and gain access to raw materials, while at the same time fostering competition and efficiency. A diffusion of innovations across national boundaries is useful by-products of international trade. A lack of such trade would inhibit the flow innovative ideas.

GLOBALISATION AND INTERNATIONAL BUSINESS

It is sometimes suggested that globalization means the advance of a homogeneous civilization and a uniform business system that would no longer require adjustment to different business environments. Nothing could be further from the truth. While globalization marches on, pressures to maintain national identity and solidarity are not subsiding. On the contrary, the growing interaction between different systems makes people more, rather than less, aware of the differences among them, often leading them to suspect foreign inputs as potentially threatening to their group identity. Unfortunately, the erroneous assumption regarding homogeneity might lead firms to believe that their strategies, practices, and products or services have universal applicability with no need to distinguish between domestic and international business. Instead, company executives should strive to learn the intricacies of the foreign environments in which they operate, because this is the only way to leverage their firms’ global reach and scale. Globalization and localization may seem contradictory, but they are two sides of the same coin and are bound to live side by side in the future. Throughout this book, you will learn about this simultaneous existence of global and local forces and their interaction in international business. The material will explore how to leverage the global resources of the multinational enterprise yet compensate for its unfamiliarity with the foreign environments in which it operates; how to extract economies of scale by selling a product in multiple locations while making product adjustments and adaptations to reflect different tastes and selling methods; and how to maintain a globally unified compensation system for employees while taking into account the vast differences in practices, values, standards of living, and taxation across the globe. Please note that we use the terms country and nation in this book to denote boundaries of economic and political units that are not necessarily sovereign states, such as Hong Kong, which is part of China but is a separate entity for foreign trade and investment purposes.

International Versus Domestic Business

Traditionally, international business has been the outgrowth of domestic business. In fact, most major corporations that are active in today’s international scene started their operations in the domestic market. Leading Japanese automakers such as Toyota and Honda started their operations in their domestic market before beginning to export to other countries. As the magnitude of their operations grew, they found it profitable or otherwise necessary to build plants and facilities in other countries, most notably the United States. While many firms still follow the traditional route of domestic growth first, international expansion second, we increasingly see firms that target international markets when launching their operations.

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Nasdaq- traded Israeli firm Checkpoint, a leader in the software security segment, is one such company. In addition, some companies engage in international activities without having a home base in the traditional sense. An example is the mainland operations of many Hong Kong investors whose “suitcase companies” do not have a presence in their home base. Although international business is often an extension of domestic business, it is significantly different from the latter in environmental dynamics and operational nature. Environmentally, the diversity that exists between countries with regard to cultures, social customs, business practices, laws, government regulations, and political stability is among the many reasons for the complexity of international business. Therefore, international business is usually riskier than domestic business, although, on the whole, presence in multiple international markets provides a measure of diversification, which mitigates risk. Variations in inflation, currency, taxation, and interest rates among different nations have a significant impact on the profitability of an international firm. For a firm that is borrowing and investing in a foreign country, higher interest rates, tax rates, and inflation rates mean higher cost of operation and lower profitability. At the same time, for a firm that is depositing money in a foreign bank, higher interest rates mean a higher return. Similarly, when the euro goes down in value against the U.S. dollar, U.S. exporters to the European Union (EU) will receive (unless hedging their currency exposure) fewer dollars for their euro denominated transaction, while U.S. importers of EU goods will be able to either lower the cost of the imports or increase their profitability. The Coca-Cola Company, described in the opening case, needs not only to hedge its currency risk but also navigate financial environments with different accounting and tax systems. It also needs to attend to different cultures and social system, different regulations, and different consumption patterns, among other factors. The competitive landscape can also be dramatically different in markets in which Coca-Cola is facing strong local competition (for example, from Wahaha in China), while in other markets the company must adjust for different rules (for instance, a ban on comparative advertising). Competition can spring from nowhere: for example, Mecca Cola emerged in the Middle East partially to take advantage of anti-American sentiment. The combined complexity entailed in operating in numerous markets that are different from each other and the uncertainty involved in the potential for a sudden change in any of those environments defines the essence of international business. This complex landscape creates opportunities (for instance, the opening of a new market such as Vietnam) but also poses risks and uncertainties. Broadly, risk refers to unpredictability of operational and financial outcomes. Uncertainty refers to the unpredictability of environmental or organizational conditions that affect firm performance. Uncertainty about environmental or organizational conditions increases the unpredictability of corporate performance and therefore increases risk. However, as earlier noticed, being in multiple markets also mitigates risk; for instance, in 2005 General Motors lost billions of dollars in North America, but its profits in China helped to somewhat narrow its overall loss. Operationally, international business tends to be more difficult and costly to manage than business activities confined to a single country. Whatever benefits might be available from international operations, they will not be realized if the firm cannot run a complex business effectively. Local employees

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and expatriates may have trouble getting along because of cultural, linguistic, and managerial style differences. The cultural diversity encountered when operating in several countries may create problems of communication, coordination, and motivation. Organizational principles and managerial philosophies may differ widely, increasing the cost and difficulty of operation.

Why Do Firms Expand Internationally?

Generally speaking, the motivations for conducting international business include market motives, economic motives, and strategic motives. The motives vary from one business activity to another, producing multiple motivations for the international firm with a broad scope of activities in different parts of the globe. Market motives can be offensive or defensive. An offensive motive is to seize market opportunities in foreign countries through trade or investment. Amway, Avon, and Mary Kay all entered China in the early 1990s in search of opportunities in the country’s direct marketing business. Besides having the largest population and one of the fastest-growing economies in the world, China’s strong culture of personal connections and the pervasiveness of closeknit families and friends helped make the country the world’s biggest direct-selling market. That the Chinese government later outlawed direct selling altogether exemplifies the inherent risk in doing business abroad, although the companies found ways to adjust (for instance, Mary Kay has opened up customer “learning centers” as a substitute for direct door-to-door marketing and sales) until the ban was lifted years later. A defensive motive is to protect and hold a firm’s market power or competitive position in the face of threats from domestic rivalry or changes in government policies. Lenovo, now the world’s third largest maker of personal computers, entered international markets via acquiring IBM’s personal computers division partially to defend from growing encroachment into its domestic market by Dell and Hewlett Packard. Similarly, many North American and Asian companies in the computer and electronics industries invested heavily in European countries to bypass various barriers against imports from non–European Union members. Foreign automakers such as French conglomerate Peugeot-Citroën have established operations in China partially to offset inroads by their global competitors into this important market

China has become a magnet for international expansion. SOURCE: Jupiterimages. Economic motives apply when firms expand internationally to increase their return through higher revenues or lower costs. International trade and investment are vehicles enabling a firm to benefit from intercountry differences in costs of labor, natural resources, and capital, as well as differences in regulatory treatments, such as taxation. For example, more than 2,000 plants have sprung up near the U.S-Mexico border to take advantage of low-wage Mexican labor to assemble American-made components for reexport to the United States. Some of the investors later relocated their plants to still cheaper China, Vietnam, and India. Fossil, a leading producer of wristwatches, opted to locate its overseas manufacturing headquarters in East Asia rather than in its home country, the United States. Firms such as Motorola, Boeing, Microsoft, AlcatelLucent, Intel, Kodak, Otis, and Coca-Cola established production facilities in China’s special economic zones

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or open coastal cities to attain a significantly lower taxation rate than that applicable in the United States. Strategic motives lead firms to participate in international business when they seek, for instance, to capitalize on distinctive resources or capabilities developed at home (e.g., technologies and economies of scale). By deploying these resources or capabilities abroad or increasing production through international trade, firms may be able to increase their cash inflows. Firms may also go international to be the first mover in the target foreign market before a major competitor gets in, gaining strategic benefits such as technological leadership, brand recognition, customer loyalty, and competitive position. Volkswagen was the second automaker to enter China and the first to locate in the all-important Shanghai market, gaining a virtual monopoly in that market for years. Additionally, firms may benefit from vertical integration involving different countries. For example, a company in the oil exploration and drilling business may integrate “downstream” by acquiring or building an oil refinery in a foreign country that has a market for its refined products. Conversely, a company that has strong distribution channels (e.g., gas stations) in a country but needs a steady source of supply of gasoline at a predictable price may integrate “upstream” and acquire an oil producer and refiner in another country. Yet another strategic motive is to follow the company’s major customers abroad (often termed “piggybacking”). Japanese tire maker Bridgestone found itself in the U.S. market when its customers—Japanese carmakers—exported their cars, with Bridgestone tires mounted on them, to the United States, and their customers needed replacement tires. Other suppliers of Honda, Nissan, and Toyota followed suit, many eventually locating manufacturing operations in the United States. Bridgestone, for instance, took over U.S. tire manufacturer Firestone to become the world’s largest tire maker. Since responsiveness and product adaptation are becoming increasingly critical for business success, proximity to foreign customers is an important driver of overseas investment.

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LESSON – 4

Contents

Political Systems, Economic Systems, Legal Systems, Cultural Environment

And Associated Risks.

International business is much more complicated than domestic business because countries differ in many ways. Countries have different political, economic, and legal systems. They vary significantly in their level of economic development and future economic growth trajectory. Cultural practices can vary dramatically, as can the education and skill level of the population.

All these differences can and do have major implications for the practice of international business. They have a profound impact on the benefits, costs, and risks associated with doing business in different countries; the way in which operations in different countries should be managed; and the strategy international firms should pursue in different countries.

A firm in international business encounters three different sets of external environment

- Domestic environment - Foreign environment - Global environment

POLITICAL SYSTEMS

By political system we mean the system of government in a nation. Political systems can be assessed according to two dimensions.

The first is the degree to which they emphasize collectivism as opposed to individualism. The second is the degree to which they are democratic or totalitarian.

Collectivism refers to a political system that stresses the primacy of collective goals over individual goals. When collectivism is emphasized, the needs of society as a whole are generally viewed as being more important than individual freedoms. In such circumstances, an individual's right to do something may be restricted on the grounds that it runs counter to "the good of society" or to "the common good."

It has two variants – communism and social democracy

The communists believed that socialism could be achieved only through violent revolution and totalitarian dictatorship, whereas the social democrats committed themselves to achieving socialism by democratic means, turning their backs on violent revolution and dictatorship. The Soviet Union had collapsed and had been replaced by a collection of 15 republics, many of which were at least nominally structured as democracies. Communism was swept out of Eastern

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Europe by the largely bloodless revolutions of 1989. Although China is still nominally a communist state with substantial limits to individual political freedom, in the economic sphere the country has moved sharply away from strict adherence to communist ideology. Other than China, communism hangs on only in a handful of small fringe states, such as North Korea and Cuba.

Social democracy also seems to have passed a high-water mark, although the ideology may prove to be more enduring than communism. Social democracy has had perhaps its greatest influence in a number of democratic Western nations, including Australia, France, Germany, Great Britain, Norway, Spain, and Sweden, where Social Democratic parties have often held political power. Other countries where social democracy has had an important influence include India and Brazil.

Individualism The opposite of collectivism, individualism refers to a philosophy that an individual should have freedom in his or her economic and political pursuits. In contrast to collectivism, individualism stresses that the interests of the individual should take precedence over the interests of the state. Like collectivism, individualism can b e traced to an ancient Greek philosopher, in this case Plato's disciple Aristotle (384-322 BC). In contrast to Plato, Aristotle argued that individual diversity and private ownership are desirable. In a passage that might have been taken from a speech by contemporary politicians who adhere to a free market ideology, he argued that private property is more highly productive than communal property and will thus stimulate progress. According to Aristotle, communal property receives little care, whereas property that is owned by an individual will receive the greatest care and be most productive. The central message of individualism, therefore, is that individual economic and political freedoms are the ground rules on which a society should be based.

DEMOCRACY AND TOTALITARIANISM

Democracy and totalitarianism are at different ends of a political dimension. Democracy refers to a political system in which government is by the people, exercised either directly or through elected representatives. Totalitarianism is a form of government in which one person or political party exercises absolute control over all spheres of human life and prohibits opposing political parties.

Democracy-The pure form of democracy, as originally practiced by several city-states in ancient Greece, is based on a belief that citizens should be directly involved in decision making. In complex, advanced societies with populations in the tens or hundreds of millions this is impractical. Most modem democratic states practice representative democracy. In a representative democracy, citizens periodically elect individuals to represent them. These elected representatives then form a government, whose function is to make decisions on behalf of the electorate. In a representative democracy, elected representatives who fail to perform this job adequately will be voted out of office at the next election. To guarantee that elected

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representatives can be held accountable for their actions by the electorate, an ideal representative democracy has a number of safeguards that are typically enshrined in constitutional law. These include ( 1) an individual's right to freedom of expression, opinion, and organization; (2) a free media; (3) regular elections in which all eligible citizens are allowed to vote; (4 ) universal adult suffrage; (5) limited terms for elected representatives; (6) a fair court system that is independent from the political system; (7) a nonpolitical state bureaucracy; (8) a nonpolitical police force and armed service; and (9) relatively free access to state information. -based economic reforms.

A second form of totalitarianism might be labeled theocratic totalitarianism. Theocratic totalitarianism is found in states where political power is monopolized by a party, group, or individual that governs according to religious principles. The most common form of theocratic totalitarianism is based on Islam and is exemplified by states such as Iran and Saudi Arabia. These states limit freedom of political and religious expression with laws based on Islamic principles.

A third form of totalitarianism might be referred to as tribal totalitarianism. Tribal totalitarianism has arisen from time to time in African countries such as Zimbabwe, Tanzania, Uganda, and Kenya. The borders of most African states reflect the administrative boundaries drawn by the old European colonial powers rather than tribal realities. Consequently, the typical African country contains a number of tribes (for example, in Kenya there are more than 40 tribes). Tribal totalitarianism occurs when a political party that represents the interests of a particular tribe (and not always the majority tribe) monopolizes power. Such one-party states still exist in Africa.

A fourth major form of totalitarianism might be described as right-wing totalitarianism. Right-wing totalitarianism generally permits some individual economic freedom but restricts individual political freedom, frequently on the grounds that it would lead to the rise of communism. A common feature of many right-wing dictatorships is an overt hostility to socialist or communist ideas.

Political risk associated:

3 types of risk:

Ownership Risk Exposes property and life

Operating Risk Interference with the ongoing operations of a firm

Transfer Risk Limitations on the outflow. Political risk may involve

Confiscation The government takeover of a firm without compensation to the owners.

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Expropriation A form of government takeover in which the firm’s owners are compensated.

Domestication The government demands transfer of ownership and management responsibility.

Economic systems

In countries where individual goals are given primacy over collective goals, we are more likely to find market-based economic systems. In contrast, in countries where collective goals are given preeminence, the state may have taken control over many enterprises; markets in such countries are likely to be restricted rather than free. We can identify three broad types of economic systems-a market economy, a command economy, and a mixed economy.

Market economy

In the archetypal pure market economy, all productive activities are privately owned, as opposed to being owned by the state. The goods and services that a country produces are not planned by anyone. Production is determined by the interaction of supply and demand and signaled to producers through the price system. If demand for a product exceeds supply, prices will rise, signaling producers to produce more. If supply exceeds demand, prices will fall, signaling producers to produce less. In this system consumers are sovereign. The purchasing patterns of consumers, as signaled to producers through the mechanism of the price system

Totalitarianism

In a totalitarian country, all the constitutional guarantees on which representative democracies are built-an individual's right to freedom of expression and organization, a free media, and regular elections-are denied to the citizens. In most totalitarian states, political repression is widespread, free and fair elections are lacking, media are heavily censored, basic civil liberties are denied, and those who question the right of the rulers to rule find themselves imprisoned, or worse.

Four major forms of totalitarianism exist in the world today. Until recently, the most widespread was communist totalitarianism. Communism, however, is in decline worldwide, and most of the Communist Party dictatorships have collapsed since 1989. Exceptions to this trend (so far) are China, Vietnam, Laos, North Korea, and Cuba, although most of these states exhibit clear signs that the Communist Party's monopoly on political power is retreating. In many respects, the governments of China, Vietnam, and Laos are communist in name only since those nations now adhere to market, determine what is produced and in what quantity.

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Command economy

In a pure command economy, the government plans the goods and services that a country produces, the quantity in which they are produced, and the prices at which they are sold. Consistent with the collectivist ideology, the objective of a command economy is for government to allocate resources for "the good of society." In addition, in a pure command economy, all businesses are state owned, the rationale being that the government can then direct them to make investments that are in the best interests of the nation as a whole rather than in the interests of private individuals. Historically, command economies were found in communist countries where collectivist goals were given priority over individual goals.

Mixed economy

Between market economies and command economies can be found mixed economies. In a mixed economy, certain sectors of the economy are left to private ownership and free market mechanisms while other sectors have significant state ownership and government planning. Mixed economies were once common throughout much of the world, although they are becoming much less so. Until the 1980s, Great Britain, France, and Sweden were mixed economies, but extensive privatization has reduced state ownership of businesses in all three nations. A similar trend occurred in many other countries where there was once a large state-owned sector, such as Brazil, Italy, and India (there are still state-owned enterprises in all of these nations).

Economic risks associated:

Exchange controls may be levied

Tax policies may be used to control corporations and their capital

Price controls may employed to control prices of imported products or services.

Legal systems

The legal system of a country refers to the rules, or laws, that regulate behavior along with the processes by which the laws are enforced and through which redress for grievances is obtained. The legal system of a country is of immense importance to international business. A country's laws regulate business practice, define the manner in which business transactions are to be executed, and set down the rights and obligations of those involved in business transactions. The legal environments of countries differ in significant ways.

Like the economic system of a country, the legal system is influenced by the prevailing political system (although it is also strongly influenced by historical tradition). The government of a country defines the legal framework within which firms do business, and often the laws that

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regulate business reflect the rulers' dominant political ideology. For example, collectivist-inclined totalitarian states tend to enact laws that severely restrict private enterprise, whereas the laws enacted by governments in democratic states where individualism is the dominant political philosophy tend to be pro private enterprise and pro-consumer.

INTERNATIONAL RELATIONS AND LAWS

International Politics: The effect of politics on international business is determined by both the bilateral political relations between home and host countries and by multilateral agreements governing the relations among groups of countries.

International Law: Plays an important role in the conduct of international business. Treaties and agreements have a strong influence on international business relations.

(International law) :

The World Trade Organization defines internationally acceptable economic practices for its member nations.

The Patent Cooperation Treaty (PCT) provides procedures for filing patent applications.

The United Nations has developed codes and guidelines that affect international business

In case of disagreement the parties can choose any of the options:

Arbitration: Procedures are quicker and often spelled out in the original contract

Litigation: Often involves extensive delays and is very costly

DIFFERENT LEGAL SYSTEMS

There are three main types of legal systems-or legal tradition-in use around the world: common law, civil law, and theocratic law.

Common Law

The common law system evolved in England over hundreds of years. It is now found in most of

Great Britain's former colonies, including the United States. Common law is based on tradition,

precedent, and custom. Tradition refers to a country's legal history, precedent to cases that have

come before the courts in the past, and custom to the ways in which laws are applied in specific

situations. When law courts interpret common law, they do so with regard to these

characteristics. This gives a common law system a degree of flexibility that other systems lack.

A "common law system" is a legal system that gives great precedential weight to common

law, so that consistent principles applied to similar facts yield similar outcomes. The body of

past common law binds judges that make future decisions, just as any other law does, to ensure

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consistent treatment. In cases where the parties disagree on what the law is, a common law court

looks to past precedential decisions of relevant courts. If a similar dispute has been resolved in

the past, the court is usually bound to follow the reasoning used in the prior decision (this

principle is known as stare decisis). If, however, the court finds that the current dispute is

fundamentally distinct from all previous cases (called a "matter of first impression"), judges have

the authority and duty to make law by creating precedent. Thereafter, the new decision becomes

precedent, and will bind future courts. Stare decisis, the principle that cases should be decided

according to consistent principled rules so that similar facts will yield similar results, lies at the

heart of all common law systems.

One third of the world's population live in common law jurisdictions or in systems mixed

with civil law.

In a common law jurisdiction several stages of research and analysis are required to determine

"what the law is" in a given situation. First, one must ascertain the facts. Then, one must locate

any relevant statutes and cases. Then one must extract the principles, analogies and statements by

various courts of what they consider important to determine how the next court is likely to rule

on the facts of the present case. Later decisions, and decisions of higher courts or legislatures

carry more weight than earlier cases and those of lower courts. Finally, one integrates all the

lines drawn and reasons given, and determines "what the law is". Then, one applies that law to

the facts.

In practice, common law systems are considerably more complicated than the simplified system

described above. The decisions of a court are binding only in a particular jurisdiction, and even

within a given jurisdiction, some courts have more power than others. For example, in most

jurisdictions, decisions by appellate courts are binding on lower courts in the same jurisdiction,

and on future decisions of the same appellate court, but decisions of lower courts are only non-

binding persuasive authority. Interactions between common law, constitutional law, statutory

law and regulatory law also give rise to considerable complexity.

Judges in a common law system have the power to interpret the law so that it applies to the unique circumstances of an individual case. In turn, each new interpretation sets a precedent that may be followed in future cases. As new precedents arise, laws may be altered, clarified, or amended to deal with new situations.

Civil Law

A civil law system is based on a detailed set of laws organized into codes. When law courts interpret civil law, they do so with regard to these codes. More than 80 countries, including Germany, France, Japan, and Russia, operate with a civil law system. Conceptually, civil law proceeds from abstractions, formulates general principles, and distinguishes substantive rules from procedural rules. It holds case law to be secondary and subordinate to statutory law. When

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discussing civil law, one should keep in mind the conceptual difference between a statute and a codal article. The marked feature of civilian systems is that they use codes with brief text that tend to avoid factually specific scenarios. Code articles deal in generalities and thus stand at odds with statutory schemes which are often very long and very detailed.

A civil law system tends to be less adversarial than a common law system, since the judges rely upon detailed legal codes rather than interpreting tradition, precedent, and custom. Judges under a civil law system have less flexibility than those under a common law system. Judges in a common law system have the power to interpret the law, whereas judges in a civil law system have the power only to apply the law.

An important common characteristic of civil law, aside from its origins in Roman law, is the

comprehensive codification of received Roman law, i.e., its inclusion in civil codes. The

earliest codification known is the Code of Hammurabi written in ancient Babylon during the 18th

century BC. However, this, and many of the codes that followed, were mainly lists of civil and

criminal wrongs and their punishments. Codification of the type typical of modern civilian

systems did not first appear until the Justinian Code.

Germanic codes appeared over the 6th and 7th centuries to clearly delineate the law in force for

Germanic privileged classes versus their Roman subjects and regulate those laws according to

folk-right. Under feudal law, a number of private custumals were compiled, first under the

Norman empire (Très ancien coutumier, 1200–1245), then elsewhere, to record the manorial –

and later regional – customs, court decisions, and the legal principles underpinning them.

Custumals were commissioned by lords who presided as lay judges over manorial courts in order

to inform themselves about the court process. The use of custumals from influential towns soon

became commonplace over large areas. In keeping with this, certain monarchs consolidated their

kingdoms by attempting to compile custumals that would serve as the law of the land for their

realms, as when Charles VII of France commissioned in 1454 an official custumal of Crown law.

The concept of codification was further developed during the 17th and 18th centuries AD, as an

expression of both natural law and the ideas of the Enlightenment. The political ideal of that era

was expressed by the concepts of democracy, protection of property and the rule of law. That

ideal required the creation of certainty of law, through the recording of law and through its

uniformity. So, the aforementioned mix of Roman law and customary and local law ceased to

exist, and the road opened for law codification, which could contribute to the aims of the above-

mentioned political ideal.

Another reason that contributed to codification was that the notion of the nation-state required

the recording of the law that would be applicable to that state.

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Certainly, there was also a reaction to law codification. The proponents of codification regarded

it as conducive to certainty, unity and systematic recording of the law; whereas its opponents

claimed that codification would result in the ossification of the law.

Civil law is primarily contrasted with common law, which is the legal system developed first in

England, and later among English speaking peoples of the world. Despite their differences, the

two systems are quite similar from a historical point of view. Both evolved in much the same

way, though at different paces. The Roman law underlying civil law developed mainly from

customary law that was refined with case law and legislation. Canon law further refined court

procedure. Similarly, English law developed from Norman and Anglo-Saxon customary law,

further refined by case law and legislation. The differences of course being that (1) Roman law

had crystallized many of its principles and mechanisms in the form of the Justinian Code, which

drew from case law, scholarly commentary, and senatorial statutes; and (2) civilian case law has

persuasive authority, not binding authority as under common law.

Codification however, is by no means a defining characteristic of a civil law system. For

example, the statutes that govern the civil law systems of Sweden and other Nordic countries or

Roman-Dutch countries are not grouped into larger, expansive codes like those found in France

and Germany.

Theocratic Law

A theocratic law system is one in which the law is based on religious teachings. Islamic law is the most widely practiced theocratic legal system in the modem world, although usage of both Hindu and Jewish law persisted into the twentieth century. Islamic law is primarily a moral rather than a commercial law and is intended to govern all aspects of life.10 The foundation for Islamic law is the holy book of Islam, the Koran, along with the Sunnah, or decisions and sayings of the Prophet Muhammad, and the writings of Islamic scholars who have derived rules by analogy from the principles established in the Koran and the Sunnah. Because the Koran and Sunnah are holy documents, the basic foundations of Islamic law cannot be changed. However, in practice Islamic jurists and scholars are constantly debating the application of Islamic law to the modem world. In reality, many Muslim countries have legal systems that are a blend of Islamic law and a common or civil law system.

This system is based on religious teachings, as they are enshrined in the religious scriptures. Islamic law, Shari at, is the most widely practiced religious legal system in today’s world. It is based on morality rather than commercial requirement of human behaviour in all aspects of a person’s self and social life. It also follows the writings of scholars and teachers of Islamic scholarship, who derived rules by analogy from the principles established in the holy Quran. The basic foundations of Islamic law remain unaltered even after many centuries because they have been derived from the holy book and are acceptable to all devout Muslims.

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Even though Islamic jurists and scholars constantly debate the application of Islamic law to the modern world, their debates are only scholastic deliberations. However, to keep pace with the advancement of life, many Muslim countries have a blend of Common law and Civil law system along with the Shari’ at law.

Theocracy is a form of government which defers not to civil development of law, but to an interpretation of the will of a God as set out in religious scripture and authorities. Law in a theocracy must be consistent with religious text the ruling religion abides by. In a theocracy, the courts are usually presided over by religious officials, who are taken as more versant in the applicable legal texts.

Legal risks associated :

Legal risk arise when a country’s legal system fails to provide adequate safeguards in the case of contract violations or to protect property rights.

In general, it can be more costly to do business in a country where:

- Strict standards (product safety , safety in the workplace ,environmental pollution) - Damages for non- compliance are very high - Lack of well- established laws for regulating business practices - Failure to adequately protect intellectual property.

In general,

More favourable environment – politically stable economies that have free markets systems and well established legal system with adequate safeguards in case of contract violations.

Less favourable environment – politically unstable nations or those that operate with a command economy and where there is lack of well- established laws for regulating business practices.

CULTURAL ENVIRONMENT

Culture is an integrated system of learned behavior patterns that are characteristic of the members of any given society. Much has been written on the subject of culture and its consequences. Whilst on the surface most countries of the world demonstrate cultural similarities, there are many differences, hidden below the surface. One can talk about "the West", but Italians and English, both belonging to the so called "West", are very different in outlook when one looks below the surface. The task of the global marketer is to find the similarities and differences in culture and account for these in designing and developing marketing plans. Failure to do so can be disastrous.

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Terpstran9 (1987) has defined culture as follows:

"The integrated sum total of learned behavioral traits that are manifest and shared by members of society"

Culture, therefore, according to this definition, is not transmitted genealogically. It is not, also innate, but learned. Facets of culture are interrelated and it is shared by members of a group who define the boundaries. Often different cultures exist side by side within countries, especially in Africa. It is not uncommon to have a European culture, alongside an indigenous culture, say, for example, Shona, in Zimbabwe. Culture also reveals itself in many ways and in preferences for colours, styles, religion, family ties and so on. The colour red is very popular in the west, but not popular in Islamic countries, where sober colours like black are preferred.

Much argument in the study of culture has revolved around the "standardisation" versus "adaption" question. In the search for standardisation certain "universals" can be identified. Murdock7 (1954) suggested a list, including age grading, religious rituals and athletic sport. Levitt5 (1982) suggested that traditional differences in task and doing business were breaking down and this meant that standardisation rather than adaption is becoming increasingly prevalent.

Culture, alongside economic factors, is probably one of the most important environmental variables to consider in global marketing. Culture is very often hidden from view and can be easily overlooked. Similarly, the need to overcome cultural myopia is paramount.

CHARACTERISTICS OF CULTURE

Culture is learned, shared, and transmitted from one generation to the next.

Culture can be passed from parents to children, by social organizations, special interest groups, the government, schools, and churches.

Culture is multidimensional, consisting of a number of common elements that are interdependent.

Approaches to the study of culture

Keegan3 (1989) suggested a number of approaches to the study of culture including the anthropological approach, Maslow's approach, the Self- Reference Criterion (SRC), diffusion theory, high and low context cultures and perception. There are briefly reviewed here.

Anthropological approach

Culture can be deep seated and, to the untrained can appear bizarre. The Moslem culture of covering the female form may be alien, to those cultures which openly flaunt the female form. The anthropologist, though a time consuming process, considers behaviour in the light of experiencing it at first hand. In order to understand beliefs, motives and values, the

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anthropologist studies the country in question anthropology and unearths the reasons for what, apparently, appears bizarre.

Maslow approach

In searching for culture universals, Maslow's6 (1964) hierarchy of needs gives a useful analytical framework. Maslow hypothesised that people's desires can be arranged into a hierarchy of needs of relative potency. As soon as the "lower" needs are filled, other and higher needs emerge immediately to dominate the individual. When these higher needs are fulfilled, other new and still higher needs emerge. Physiological needs are at the bottom of the hierarchy. These are basic needs to be satisfied like food, water, air, comfort. The next need is safety - a feeling of well being. Social needs are those related to developing love and relationships. Once these lower needs are fulfilled "higher" needs emerge like esteem - self respect - and the need for status improving goods. The highest order is self actualisation where one can now afford to express oneself as all other needs have been met.

Whilst the hypothesis is simplistic it does give an insight into universal truisms. In Africa, for example, in food marketing, emphasis may be laid on the three lower level needs, whereas in the developed countries, whilst still applicable, food may be bought to meet higher needs. For example, the purchase of champagne or caviar may relate to esteem needs.

The self reference criterion (SRC)

Perception of market needs can be blocked by one's own cultural experience. Lee (1965)4 suggested a way, whereby one could systematically reduce this perception. He suggested a four point approach.

a) Define the problem or goal in terms of home country traits, habits and norms.

b) Define the problem or goal in terms of the foreign culture traits, habits and norms.

c) Isolate the SRC influence in the problem and examine it carefully to see how it complicates the pattern.

d) Redefine the problem without the SRC influence and solve for the foreign market situation.

The problem with this approach is that, as stated earlier, culture may be hidden or non apparent. Uneartherning the factors in b) may, therefore, be difficult. Nonetheless, the approach gives useful guidelines on the extent for the need of standardisation or adaption in marketing planning.

Diffusion theory

Many studies have been made since the 1930's to assess how new innovations are diffused in a society. One of the most prolific writers was Everett Rogers8. In his book, "Diffusion of Innovations" (1962) he suggested that adoption was a social phenomenon, characterised by a normal distribution.

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In this case the innovators are a small percentage who like to be seen to lead, then the others, increasingly more conservative, take the innovation on. The adoption process itself is done in a series of stages from awareness of the product, through to interest, evaluation, trial and either adoption or rejection (in the case of non adopters). The speed of the adoption process depends on the relative advantage provided by the product, how compatible or not it is with current values or experiences, its complexity, divisibility (how quickly it can be tried) and how quickly it can be communicated to the potential market. In international marketing an assessment of the product or service in terms of these latter factors is very useful to the speed of its adoption. Most horticultural products, for example, have no problem in transfer from one culture to another, however specific types may have. It is unlikely that produce like "squash" would sell well in Europe, but it does in Zimbabwe.

High and low context culture

High-context culture

context is at least as important as what is actually said

what is not being said can carry more meaning than what is said

focuses on group development

Japan and Saudi Arabia are examples

Low-context culture

most of the information is contained explicitly in words

what is said is more important that what is not said

focuses on individual development

The U.S. is an example

Perception

Perception is the ability to see what is in culture. The SRC can be a very powerful negative force. High perceptual skills need to be developed so that no one misperceive a situation, which could lead to negative consequences. Many of these theories and approaches have been "borrowed" from other contexts themselves, but they do give a useful insight into how one might avoid a number of pitfalls of culture in doing business overseas.

Consumer products are likely to be more culturally sensitive than business to business products, primarily because technology can be universally learned. However there are dangers in over generalisations. For example, drink can be very universal and yet culture bound. Whilst appealing to a very universal physiological need - thirst - different drink can satiate the same need. Tea is a very English habit, coffee American but neither are universals in African culture.

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However, Coca Cola may be acceptable in all three cultures, with even the same advertising appeal.

Cultural universals

Cultural universals are manifestations of the total way of life of any group of people.

These include elements such as bodily adornment, courtship rituals, etiquette, concept of family, gestures, joking, mealtime customs, music, personal names, status differentiation, and trade customs.

Elements of Culture

- Language (verbal and non- verbal) - Religion - Values and attitudes - Manners and customs - Material elements - Social institutions - Material elements - Education

The four roles of language

Language aids in information gathering and evaluation.

Language provides access to local society.

Language capability is increasingly important in company communications.

Language provides more than the ability to communicate because it extends beyond mechanics to the interpretation of contexts that may influence business Cultural knowledge

Cultural knowledge can be defined by the way it is acquired:

objective or factual information is obtained through communication, research, and education.

experiential knowledge can be acquired only by being involved in a culture other than one’s own.

Interpretive knowledge is the ability to understand and fully appreciate the nuances of different cultural traits and patterns.

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DIMENSIONS OF CULTURE

Differences in cultural lifestyle can be explained by:

individualism

power distance

uncertainty avoidance

Masculinity

Asian countries tend to have high uncertainty avoidance and low masculinity.

Western countries tend to have low uncertainty avoidance and high masculinity

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LESSON – 5

Contents

Framework for analyzing international business environment

FRAMEWORK FOR ANALYSING INTERNATIONAL BUSINESS ENVIRONMENT

Environmental analysis is defined as ―the process by which strategists monitor the economic, governmental/legal, market/competitive, supplier/technological, geographic, and social settings to determine opportunities and threats to their firms. ―Environmental diagnosis consists of managerial decisions made by analyzing the significance of the data (opportunities and threats) of the environmental analysis‖. The definition of environmental analysis given above has been made in the context of the strategic management process for an existing firm. It is, however, quite obvious that environmental analysis is the cornerstone of new business opportunity analysis too. Indeed, today a much more greater emphasis is given than in the past to the fact that environmental analysis is an essential prerequisite for strategic management decision-making.

It is now unquestionably accepted that the prospects of a business depend not only on its resources but also on the environment. An analysis of the strengths, weaknesses, opportunities and threats (SWOT) is very much essential for the business policy formulation. Just as the life and success of an individual depend on his innate capability, including physiological factors, traits and skills, to cope with the environment, the survival and success of a business firm depend on its innate strength – the resources as its command, including physical resources, financial resources, skill and organization – and its adaptability to the environment. Every business enterprise, thus, consists of a set of internal factors and is confronted with a set of external factors. The internal factors are generally regarded as controllable factors because the company has control over these factors; it can alter or modify such factors as its personnel, physical facilities, organization and functional means, such as the marketing mix, to suit the environment.

The external factors, on the other hand, are by and large, beyond the control of a company. The external or environmental factors such as the economic factors, socio-cultural factors, government and legal factors, demographic factors, geophysical factors etc. are, therefore, generally regarded as uncontrollable factors. As the environmental factors are beyond the control of a firm, its success will depend to a very large extent on its adaptability to the environment, i.e. its ability to properly design and adjust the internal (the controllable) variables to take advantage of the opportunities and to combat the threats in the environment. The business environment comprises a microenvironment and a macro environment.

Micro environment ―The micro environment consists of the actors in the company‘s immediate environment‖ that effect the performance of the company. These include the suppliers, marketing intermediaries, competitors, customers, and publics. ―The macro environment consists of the larger societal forces that affect all the actors in the company‘s micro environment

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namely, the demographic, economic, natural, technological, political and cultural forces‖. It is quite obvious that the micro environmental factors are more intimately linked with the company than the macro factors. The micro forces need not necessarily affect all the firms in a particular industry in the same way. Some of the micro factors may be particular to a firm. For example, a firm, which depends on a supplier, may have a supplier environment, which is entirely different from that of a firm whose supply source is different. When competing firms in an industry have the same microelements, the relative success of the firms depends on their relative effectiveness in dealing with these elements. Suppliers an important force in the microenvironment of a company is the supplier, i.e., those who supply the inputs like raw materials and components to the company. The importance of reliable source/sources of supply to the smooth functioning of the business is obvious. Uncertainty regarding the supply or other supply constraints often compels companies to maintain high inventories causing cost increases. It has been pointed out that factories in India maintain indigenous stocks of 3-4 months and imported stocks of 9 months as against an average of a few hours to two weeks in Japan. Because of the sensitivity of the supply, many companies give high importance to vendor development. Vertical integration, where feasible, helps solve the supply problem. It is very risky to depend on a single because a strike, lock out or any other production problem with that supplier may seriously affect the company. Similarly, a change in the attitude or behavior of the supplier may also affect the company. Hence, multiple sources of supply often help reduce such risks. The supply management assumes more importance in a scarcity environment. ―Company purchasing agents are learning how to ―wine and dine‖ suppliers to obtain favorable treatment during periods of shortages. In other words, the purchasing department might have to ―market‖ itself to suppliers‖.

Customers- As it is often, exhorted, the major task of a business is to create and sustain customers. A business exists only because of its customers. Monitoring the customer sensitivity is, therefore, a prerequisite for the business success. A company may have different categories of consumers like individuals, households, industries and other commercial establishments, and government and other institutions. For example, the customers of a tyre company may include individual automobile owners, automobile manufacturers, public sector transport undertakings and other transport operators. Depending on a single customer is often too risky because it may place the company in a poor bargaining position, apart from the risks of losing business consequent to the winding up of business by the customer or due to the customer‘s switching over the competitors of the company. The choice of the customer segments should be made by considering a number of factors including the relative profitability, dependability, stability of demand, growth prospects and the extent of competition.

Competitors- A firm‘s competitors include not only the other firms, which market the same or similar products, but also all those who compete for the discretionary income of the consumers. For example, the competition for a company‘s televisions may come not only from other T.V. manufacturers but also from two-wheelers, refrigerators, cooking ranges, stereo sets and so on and from firms offering savings and investment schemes like banks, Unit Trust of India,

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companies accepting public deposits or issuing shares or debentures etc. This competition among these products may be described as desire competition as the primary task here is to influence the basic desire of the consumer. Such desire competition is generally very high in countries characterized by limited disposable incomes and many unsatisfied desires (and, of course, with many alternatives for spending/investing the disposable income). If the consumer decides to spend his discretionary income on recreation (or recreation cum education) he will still confronted with a number of alternatives choose from like T.V., stereo, two-in-one, three –in-one etc. The competition among such alternatives, which satisfy a particular category of desire, is called generic competition. If the consumer decides to go in for a T.V. the next question is which form of the T.V. – black and white or colour, with remote-control or without it etc. In other words, there is a product form competition. Finally the consumer encounters the brand competition i.e., the competition between the different brands of the same product form. An implication of these different demands is that a marketer should strive to create primary and selective demand for his products.

Marketing intermediaries- The immediate environment of a company may consist of a number of marketing intermediaries which are ―firms that aid the company in promoting, selling and distributing its goods to final buyers‖. The marketing intermediaries include middlemen such as agents and merchants who ―help the company find customers or close sales with them‖, physical distribution firms which ―assist the company in stocking and moving goods form their origin to their destination‖ such as warehouses and transportation firms; marketing service agencies which ―assist the company in targeting and promoting its products to the right markets‖ such as advertising agencies, marketing research firms, media firms and consulting firms; and financial intermediaries which finance marketing activities and insure business risks. Marketing intermediaries are vital links between the company and the final consumers. A dislocation or disturbance of this link, or a wrong choice of the link, may cost the company very heavily. Retail chemists and druggists in India once decided to boycott the products of a leading company on some issue such as poor retail margin. This move for collective boycott was, however, objected to by the MRTP commission; but for this company would, perhaps, have been in trouble.

Democratic- A company may encounter certain publics in its environment. ―A public is any group that has an actual or potential interest in or impact on an organisation‘s ability to achieve its interests. Media publics, citizens action publics and local publics are some examples. For example, one of the leading companies in India was frequently under attack by the media public, particularly by a leading daily, which was allegedly bent on bringing down the share prices of the company by tarnishing its image. Such exposures or campaigns by the media might even influence the government decisions affecting the company. The local public also affects many companies. Environmental pollution is an issue often taken up by a number of local publics. Actions by local publics on the issue have caused some companies to suspend operations and/or take pollution abatement measures.

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GROWTH OF CONSUMER PUBLIC IS AN IMPORTANT DEVELOPMENT AFFECTING BUSINESS- It is wrong to think that all publics are threats to business. Some of the actions of the publics may cause problems for companies. However, some publics are an opportunity for the business. Some businessmen, for example, regard consumerism as an opportunity for the business. The media public may be used to disseminate useful information. Similarly, fruitful cooperation between a company and the local publics may be established for the mutual benefit of the company and the local community.

Macro environment- As stated earlier, a company and the forces in its microenvironment operate in a larger macro environment of forces that shape opportunities and pose threats to the company. The macro forces are, generally, more uncontrollable than the micro forces. A sketch picture of the important macro-environmental forces is given below.

Economic environment- Economic conditions, economic policies and the economic system are the important external factors that constitute the economic environment of a business. The economic conditions of a country-for example, the nature of the economy, the stage of development of the economy, economic resources, the level of income, the distribution of income and assets, etc- are among the very important determinants of business strategies. In a developing country, the low income may be the reason for the very low demand for a product. The sale of a product for which the demand is income elastic naturally increases with an increase in income. But a firm is unable to increase the purchasing power of the people to generate a higher demand for its product. Hence, it may have to reduce the price of the product to increase the sales. The reduction in the cost of production may have to be effected to facilitate price reduction. It may even be necessary to invent or develop a new low-cost product to suit the low-income market. Thus Colgate designed a simple, hand-driven, inexpensive ($10) washing machine for low-income buyers in less developed countries. Similarly, the National Cash Register Company took an innovative step backward by developing a crank-operated cash register that would sell at half the cost of a modern cash register and this was well received in a number of developing countries. In countries where investment and income are steadily and rapidly rising, business prospects are generally bright, and further investments are encouraged. There are a number of economists and businessmen who feel that the developed countries are no longer worthwhile propositions for investment because these economies have reached more or less saturation levels in certain respects. In developed economies, replacement demand accounts for a considerable part of the total demand for many consumer durables whereas the replacement demand is negligible in the developing economies. The economic policy of the government, needless to say, has a very great impact on business. Some types or categories of business are favorably affected by government policy, some adversely affected, while it is neutral in respect of others. For example, a restrictive import policy, or a policy of protecting the home industries, may greatly help the import-competing industries. Similarly, an industry that falls within the priority sector in terms of the government policy may get a number of incentives and other positive support from the government, whereas those industries which are regarded as inessential

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may have the odds against them. In India, the government‘s concern about the concentration of economic power restricted the role of the large industrial houses and foreign concerns to the core sector, the heavy investment sector, the export sector and backward regions. The monetary and fiscal policies, by the incentives and disincentives they offer and by their neutrality, also affect the business in different ways. An industrial undertaking may be able to take advantage of external economies by locating itself in a large city; but the Government of India‘s policy was to discourage industrial location in such places and constrain or persuade industries undertaking, a backward area location may have many disadvantages. However, the incentives available for units located in these backward areas many compensate them for these disadvantages, at least to some extent. According to the industrial policy of the Government of India until July 1991, the development of 17 of the most important industries were reserved for the state. In the development of another 12 major industries, the state was to play a dominant role. In the remaining industries, co-operative enterprises, joint sector enterprises and small scale units were to get preferential treatment over large entrepreneurs in the private sector. The government policy, thus limited the scope of private business. However, the new policy ushered in since July 1991 has wide opened many of the industries for the private sector. The scope of international business depends, to a large extent, on the economic system. At one end, there are the free market economies or capitalist economies, and at the other end are the centrally planned economies or communist countries. In between these two are the mixed economies. Within the mixed economic system itself, there are wide variations. The freedom of private enterprise is the greatest in the free market economy, which is characterized by the following assumptions: (i) The factors of production (labor, land, capital) are privately owned, and production occurs at the initiative of the private enterprise. (ii) Income is received in monetary form by the sale of services of the factors of production and from the profits of the private enterprise. (iii) Members of the free market economy have freedom of choice in so far as consumption, occupation, savings and investment are concerned. (iv) The free market economy is not planned controlled or regulated by the government. The government satisfies community or collective wants, but does not compete with private firms, nor does it tell the people where to work or what to produce. The completely free market economy, however, is an abstract system rather than a real one. Today, even the so-called market economies are subject to a number of government regulations. Countries like the United States, Japan, Australia, Canada and member countries of the EEC are regarded as market economies. The communist countries have, by and large, a centrally planned economic system. Under the rule of a communist or authoritarian socialist government, the state owns all the means of production, determines the goals of production and controls the economy according to a central master plan. There is hardly any consumer sovereignty in a centrally planned economy, unlike in the free market economy. The consumption pattern in a centrally planned economy is dictated by the state. China, East Germany Soviet Union, Czechoslovakia, Hungary, Poland etc., had centrally planned economies. However, recently several of these countries have discarded communist system and have moved towards the market economy. In between the capitalist system and the centrally planned system falls the system of the mixed

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economy, under which both the public and private sectors co-exist, as in India. The extent of state participation varies widely between the mixed economies. However, in many mixed economies, the strategic and other nationally very important industries are fully owned or dominated by the state. The economic system, thus, is a very important determinant of the scope of private business. The economic system and policy are, therefore, very important external constraints on business.

Political and legal environment- Political and government environment has close relationship with the economic system and economic policy. For example, the communist countries had a centrally planned economic system. In most countries, apart from those laws that control investment and related matters, there are a number of laws that regulate the conduct of the business. These laws cover such matters as standards of products, packaging, promotion etc. In many countries, with a view to protecting consumer interests, regulations have become stronger. Regulations to protect the purity of the environment and preserve the ecological balance have assumed great importance in many countries. Some governments specify certain standards for the products (including packaging) to be marketed in the country; some even prohibit the marketing of certain products. In most nations, promotional activities are subject to various types of controls. Media advertising is not permitted in Libya. Several European countries restrain the use of children in commercial advertisements. In a number of countries, including India, the advertisement of alcoholic liquor is prohibited. Advertisements, including packaging, of cigarettes must carry the statutory warning that ―cigarette smoking is injurious to health‖. Similarly, advertisements of baby food must necessarily inform the potential buyer that breast-feeding in the best. In countries like Germany, product comparison advertisements and the use of superlatives like ‗best‘ or ‗excellent‘ in advertisements is not allowed In the United States, the Federal Trade Commission is empowered to require a company to provide the quality, performance or comparative prices of its products. ―What is being asked of the drug industry and of American business in general is a fuller disclosure of the relevant facts about products. For drugs, food additives, some cosmetic preparations, and so forth, a full disclosure requires more knowledge of the long-range side effects of materials ingested into the complex human body. For American industry as a whole, greater candour has been called for under such legislation as Truth in Lending and Fair Packaging Act, under administrative decrees such as the warning requirement on cigarette packages and advertising, under the threats of private damage suits using the common-law concepts of warranty, and under voluntary programmes such as unit pricing and listing nutritional content of foods. The increasing complexity of products and the variety of product choices suggest further moves away from ‗caveat emptor‘ or ‗let the buyer beware‘ doctrines, moves which on the whole should prove a welcome although sometimes inconvenient challenge for business. There are a host of statutory controls on business in India. If the MRTP companies wanted to expand their business substantially, they had to convince the government that such expansion was in the public interest. Indeed, the ―Government in India has an all-pervasive and predominantly restrictive influence over various aspects of business, e.g, industrial licensing which decides location, capacity and process; import licensing for machinery

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and materials; size and price of capital issue; loan finance; pricing; managerial remuneration; expansion plans; distribution restrictions and a host of other enactments. Therefore, a considerable part of attention of a Chief Executive and his senior colleagues has to be devoted to a continuous dialogue with various government agencies to ensure growth and profitability within the framework of controls and restraints. Many countries today have laws to regulate competition in the public interest. Elimination of unfair competition and dilution of monopoly power are the important objectives of these regulations. In India, the monopolistic undertakings, dominants undertakings and large industrial houses are subject to a number of regulations which prevent the concentration of economic power to the common detriment. The MRTP Act also controls monopolistic, restrictive and unfair trade practices which are prejudicial to public interest. Such regulations brighten the prospects of small and new firms. They also increase the scope of some of the existing firms to venture into new areas of business. The special privileges available to the small scale sector have also contributed to the phenomenal success of the Nirma. Certain changes in government policies such as the industrial policy, fiscal policy, tariff policy etc. may have profound impact on business. Some policy developments create opportunities as well as threats. In other words, a development which brightens the prospects of some enterprises may pose a threat to some others. For example, the industrial policy liberalizations in India, particularly around the mid-eighties have opened up new opportunities and threats. They have provided a lot of opportunities to a large number of enterprises to diversify and to make their product mix better. But they have also given rise to serious threat to many existing products by way of increased competitions; many seller‘s markets have given way to buyer‘s markets. Even products which were seldom advertised have come to be promoted very heavily. This battle for the market has provided a splendid opportunity for the advertising industry. Advertising billing has been increasing substantially. That an estimated cost savings of about Rs. 200 crores per year have accrued to the Reliance Industries as a result of the changes in duties on some of the material inputs used by them is just an indication of the tremendous impact the fiscal and tariff policies can have on the business.

Socio-cultural environment- The socio-cultural fabric is an important environmental factor that should be analysed while formulating business strategies. The cost of ignoring the customs, traditions, taboos, tastes and preferences, etc., of people could be very high. The buying and consumption habits of the people, their language, beliefs and values, customs and traditions, tastes and preferences, education are all factors that affect business. For a business to be successful, its strategy should be the one that is appropriate in the socio-cultural environment. The marketing mix will have to be so designed as best to suit the environmental characteristics of the market. In Thailand, Helene Curtis switched to black shampoo because Thai women felt that it made their hair look glossier. Nestle, a Swiss multinational company, today brews more than forty varieties of instant coffee to satisfy different national tastes.

Even when people of different cultures use the same basic product, the mode of consumption, conditions of use, purpose of use or the perceptions of the product attributes may vary so much

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so that the product attributes method of presentation, positioning, or method of promoting the product may have to be varied to suit the characteristics of different markets. For example, the two most important foreign markets for Indian shrimp are the U.S and Japan. The product attributes for the success of the product in these two markets differ. In the U.S. market, correct weight and bacteriological factors are more important rather than eye appeal, colour, uniformity of size and arrangement of the shrimp which are very important in Japan. Similarly, the mode of consumption of tuna, another seafood export from India, differs between the U.S. and European countries. Tuna fish sandwiches, an American favourite which accounts for about 80 per cent of American tuna consumption, have little appeal in high tuna consumption European countries where people eat it right from the can. A very interesting example is that of the Vicks Vaporub, the popular pain balm, which is used as a mosquito repellant in some of the tropical areas. The differences in languages sometimes pose a serious problem, even necessitating a change in the brand name. Preett was, perhaps, a good brand name in India, but it did not suit in the overseas market; and hence it was appropriate to adopt Prestige‘ for the overseas markets. Chevrolet‘s brand name Nova‘ in Spanish means ―it doesn‘t go. In Japanese, General Motors‘ ―Body by Fisher translates as corpse by Fisher. In Japanese, again, 3M‘s slogan ―sticks like crazy ―translates as ―sticks foolishly‖. In some languages, Pepsi-Cola‘s slogan ―come alive translates as ―come out of the grave‖. The values and beliefs associated with colour vary significantly between different cultures. Blue, considered feminine and warm in Holland, is regarded as masculine and cold in Sweden. Green is a favourite colour in the Muslim world; but in Malaysia, it is associated with illness. White indicates death and mourning in China and Korea; but in some countries, it expresses happiness and is the colour of the wedding dress of the bride. Red is a popular colour in the communist countries; but many African countries have a national distaste for red colour. Social inertia and associated factors come in the way of the promotion of certain products, services or ideas. We come across such social stigmas in the marketing of family planning ideas, use of bio-gas for cooking, etc. In such circumstances, the success of marketing depends, to a very large extent, on the success in changing social attitudes or value systems. There are also a number of demographic factors, such as the age, and sex composition of population, family size, habitat, religion, etc., which influence the business. While dealing with the social environment, we must also consider the social environment of the business which encompasses its social responsibility and the alertness or vigilance of the consumers and of society at large. The societal environment has assumed great importance in recent years. As Barker observes, business ―traditionally has been held responsible for quantities for the supply of goods and jobs, for costs, prices, wages, hours of works, and for standards of living. Today, however, business is being asked to take a responsibility for the quality of life in our society. The expectation is that business- in addition to its traditional accountability for economic performance and results – will concern itself with the health of the society, that it will come up with the cures for the ills that currently beset us and, indeed, will find ways of anticipating and preventing future problems in these areas‖. As Stern succinctly points out, the ―more educated the society becomes, the more interdependent it becomes, and

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the more discretionary the use of its resources, the more marketing will become enmeshed in social issues. Marketing personnel are at interface between company and society. In this position, they have the responsibility not merely for designing a competitive marketing strategy, but for sensitizing business to the social, as well as the product demand of society.

Demographic environment- Demographic factors like the size, growth rate, age composition, sex composition, etc. of the population, family size, economic stratification of the population, educational levels, languages, caste, religion etc. Are all factors that are relevant to business? Demographic factors such as size of the population, population growth rate, age composition, life expectancy, family size, spatial dispersal, occupational status, employment pattern etc, affect the demand for goods and services. Markets with growing population and income are growth markets. But the decline in the birth rates in countries like the United States have affected the demand for baby products. Johnson and Johnson have overcome this problem by repositioning their products like baby shampoo and baby soap, promoting them also to the adult segment, particularly to the females. A rapidly increasing population indicates a growing demand for many products. High population growth rate also indicates an enormous increase in labour supply. When the Western countries experienced the industrial revolution, they had the problem of labour supply, for the population growth rate was comparatively low. Labour shortage and rising wages encouraged the growth of labour-saving technologies and automation. But most developing countries of today are experiencing a population explosion and a situation of labour surplus. The governments of developing countries, therefore, encourage labour intensive methods of production. Capital intensive methods, automation and even rationalization are apposed by labour and many sociologists, politicians and economists in these countries. The population growth rate, thus, is an important environmental factor which affects business. Cheap labour and a growing market have encouraged many multinational corporations to invest in developing countries. The occupational and spatial mobilities of population have implications for business. If labour is easily mobile between different occupations and regions, its supply will be relatively smooth, and this will affect the wage rate. If labour is highly heterogeneous in respect of language, caste and religion, ethnicity, etc., personnel management is likely to become a more complex task. The heterogeneous population with its varied tastes, preferences, beliefs, temperaments, etc. gives rise to differing demand patterns and calls for different marketing strategies. References to a number of demographic factors that have business implications have already been made under ―socio-cultural environment.

Natural environment Geographical and ecological factors, such as natural resource endowments, weather and climatic conditions, topographical factors, locational aspects in the global context, port facilities, etc., are all relevant to business. Differences in geographical conditions between markets may sometimes call for changes in the marketing mix. Geographical and ecological factors also influence the location of certain industries. For example, industries with high material index tend to be located near the raw material sources. Climatic and weather conditions affect the location of certain industries like the cotton textile industry. Topographical

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factors may, affect the demand pattern. For example, in hilly areas with a difficult terrain, jeeps may be in greater demand than cars. Ecological factors have recently assumed great importance. The depletion of natural resources, environmental pollution and the disturbance of the ecological balance has caused great concern. Government policies aimed at the preservation of environmental purity and ecological balance, conservation of non-replenishale resources, etc., have resulted in additional responsibilities and problems for business, and some of these have the effect of increasing the cost of production and marketing. Externalities have become an important problem the business has to confront with.

Physical and technological environment Physical Factors, such as geographical factors, weather and climatic conditions may call for modifications in the product, etc., to suit the environment because these environmental factors are uncontrollable. For example, Esso adapted its gasoline formulations to suit the weather conditions prevailing in different markets. Business prospects depend also on the availability of certain physical facilities. Some products, like many consumer durables, have certain use facility characteristics. The sale of television sets, for example, is limited by the extent of the coverage of the telecasting. Similarly, the demand for refrigerators and other electrical appliances is affected by the extent of electrification and the reliability of power supply. The demand for LPG gas stoves is affected by the rate of growth of gas connections. Technological factors sometimes pose problems. A firm, which is unable to cope with the technological changes, may not survive. Further, the differing technological environment of different markets or countires may call for product modifications. For example, many appliances and instruments in the U.S.A. are designed for 110 volts but this needs to be converted into 240 volts in countries which have that power system. Technological developments may increase the demand for some existing products. For example, voltage stabilisers help increase the sale of electrical appliances in markets characterised by frequent voltage fluctuations I power supply. However, the introduction of TV‘s, Fridges etc, with in built voltage stabilizer adversely affects the demand for voltage stabilizers. Advances in the technologies of food processing and preservation, packaging etc., have facilitated product improvements and introduction of new products and have considerably improved the marketability of products. The television has added a new dimension to product promotion. The advent of TV and VCP/VCR has, however, adversely affected the cinema theatres.

The fast changes in technologies also create problems for enterprises as they render plants and products obsolete quickly. Product-market-technology matrix generally has a much shorter life today than in the past. It is particularly so in the international marketing context. It may be interesting to note that almost half of Hindustan Lever‘s 1980 export business did not exist in 1987. In fact, as much as a third of the company‘s 1987 turnover was from products and markets, which were under three years of age.

International environment The international environment is very important from the point of view of certain categories of business. It is particularly important for industries directly depending on imports or exports and import-competing industries. For example, a recession in

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foreign markets, or the adoption of protectionist policies by foreign nations, may create difficulties for industries depending on exports. On the other hand, a boom in the export market or a relaxation of the protectionist policies may help the export-oriented industries. A liberalization of imports may help some industries which use imported items, but may adversely affect import-competing industries. It has been observed that major international developments have their spread effects on domestic business. The Great Depression in the United States sent its shock waves to a number of other countries. Oil price hikes have seriously affected a number of economies. These hikes have increased the cost of production and the prices of certain products, such as fertilizers, synthetic fibres, etc. The high oil price has led to an increase in the demand for automobile models that economise energy consumption. The demand for natural fibres increased because of the oil crisis. The oil crisis also prompted some companies to resort to demarketing. ―Demarketing refers to the process of cutting consumer demand for a product back to level that can be supplied by the firm‖. Some oil companies-the Indian Oil Corporation, for example-have publicized tips o how to cut oil consumption. When the fertilizer price shot up following the oil crisis, some fertilizer companies appealed to the farmers to use fertilizers only for important and remunerative crops. The importance of natural manure like compost as a substitute for chemical fertilizers was also emphasized. The oil crisis led to a reorientation of the Government of India‘s energy policy. Such developments affect the demand, consumption and investment pattern. A good export market enables a firm to develop a more profitable product mix and to consolidate its position in the domestic market. Many companies now plan production capacities and investment taking into account also the foreign markets. Export marketing facilitates the attainment of optimum capacity utilization; a company may be able to mitigate the effects of domestic recession by exporting. However, a company which depends on the export market to a considerable extent has also to face the impact of adverse developments in foreign markets.

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LESSON 6

THEORIES OF TRADE

International trade theory has shaped the economic policy of many nations for the past 50 years. It was the driver behind the formation of the World Trade Organization and regional trade blocs such as the European Union and the North American Free Trade Agreement (NAFTA). The 1990s, in particular, saw a global move toward greater free trade. It is crucially important to understand, therefore, what these theories are and why they have been so successful in shaping the economic policy of so many nations and the competitive environment in which international businesses compete.

Example

The growth of the Indian pharmaceutical industry is an example of the benefits of free trade and globalization. Before 2005 Indian pharmaceutical companies were shut out of many developed markets by legal barriers to trade. The fact that India did not respect drug patents, and allowed domestic companies to make counterfeit versions of patented medicines, meant that Indian companies were prohibited from selling these products in developed nations. In 2005 India signed an agreement that brought it into compliance with global patent rules. Indian companies stopped making counterfeit medicines, so they could now trade freely with developed countries. This opened up a host of legitimate business opportunities. Today, the fast-growing Indian pharmaceutical industry manufactures low-cost generic and patented medicines for sale around the world, often in partnership with Western drug companies.

An Overview of Trade Theory

We start with a discussion of mercantilism. Propagated in the sixteenth and seventeenth centuries, mercantilism advocated that countries should simultaneously encourage exports and discourage imports. Although mercantilism is an old and largely discredited doctrine, its echoes remain in modem political debate and in the trade policies of many countries. Next, we will look at Adam Smith's theory of absolute advantage. Proposed in 1776, Smith's theory was the first to explain why unrestricted free trade is beneficial to a country. Free trade refers to a situation where a government does not attempt to influence through quotas or duties what its citizens can buy from another country, or what they can produce and sell to another country. Smith argued that the invisible hand of the market mechanism, rather than government policy, should determine what a country imports and what it exports. His arguments imply that such a laissezfaire stance toward trade was in the best interests of a country. Building on Smith's work are two additional theories that we shall review. One is the theory of comparative advantage, advanced by the nineteenth-century English economist David Ricardo. This theory is the intellectual basis of the modem argument for unrestricted free trade. In the twentieth century,

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Ricardo's work was refined by two Swedish economists, Eli Heckscher and Bertil Ohlin, whose theory is known as the Heckscher-Ohlin theory.

THE BENEFITS OF TRADE

- Exchange products produced at low cost for products that are produced at high cost. - Specialize in the manufacture of products that can be produced most efficiently

Example – US specializes in the production of capital goods while INDIA exports a lot of agricultural products and textiles.

Why study trade theory ?

- to decide what should be imported and exported - government use these theories when they design policies - managers use them to identify promising markets.

THEORIES OF INTERNATIONAL TRADE

Mercantilism

The first theory of international trade, mercantilism, emerged in England in the midsixteenth century. The principle assertion of mercantilism was that gold and silver were the mainstays of national wealth and essential to vigorous commerce. At that time, gold and silver were the currency of trade between countries; a country could earn gold and silver by exporting goods. Conversely, importing goods from other countries would result in an outflow of gold and silver to those countries. The main tenet of mercantilism was that it was in a country's best interests to maintain a trade surplus, to export more than it imported. By doing so, a country would accumulate gold and silver and, consequently, increase its national wealth, prestige, and power.

Consistent with this belief, the mercantilist doctrine advocated government intervention to achieve a surplus in the balance of trade. The mercantilists saw no virtue in a large volume of trade. Rather, they recommended policies to maximize exports and minimize imports. To achieve this, imports were limited by tariffs and quotas, while exports were subsidized.

The flaw with mercantilism was that it viewed trade as a zero-sum game. (A zero sum game is one in which a gain by one country results in a loss by another.). According to David Hume, in the long run no country could sustain a surplus on the balance of trade and so accumulate gold and silver as the mercantilists had envisaged. It was left to Adam Smith and David Ricardo to show the shortsightedness of this approach and to demonstrate that trade is a positive-sum game, or a situation in which all countries can benefit. Unfortunately, the mercantilist doctrine is by no means dead. Neo-mercantilists equate political power with economic power and economic power with a balance-of trade surplus. Critics argue that many nations have adopted a neo-mercantilist strategy that is designed to simultaneously boost exports and limit imports.3 For example, critics charge that China is pursuing a neo-mercantilist policy, deliberately keeping its currency value

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low against the U.S. dollar in order to sell more goods to the United States and other developed nations, and thus amass a trade surplus and foreign exchange reserves .

Absolute Advantage

In his 1776 landmark book The Wealth of Nations, Adam Smith attacked the mercantilist assumption that trade is a zero-sum game. Smith argued that countries differ in their ability to produce goods efficiently. In his time, the English, by virtue of their superior manufacturing processes, were the world's most efficient textile manufacturers. Due to the combination of favorable climate, good soils, and accumulated expertise, the French had the world's most efficient wine industry. The English had an absolute advantage in the production of textiles, while the French had an absolute advantage in the production of wine. Thus, a country has an absolute advantage in the production of a product when it is more efficient than any other country in producing it. According to Smith, countries should specialize in the production of goods for which they have an absolute advantage and then trade these for goods produced by other countries. In Smith's time, this suggested the English should specialize in the production of textiles while the French should specialize in the production of wine. England could get all the wine it needed by selling its textiles to France and buying wine in exchange. Similarly, France could get all the textiles it needed by selling wine to England and buying textiles in exchange. Smith's basic argument, therefore, is that a country should never produce goods at home that it can buy at a lower cost from other countries. Smith demonstrates that, by specializing in the production of goods in which each has an absolute advantage, both countries benefit by engaging in trade.

Comparative Advantage

David Ricardo took Adam Smith's theory one step further by exploring what might happen when one country has an absolute advantage in the production of all goods.5 Smith's theory of absolute advantage suggests that such a country might derive no benefits from international trade. In his 181 7 book Principles of Political Economy, Ricardo showed that this was not the case. According to Ricardo's theory of comparative advantage, it makes sense for a country to specialize in the production of those goods that it produces most efficiently and to buy the goods that it produces less efficiently from other countries, even if this means buying goods from other countries that it could produce more efficiently itself.

Heckscher-Ohlin Theory

Ricardo's theory stresses that comparative advantage arises from differences in productivity. Thus, whether Ghana is more efficient than South Korea in the production of cocoa depends on how productively it uses its resources. Ricardo stressed labor productivity and argued that differences in labor productivity between nations underlie the notion of comparative advantage.

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Swedish economists Eli Heckscher (in 1919) and Bertil Ohlin (in 1933) put forward a different explanation of comparative advantage. They argued that comparative advantage arises from differences in national factor endowments. By factor endowments they meant the extent to which a country is endowed with such resources as land, labor, and capital.

Nations have varying factor endowments, and different factor endowments explain differences in factor costs; specifically, the more abundant a factor, the lower its cost. The Heckscher-Ohlin theory predicts that countries will export those goods that make intensive use of factors that are locally abundant, while importing goods that make intensive use of factors that are locally scarce. Thus, the Heckscher-Ohlin theory attempts to explain the pattern of international trade that we observe in the world economy. Like Ricardo's theory, the Heckscher-Ohlin theory argues that free trade is beneficial. Unlike Ricardo's theory, however, the Heckscher-Ohlin theory argues that the pattern of international trade is determined by differences in factor endowments, rather than differences in productivity. The Heckscher-Ohlin theory has commonsense appeal. For example, the United States has long been a substantial exporter of agricultural goods, reflecting in part its unusual abundance of arable land. In contrast, China excels in the export of goods produced in labor-intensive manufacturing industries, such as textiles and footwear. This reflects China's relative abundance of low-cost labor. The United States, which lacks abundant low-cost labor, has been a primary importer of these goods. Note that it is relative, not absolute, endowments that are important; a country may have larger absolute amounts of land and labor than another country, but be relatively abundant in one of them.

The Leontief Paradox

The Heckscher-Ohlin theory has been one of the most influential theoretical ideas in international economics. Most economists prefer the Heckscher-Ohlin theory to Ricardo's theory because it makes fewer simplifying assumptions. Because of its influence, the theory has been subjected to many empirical tests. Beginning with a famous study published in 1953 by Wassily Leontief (winner of the Nobel Prize in economics in 1973), many of these tests have raised questions about the validity of the Heckscher Ohlin theory.24 Using the Heckscher-Ohlin theory, Leontief postulated that since the United States was relatively abundant in capital compared to other nations, the United States would be an exporter of capital-intensive goods and an importer of labor-intensive goods. To his surprise, 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 has become known as the Leontief paradox. No one is quite sure why we observe the Leontief paradox. One possible explanation is that the United States has a special advantage in producing new products or goods made with innovative technologies. Such products may be less capital intensive than products whose technology has had time to mature and become suitable for mass production. Thus, the United States may be exporting goods that heavily use skilled labor and innovative entrepreneurship, such as computer software, while importing heavy manufacturing products that use large amounts of capital. Some empirical studies tend to confirm this. Still,

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tests of the Heckscher-Ohlin theory using data for a large number of countries tend to confirm the existence of the Leontief paradox.

The Product Life-Cycle Theory

Raymond Vernon initially proposed the product life-cycle theory in the mid-1960s.29 Vernon's theory was based on the observation that for most of the twentieth century a very large proportion of the world's new products had been developed by U.S. firms and sold first in the U.S. market (e.g., mass-produced automobiles, televisions, instant cameras, photocopiers, personal computers, and semiconductor chips). To explain this, Vernon argued that the wealth and size of the U.S. market gave U.S. firms a strong incentive to develop new consumer products. In addition, the high cost of U.S. labor gave U.S. firms an incentive to develop cost-saving process innovations. Just because a new product is developed by a U.S. firm and first sold in the U.S. market, it does not follow that the product must be produced in the United States. It could be produced abroad at some low-cost location and then exported back into the United States. However, Vernon argued that most new products were initially produced in America. Apparently, the pioneering firms believed it was better to keep production facilities close to the market and to the firm's center of decision making, given the uncertainty and risks inherent in introducing new products. Also, the demand for most new products tends to be based on nonprice factors. Consequently, firms can charge relatively high prices for new products, which obviates the need to look for low-cost production sites in other countries.

Over time, demand for the new product starts to grow in other advanced countries (e.g., Great Britain, France, Germany, and Japan). As it does, it becomes worthwhile for foreign producers to begin producing for their home markets. In addition, U.S. firms might set up production facilities in those advanced countries where demand is growing. Consequently, production within other advanced countries begins to limit the potential for exports from the United States. As the market in the United States and other advanced nations matures, the product becomes more standardized, and price becomes the main competitive weapon. As this occurs, cost considerations start to play a greater role in the competitive process. Producers based in advanced countries where labor costs are lower than in the United States (e.g., Italy, Spain) might now be able to export to the United States. If cost pressures become intense, the process might not stop there. The cycle by which the United States lost its advantage to other advanced countries might be repeated once more, as developing countries (e.g., Thailand) begin to acquire a production advantage over advanced countries. Thus, the locus of global production initially switches from the United States to other advanced nations and then from those nations to developing countries. The consequence of these trends for the pattern of world trade is that over time the United States switches from being an exporter of the product to an importer of the product as production becomes concentrated in lower-cost foreign locations. Figure 6.5 shows the growth of production and consumption over time in the United States, other advanced countries, and developing countries.

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New Trade Theory

The new trade theory began to emerge in the 1970s when a number of economists pointed out that the ability of firms to attain economies of scale might have important implications for international trade.30 Economies of scale are unit cost reductions associated with a large scale of output. Economies of scale have a number of sources, including the ability to spread fixed costs over a large volume, and the ability of large-volume producers to utilize specialized employees and equipment that are more productive than less specialized employees and equipment. Economies of scale are a major source of cost reductions in many industries, from computer software to automobiles, and from pharmaceuticals to aerospace.

For example, Microsoft realizes economies of scale by spreading the fixed costs of developing new versions of its Windows operating system, which runs to about $5 billion, over the 250 million or so personal computers upon which each new system is ultimately installed. Similarly, automobile companies realize economies of scale by producing a high volume of automobiles from an assembly line where each employee has a specialized task.

New trade theory makes two important points: First, through its impact on economies of scale, trade can increase the variety of goods available to consumers and decrease the average cost of those goods. Second, in those industries when the output required to attain economies of scale represents a significant proportion of total world demand, the global market may be able to support only a small number of enterprises. Thus, world trade in certain products may be dominated by countries whose firms were first movers in their production.

New trade theory makes two important points: First, through its impact on economies of scale, trade can increase the variety of goods available to consumers and decrease the average cost of those goods. Second, in those industries when the output required to attain economies of scale represents a significant proportion of total world demand, the global market may be able to support only a small number of enterprises. Thus, world trade in certain products may be dominated by countries whose firms were first movers in their production.

- Increasing Product Variety and Reducing Costs In industries where economies of scale are important, both the variety of goods that a country can produce and the scale of production are limited by the size of the market. If a national market is small, there may not be enough demand to enable producers to realize economies of scale for certain products. Accordingly, those products may not be produced, thereby limiting the variety of products available to consumers. Alternatively, they may be produced, but at such low volumes that unit costs and prices are considerably higher than they might be if economies of scale could be realized. The implication, according to new trade theory, is that each nation may be able to specialize in producing a narrower range of products than it would in the absence of trade, yet by buying goods that it does not make from other countries, each nation can simultaneously

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increase the variety of goods available to its consumers and lower the costs of those goods thus trade offers an opportunity for mutual gain even when countries do not differ in their resource endowments or technology.

- Economies of Scale, First-Mover Advantages, and the Pattern of Trade A second theme in new trade theory is that the pattern of trade we observe in the world economy may be the result of economies of scale and first-mover advantages. Firstmover advantages are the economic and strategic advantages that accrue to early entrants into an industry. The ability to capture scale economies ahead of later entrants, and thus benefit from a lower cost structure, is an important first-mover advantage. New trade theory argues that for those products where economies of scale are significant and represent a substantial proportion of world demand, the first movers in an industry can gain a scale-based cost advantage that later entrants find almost impossible to match. Thus, the pattern of trade that we observe for such products may reflect first-mover advantages. Countries may dominate in the export of certain goods because economies of scale are important in their production, and because firms located in those countries were the first to capture scale economies, giving them a first-mover advantage.

- Implications of New Trade Theory New trade theory has important implications. The theory suggests that nations may benefit from trade even when they do not differ in resource endowments or technology. Trade allows a nation to specialize in the production of certain products, attaining scale economies and lowering the costs of producing those products, while buying products that it does not produce from other nations that specialize in the production of other products. By this mechanism, the variety of products available to consumers in each nation is increased, while the average costs of those products should fall, as should their price, freeing resources to produce other goods and services. New trade theory is at variance with the Heckscher-Ohlin theory, which suggests a country will predominate in the export of a product when it is particularly well endowed with those factors used intensively in its manufacture. New trade theorists argue that the United States is a major exporter of commercial jet aircraft not because it is better endowed with the factors of production required to manufacture aircraft, but because one of the first movers in the industry, Boeing, was a U.S. firm. The new trade theory is not at variance with the theory of comparative advantage. Economies of scale increase productivity. Thus, the new trade theory identifies an important source of comparative advantage. This theory is quite useful in explaining trade patterns. Empirical studies seem to support the predictions of the theory that trade increases the specialization of production within an industry, increases the variety of products available to consumers, and results in lower average prices.

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National Competitive Advantage: Rorter's Diamond

In 1990 Michael Porter of the Harvard Business School published the results of an intensive research effort that attempted to determine why some nations succeed and others fail in international competition.35 Porter and his team looked at 100 industries in 10 nations. Like the work of the new trade theorists, Porter's work was driven by a belief that existing theories of international trade told only part of the story. For Porter, the essential task was to explain why a nation achieves international success in a particular industry.

Porter theorizes that four broad attributes of a nation shape the environment in which local firms compete, and these attributes promote or impede the creation of competitive advantage . These attributes are -

• Factor endowments-a nation's position in factors of production such as skilled labor or the infrastructure necessary to compete in a given industry.

• Demand conditions-the nature of home demand for the industry's product or service. • Relating and supporting industries-the presence or absence of supplier industries and related industries that are internationally competitive.

• Firm strategy, structure, and rivalry-the conditions governing how companies are created, organized, and managed and the nature of domestic rivalry.

Porter speaks of these four attributes as constituting the diamond. He argues that firms are most likely to succeed in industries or industry segments where the diamond is most favorable. He also argues that the diamond is a mutually reinforcing system. The effect of one attribute is contingent on the state of others. Porter maintains that two additional variables can influence the national diamond in important ways: chance and government. Chance events, such as major innovations, can reshape industry structure and provide the opportunity for one nation's firms to supplant another's. Government, by its choice of policies, can detract from or improve national advantage. For example, regulation can alter home demand conditions, antitrust policies can influence the intensity of rivalry within an industry, and government investments in education can change factor endowments.

Factor Endowments

Factor endowments lie at the center of the Heckscher-Ohlin theory. While Porter does not propose anything radically new, he does analyze the characteristics of factors of production. He recognizes hierarchies among factors, distinguishing between basic factors (e.g., natural resources, climate, location, and demographics) and advanced factors (e.g., communication infrastructure, sophisticated and skilled labor, research facilities, and technological know-how). He argues that advanced factors are the most significant for competitive advantage. Unlike the naturally endowed basic factors, advanced factors are a product of investment by individuals, companies, and governments. Thus, government investments in basic and higher education, by improving the general skill and knowledge level of the population and by stimulating advanced

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research at higher education institutions, can upgrade a nation's advanced factors. The relationship between advanced and basic factors is complex. Basic factors can provide an initial advantage that is subsequently reinforced and extended by investment in advanced factors. Conversely, disadvantages in basic factors can create pressures to invest in advanced factors. An obvious example of this phenomenon is Japan, a country that lacks arable land and mineral deposits and yet through investment has built a substantial endowment of advanced factors.

Demand Conditions

Porter emphasizes the role home demand plays in upgrading competitive advantage. Firms are typically most sensitive to the needs of their closest customers. Thus, the characteristics of home demand are particularly important in shaping the attributes of domestically made products and in creating pressures for innovation and quality. Porter argues that a nation's firms gain competitive advantage if their domestic consumers are sophisticated and demanding. Such consumers pressure local firms to meet high standards of product quality and to produce innovative products.

Related and Supporting Industries

The third broad attribute of national advantage in an industry is the presence of suppliers or related industries that are internationally competitive. The benefits of investments in advanced factors of production by related and supporting industries can spill over into an industry, thereby helping it achieve a strong competitive position internationally. One consequence of this process is that successful industries within a country tend to be grouped into clusters of related industries. This was one of the most pervasive findings of Porter's study.

Firm Strategy, Structure, and Rivalry

The fourth broad attribute of national competitive advantage in Porter's model is the strategy, structure, and rivalry of firms within a nation. Porter makes two important points here. First, different nations are characterized by different management ideologies, which either help them or do not help them to build national competitive advantage. Porter's second point is that there is a strong association between vigorous domestic rivalry and the creation and persistence of competitive advantage in an industry. Vigorous domestic rivalry induces firms to look for ways to improve efficiency, which makes them better international competitors. Domestic rivalry creates pressures to innovate, to improve quality, to reduce costs, and to invest in upgrading advanced factors. All this helps to create world-class competitors.

Case for free trade

The strategic trade policy arguments of the new trade theorists suggest an economic justification for government intervention in international trade. This justification challenges the rationale for unrestricted free trade found in the work of classic trade theorists such as Adam Smith and David

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Ricardo. In response to this challenge to economic orthodoxy, a number of economists-including some of those responsible for the development of the new trade theory, such as Paul Krugman-point out that although strategic trade policy looks appealing in theory, in practice it may be unworkable. This response to the strategic trade policy argument constitutes the revised case for free trade.

Retaliation and Trade War

Krugman argues that a strategic trade policy aimed at establishing domestic firms in a dominant position in a global industry is a beggar-thy-neighbor policy that boosts national income at the expense of other countries. A country that attempts to use such policies will probably provoke retaliation. In many cases, the resulting trade war between two or more interventionist governments will leave all countries involved worse off than if a hands-off approach had been adopted in the first place. If the U.S. government were to respond to the Airbus subsidy by increasing its own subsidies to Boeing, for example, the result might be that the subsidies would cancel each other out. In the process, both European and U.S. taxpayers would end up supporting an expensive and pointless trade war, and both Europe and the United States would be worse off. Krugman may be right about the danger of a strategic trade policy leading to a trade war. The problem, however, is how to respond when one's competitors are already being supported by government subsidies; that is, how should Boeing and the United States respond to the subsidization of Airbus? According to Krugman, the answer is probably not to engage in retaliatory action but to help establish rules of the game that minimize the use of trade-distorting subsidies. This is what the World Trade Organization seeks to do.

Domestic Policies

Governments do not always act in the national interest when they intervene in the economy; politically important interest groups often influence them. The European Union's support for the Common Agricultural Policy (CAP), which arose because of the political power of French and German farmers, is an example. The CAP benefits inefficient farmers and the politicians who rely on the farm vote, but not consumers in the EU, who end up paying more for their foodstuffs. Thus, a further reason for not embracing strategic trade policy, according to Krugman, is that such a policy is almost certain to be captured by special-interest groups within the economy, which will distort it to their own ends. Krugman concludes that in the United States,

To ask the Commerce Department to ignore special-interest politics while formulating detailed policy for many industries is not realistic: To establish a blanket policy of free trade, with exceptions granted only under extreme pressure, may not be the optimal policy according to the theory but may be the best policy that the country is likely to get.

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LESSON 7

GOVERNMENT INTERVENTION IN INTERNATIONAL TRADE

Content

Foreign trade multiplier. Instruments of trade policy. Arguments for government intervention. The foreign trade multiplier also known as export multiplier operates like the investment multiplier of Keynes. It may be defined as the amount by which national income of a nation will be raised by a unit increase in domestic investment on exports. As exports increase there is an increase in the income of all persons associated with the exports industries. These in turn create demand for goods. But this is dependent upon their marginal propensity to save (MPS) and marginal propensity to import (MPM). The smaller these two propensities are, the larger will be the value of multiplier and vice versa.

The foreign trade multiplier based on the following:

1. There is full employment in the domestic economy.

2. There is direct link between domestic and foreign country in exporting and importing goods

and the country is small with no foreign country.

3. It is on a fixed exchange-rate system, the multiplier is based in instantaneous process without

time lag and the domestic Investment(id) remains invariable.

4. There is no accelerator and the analysis is applicable to only two countries.

5. There are no tariff barriers and exchange controls.

6. The government expenditure is constant.

Government intervention in International trade

There are many theoretical benefits of trade. However, national government officials do not always embrace the concept. National governments continue to protect all or some of their industries using a myriad of tactics. Free trade is a policy in international markets and also a pattern of exports and imports without trade barriers; governments do not restrict imports or exports. Free trade is the pattern of imports and exports that would result in the absence of trade barriers. There are many reasons why a government would intervene in trade. Governments impose trade restrictions for economic, political and/or cultural reasons. Many governments impose some protectionist policies that are intended to support local employment, such as applying tariffs to imports or subsidies to exports. Governments may also restrict free trade to

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limit exports of natural resources. Other barriers that may hinder trade include import quotas, taxes, and non-tariff barriers, such as regulatory legislation.

Some of the political motives for protectionist policies include: job protection that lowers unemployment numbers and also preservation of “National Security Industries” in an effort to protect imports and exports for security including defense-related goods like military uniforms, weapons and missiles. Many countries fiercely protect their agricultural sector for national security reasons because a nation that imports its food supplies could face starvation in times of war.

Governments have mechanisms to respond to “Unfair” Trade Practices. They may threaten to close their ports or to impose high tariffs if another nation does not concede on a certain trade issue. Some of the economic motives that governments deploy include: protecting innovative “Infant” and emerging industries during their development phase so they can become efficient and competitive. Cultural motives to restrict trade are concerned with unwanted cultural exposure and influence “to people and products of other countries that could potentially slowly alters cultural beliefs.” Many countries have laws that protect their media and entertainment programming for cultural reasons.

The government also has methods for promoting trade. They can offer a subsidy; financial assistance to domestic producers in the form of low-interest loans, tax breaks or cash payments to help domestic companies protect themselves from international rivals. The government can also offer export financing through loans and loan guarantees. U.S. companies can obtain export financing from the Export-Import Bank and the Overseas Private Insurance Corporation (OPIC). “OPIC insures against losses due to: (1) expropriation, (2) currency inconvertibility, and (3) war, revolution, and insurrection.”

Foreign trade zones minimize problems associated with exports because the intervention of the customs authorities is reduced.” Goods are allowed to pass through with lower customs duties and fewer customs procedures and administrative delays which are regulatory controls or bureaucratic rules designed to impair the rapid flow of imports into a country.

These Foreign-trade zones are organized around major seaports, international airports, and national frontiers. Customs duties increase production costs and delay delivery time. Companies can reduce such costs and time by establishing a facility inside a foreign trade zone.

China has established very large foreign trade zones. Mexico’s maquiladora zones are similar to foreign trade zones because they import materials from the United States and then process them and re-export them to the United States. Duties are only computed on the value added in Mexico. Governments have special agencies responsible for promoting exports and frequently organize trips for trade officials and business representatives to visit other countries.

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Instruments of Trade Policy

Trade policy uses seven main instruments: tariffs, subsidies, import quotas, voluntary export restraints, local content requirements, administrative policies, and antidumping duties.

Tariffs

A tariff is a tax levied on imports (or exports). Tariffs fall into two categories. Specific tariffs are levied as a fixed charge for each unit of a good imported (for example, $3 per barrel of oil). Ad valorem tariffs are levied as a proportion of the value of the imported good. In most cases, tariffs are placed on imports to protect domestic producers from foreign competition by raising the price of imported goods. However, tariffs also produce revenue for the government. Until the income tax was introduced, for example, the U.S. government received most of its revenues from tariffs. The important thing to understand about an import tariff is who suffers and who gains. The government gains, because the tariff increases government revenues. Domestic producers gain, because the tariff affords them some protection against foreign competitors by increasing the cost of imported foreign goods. Consumers lose because they must pay more for certain imports.

There are many ways to restrict trade. A tariff is a trade-restricting government tax levied on a product as it enters or leaves a country. There are 3 basic types of tariffs: (1) export tariff, (2) transit tariff, and (3) import tariff.

An ad valorem tariff is an import tariff levied as a percentage of the stated price of an imported product. A specific tariff is levied as a specific fee for each unit (by number or weight) of an imported product. A compound tariff is calculated partly as a percentage of the stated price of an imported product, and partly as a specific fee for each unit. Because import tariffs raise the cost of an imported good, domestically produced goods appear more attractive to buyers. Tariffs generate revenue for the government. As countries develop, they generate a greater portion of their revenues from taxes on income, capital gains, and other economic activities; as opposed to generating revenue from tariffs.

In general, two conclusions can be derived from economic analysis of the effect of import tariffs.

First, tariffs are generally pro-producer and anti-consumer. While they protect producers from foreign competitors, this restriction of supply also raises domestic prices. For example, a study by Japanese economists calculated that tariffs on imports of foodstuffs, cosmetics, and chemicals into Japan cost the average Japanese consumer about $890 per year in the form of higher prices. Almost all studies find that import tariffs impose significant costs on domestic consumers in the form of higher prices.

Second, import tariffs reduce the overall efficiency of the world economy. They reduce efficiency because a protective tariff encourages domestic firms to produce products at home that, in theory, could be produced more efficiently abroad. The consequence is an inefficient

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utilization of resources. For example, tariffs on the importation of rice into South Korea have led to an increase in rice production in that country; however, rice farming is an unproductive use of land in South Korea. It would make more sense for the South Koreans to purchase their rice from lower-cost foreign producers and to utilize the land now employed in rice production in some other way, such as growing foodstuffs that cannot be produced more efficiently elsewhere or for residential and industrial purposes. Sometimes tariffs are levied on exports of a product from a country. Export tariffs are far less common than import tariffs. In general, export tariffs have two objectives: first, to raise revenue for the government, and second, to reduce exports from a sector, often for political reasons. For example, in 2004 China imposed a tariff on textile exports. The primary objective was to moderate the growth in exports of textiles from China, thereby alleviating tensions with other trading partners.

Subsidies

A subsidy is a government payment to a domestic producer. Subsidies take many forms, including cash grants, low-interest loans, tax breaks, and government equity participation in domestic firms. By lowering production costs, subsidies help domestic producers in two ways: (1) competing against foreign imports and (2) gaining export markets. While the purpose of the subsidies was to help them survive a very difficult economic climate, one of the consequences was to give subsidized companies an unfair competitive advantage in the global auto industry.

Agriculture tends to be one of the largest beneficiaries of subsidies in most countries. In the mid-2000s, the European Union was paying about €44 billion annually ($55 billion) in farm subsidies. Not to be outdone, in May 2002 President George W. Bush signed into law a bill that contained subsidies of more than $180 billion for U.S. farmers spread over 10 years. This was followed in 2007 by a farm bill that contained $286 billion in subsidies for the next 10 years. The Japanese also have a long history of supporting inefficient domestic producers with farm subsidies. The accompanying Country Focus looks at subsidies to wheat producers in Japan. Nonagricultural subsidies are much lower, but they are still significant. For example, subsidies historically were given to Boeing and Airbus to help them lower the cost of developing new commercial jet aircraft. In Boeing's case, subsides came in the form of tax credits for R&D spending or Pentagon money that was used to develop military technology, which then was transferred to civil aviation projects. In the case of Airbus, subsidies took the form of government loans at below-market interest rates. The main gains from subsidies accrue to domestic producers, whose international competitiveness is increased as a result. Whether subsidies generate national benefits that exceed their national costs is debatable. In practice, many subsidies are not that successful at increasing the international competitiveness of domestic producers. Rather, they tend to protect the inefficient and promote excess production.

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Import Quotas and Voluntary Export Restraints

An import quota is a direct restriction on the quantity of some good that may be imported into a country. The restriction is usually enforced by issuing import licenses to a group of individuals or firms. For example, the United States has a quota on cheese imports. The only firms allowed to import cheese are certain trading companies, each of which is allocated the right to import a maximum number of pounds of cheese each year. In some cases, the right to sell is given directly to the governments of exporting countries.

A common hybrid of a quota and a tariff is known as a tariff rate quota. Under a tariff rate quota, a lower tariff rate is applied to imports within the quota than those over the quota. Tariff rate quotas are common in agriculture, where their goal is to limit imports over quota. An example is given in the Country Focus that looks at how Japan uses the combination of a tariff rate quota and subsidies to protect inefficient Japanese wheat farmers from foreign competition.

A variant on the import quota is the voluntary export restraint. A voluntary export restraint (VER) is a quota on trade imposed by the exporting country, typically at the request of the importing country's government. Foreign producers agree to VERs because they fear more damaging punitive tariffs or import quotas might follow if they do not. Agreeing to a VER is seen as a way to make the best of a bad situation by appeasing protectionist pressures in a country. As with tariffs and subsidies, both import quotas and VERs benefit domestic producers by limiting import competition. As with all restrictions on trade, quotas do not benefit consumers. An import quota or VER always raises the domestic price of an imported good. When imports are limited to a low percentage of the market by a quota or VER, the price is bid up for that limited foreign supply.

Export quotas hurt consumers in the importing nation because of reduced selection and higher

prices. Export quotas might help retain jobs if foreign imports threaten to put domestic producers

out of business. Japanese car manufacturers have used VER.

Local Content Requirements

A local content requirement is a requirement that some specific fraction of a good be produced domestically. The requirement can be expressed either in physical terms (e.g., 75 percent of component parts for this product must be produced locally) or in value terms (e.g., 75 percent of the value of this product must be produced locally). Local content regulations have been widely used by developing countries to shift their manufacturing base from the simple assembly of products whose parts are manufactured elsewhere into the local manufacture of component parts. They have also been used in developed countries to try to protect local jobs and industry from foreign competition. Local content regulations provide protection for a domestic producer of parts in the same way an import quota does: by limiting foreign competition. The aggregate economic effects are also the same; domestic producers benefit, but the restrictions on imports raise the prices of imported components. In turn, higher prices for imported components are

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passed on to consumers of the final product in the form of higher final prices. So as with all trade policies, local content regulations tend to benefit producers and not consumers.

Administrative Policies

In addition to the formal instruments of trade policy, governments of all types sometimes use informal or administrative policies to restrict imports and boost exports. Administrative trade policies are bureaucratic rules designed to make it difficult for imports to enter a country. It has been argued that the Japanese are the masters of this trade barrier. In recent decades Japan's formal tariff and nontariff barriers have been among the lowest in the world. However, critics charge that the country's informal administrative barriers to imports more than compensate for this. As with all instruments of trade policy, administrative instruments benefit producers and hurt consumers, who are denied access to possibly superior foreign products.

Antidumping Policies

In the context of international trade, dumping is variously defined as selling goods in a foreign market at below their costs of production or as selling goods in a foreign market at below their "fair" market value. There is a difference between these two definitions; the fair market value of a good is normally judged to be greater than the costs of producing that good because the former includes a "fair" profit margin. Dumping is viewed as a method by which firms unload excess production in foreign markets. Some dumping may be the result of predatory behavior, with producers using substantial profits from their home markets to subsidize prices in a foreign market with a view to driving indigenous competitors out of that market.

An alleged example of dumping occurred in 1997, when two South Korean manufacturers of semiconductors, LG Semicon and Hyundai Electronics, were accused of selling dynamic random access memory chips (DRAMs) in the U.S. market at below their costs of production. This action occurred in the middle of a worldwide glut of chip-making capacity. It was alleged that the firms were trying to unload their excess production in the United States. Antidumping policies are designed to punish foreign firms that engage in dumping. The ultimate objective is to protect domestic producers from unfair foreign competition. Although antidumping policies vary somewhat from country to country, the majority are similar to those used in the United States. If a complaint has merit, the Commerce Department may impose an antidumping duty on the offending foreign imports (antidumping duties are often called countervailing duties). These duties, which represent a special tariff, can be fairly substantial and stay in place for up to five years.

Arguments for Government Intervention

The various instruments of trade policy that governments can use, it is time to look at the case for government intervention in international trade. Arguments for government intervention take two paths: political and economic. Political arguments for intervention are concerned with

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protecting the interests of certain groups within a nation (normally producers), often at the expense of other groups (normally consumers), or with achieving some political objective that lies outside the sphere of economic relationships, such as protecting the environment or human rights. Economic arguments for intervention are typically concerned with boosting the overall wealth of a nation (to the benefit of all, both producers and consumers).

Political Arguments For Intervention

Political arguments for government intervention cover a range of issues, including preserving jobs, protecting industries deemed important for national security, retaliating against unfair foreign competition, protecting consumers from "dangerous" products, furthering the goals of foreign policy, and advancing the human rights of individuals in exporting countries.

Protecting Jobs and Industries Perhaps the most common political argument for government intervention is that it is necessary for protecting jobs and industries from unfair foreign competition

This is true of many attempts to protect jobs and industries through government intervention. For example, the imposition of steel tariffs in 2002 raised steel prices for American consumers, such as automobile companies, making them less competitive in the global marketplace.

National Security

Countries sometimes argue that it is necessary to protect certain industries because they are important for national security. Defense-related industries often get this kind of attention (e.g., aerospace, advanced electronics, semiconductors, etc.). Although not as common as it used to be, this argument is still made. Those in favor of protecting the U.S. semiconductor industry from foreign competition, Initially, the U.S. government provided Sematech with $100 million per year in subsidies. By the mid-1990s, however, the U.S. semiconductor industry had regained its leading market position, largely through the personal computer boom and demand for microprocessor chips made by Intel. In 1994, the consortium's board voted to seek an end to federal funding, and since 1996 the consortium has been funded entirely by private money.

Retaliation

Some argue that governments should use the threat to intervene in trade policy as a bargaining tool to help open foreign markets and force trading partners to "play by the rules of the game."

A politically motivated rationale for government intervention may liberalize trade and bring with it resulting economic gains. It is a risky strategy, however. A country that is being pressured may not back down and instead may respond to the imposition of punitive tariffs by raising trade barriers of its own. This is exactly what the Chinese government threatened to do when pressured by the United States, although it ultimately did back down. If a government does not

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back down, however, the results could be higher trade barriers all around and an economic loss to all involved.

Protecting Consumers

Many governments have long had regulations to protect consumers from unsafe products. The indirect effect of such regulations often is to limit or ban the importation of such products.

As enticing as such innovations sound, they have met with intense resistance from consumer groups, particularly in Europe. The fear is that the widespread use of genetically altered seed com could have unanticipated and harmful effects on human health and may result in "genetic pollution." (An example of genetic pollution would be when the widespread use of crops that produce natural pesticides stimulates the evolution of "superbugs" that are resistant to those pesticides.) Such concerns have led Austria and Luxembourg to outlaw the importation, sale, or use of genetically altered organisms. Sentiment against genetically altered organisms also runs strong in several other European countries, most notably Germany and Switzerland. It seems likely, therefore, that the World Trade Organization will be drawn into the conflict between those that want to expand the global market for genetically altered organisms, such as Monsanto, and those that want to limit it, such as Austria and Luxembourg

Furthering Foreign Policy Objectives

Governments sometimes use trade policy to support their foreign policy objectives.18 A government may grant preferential trade terms to a country with which it wants to build strong relations. Trade policy has also been used several times to pressure or punish "rogue states" that do not abide by international law or norms. . The theory is that such pressure might persuade the rogue state to mend its ways, or it might hasten a change of government. The United States also has had trade sanctions in place against Libya and Iran, both of which it accuses of supporting terrorist action against U.S. interests and building weapons of mass destruction. In late 2003, the sanctions against Libya seemed to yield some returns when that country announced it would terminate a program to build nuclear weapons, and the U.S. government responded by relaxing those sanctions. Other countries can undermine unilateral trade sanctions. The U.S. sanctions against Cuba, for example, have not stopped other Western countries from trading with Cuba.

Protecting Human Rights

Protecting and promoting human rights in other countries is an important element of foreign policy for many democracies. Governments sometimes use trade policy to try to improve the human rights policies of trading partners. For years, the most obvious example of this was the annual debate in the United States over whether to grant most favored nation (MFN) status to China. MFN status allows countries to export goods to the United States under favorable terms. Under MFN rules, the average tariff on Chinese goods imported into the United States was 8 percent. If China's MFN status were rescinded, tariffs could have risen to about 40 percent.

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Trading partners who are signatories of the World Trade Organization, as most are, automatically receive MFN status. However, China did not join the WTO until 2001, so historically the decision of whether to grant MFN status to China was a real one. The decision was made more difficult by the perception that China had a poor human rights record. As indications of the country's disregard for human rights, critics of China often point to the 1989 Tiananmen Square massacre, China's continuing subjugation of Tibet (which China occupied in the 1950s), and the squashing of political dissent in China. These critics argue that it was wrong for the United States to grant MFN status to China, and that instead, the United States should withhold MFN status until China showed measurable improvement in its human rights record. The critics argue that trade policy should be used as a political weapon to force China to change its internal policies toward human rights. Others contend that limiting trade with such countries would make matters worse, not better. They argue that the best way to change the internal human rights stance of a country is to engage it through international trade. At its core, the argument is simple: Growing bilateral trade raises the income levels of both countries, and as a state becomes richer, its people begin to demand, and generally receive, better treatment with regard to their human rights.

Protecting the Environment

Protecting the environment has become an important policy objective of many nations. Increasingly, environmental interest groups such as Friends of the Earth and the Sierra Club have been pressuring governments to regulate international trade in a way that protects the environment. The growing concern over climate change has added an important dimension to this debate. One argument frequently made by environmental organizations is that there is a strong relationship between income levels and environmental pollution and degradation (i.e., industrial development leads to more pollution). Thus, to the extent that international trade leads to higher income levels, it can also be expected to lead to a decline in environmental quality.

There is a very important exception to these trends, however, and that is emissions of carbon dioxide. Carbon dioxide emissions do rise with income levels. Thus, the country with the highest income per capita, the United States, also produces the greatest carbon dioxide emissions per capita. Carbon dioxide emissions are a by-product of energy use (i.e., oil, gas, or coal burning). Richer societies are more energy intensive, and to the extent that they use hydrocarbons to produce that energy, this leads to higher carbon dioxide emissions. Carbon dioxide is the greenhouse gas at the center of concerns over global warming. These concerns can be stated simply. First, the burning of fossil fuels to produce energy also releases carbon dioxide into the atmosphere (and atmospheric carbon dioxide concentrations have steadily increased since preindustrial times). Second, carbon dioxide absorbs heat radiated from the earth, warming the atmosphere. Third, as a consequence, average global temperatures will increase. Indeed, estimates suggest average global temperatures increased by 0. 7 degree Centigrade during the last century, and they are forecasted to rise by between 1.1 and 6.4 degrees centigrade this century. 22 Fourth, as global temperatures increase, there will be environmental dislocation, ice

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caps will melt, sea levels will rise and flood low-lying costal areas, weather patterns will change, the frequency of violent storms will increase, tropical diseases (such as malaria) will move northward, species will go extinct, and so on. Of course, the global climate varies naturally due to, for example, changes in solar radiation connected with the well-known sunspot cycle, volcanic activity (which can inject large amounts of sulfur dioxide particles into the atmosphere, temporarily cooling it), changes in the circulation of ocean currents, and long-term changes in the orbit of the earth and the tilt of its axis. Human-induced climate change is overlaid on these natural variations. Thus, a natural cooling trend might be moderated by greater atmospheric carbon dioxide concentrations, and a natural warming trend exacerbated by them. Although there is debate over the precise relationship between carbon dioxide concentrations and the extent of future global warming, the vast majority of climate scientists have concluded that unless we take rapid action, we are faced with a rate of warming that is unprecedented during the history of our civilization and may cause major environmental dislocation. Given this, they advocate restricting greenhouse gas emissions, particularly carbon dioxide. However, looking forward, adherence to targets regarding carbon emissions might start to factor into trade agreements. A second argument made with regard to environmental regulations is that in order to save money, corporations will move production to countries where environmental regulations are lax. In sum, although environmental concerns have not figured significantly in trade treaties to date, there is a good chance they will do so in the future, particularly with regard to the emission of carbon dioxide and other greenhouse gases.

Economic Arguments for Intervention

The development of the new trade theory and strategic trade policy, the economic arguments for government intervention have undergone a renaissance in recent years. Until the early 1980s, most economists saw little benefit in government intervention and strongly advocated a free trade policy.

The Infant Industry Argument

The infant industry argument is by far the oldest economic argument for government intervention. Alexander Hamilton proposed it in 1792. According to this argument, many developing countries have a potential comparative advantage in manufacturing, but new manufacturing industries cannot initially compete with established industries in developed countries. To allow manufacturing to get a toehold, the argument is that governments should temporarily support new industries (with tariffs, import quotas, and subsidies) until they have grown strong enough to meet international competition. This argument has had substantial appeal for the governments of developing nations during the past 50 years, and the GATT has recognized the infant industry argument as a legitimate reason for protectionism. Nevertheless, many economists remain critical of this argument for two main reasons. First, protection of manufacturing from foreign competition does no good unless the protection helps make the industry efficient. In case after case, however, protection seems to have done little more than

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foster the development of inefficient industries that have little hope of ever competing in the world market.

Second, the infant industry argument relies on an assumption that firms are unable to make efficient long-term investments by borrowing money from the domestic or international capital market. Consequently, governments have been required to subsidize long-term investments.

Strategic Trade Policy

Some new trade theorists have proposed the strategic trade policy argument. The new trade theory argues that in industries in which the existence of substantial economies of scale implies that the world market will profitably support only a few firms, countries may predominate in the export of certain products simply because they have firms that were able to capture first-mover advantages. The long-term dominance of Boeing in the commercial aircraft industry has been attributed to such factors. The strategic trade policy argument has two components. First, it is argued that by appropriate actions, a government can help raise national income if it can somehow ensure that the firm or firms that gain first-mover advantages in an industry are domestic rather than foreign enterprises. Thus, according to the strategic trade policy argument, a government should use subsidies to support promising firms that are active in newly emerging industries. The second component of the strategic trade policy argument is that it might pay a government to intervene in an industry by helping domestic firms overcome the barriers to entry created by foreign firms that have already reaped first-mover advantages.

If these arguments are correct, they support a rationale for government intervention in international trade. Governments should target technologies that may be important in the future and use subsidies to support development work aimed at commercializing those technologies. Furthermore, government should provide export subsidies until the domestic firms have established first-mover advantages in the world market. Government support may also be justified if it can help domestic firms overcome the first-mover advantages enjoyed by foreign competitors and emerge as viable competitors in the world market (as in the Airbus and semiconductor examples). In this case, a combination of home-market protection and export-promoting subsidies may be needed.

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LESSON 8

WORLD TRADING SYSTEM

Contents

Agricultural Agreement –Agreements of WTO

Development of World Trading System

Strong economic arguments support unrestricted free trade. While many governments have recognized the value of these arguments, they have been unwilling to unilaterally lower their trade barriers for fear that other nations might not follow suit. Consider the problem that two neighboring countries, say, Brazil and Argentina, face when deciding whether to lower trade barriers between them. In principle, the government of Brazil might favor lowering trade barriers, but it might be unwilling to do so for fear that Argentina will not do the same. Instead, the government might fear that the Argentineans will take advantage of Brazil's low barriers to enter the Brazilian market, while at the same time continuing to shut Brazilian products out of their market through high trade barriers. The Argentinean government might believe that it faces the same dilemma. The essence of the problem is a lack of trust. Both governments recognize that their respective nations will benefit from lower trade barriers between them, but neither government is willing to lower barriers for fear that the other might not follow. Such a deadlock can be resolved if both countries negotiate a set of rules to govern cross-border trade and lower trade barriers.

While it might sound unlikely that any government would compromise its national sovereignty by submitting to such an arrangement, since World War II an international trading framework has evolved that has exactly these features. For its first 50 years, this framework was known as the General Agreement on Tariffs and Trade. Since 1995, it has been known as the World Trade Organization. Here we look at the evolution and workings of the GATT and WTO.

The WTO risks losing its centricity in the world trading system due to its focus on 20th century trade issues and lack of progress in the Doha Round. This column introduces a new eBook that looks at how Asia meanwhile built a deep network of supply chains and is experimenting with new forms of regional trade governance. Asia’s experience of open trade-led development offers lessons for other regions. Better coherence is also vital between Asia’s regional trade rules and global trade governance.

From Smith to the Great Depression

The theoretical case for free trade dates to the late eighteenth century and the work of Adam Smith and David Ricardo. Free trade as a government policy was first officially embraced by Great Britain in 1846, when the British Parliament repealed the Corn Laws. The Corn Laws

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placed a high tariff on imports of foreign corn. The objectives of the Corn Laws tariff were to raise government revenues and to protect British corn producers. There had been annual motions in Parliament in favor of free trade since the 1820s when David Ricardo was a member. However, agricultural protection was withdrawn only as a result of a protracted debate when the effects of a harvest failure in Great Britain were compounded by the imminent threat of famine in Ireland. Faced with considerable hardship and suffering among the populace, Parliament narrowly reversed its long-held position. During the next 80 years or so, Great Britain, as one of the world's dominant trading powers, pushed the case for trade liberalization, but the British government was a voice in the wilderness. Its major trading partners did not reciprocate the British policy of unilateral free trade. The only reason Britain kept this policy for so long was that as the world's largest exporting nation, it had far more to lose from a trade war than did any other country.

Economic problems were compounded in 1930 when the U.S. Congress passed the Smoot-Hawley tariff. Aimed at avoiding rising unemployment by protecting domestic industries and diverting consumer demand away from foreign products, the Smoot-Hawley Act erected an enormous wall of tariff barriers. Almost every industry was rewarded with its "made-to-order" tariff. A particularly odd aspect of the Smoot-Hawley tariff-raising binge was that the United States was running a balance-of-payment surplus at the time and it was the world's largest creditor nation. The Smoot-Hawley Act had a damaging effect on employment abroad. Other countries reacted to the U.S. action by raising their own tariff barriers. U.S. exports tumbled in response, and the world slid further into the Great Depression.

1947-1979: Gatt, Trade Liberalization, and Economic Growth

Economic damage caused by the beggar-thy-neighbor trade policies that the SmootHawley Act ushered in exerted a profound influence on the economic institutions and ideology of the post-World War II world. The United States emerged from the war both victorious and economically dominant. After the debacle of the Great Depression, opinion in the U.S. Congress had swung strongly in favor of free trade. Under U.S. leadership, the GATT was established in 1947. The GATT was a multilateral agreement whose objective was to liberalize trade by eliminating tariffs, subsidies, import quotas, and the like. From its foundation in 194 7 until it was superseded by the WTO, the GATT's membership grew from 19 to more than 120 nations. The GATT did not attempt to liberalize trade restrictions in one fell swoop; that would have been impossible. Rather, tariff reduction was spread over eight rounds. The last, the Uruguay Round, was launched in 1986 and completed in December 1993. In these rounds, mutual tariff reductions were negotiated among all members, who then committed themselves not to raise import tariffs above negotiated rates. GATT regulations were enforced by a mutual monitoring mechanism. If a country believed that one of its trading partners was violating a GATT regulation, it could ask the Geneva-based bureaucracy that administered the GATT to investigate. If GATT investigators found the complaints to be valid, member countries could be asked to pressure the offending party to change its policies. In general, such pressure was sufficient to get an offending country

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to change its policies. If it were not, the offending country could be expelled from the GATT. In its early years, the GATT was by most measures very successful. For example, the average tariff declined by nearly 92 percent in the United States between the Geneva Round of 1947 and the Tokyo Round of 1973-79. Consistent with the theoretical arguments first advanced by Ricardo and reviewed in Chapter 5, the move toward free trade under the GATT appeared to stimulate economic growth. From 1953 to 1963, world trade grew at an annual rate of 6.1 percent, and world income grew at an annual rate of 4.3 percent. Performance from 1963 to 1973 was even better; world trade grew at 8.9 percent annually, and world income grew at 5.1 percent annually.

1980-1993: Protectionist Trends

During the 1980s and early 1990s, the world trading system erected by the GATT came under strain as pressures for greater protectionism increased around the world. Three reasons caused the rise in such pressures during the 1980s. First, the economic success of Japan during that time strained the world trading system (much as the success of China has created strains today). Japan was in ruins when the GATT was created. By the early 1980s, however, it had become the world's second-largest economy and its largest exporter. Japan's success in such industries as automobiles and semiconductors might have been enough to strain the world trading system. Things were made worse by the widespread perception in the West that despite low tariff rates and subsidies, Japanese markets were closed to imports and foreign investment by administrative trade barriers. Second, the world trading system was strained by the persistent trade deficit in the world's largest economy, the United States. Although the deficit peaked in 1987 at more than $170 billion, by the end of 1992 the annual rate was still running about $80 billion. From a political perspective, the matter was worsened in 1992 by the $45 billion U.S. trade deficit with Japan, a country perceived as not playing by the rules. The consequences of the U.S. deficit included painful adjustments in industries such as automobiles, machine tools, semiconductors, steel, and textiles, where domestic producers steadily lost market share to foreign competitors. The resulting unemployment gave rise to renewed demands in the U.S. Congress for protection against imports. A third reason for the trend toward greater protectionism was that many countries found ways to get around GATT regulations. Bilateral voluntary export restraints, or VERs, circumvent GATT agreements, because neither the importing country nor the exporting country complains to the GATT bureaucracy in Geneva-and without a complaint, the GATT bureaucracy can do nothing. Exporting countries agreed to VERs to avoid more damaging punitive tariffs. One of the best-known examples is the automobile VER between Japan and the United States, under which Japanese producers promised to limit their auto imports into the United States as a way of defusing growing trade tensions. According to a World Bank study, 13 percent of the imports of industrialized countries in 1981 were subjected to nontariff trade barriers such as VERs. By 1986, this figure had increased to 16 percent. The most rapid rise was in the United States, where the value of imports affected by nontariff barriers (primarily VERs) increased by 23 percent between 1981 and 1986.

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The Uruguay Round and the World Trade Organization

Against the background of rising pressures for protectionism, in 1986 GATT members embarked on their eighth round of negotiations to reduce tariffs, the Uruguay Round (so named because it occurred in Uruguay). This was the most difficult round of negotiations yet, primarily because it was also the most ambitious. Until then, GAIT rules had applied only to trade in manufactured goods and commodities. In the Uruguay Round, member countries sought to extend GAIT rules to cover trade in services. They also sought to write rules governing the protection of intellectual property, to reduce agricultural subsidies, and to strengthen the GAIT's monitoring and enforcement mechanisms. The Uruguay Round dragged on for seven years before an agreement was reached December 15, 1993. It went into effect July 1, 1995. The Uruguay Round contained the following provisions: 1. Tariffs on industrial goods were to be reduced by more than one-third, and tariffs were to be scrapped on more than 40 percent of manufactured goods. 2. Average tariff rates imposed by developed nations on manufactured goods were to be reduced to less than 4 percent of value, the lowest level in modem history. 3. Agricultural subsidies were to be substantially reduced. 4. GAIT fair trade and market access rules were to be extended to cover a wide range of services. 5. GAIT rules also were to be extended to provide enhanced protection for patents, copyrights, and trademarks (intellectual property). 6. Barriers on trade in textiles were to be significantly reduced over 10 years. 7. The World Trade Organization was to be created to implement the GAIT agreement.

Services and Intellectual Property

In the long run, the extension of GAIT rules to cover services and intellectual property may be particularly significant. Until 1995, GAIT rules applied only to industrial goods (i.e., manufactured goods and commodities). In 2007, world trade in services amounted to $3.260 billion (compared to world trade in goods of $13,570 billion).35 Ultimately, extension of GAIT rules to this important trading arena could significantly increase both the total share of world trade accounted for by services and the overall volume of world trade. The extension of GATT rules to cover intellectual property will make it much easier for high-technology companies to do business in developing nations where intellectual property rules historically have been poorly enforced .

The World Trade Organization The clarification and strengthening of GAIT rules and the creation of the World Trade Organization also hold out the promise of more effective policing and enforcement of GAIT rules. The WTO acts as an umbrella organization that encompasses the GAIT along with two new sister bodies, one on services and the other on intellectual property. The WTO's General Agreement on Trade in Services (OATS) has taken the lead to extending free trade agreements to services. The WTO's Agreement on Trade-Related Aspects of Intellectual Property Rights (TRIPS) is an attempt to narrow the gaps in the way intellectual property rights are protected around the world and to bring them under common international rules. WTO has taken over responsibility for arbitrating trade disputes and monitoring the trade

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policies of member countries. While the WTO operates on the basis of consensus as the GAIT did, in the area of dispute settlement, member countries are no longer able to block adoption of arbitration reports. Arbitration panel reports on trade disputes between member countries are automatically adopted by the WTO unless there is a consensus to reject them. Countries that have been found by the arbitration panel to violate GAIT rules may appeal to a permanent appellate body, but its verdict is binding. If offenders fail to comply with the recommendations of the arbitration panel, trading partners have the right to compensation or, in the last resort, to impose (commensurate) trade sanctions. Every stage of the procedure is subject to strict time limits. Thus, the WTO has something that the GAIT never had-teeth.

Implementation of the WTO Agreement on Agriculture in India

The Uruguay Round (UR) of multilateral trade negotiations was completed in 1994 with the signing of the Marrakesh Declaration. Among the most significant accomplishments of the Uruguay Round was its focus on agricultural trade and the resulting new disciplines on agricultural trade policy. Up to 1995, the rules of the General Agreement on Tariffs and Trade (GATT) were largely ineffective in disciplining key aspects of agricultural trade. In particular, export and domestic subsidies came to dominate many areas of world agricultural trade, while the stricter disciplines on import restrictions were often flouted. The Uruguay Round negotiations went a long way toward changing all that. This chapter will first outline the results of these negotiations, the WTO Agreement on Agriculture (AoA). Next, it will examine the implementation and the impact of this agreement on the agricultural sector in India. Agriculture trade is now firmly established within the multilateral trading system. Under the Agreement on Agriculture, member countries agreed to reduce agricultural support and protection substantially by establishing disciplines in the areas of market access, domestic support, and export subsidies. Under market access, countries agreed to open markets by prohibiting non-tariff barriers, converting existing non-tariff barriers to tariffs, and reducing tariffs. Members also agreed to reduce expenditures on export subsidies and the quantity of agricultural products exported with subsidies. Domestic support reductions were realized through commitments to reduce the Aggregate Measure of Support (AMS), a numerical measure of the value of most trade-distorting domestic policies. The agreement was implemented over a 6-year period, to 2000. Though the original GATT 1947 applied to trade in agriculture, it allowed various exceptions to the rules, which led to severe distortions in world agricultural trade. For instance, the GATT 1947 allowed countries to use export subsidies on agricultural primary products, whereas export subsidies on industrial products were prohibited. The GATT rules also allowed countries to resort to import restrictions (e.g. import quotas) in the agricultural sector under certain conditions, notably when these restrictions were necessary to enforce measures to effectively limit domestic production. The result of all this was a proliferation of impediments to world agricultural trade. When the Uruguay Round of trade negotiations started in 1986, one of the most important goals was to remove trade distortions in the agricultural sector resulting from different levels of input

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subsidies, price and market support, export subsidies, and other kinds of trade-distorting support across countries.

WTO Agreement on Agriculture

Prior to the Uruguay Round Agreement on Agriculture (URAA), GATT rules on trade in agricultural products were limited and often ineffective. A number of exceptions exempted agricultural products from most of the disciplines applying to manufactured goods. As a result, countries often resorted to measures such as export subsidies, which are not permitted in other sectors, as well as a multitude of non-tariff barriers that restricted agricultural trade. The URAA was a turning point in the reform of the agricultural trade system. Countries agreed to reduce agricultural support and protection substantially by establishing disciplines and rules on market access; export competition; toward domestic policies. These three sets of disciplines on agricultural policy are sometimes referred to as the three “pillars” of the URAA. In addition to the three “pillars”, a new Agreement on the Application of Sanitary and Phytosanitary Measures (SPS) was signed. The SPS provides for countries to take measures to protect human, animal, and plant health, while at the same time establishing rules to prevent countries from using arbitrary and unjustified health and environmental regulations as disguised barriers to trade. The URAA has produced positive results, principally: · Non-tariff barriers (including quantitative import restrictions, variable import levies, discretionary import licensing, and voluntary export restraints) were converted to tariffs, which are bound and subject to reduction commitments. · Export subsidies on agricultural products are for the first time subject to disciplines. · Domestic policies that affect the production and trade of agricultural products are subject to a set of rules and bindings, in the process are becoming more transparent. · The AoA acknowledged the need for special and differential (S&D) treatment for developing countries; these are reflected only as differences in phasing and percentage reduction.

Uruguay Round targets for cutting subsidies and protection in agriculture Category Developed Countries 6 years: 1995-2000 Developing Countries 10 years: 1995-2004 Tariffs Average cut for all agricultural products Minimum cut per product -36% -15% -24% -13% Domestic Support Cuts in total ‘AMS’ support -20% -13% Exports Value of subsidies-outlays Subsidised quantities -36% -21% -24% -14% Source: WTO, 2002. Note: Least-developed countries do not have to reduce tariffs or subsidies.

These are important systemic changes from the pre-Uruguay Round period. However, distortions to agricultural production and trade remain high. In practice, the URAA achieved only limited reduction in effective protection. For example, the differences in commitments in respect of reduction in tariffs between developed and developing countries is illusory in as much as: developed countries had protected their agriculture substantially before the Uruguay Round so that even after a 36% reduction, their rates are absolutely and relatively very high; the AoA did not mandate reductions in absolute terms but only in relative terms; and allowing mandatory reductions to be established on an unweighted basis enabled developed countries to lower higher

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tariffs on products of export interest to developing countries by the minimum level of 15% and to avoid making substantial reductions on items of importance to them.

WTO Agreements Related to Agriculture

The AoA is only one of 28 Uruguay Round agreements. There are other WTO agreements that influence free and fair trade in agriculture. The agreement on Sanitary and Phytosanitary (SPS) measures is one that has direct bearing on agricultural trade. In other agreements, a few provisions influence trade in agriculture. The issue of patenting plant varieties, as per the Agreement on Trade-Related Aspects of Intellectual Property Rights (TRIPS), is an example. Some of these WTO agreements are briefly presented below:

Agreement on Sanitary and Phytosanitary Measures (SPS)

The agreement on SPS recognizes the right of a government to take measures to ensure food safety and to protect animal and plant health. The agreement requires that such measures be applied only to the extent necessary to meet these ends. The measures must be based on scientific criteria and not serve as disguised protectionist measures. A number of relevant international standards are provided by specialized institutions, such as the Codex Alimentarius Commission for Human Health, the Office International des Epizooties (OIE, World Organisation for Animal Health), and the International Plant Protection Convention (IPPC). These standards are recognised by the WTO and the protection measures pertaining to them are accepted. On the other hand, any national legislation leading to a stricter protection of trade must be justified scientifically.

Agreement on Technical Barriers to Trade (TBT)

The agreement on TBT is another amongst the WTO agreements that have indirect bearing on trade in agriculture. It covers all technical regulations and procedures to evaluate conformity other than those concerning human, animal, and plant health covered by the SPS agreement. The agreement requires that technical standards and regulations should not be drawn up with the aim of restricting trade. It encourages the use of international standards and calls for national testing and certifying bodies to avoid discrimination against imports, and as far as possible, recognition of other countries’ tests and certificates. It also includes elaborate procedures for notification and consultation, and provisions for technical assistance to developing countries and for greater flexibility for these countries.

Agreement on Trade-Related Aspects of Intellectual Property Rights (TRIPS)

This is a very important agreement because it incorporates the trade in “ideas” within the sphere of the WTO’s activities. It obliges signatory countries to define in their national legislation the minimal standards for protecting intellectual property, as well as the means to ensure compliance with these norms. Agriculture in developing countries is very much affected, since this

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agreement covers all living organisms (animals, plants, micro-organisms, genes, etc.). It clearly addresses the question of the appropriation of seeds, biological resources, or traditional knowledge and, in exchange, the cost of access to them and their use. In a country like India where a significant proportion of the population is still living below the poverty line, farmers losing rights over seeds will adversely affect food security for millions of poor people.

Indian Agricultural Trade: A Brief Overview

A major proportion of Indian farm produce goes toward supplying food for the country’s population and raw materials for industry. Seventy-five per cent of the country’s population is still in rural areas and hilly terrain and 60-70% of GDP from agriculture comes from subsistence agriculture. Although agriculture contributes about 25% of GDP, India’s share in total world merchandise trade is not significant. Overall, with a negligible 0.7% share in world imports and 0.6% in exports, India is not very visible in the arena of international trade. For the last few years, India has experienced record foodgrains production. The year 1999-2000 registered foodgrains output of 208.9 million tonnes, which included 89.5 million tonnes of rice and 75.6 million tonnes of wheat. Commercial crops too did fairly well, except for oilseeds and cotton. But at the same time, more than 200 million people are living below the poverty line and go to bed hungry. Liberalization of world trade in agriculture has opened up new vistas of growth. India has a competitive advantage in several agricultural commodities because of near self-sufficiency of inputs, relatively low labour costs and diverse agro-climatic conditions. These factors have enabled the export of several agricultural commodities over the years, such as cereals, cashews, tea, coffee, spices, oil meals, fruits and vegetables, castor, and tobacco. For certain commodities, like basmati rice, India has a niche market access in spite of competition. Agricultural exports have a sizeable share of about 18-20% in India’s total exports. Agricultural imports are about 5-6% of total imports in the country. Only a few commodities, like edible oil, cotton, pulses, and wood and wood products, are imported. In the post-WTO period, raising the level of productivity and quality standards to internationally competitive levels is one of the major challenges before the Indian agriculture sector. As per the WTO AoA, India has also dismantled quantitative restrictions on nearly all items during 1990-2001, with a view to enabling better market access for the rest of the world and also to making its products competitive. At present, for several commodities, India’s national productivity is less than the world average. Pursuant to the Uruguay Round agreements, India has also undertaken many steps toward reforming its agricultural sector. India has dismantled quantitative restrictions in five phases to enable better market access and provide quality and cheap products to domestic consumers. This step was taken to fulfill the commitments under the AoA market access clause. As shown below, the Aggregate Measurement of Support (AMS) has already been proven negative in the case of India. Therefore, India does not need to reduce its subsidies. On the export subsidy front, not many significant measures were required from India, as Indian exporters do not get any direct export subsidy. Apart from these measures, India also took some unilateral steps to liberalize its agricultural sector. For example, in January 1994, the government

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abolished the minimum export price of basmati rice; in March 1994, import controls on sugar and cotton were removed; in February 1995, a major decision was taken to put almost all edible oils (except coconut oil) under open general license.

The Future of the Wto: Unresolved Issues and the Doha Round

Much remains to be done on the international trade front. Four issues at the forefront of the current agenda of the WTO are the increase in antidumping policies, the high level of protectionism in agriculture, the lack of strong protection for intellectual property rights in many nations, and continued high tariff rates on nonagricultural goods and services in many nations. We shall look at each in turn before discussing the latest round of talks between WTO members aimed at reducing trade barriers, the Doha Round, which began in 2001 and was still ongoing as of 2011.

Antidumping Actions

Antidumping actions proliferated during the 1990s. WTO rules allow countries to impose antidumping duties on foreign goods that are being sold cheaper than at home, or below their cost of production, when domestic producers can show that they are being harmed. Unfortunately, the rather vague definition of what constitutes "dumping" has proved to be a loophole that many countries are exploiting to pursue protectionism. It is not unreasonable, therefore, to hypothesize that the high level of antidumping actions in these industries represents an attempt by beleaguered manufacturers to use the political process in their nations to seek protection from foreign competitors, who they claim are engaging in unfair competition. While some of these claims may have merit, the process can become very politicized as representatives of businesses and their employees lobby government officials to "protect domestic jobs from unfair foreign competition," and government officials, mindful of the need to get votes in future elections, oblige by pushing for antidumping actions.

Protectionism in Agriculture

Another recent focus of the WTO has been the high level of tariffs and subsidies in the agricultural sector of many economies. Tariff rates on agricultural products are generally much higher than tariff rates on manufactured products or services. For example, in the mid-2000s the average tariff rates on nonagricultural products were 4.2 percent for Canada, 3.8 percent for the European Union, 3.9 percent for Japan, and 4.4 percent for the United States. On agricultural products, however, the average tariff rates were 21.2 percent for Canada, 15.9 percent for the European Union, 18.6 percent for Japan, and 10.3 percent for the United States.44 The implication is that consumers in these countries are paying significantly higher prices than necessary for agricultural products imported from abroad, which leaves them with less money to spend on other goods and services.

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The biggest defenders of the existing system have been the advanced nations of the world, which want to protect their agricultural sectors from competition by low-cost producers in developing nations. In contrast, developing nations have been pushing hard for reforms that would allow their producers greater access to the protected markets

Protecting Intellectual Property

Another issue that has become increasingly important to the WTO has been protecting intellectual property. The 1995 Uruguay agreement that established the WTO also contained an agreement to protect intellectual property (the Trade-Related Aspects of Intellectual Property Rights, or TRIPS, agreement). The TRIPS regulations oblige WTO members to grant and enforce patents lasting at least 20 years and copyrights lasting 50 years. Rich countries had to comply with the rules within a year. Poor countries, in which such protection generally was much weaker, had five years' grace, and the very poorest had 10 years. The basis for this agreement was a strong belief among signatory nations that the protection of intellectual property through patents, trademarks, and copyrights must be an essential element of the international trading system. Inadequate protections for intellectual property reduce the incentive for innovation. Because innovation is a central engine of economic growth and rising living standards, the argument has been that a multilateral agreement is needed to protect intellectual property

Market Access for Nonagricultural Goods and Services

Although the WTO and the GAIT have made big strides in reducing the tariff rates on nonagricultural products, much work remains. Although most developed nations have brought their tariff rates on industrial products down to an average of 3.8 percent of value, exceptions still remain. In particular, while average tariffs are low, high tariff rates persist on certain imports into developed nations, which limit market access and economic growth.

Looking further out, the WTO would like to bring down tariff rates on imports of nonagricultural goods into developing nations. Many of these nations use the infant industry argument to justify the continued imposition of high tariff rates; however, ultimately these rates need to come down for these nations to reap the full benefits of international trade. For example, the bound tariff rates of 53.9 percent on imports of transportation equipment into India and 33.6 percent on imports into Brazil, by raising domestic prices, help to protect inefficient domestic producers and limit economic growth by reducing the real income of consumers who must pay more for transportation equipment and related services

A New Round of Talks:

Doha Antidumping actions, trade in agricultural products, better enforcement of intellectual property laws, and expanded market access were four of the issues the WTO wanted to tackle at the 1999 meetings in Seattle, but those meetings were derailed. In late 2001, the WTO tried

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again to launch a new round of talks between member states aimed at further liberalizing the global trade and investment framework. For this meeting, it picked the remote location of Doha in the Persian Gulf state of Qatar, no doubt with an eye on the difficulties that antiglobalization protesters would have in getting there. Unlike the Seattle meetings, at Doha, the member states of the WTO agreed to launch a new round of talks and staked out an agenda. The talks were originally scheduled to last three years, although they have already gone on longer and may not be concluded for a while.

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LESSON 9

WORLD TRADE ORGANIZATION

The birth of World Trade Organisation (WTO) on January 1, 1995 holds a great promise for the entire world economy in respect of international trade. This World Trade Organisation will administer the new global trade rules establishing the rule of law in international Trade, which amounted to nearly five trillion dollars last year for goods and services.

Peter Sutherland, the first Director General of WTO recently said, “The WTO binds nations in a global co-operative endeavour to raise incomes and create good jobs through fair and open trade.”

The latest issue of GATT/WTO News (January, 1995) observed that the new global trade rules were achieved after seven years of negotiations among more than 120 countries and through the WTO agreements and market access commitments, world income is expected to rise by over 500 billion dollar annually by the year 2005 and annual global trade growth will be as much as a quarter higher by the same year than it would have been otherwise. It is also further estimated that WTO agreements would add US $ 2800 billion to global income by 2015.

Main features of WTO are: (i) It is a powerful international organisation to promote multi-lateral trade.

(ii) It has replaced the GATT set up.

(iii) It facilitates face trade by removing tariff and non-tariff barriers in international trade.

(iv) WTO has finalised set of rules and regulations and has its legal status—which are mutually designed by members.

(v) Agreements reached by member countries are binding on all members of WTO.

(vi) It includes trade in goods, trade in services, and also protects intellectual property rights, foreign investment for all members.

(vii) It is not a agent of United National unlike IMF and World Bank.

(viii) All members have equal voting rights (one country-one vote).

(ix) WTO has a large secretariat and also has a huge organisational set up.

Main objectives of WTO are: (i) Basic aim of WTO is to implement the new world trade agreement.

(ii) To promote multi-lateral trade among many nations.

(iii) To promote free trade by removing all barriers.

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(iv) To promote world trade benefitting all members.

(v) To remove all hurdles for developing in open world trading system to boost economic growth in all member countries.

(vi) To protect the interest of developing countries in respect of international trade.

(vii) To enhance competition among all members.

(viii) To increase level of production and productivity for raising the level of employment.

(ix) To expand and utilise world economic resources in a most optimum manner.

(x) To improve the level of livings for the population of this globe and speed up rate of economic developed among member countries.

(xi) To undertake special steps for initiating development of poorest nations of this world.

Thus, WTO is among the most powerful and one of the most secretive international bodies on earth. It is rapidly assuming the role of global government, as 134 nation-states including USA have ceded to its vast authority and powers. WTO also represents the ruls-based reginue of the policy of economic globalization throughout this globe.

The World Trade Organisation (WTO) is playing an important role for administering the new global trade rules in the following manner:

Firstly, the WTO administers, through various councils and committees, the 28 agreements contained in the final act of the Uruguay Round, plus a number of plurilateral agreements, including one government procurement.

Secondly, the WTO also oversees the implementation of the significant tariff cuts (averaging 40 per cent) and reduction of non-tariff measures agreed to in the trade negotiations.

Thirdly, the WTO is a watchdog of international trade, regularly examining the trade regimes of individual members. In its various bodies, members flag proposed or draft measures by others that can cause trade conflicts. Members are also required to notify in detail various trade measures and statistics, which are maintained by the WTO in a large data base.

Fourthly, the WTO provides several conciliation mechanisms for finding an amicable solution to trade conflicts that can arise among members.

Fifthly, trade disputes that cannot be solved through bilateral talks are adjudicated under the WTO Dispute Settlement Court. Panels of independent experts are established to examine disputes in the light of WTO rules and provide rulings. This tougher streamlined procedure ensures equal treatment for all trading partners and encourages members to live up to their obligations.

Sixthly, the WTO is a management consultant for world trade. Its economists keep a close watch on the pulse of the global economy and provide studies on the main trade issues of the day. The secretariat assists developing countries in the implementation of Uruguay Round results through

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a newly established development division and strengthened technical co-operation and training division.

Finally, the WTO will be a forum where countries continuously negotiate exchange of trade barriers all over the world. And the WTO already has a substantial agenda for further negotiations in many areas.

It can be expected that the WTO is different from and an improvement upon GATT, on the ground that firstly, the WTO will be more global in its membership than the GATT. Its perspective membership already comprises of around 150 countries and territories, with many others considering joining it. Secondly, the WTO has a far wider scope than its predecessor, bringing into the multi-lateral trading system for the first time, commercial activities like trade in services, the exchange of ideas in the context of intellectual property protection and investment.

At present, the WTO has been passing through trials, tribulations and challenges. But the organisation has taken the stresses and strains it had to bear in its infancy rather well. It has already begun to show promising signs of growing into a vibrant body which is destined to play a vital role in future development of World trade and economy.

The WTO presently offers a far more powerful mechanism in order to resolve disputes over trade. Growing competition for markets among the member countries is bound to give rise to frequent quarrels and disputes among the trading partners. Thus a trade-dispute resolving mechanism is very much required under the present situation. WTO is now charged with the responsibility to provide such mechanism.

A world body such as WTO is required to oversee this whole process of economic globalization and integration. Considering the suitability of WTO under the world trade scenario, China has recently decided to scrap the decade long state monopoly on foreign trade and financial services as part of the Government efforts to open up to get an early accession to World Trade Organisation (WTO).

Dispute settlement mechanism of WTO

The WTO presently offers a far more powerful mechanism in order to resolve disputes over trade, arising out of growing competition for markets among the members. Under the present situation facing frequent quarrels and disputes among the trading partners a trade-dispute settlement mechanism is very much required. WTO is now charged with the responsibility to provide such mechanism.

A recent report of WTO observed that developing countries are emerging more as active users of the multilateral dispute-settlement mechanism than the developed nations. Such a move has been noticed more so in the World Trade Organisation than in the General Agreement on Tariffs and Trade.

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On March 5, 1996, the Dispute Settlement Body (DSB) established two panels at the request of Philippines and Costa Rica. The DSB decision raised the number of active panels in WTO to four, with three of them involving developing country complainants.

The first WTO dispute, which had been settled bilaterally, involved two developing countries Singapore and Malaysia. An in-depth analysis shows that in contrast, the vast majority of dispute-settlement cases in GATT were between developed countries.

Improvements in the WTO is dispute-settlement procedures over those of GATT have facilitated the lodging of formal complaints for all members.

These improvements include:

(i) Near automaticity of establishment of panels and adoption of their reports , and

(ii) Precise deadlines for every step of the panel process.

At present the WTO is making an all-out effort to evolve a consensus on controversial and key issues like inclusion of social clause on trade agenda. The Director General of the Geneva-based WTO, Mr. Renato Ruggiero says that the immediate challenge is to build a consensus on the subject of trade and labour standards in order to avoid this becoming a divisive issue.

The new WTO agreement extends the amount of Government procurement opened to international competition by 10 times compared to the earlier agreement. However, it remains only a plurilateral agreement with limited membership.

WTO—The Third Pillar in International Economic Relations and Its Benefits:

Besides the World Bank and the IMF the World Trade Organisation (WTO) is now being considered as the third pillar in the post-war international economic relations. The WTO will have three main legal instruments: The General Agreement on Tariffs and Trade (GATT) along with associated agreements and jurisprudence; the General Agreement on Trade in Services (GATS) and the agreement on Trade-related Intellectual Property Rights (TRIPs).

A particularly noteworthy feature of WTO is that its highest decision-making body would be the Ministerial Conference which alone will have the authority to take decisions on all matters under any of the agreements covered by the WTO. During the intervals between the meetings of the Ministerial Conference, the General Council would carry out its functions, including its role as the dispute settlement body.

Reacting to the establishment of the WTO and ratification of the Final Act by different countries, trade experts contend that the significant reductions in tariff and non-tariff barriers negotiated in the round would give the international trading environment a new dynamism and vitality.

Enumerating the benefits of the WTO, it can be observed that increasing market access opportunities and efficient rules for undistorted competition would help the developing countries in the context of their liberalised economic policies.

The GATT secretariat, predecessor to the WTO, has estimated that by

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the year 2005, the volume of world trade would range between 9 to 24 per cent above the level that would have occurred in the absence of Uruguay Round. It further noted that by the year 2005 the increase in world income from trade liberalisation in goods could range between $ 110 billion and $ 510 billion annually.

Thus, the World Trade Organisation (WTO) will strengthen the institutional framework for trade relations among member countries. Accordingly, with the establishment of WTO, a new trade order was likely to emerge.

But the ultimate impact of the Uruguay Round would depend on gains in productivity in various sectors resulting from realisation of economies of scale, technology transfer and increased trade and investment. An OECD study had indicated that GATT’s final act could increase the income of developing countries by 70 billion dollars by 2002.

The task before the WTO, as the initial experience suggests, is not going to be easy, by any means. The WTO had to contend with several disputes during this initial short period. Firstly, there was the dispute over the appointment of WTOs chief. After that there was a row over constituting a WTO Committee that will oversee the demise of Multi-Fibre Arrangement in phases over the next seven years.

Another serious dispute arose over the issue of trade in financial services. WTO has become successful to tackle all these disputes. It is now getting firmly established as an effective institution for recording and reprocessing of world trade and international economic relations towards the path of free flow of trade in goods and services.

WTO in its report, ‘International Trade—Trends and statistics’ observed that world trade in merchandise goods is expected to increase in volume by eight per cent in 1995 and therefore, marginally declined from the very high 9.5 per cent achieved during 1994.

The report further pointed out that though the current outlook shows that there is likely to be a further modest slowing down next year, trade growth would remain above the average of the past decade.

Regional Trading Blocks—A Threat to WTO:

In the mean time, various regional trading blocks have been formed among various countries of the world under different regions which are going to frustrate the very spirit of globalisation and multilateralism in world trade. Therefore, doubts have also been arisen over the rise of regional trading arrangements which, it is feared would militate multilateralism.

The magnitude, handling and scrutiny of regional trading arrangements such as the European Union (EU), North Atlantic Free Trade Arrangements (NAFTA) and the Asia Pacific Economic Co-operation (APEC) and their link with the credibility of the strengthened multilateral trading system is obvious.

Critics of World trade body contend that the time is now ripe for a substantial review of the way in which working parties who belong to these regional trading blocks fulfill their obligations

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under Article XXIV of the Final Act, especially to ensure that the results of their efforts are both transparent and meaningful for multilateral co-operation and promotion of global trade.

But there is a growing tendency of countries located in a geographical region to form their own trading block. Now there is a talk of forming another regional economic co-operation grouping of 29 Indian Ocean Rim Countries. But regionalism must be compatible with multilateralism of WTO and to attain that regional groups must treat each other favorably in matters of trade and should not apply any discrimination against those countries outside the regional grouping.

Solutions to issues relating to the social clauses, as applied to trade, can never come from protectionist barriers. Regionalism till late had been one of the main building blocks for liberalization and reform around the world and has increased the possibilities of improving liberalisation of trade.

However, it was no longer an exception to the system and was becoming a status symbol for nations to join a regional trading bloc. However, the emergence of regionalism was still not a threat to the existence of the multilateral trading system.

The answer to this problem of regionalism had to be found in multilateralism along with inter-dependence through which developments would be influenced. The future of growth and employment generation depends much on the inter-dependence of the developed world and the developing countries.

India’s Obligations Under AoA and Implementation Status Market Access All member countries are required to convert non-tariff barriers into tariff barriers and submit ceiling tariff bindings for all commodities. In other words, the AoA states that there can be no restrictions on farm trade except through tariffs. Tariffs resulting from this “tariffication process” as well as other tariffs are to be reduced by a simple average of 36% over 6 years in the case of developed countries and 24% over 10 years in the case of developing countries. India has submitted high tariff bindings of 100%, 150%, and 300% respectively for primary products, processed products and edible oils, except for certain items (comprising about 119 tariff lines), which were historically bound at a lower level in the earlier negotiations. Out of these low-bound tariff lines, bindings on 15 tariff lines, which included skimmed milk powder, spelt wheat, corn, paddy, rice, maize, millet, sorghum, rape, colza and mustard oil, fresh grapes, and other items, were successfully negotiated under GATT Article XXVIII in December 1999 and the binding levels were revised upward to provide adequate protection to the domestic producers. India has maintained quantitative restrictions for balance of payment reasons. It has followed a consistent policy of gradual removal of restrictions on imports since 1991, when the domestic economic reforms were initiated. The process of removing import restrictions on balance of payment grounds has been completed with the removal of restrictions on 715 remaining items in the Export-Import Policy announced on March 31, 2001. Quantitative restrictions are, however, still being maintained on about 5% of tariff lines (538 items), as permissible under Article XX and XXI of GATT, on grounds of health, safety, and moral conduct. Most of them are agricultural products (GOI 2002). Out of the 715 items on which quantitative restrictions were removed, there were 342 textile

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products, 147 agricultural products including alcoholic beverages, and 226 other manufactured products, including automobiles. Imports of agricultural products like wheat, rice, maize, other coarse cereals, copra, and coconut oil were placed in the category of State Trading. The nominated State Trading Enterprise will conduct the imports of these commodities according to commercial considerations (GOI 2001a). India has not made any commitment to provide minimum market access opportunities. Other countries that had tariffied their quantitative restrictions had to offer minimum access to the extent of 3% of their domestic consumption, going up to 5% at the end of the implementation period. India is not entitled to use the Special Safeguard Mechanism of the Agreement, as only countries that have tariffied can use it. India can, however, take safeguard action under the WTO Agreement on Safeguards if there is a surge in imports causing serious injury or if there is a threat of serious injury to domestic producers. Domestic Support The AoA distinguishes between three types of production support, grouped into “boxes”: green (permitted), amber (to be reduced, with an upper limit), and blue (subsidies that are tied to programs that limit production). There are also exemptions for developing countries in the form of special and differential (S&D) treatment.

Domestic support measures, according to the agreement, are meant to identify acceptable measures of support to farmers and curtail unacceptable trade-distorting support to farmers. Trade-distorting domestic support is measured in terms of what is called the “Total Aggregate Measurement of Support,” which is expressed as a percentage of the total value of agricultural output and includes both product-specific and non-product-specific support. The AoA stipulates a reduction commitment of total AMS by 20% for developed countries in six years (1995-2000) and by 13-1/3% for developing countries in 10 years (1995- 2004), taking 1986-88 as the base period. However, domestic support given to the agricultural sector is allowed — up to 10% of the total value of agricultural produce in developing countries and 5% in developed countries. In other words, AMS within this limit is not subject to any reduction commitment. India has basically two types of support operation for farmers. First, market price support, which takes the form of minimum support prices announced every year by the government for different commodities. In 1998, 24 important crops were covered by the price control measures (WTO 1998). These measures have two policy goals. First, they aim at ensuring that farmers receive a minimum remunerative price. But also, traditionally, prices were maintained at lower than market prices, to ensure low costs of food procurement. Because domestic prices are below international prices, India’s total product-specific AMS is negative. In India, the level of product specific support in the year 1995-96 (the year for which the latest official information from WTO is available) was negative to the extent of 38.5% (Gulati 2001). The second support is in the form of input subsidies on inputs like fertilizers, irrigation, electricity, credit, and seeds, which amounted to US$5.8 billion in 1995-96. Direct payments are not given to farmers in India. Since non-product specific support, such as, power, irrigation, fertilizers, etc., amounts to 7.5% of the value of agricultural production, the AMS to Indian agriculture could still be well below the level of 10% in terms of Uruguay Round stipulations. A negative AMS exempts India from reducing its domestic support levels either in aggregate terms or for any individual crops. In its proposals

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on the negotiations on AoA, India has suggested that the AMS, as the term suggests, be calculated as a sum of the product-specific and non-product specific support (WTO 2001). If the productspecific support is still negative in the case of India, then the AMS would be below 7.5% of the value of agricultural production. As it is, input subsidies to help poor farmers, which come under non-product specific support, are exempt from reduction commitments under the WTO provisions. If India avails of this, the non-product specific support may come down further, to less than half of what is being shown today (Gulati 2001). In view of this, it may not be in India's interest to fight within the WTO for greater domestic support to agriculture, especially if this blunts India’s opposition to farm support and its criticism of inadequate access to markets in industrialized countries.

Export Subsidies

Export subsidies were subject to a reduction commitment under the AoA, though several kinds of direct payment were exempted. The export subsidy commitment was in the form of a cut either in budgetary outlay or in export quantity. Export subsidy budgets were to be reduced by 36% for developed countries and 24% for developing countries. The volume of exports receiving subsidies was to be reduced by 21% per product or group of products for developed countries and by 16% for developing countries. The LDCs were not subject to any reduction commitments. The commitments were defined over commodity aggregates rather than individual tariff lines. Indian exporters of agricultural commodities do not get direct export subsidy. The only subsidies available to exporters of agricultural commodities are in the form of: income tax exemptions on profits from export sales, and subsidies on freight costs for certain products like fruits, vegetables, and floricultural products. Since these payments are exempt from reduction commitments by developing countries during the implementation period, they will not cause any adverse impact on agricultural exports from India, at least during this period. Therefore, India is making use of these subsidies in certain schemes of the Agricultural and Processed Food Products Export Development Authority (APEDA), especially for facilitating horticultural exports. Once the export supplies become self-sustaining, the subsidies will be withdrawn. Thus, it appears that, of the three commitments that India has made under the URA, at least two are unlikely to have any impact on Indian agriculture because: India is not required to reduce its domestic subsidy levels, as its AMS is below the cut-off point of 10% (being in fact negative); and India has not subsidized its exports of agricultural commodities, and hence it remains unaffected by the export subsidy reduction commitments. So the only commitment that can affect Indian agriculture is that of market access or tariffication of quantitative restrictions for balance of payments reasons. However, the balance of payments justification for India's continued use of quantitative restrictions has come under increasing pressure recently because of the increase in its foreign exchange reserves.

Impact of AOA and Trade Liberalization on India The momentum to open up Indian agriculture to world markets has mostly come from India’s own program of economic liberalization, initiated in July 1991. In the beginning, agricultural trade liberalization was never a part of the

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liberalization agenda. The focus of the structural adjustment program was on industry, which was increasingly exposed to foreign competition. But the real policy changes on the agricultural front came only when India signed the WTO AoA. Steps to liberalize agricultural trade were initiated in early 1994, followed by a number of bolder reforms during 1995 and 1996. With exchange rate liberalization and an opening up of the economy, the terms of trade for agriculture have shown a significant improvement. As a result, private investment in agriculture registered a steep rise in the post-reform period. At 1993-94 prices, private investment in agriculture was over 50% higher in 1999-2000 when compared to 1993-94. Exports of agricultural commodities, particularly foodgrains, accelerated in this period. For example, for the first time since independence, India has been a net exporter of foodgrains consecutively for the last six years — net exports amounting, on an average, to around 1.8mn tonnes per annum.

The Export-Import (Exim) Policy 2001 completed the process of dismantling quantitative restrictions on balance on payments grounds on the remaining 715 items from April 1, 2001. There was concern that the removal of quantitative restrictions might result in a surge and dumping of imports in the country, thus affecting adversely the domestic industry. However, these apprehensions were not borne out by actual import growth over this period. Import data for the full financial year 2000-01 on 714 items, on which restrictions were removed with effect from March 31, 2000, do not reveal any surge in their imports (GOI 2002). In the light of this evidence, the fears being expressed in certain quarters that foodgrain imports under the new liberalized trade regime would dampen foodgrain prices in the country were misplaced. In the post-WTO era, although private investment in agriculture was stepped up in response to the liberalization of the economy and favourable terms of trade, real public investment continued to decline because of fiscal compression. As a result, the development of infrastructure like irrigation, rural electrification, roads, and markets was a major casualty. These shortfalls in public investment and in the provision of agricultural services account for the failure of agricultural supplies to respond to the favourable incentive framework created by macroeconomic reforms, including trade liberalization, in the 1990s. The average annual growth of GDP in agriculture and allied sectors slowed down in the 1990s when compared to the preceding decade, while the growth of crop output, especially foodgrains, decelerated (GOI 2001b). The experience of the 1990s clearly demonstrates that, far from trade liberalization dampening the performance of agriculture, the failure of public investment was responsible for the inability to increase and diversify agricultural output in a cost-effective way, and thus, the inability to benefit from trade liberalization.

Future Strategy

India’s stand on agriculture in the WTO has to be an integral part of the overall position it takes on trade liberalization. Domestic policy changes must follow the developments taking place at the WTO. On the external front, the major challenge to the viability of agriculture of most developing countries, including India, is posed by developed countries’ high domestic support, export subsidies, and denial of market access through various tariff and non-tariff barriers. India

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has been fighting in league with other developing countries in the WTO for the removal of such barriers. In the Doha Declaration, members once again committed themselves to comprehensive negotiations on substantial improvement in market access, as well as reductions of, with a view to phasing out, all forms of export subsidies and toward domestic support.

There is also a need for extreme vigilance so as to be able to take timely measures, within the existing tariff bindings, to arrest large imports of certain commodities. Also, since the philosophy behind trade liberalization is the maximization of global welfare through efficiency gains, mapping out comparative advantages across countries for different commodities in a dynamic setting is necessary as a basis for meaningful negotiations in the WTO. The developed countries are very well equipped with technical and legal expertise, even though these capabilities are used to advance their case for the perpetuation of domestic support to agriculture and the restriction of market access, both of which are quite untenable. On the other hand, the capabilities of developing countries, including India, are poor in this respect. Therefore, there is a need to give a high priority to the development of these skills in the country (Rao 2001). On the domestic front, a major effort is required raise farm sector productivity by stepping up public investment, by accelerating the evolution and adoption of cost-reducing technologies, and by removing restrictions on agricultural trade, and marketing processing within the country. All this needs to be achieved through major reforms in governance and institutions, particularly at the state level (Rao 2001). In September 2000, the Government of India appointed a Task Force on Agriculture (TFA) to assess the impact of WTO commitments on Indian agriculture and to suggest steps to safeguard the interests of the sector, while exploiting the opportunities presented by this treaty. The TFA, in its final report submitted in August 2001, came out with some very interesting findings. It highlighted the practical difficulties in the form of structural defects and deficiencies of the Indian economy that are hampering the prospects of farm exports. The TFA also identified some other areas where India can reap advantages in the international market . Stepping up public investment, bringing timely changes in domestic policy, in tune with development at the international level, and identifying unexplored markets should be the focus of policy-making in India. Further, in the post-quota-free regime, it has become essential for the Indian government to monitor the inflow of imports and fluctuations in international prices of farm products and take desirable action to protect the interests of farmers and consumers. The TFA has already listed a few virgin fields where India can reap a considerable comparative advantage. The national agricultural policy should take this into account and diversify cropping patterns accordingly. Production of organic agricultural products and ecofriendly products has to be encouraged.

At the WTO, India should further step up pressure on developed countries to reduce and phase out their trade-distorting domestic support measures and export subsidies. India , in its submission to the WTO, has called for a “food security box” or a “Development Box” to address the livelihood and food security concerns of developing and poor countries. But it also must be ensured that livelihood and food security concerns should not be equated with non-trade

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concerns, such as the “multifunctionality of agriculture,” used by some developed countries to provide legitimacy to their trade-distorting practices.

The prospects of agricultural exports are bleak because of certain structural defects and deficiencies of the Indian economy and of the agricultural environment: · A serious practical difficulty arises from the weak infrastructure. The Farm-gate prices in India suggest it has a substantial comparative advantage in several products. But, by the time the produce is packaged and transported to port of embarkation, most of that advantage is eroded. · The land reform legislation, including tenancy laws and ceiling acts, does not permit cultivation specifically targeted for exports. There is little varietal uniformity and standardization of packaging technology. If an enterprising person with modern know-how wishes to enter the field, that person is discouraged by the fact that even a marginal consolidation of fragmented pieces of land is not permitted for more than three years under the land legislation. · Most Indian agriculture is small-scale, quite innocent of large-scale modern organizational structure. Large-scale corporations handle 85-90% of international trade, yet in India a considerable amount of export is handled by mini-enterprises. · Dependence on erratic monsoons is a perpetual threat that jeopardizes regularity of supply and standardization of quality; this is a very serious handicap in the export business. · Most agricultural inputs are more expensive in India than elsewhere. Fertilizers, agricultural machinery, pesticides, and petro-products cost much more in India than abroad. The comparative advantage of Indian produce at the farm-gate is largely because of cheap rural labour. · The uncertainty in government policies regarding exports and imports, the absence of future markets, the poor banking infrastructure, and the sheer crudeness of the agricultural marketing mechanism result in wide fluctuations in prices. Attempts at contract farming have run into trouble , as farmers who are anxious to supply their produce for processing and export in years of lean prices are reluctant when the prices are high and rising.

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LESSON 10

INDIA AND WORLD TRADE ORGANIZATION

India’s Role in World Trade Organization!

India has consistently taken the stand that the launch of any new round of talks depends on a full convergence of views amongst the entire WTO membership on the scope and framework for such negotiations. Our more urgent task is to resolve the concerns of developing countries on implementation of the Uruguay Round agreements. We are against calls for new commitments from the developing world for achieving symmetry and equity in the existing agreements. It is in favour of non-trade’ issues be permanently kept off the negotiating table.

Incorporating Livelihood Clause:

Ensuring food and livelihood security is critical, particularly for a large agrarian economy like India. India’s proposal in ongoing negotiations includes suggestions like allowing developing countries to maintain appropriate level of tariff bindings, commensurate with their developmental needs and the prevailing distortions in international markets.

We are also seeking a separate safeguard mechanism including provision for imposition of quantitative restrictions under specified circumstances, particularly in case of a surge in imports or decline in prices; exemptions for developing countries from obligations to provide minimum market access; exemptions of all measures taken by developing countries for poverty alleviation, rural development and rural employment.

Our immediate priority is that the agreements reached earlier with the developing countries should be implemented so as to correct inherent imbalances in some of the Uruguay Round agreements. Sincere and meaningful implementation of commitments undertaken by developed countries and operationalisation of all special and differential treatment clauses for developing countries in the various agreements is made.

We also strongly favour extension of higher levels of protection to the geographical indications for products like Basmati rice, Darjeeling tea, and Alphonso mangoes at par with that provided to wines and spirits under the Trade-related Aspects of Intellectual Property Rights (TRIPS) agreement. In the TRIMS (Agreement on Trade-Related Investment Measures) review we want flexibility for developing countries in adopting appropriate domestic policy while permitting foreign investment.

Developed Countries Demand and Singapore Issues:

Developed countries are pushing for a comprehensive agenda like rules on investment, environment, competition policy, trade facilitation, transparency in government procurement,

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labour standards etc. They are pressing for incorporating non-trade issues of environment and labour standards.

Using as an excuse that production of products in developing countries are not being done under proper environment and labour standards they can ban the imports of their products or impose other non-tariff restrictions. The developing countries are opposed to these non-trade issues

WTO and Indian Agriculture and Farmers:

Some critics of WTO have expressed the fears that Indian farmers are threatened by the WTO. There is however no adverse impact. India has bound its tariff to the extent of 100 per cent for primary agricultural products, 150 per cent for processed agricultural products and 300 per cent for edible oils. A few agricultural products had been bound historically at low levels but these bindings have been raised following the Article XXVIII negotiations held in this regard.

It has also been possible to maintain without hindrance the domestic policy instruments for promotion of agriculture or for targeted supply of food grains. Domestic policy measures like the operation of minimum support price, public distribution system as well as provision of input subsidies to agriculture have not in any way been constrained by the WTO agreement.

Certain provisions in the Agreement on Agriculture (AoA) also give us flexibility to provide support for research, pest and disease control, marketing and promotion services, infrastructure development, payments for relief from natural disasters, payments under the regional assistance programmes for disadvantaged regions and payments under environmental programmes. Indian farmers now need to take advantage of the opportunity provided by the AoA, by addressing productivity issues and making their products more competitive globally.

WTO and Indian Industries:

Indian industry has had to face greater competition in the wake of globalisation. But it has successfully completed, as can be inferred from the fact that there has been no particular surge in imports. In fact, as per the provisional data for 2000-01 our non-oil imports declined by 14 per cent while our exports rose by over 20 per cent in the same period. A close watch is also being kept to ensure that Indian industry does not have to face unfair competition from dumped or subsidised imports of other countries.

As for drug prices, safeguards are provided like compulsory licensing, price controls, and parallel imports which should help address this concern. It must also be recognised that the prices of medicines are influenced by several factors including the level of competition, size of market, purchasing capacity etc.

The issue of affordable access to treatment for AIDS, which has gathered international attention in recent months, is hopefully a pointer in the right direction. The TRIPS agreement should not be allowed to hinder the efforts of developing countries to provide affordable access to medicines.

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The apex Indian organisations representing various industries are sincerely working towards ensuring a gainful transition with least disadvantage into the global economy. The government also has to strive to improve infrastructure and provide a facilitating environment for inducing acceleration in trade.

Developed countries have been putting pressures on inclusion of non-trade issues such as labour standards, environment protection, human rights, rules on investment, competition policy in the WTO agreements.

This is because by asserting that particular developing countries are not observing and implementing the rules in regard to the non-trade issues so that the developed countries can ban the imports of some goods in their countries, as the USA has been trying to do so from time to time. We are against any inclusion of non-trade issues that are directed in the long run at enforcing protectionist measures, particularly against developing countries.

Emergence of WTO and India’s Gain as a Founder Member:

In a country like India, the benefits accruing from being a founder member of World Trade Organisation (WTO) are immense. At present, only just five per cent of our tariff lines remain bound. With the finalization of the Uruguay Round, about 68 per cent of India’s tariff lines covering basically raw materials, components and capital goods, but excluding consumer goods, petroleum, fertilisers and some non-ferrous metals would have been bound.

The Government is of the view that it is in the long term interest of India to have low duties on raw materials, components and capital goods since they satisfy the production needs of the economy. Regarding the threat arising out of TRIPs, the Commerce Minister, Pranab Mukherjee is on record saying that exclusive marketing rights to be provided for patent holders would in no way dilute the national interest in such crucial areas as agriculture, drugs and pharmaceuticals as enough safeguards had been built into the system to take care of the concern voiced by developing countries including India.

India now stands to gain immensely from the membership of WTO. At the time the question of this country joining the WTO was broadly under consideration, the opposition political parties strongly opposed our joining the World body.

The fears expressed by the opposition parties regarding adverse effects

of membership on farmers and the agricultural sector, prices of food grains due to withdrawal of food subsidies which would become obligatory under the terms of membership of that body and life savings drugs and medicines becoming out-of-the reach to the poor due to enforcement of new Patent laws that WTO would require us to enact have all proved almost groundless.

India being a founder country has already started to assert itself in the meetings of WTO council.

Although a great deal of misinformation has been spread throughout the country on the otherwise beneficial aspects of the multi-lateral treaty, but it is to be seen how far these safeguards built

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into the system by the Government are sufficient enough to take care the interest of the masses as well as the country as a whole.

But the ultimate impact of the Uruguay Round and the formation of WTO would depend on gains in productivity in various sectors resulting from realisation of economies of scale, technology transfer and increased trade and investment.

Moreover, India is also facing a serious threat from the attempt of the developed countries to introduce social and environmental clauses in multilateral trading system and thereby imposing countervailing duty on imports from India and other developing countries.

These type of proposals have shocked the experts of the developing countries because it will deprive’ the developing countries of their only competitive advantage arising out of cheap and abundant labour force.

WTO Negotiations and India’s Role:

The Doha Round of trade negotiations in the WTO which began in 2001 remains unfinished due to differences among members on various issues. The Eighth Ministerial Meeting of the WTO which was held in December 2011 in Geneva provided political guidance to the member to resolve the issues involved. However, there was no significant progress in 2012.

Efforts are being made for an early harvest on some issues in time for the Ninth Ministerial Conference of the WTO (MC9) to be held in December 2013. India is of the view that any early outcome of the negotiations should invariably address issues of interest to the developing countries, especially the least developed countries (LDCs) and the small vulnerable economies (SVEs).

The Uruguay Round

The 146 member countries of the World Trade Organization (WTO) are currently engaged in a round of trade negotiations. This new round is meant to focus on the needs of developing countries. Indeed, at the last meeting of trade ministers in Qatar in 2001, WTO members agreed to a development agenda, in response to the growing sense among many developing countries that the organization and its agreements were not supportive of their economic and human development. This book addresses one of the sources of this “discontent”: the agreements negotiated at the last round of trade talks, the Uruguay Round (UR) agreements. The Uruguay Round was supposed to be a great “North-South bargain” (Ostry 2000). Industrial countries were to decrease their barriers to exports from the South, especially in the most important sectors (i.e., in textiles and clothing and in agriculture). In exchange for better market access, developing countries would agree to several new trade agreements which would mainly benefit industrial countries. The most important ones are the agreements on intellectual property and on services. However, there have been increasing signs of the asymmetrical value of the North-South bargain. On one hand, it appears that the costs of implementing agreements such as Trade-Related Aspects of Intellectual Property Rights (TRIPS) are very high, even higher than

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expected. On the other hand, it is not clear that the promises of greater access to Northern markets have materialized yet for many developing countries. In agriculture, this was mostly expected, as the core of the Northern piece of the bargain was a commitment to further liberalization in new negotiations starting in 2000. Still, the Uruguay Round included commitments from industrial countries to decrease agricultural subsidies; but in the United States and the European Union, such subsidies have actually increased. In textiles, developing countries have complained of implementation tactics used to delay the opening of markets.

In order to document the value of this exchange of concessions and the trends in North-South trade, we brought together a group of researchers from the South and the North. The authors come from various backgrounds: academia, non-governmental research organizations or think tanks, and governments. They offer a diversity of perspectives. Given the wide range of issues now part of the WTO’s domain, the authors were asked to focus on one specific aspect of the new regime or its impact on one region/country. The Uruguay Round was the first of its kind in terms of developing country participation. Indeed, in earlier multilateral trade negotiations, developing countries were allowed to pick and choose which agreements they would sign. Developing countries were generally not very active in what was then called the General Agreements on Tariffs and Trade (GATT). With the Uruguay Round, in the so-called single undertaking, all members had to be signatories to all the agreements. In a way, developing countries became full-fledged members of the organization. For the actors involved in the current round of multilateral trade negotiations, there are many lessons to be learned from the earlier experiences, to ensure that the trade arrangements that are being discussed contribute to development and poverty reduction.

Outcomes of the Uruguay Round Unfinished business from the previous Tokyo Round was only a small part of the Uruguay Round negotiating agenda. Despite difficulties in launching the Uruguay Round, the negotiating agenda finally adopted in 1986 was wide-ranging and ambitious. The round encompassed traditional tariff cutting, and tackled long-standing and intractable issues such as textiles and clothing and agriculture. It also refurbished the dispute settlement system, instituted the trade policy review mechanism for examining the trade policies of individual countries, transformed aspects of the institution and the GATT’s legal status, and took on the entirely new issues of trade in services and trade-related intellectual property rights. In view of the extraordinary comprehensiveness of this agenda, it is not surprising that the Uruguay Round proved nearly as difficult to close as it was to launch. In December 1993, some decisions were adopted by the Trade Negotiations Committee. Even then, a few loose ends had to be tied up, and negotiations in various areas, most notably services, continued. The Uruguay Round really ended in April 1994, eight years after the negotiations had begun. The negotiations had proved challenging precisely because governments were seeking far-reaching agreement in difficult areas. No government could agree easily to such a wide-ranging package, knowing that important commitments were at stake which would involve significant policy changes. The Uruguay Round is a complex agreement that covers six broad areas: 1. Tariff reductions in manufactured products. 2. The tariffication of non-tariff barriers in agriculture, as well as binding

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commitments to reduce the level of agricultural protection. 3. The elimination of voluntary export restraints (VERs) and of quotas in textiles and clothing. 4. Institutional and rule changes, such as the creation of the WTO and safeguards, anti-dumping, and countervailing duty measures. 5. New areas such as Trade -Related Investment Measures (TRIMs), Trade-Related Aspects of Intellectual Property Rights (TRIPS), and the General Agreement on Trade in Services (GATS). 6. Areas receiving greater coverage than earlier, such as customs valuation. In the field of tariffs, the Uruguay Round saw average cuts of 40% on industrial products. Prior to the Uruguay Round, developing countries had on average only bound 21% of their tariff lines. This figure rose to 73% after the Uruguay Round. Developed countries and transition economies increased their shares of bindings in total tariff lines from 78% and 73% to 99% and 98% respectively. These commitments added significantly to security and predictability in world trade (WTO 1998). After more than four decades of futile efforts to bring trade liberalization to the agricultural sector, the Uruguay Round finally put in place a comprehensive program of reform, encompassing liberalization commitments with respect to tariffs, domestic supports, and export subsidies. All quantitative restrictions and other non-tariff measures used against imports were replaced by tariffs. In textiles, following years of special arrangements entailing discriminatory restrictions maintained by most developed countries against developing country exports, an agreement was reached to phase out these arrangements. Under the Agreement on Textiles and Clothing (ATC), country-specific quotas are to be phased out in three phases over a period of ten years, ending in 2005.

A new safeguards agreement was established in the Uruguay Round — an achievement that had eluded negotiators for many years. This new agreement instituted strengthened procedures and public accountability, combined with greater flexibility to allow governments to take the necessary temporary measures to deal with pressing adjustment problems. Its adoption entailed the elimination of “grey area” measures, such as voluntary export restrictions. Provisions relating to trade remedy measures such as anti-dumping and countervailing duties were strengthened, as were those on state trading, technical barriers to trade, customs valuation, and import licensing procedures. The provisions on subsidies were further developed, establishing a definition of subsidies for the first time, and making the rules and remedies clearer. Additional clarifications were made to GATT Article XXIV, dealing with customs unions and free trade areas. New agreements were reached on sanitary and phytosanitary (SPS) measures, rules of origin, and import licensing procedures. An agreement on TRIMs, applying only in the area of goods, seeks to control the use of investment-linked measures that affect trade, such as local content and trade balancing requirements. The Uruguay Round General Agreement on Trade in Services (GATS) represented the first attempt to bring a sector of ever-growing importance into the multilateral framework of rule making. Built on the conceptual foundations of the GATT, the GATS is both a set of rules and a mechanism for progressively pursuing trade liberalization. Under the agreement, a framework was established for WTO members to bind, reduce, or eliminate impediments to the supply of services by foreign providers, followed up by the agreements on basic telecommunications and financial services in 1997. The Agreement on Trade-Related

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Aspects of Intellectual Property Rights (TRIPS) is as remarkable as that on trade in services. It establishes standards for the protection of all the main intellectual property rights, copyright and related rights, trademarks, geographical indications, industrial designs, patents, layout designs of integrated circuits, and undisclosed information. The agreement also establishes a range of obligations designed to ensure that adequate enforcement mechanisms exist at the domestic level.

Impact on Institutional Setup

After more than four decades of legal limbo, during which the GATT was essentially a provisional arrangement, it was, on January 1, 1995, finally transformed into the WTO — a permanent organization with a sound legal basis. Under the GATT 1947, all decision-making authority was attributed to (and then delegated by) a single organ, the “Contracting Parties” acting jointly. The framers of the Agreement Establishing the WTO, however, carefully negotiated a more complex institutional structure under which separate judicial and political bodies are empowered to make binding decisions that confirm, define or alter the rights and obligations of members. The decision-making in the WTO is divided between: · The membership of the WTO acting under the amendment and other rule -making provisions of the WTO Agreement (the “legislative branch”); · The political organs of the WTO, such as the Committee on Regional Trade Agreements, the Committee on Subsidies and Countervailing Measures, the Safeguards Committee, and the Committee on Balance-of-Payments Restrictions (the “executive authorities”); and · The judicial organs of the WTO, in particular the panels, arbitrators, and the Appellate Body (the “judicial powers”). The Uruguay Round resulted in the most profound institutional reform of the multilateral trading system since the establishment of the GATT in 1947. The trading rules were reformed across the whole spectrum, and the new rules were brought in under the aegis of the WTO. Some of the distinct features, which make the WTO a potentially better-equipped organization to administer the world trading system, are discussed below in brief.

Trade Policy Review Mechanism

The first major result of Uruguay Round negotiations was the decision to establish a trade policy review mechanism. Participants agreed to start the reviews at the December 1988 ministerial meeting that was intended to be the mid-way assessment of the Uruguay Round. Initially, these reviews took place under the GATT, and like the GATT, they focused on trade in goods only. With the creation of the WTO in 1995, their scope was extended, like the WTO, to include services and intellectual property. The objective was to increase the transparency and understanding of countries’ trade policies and practices, through regular monitoring, as well as to improve the quality of public and intergovernmental debate on the issues and to enable a multilateral assessment of the effects of policies on the world trading system. While the reviews focus on a member’s own trade policies and practices, they also take into account countries’ wider economic and developmental needs, their policies and objectives, and the external economic environment.

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Dispute Settlement System

No review of the institutional achievements of the Uruguay Round would be complete without mention of the dispute settlement system. The dispute settlement procedures of the WTO are substantially stronger than those of the GATT. A procedure for settling disputes existed under the GATT too, but it had no fixed timetables, and rulings were easily blocked. Many cases dragged on over several months inconclusively. The Uruguay Round agreement introduced a more structured process with more clearly defined stages in the procedure. It introduced greater discipline procedure, all on the understanding that prompt settlement was essential if the WTO was to function effectively. The Uruguay Round agreement also made it impossible for countries losing a case to block the adoption of a ruling, a complete reversal from the previous GATT provisions for settling disputes. Under the previous GATT procedure, rulings could only be adopted by consensus, meaning that a single objection could block the ruling. Now, a ruling is automatically adopted unless there is a consensus to reject it. The new WTO system is stronger, more automatic , and more credible than its GATT predecessor. This is reflected in the diversity of countries now using it. In 2000, the number of complaints filed under the WTO’s Dispute Settlement Understanding (DSU) since the start of the WTO had reached 200 (WTO 2001a). This indicates a continued heavy use of the dispute settlement procedures by WTO members. In contrast, only some 300 cases were brought before the GATT during its entire life span. Technical Cooperation

Technical assistance to developing countries, least developed countries (LDCs) and countries in transition from centrally-planned economies is an integral part of WTO work. The objective is to help build the necessary institutions and to train officials. It aims to improve the understanding of the agreements and facilitate implementation of obligations. At the same time, emphasis is increasingly being placed on enhancing the capacity of countries to integrate into the world economy in order to realize the benefits of the market access opportunities that are available to them as a result of being WTO members. Despite their vital nature, technical assistance and cooperation activities in 1999 and 2000 have been sustained only by the generous extra-budgetary voluntary donations of certain WTO members, given that the regular budget for such activities has remained inadequate to respond to needs, funding just 10% of activities in 1999 (WTO 2001a). Increased funding for technical assistance in the core budget of the WTO would create a more permanent basis for such activities. In the fourth Ministerial Conference at Doha, members agreed that there is a need for technical assistance to receive secure and predictable funding. Pursuant to this, in December 2001 the WTO’s Committee on Budget, Finance and administration agreed to the establishment of a “Doha Development Agenda Trust Fund” of at least 15 million Swiss Francs (CHF) — approximately US$9.1 million. This proposed amount would go toward the implementation of technical assistance commitments as mandated by the Doha Ministerial Declaration. The existing WTO Global Trust Fund was established in July

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1999 to receive extra-budgetary donations from WTO members to finance technical cooperation activities carried out by the WTO.

Ministerial Conference Negotiators also paid attention to other important institutional aspects of the multilateral trading system. In order to ensure an adequate degree of high-level political involvement in the WTO, it was agreed that members would meet at the ministerial level at least once every two years. The Ministerial Conference is the highest WTO body. So far, four WTO Ministerial Conferences have been held since 1995. Impact on World Trade The real success of the eight years of intensive Uruguay Round trade negotiations, followed by over seven years of implementation of WTO agreements, can be judged in terms of their contributions toward establishing a free and fair trade regime, and in terms of how far the integration of poor countries, especially LDCs, into the multilateral trading system has advanced. Potential indicators are the share of developing countries in world merchandise exports and the composition of their export basket. World Exports of Merchandise The 1990s witnessed a boom in world trade, with an average annual increase of 6.3% in the volume of global merchandise trade (1990-99). It outpaced global gross domestic product (GDP) growth by an average of 4.2% per year over the same time period. Exports grew faster than output in every major region (World Bank 2001). Developing countries made a significant contribution to the vigorous expansion of world trade in the last decade. The share of developing countries in global export markets rose by almost seven percentage points, to about 25% of world non-energy merchandise trade, primarily based on superior performance in manufacturing. They accounted for 27% of world exports of manufactures in 2000, a remarkable increase from their 17% share in 1990.