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International Cooperation Among Nations

After studying this chapter students should be able to: > Explain the importance of GATT and the WTO to international businesses. > Contrast the different forms of economic integration among cooperating countries. > Analyze the opportunities for international businesses created by completion of the EUs internal market. > Describe the other major trading blocs in todays world economy. LECTURE OUTLINE OPENING CASE: Trade and Prosperity: The Case of Mexico The opening case examines Mexico's recent economic development and concludes that Mexico's success is based on its openness to international trade and investment. Key Points


From 1917 to 1982, Mexico relied on inward inward-looking economic policies such as high tariffs, restrictions on FDI, and government ownership of business. The last four Mexican presidents have reversed these policies by lowering tariffs, privatization, encouraging FDI, and joining the GATT and WTO. Mexico's participation in NAFTA and recent agreement with the EU further opened its economy to the outside world. Many industries in Mexico are now booming. However, Chinas joining the WTO (and increasing attractiveness to foreign investors) poses a threat. CHAPTER SUMMARY Chapter Ten explores how nations cooperate to minimize trade restrictions. The chapter begins with a discussion of the General Agreement on Tariffs and Trade, then examines economic integration and other types of regional trading blocs. I. THE GENERAL AGREEMENT ON TARIFFS AND TRADE AND THE WTO

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The General Agreement on Tariffs and Trade (GATT) is a multilateral treaty designed to minimize trade barriers. GATT went into effect in 1948. It provided a forum for trade ministers to discuss policies and problems of common concern. GATTs mission was adopted by the World Trade Organization (WTO), which replaced GATT in 1995. The Role of the General Agreement on Tariffs and Trade

The goal of GATT was to promote a free and competitive trading environment that benefits efficient producers. To that end, GATT sponsored international negotiations, called rounds, to reduce trade barriers (both tariff and nontariff). GATT successfully oversaw a reduction of tariffs from an average of over 40% in 1948 to approximately 3% today, and promoted a dramatic increase in world trade. Discuss Table 10.1 and Figure 10.1 here. To ensure that international trade is conducted on a nondiscriminatory basis, GATT follows the most favored nation (MFN) principle which requires one nation to treat a second nation no worse than it treats any third nation. Any preferential treatment that is extended to one country must be extended to all countries. Thus, the principle implies multilateral rather than bilateral trade negotiations. Most Nations are Favored Though not required to do so, WTO member countries often grant MFN status to countries not belonging to the WTO. In the United .States. only, a few countries (such as Afghanistan, Cuba, Laos, North Korea, Libya, and Vietnam) are excluded. The Clinton administration changed the term "Most Favored Nation" (MFN) to "Normal Trade Relations" (NTR).

There are two exceptions to the MFN clause. First, in an effort to assist poorer nations with economic development, GATT permits nations to lower tariffs to developing countries without lowering them for more developed countries. For example, the United .States. follows the Generalized System of Preferences (GSP) code to offer developingg nations reduced tariffs. Second, regional agreements promoting economic integration such as the EU or NAFTA are exempt from the MFN clause. Nations following GATT principles are still able to protect domestic industries by finding loopholes in the tTreaty. For example, countries may adopt quotas and other nontariff barriers yet still comply with the GATT. The final meeting of GATT took place in Uruguay. The round was ratified in 1994, and took effect in 1995. As in previous rounds, negotiations focused on reducing tariff barriers. Negotiations also took place to reduce nontariff barriers to trade. Other key areas that were considered include: agricultural policy, trade in services, intellectual property rights, and the creation of the World Trade Organization.

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The World Trade Organization

The World Trade Organization (WTO) was founded in 1995, and is comprised of 146 member countries and 30 observer countries. The WTO has three primary goals: to promote trade flows by encouraging nations to adopt non-discriminatory and predictable trade policies, to reduce remaining trade barriers through multilateral negotiations, and to establish impartial procedures for resolving trade disputes among members. Discuss Figure 10.2 here. Problem Sectors. One challenge facing the WTO is dealing with sectors of the economy such as agriculture and textiles that most nations protect. Groups including the Cairns Group (a group of major agricultural exporters) have pressured the WTO to ensure that the Uruguay Round policies dealing with agricultural trade are implemented according to schedule. Similarly, developing countries are monitoring the dismantling of the Multifibre Agreement (MFA), which created a complex array of quotas and tariffs on trade in textiles and apparel. The General Agreement on Trade in Services (GATS). The WTO is also focusing on reducing barriers to trade in services. One approach currently in use is the principle of national treatment, in which a country treats foreign firms the same as it treats domestic firms. The WTO began negotiating a new GATS agreement in 2000, but progress has been slow. Agreement on Trade-Related Aspects of Intellectual Property Rights (TRIPS). The third challenge for the WTO is intellectual property rights (patents, copyrights, trademarks, and brand names). Efforts to improve intellectual property right protection, agreed upon at the Uruguay round, to improve intellectual property right protection will be phased in over the space of a decade. In 2001, the WTO launched the Doha round of negotiations. Several contentious issues are slated to be discussed, including agriculture trade, intellectual property rights, and trade in services. Trade-Related Investment Measures Agreement (TRIMS). The TRIMS agreement is a start toward eliminating national regulations on FDI, which may distort or restrict trade. It affects trade balancing rules, foreign exchange access, and domestic sales requirements. Enforcement of WTO Decisions. The WTO, unlike its predecessor GATT, has more power to punish violators of the WTO rules. Most experts feel that the WTO has been successful in implementing its policies during its first years of existence. II. REGIONAL ECONOMIC INTEGRATION Forms of Economic Integration Countries are seeking to integrate their economies to open new markets for their businesses and lower prices for their consumers. There are five types of regional economic integration between countries. 1. Free Trade Area

A free trade area eliminates all barriers to trade among member countries, but allows each country to establish its own external trade barriers. The North American Free Trade Area (NAFTA) is an imperfect example of a free trade area.

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A problem with free trade areas is the potential for trade deflection whereby non-member countries try to avoid trade barriers by initially exporting their products to a member country with low trade barriers, then re-exporting the products to a member country with high trade barriers. Most free trade agreements specify rules of origin, which detail the conditions under which a good is classified as a member or non-member good to try to prevent trade deflection. 2. Customs Union

A customs union combines the elimination of barriers to internal trade among member countries with the adoption of common external trade policies toward non-members. Trade deflection is not an issue in a customs union since member countries treat non-members in a uniform manner. A current example of a customs union is the Mercosur Accord, an agreement between Argentina, Brazil, Paraguay, and Uruguay. 3. Common Market

A common market combines the elements of a customs union with a policy that allows for the mobility of factors of production. Productivity is expected to rise in a common market because factors of production are free to locate where the returns to them are highest. The European Union is an example of a common market. 4. Economic Union

An economic union eliminates trade barriers between member countries, establishes a common external trade policy, follows a policy of factor mobility, and coordinates economic policies of member countries. An example of an economic union is the Belgium-Luxembourg Economic Union. In addition, the European Union is currently moving toward economic union status. 5. Political Union

A political union combines the elements of an economic union with the added feature of complete political integration. The United States, transformed from 13 separate colonies into one, is an example of a political union. Figure 10.3, which summarizes the five forms of economic integration, should be discussed here. The Impact of Economic Integration on Firms Regional economic integration has both advantages and disadvantages for businesses. On the positive side, because the elimination of trade barriers among member countries opens up new markets, firms can gain scale economies from longer production runs. The lower costs also provide an advantage when operating in non-member countries. However, competition in the home market may be increased as firms in non-member countries increase their investment as they seek insider status.

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Economic integration may help a country as a whole, but hurt particular sectors or communities within a country. Therefore, integration is not always fully supported and agreements frequently include certain exemptions. Teaching Note: Most students are aware of some of the controversy surrounding the North American Free Trade Agreement. Instructors may wish to create a debate situation in which students are asked to play the role of an American worker who has lost his job to a Mexican worker. III. THE EUROPEAN UNION

The European Union (EU) is the most important trading bloc in the world today. Fifteen countries currently belong to the EU, making it the worlds richest market, with a total GDP of $7.9 trillion. Discuss Table 10.2 and Map 10.1 here.

Ten more countries are slated to join the EU in 2004. Use Table 10.3 here. The European Economic Community (EEC) was established at the Treaty of Rome in 1957 by six nations (Belgium, France, Luxembourg, Germany, Italy, and the Netherlands). The goal of the EEC was to create a common market. The name EU was a result of a name change in 1993. Governing the European Union

The EU is governed by four organizations. The Council of the Economic Union, made up of 15 members, each of whom is responsible to his or her home government, is the EUs main decision-makingdecision making body. Because of its composition, the Council reflects the desire of member states to retain national sovereignty and power. The European Commission is composed of 20 individuals whose loyalty is to the EU rather than their home countries. Its mandate is to be guardian of the Treaties. The European Parliament, made of 626 elected representatives, is the weakest of the governing bodies. It originally acted in a consultative manner in EU policy making, but has expanded its role under the Maastrict Treaty. Finally, the European Court of Justice interprets the meaning of EU law and ensures that EU regulations and policies are followed by member states. The Legislative Process. The legislative process in the EU, which is usually initiated by the Commission, is a complicated one. In fact, transforming a Commission proposal into law may take years. Discuss Figure 10.4 here. The complex process reflects the desires of member countries to retain their sovereignty yet create a supranational government.

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Lobbying the European Union This Global Learning Box discusses how firms can influence EU decision -makers in their legislative actions. EU decision makers have the difficult job of juggling the diverse interests of member nations, and consequently may not take into consideration the interests of foreign firms. Lobbying either the Commission or an ally on the Council may prevent adverse legislative proposals from being passed. This Bbox fits in well with a discussion of the EU, with a discussion of trade barriers, and with Discussion Questions 2, 3, and 5. The Struggle to Create a Common Market As a result of pressures from domestic special interest groups, the process of transforming the members of the EU into a common market was a slow one. Even through the 1980s, firms doing business within the area had to comply with 12 different sets of national laws and regulations. The text provides several examples of the regulations followed by different members of the EU. Initially, the EU relied on a process of harmonization (whereby the EC encouraged members to voluntarily adopt common harmonized regulations) to eliminate conflicting regulations. However, because the process moved so slowly (see the text for some examples), one of the ECs governing bodies, the European Commission, issued the White Paper on Completing the Internal Market. The White Paper called for accelerated progress on ending all trade barriers and restrictions on the movement of the factors of production. Countries that accepted the White Paper signed the Single European Act and adopted its goal of completing the transformation to a common market by the end of 1992. The goal is known as EC 92. Substantial progress toward meeting the goal in the areas of physical, technical, and fiscal barriers has been made. From Common Market to Economic Union

Many Europeans have argued for further integration, suggesting that the EU become an economic union. To that end, the Treaty on European Union (also known as the Maastricht Treaty) was reached in 1991. The treaty came into force in 1993. The Maastrict Treaty rests on three pillars designed to further the economic and political integration of Europe. First is the agreement to create a common foreign and defense policy among member states. Second is an agreement to cooperate on police, judicial, and public safety matters. Third are new provisions to create an economic and monetary union among member states to augment the basic European Community agreement. The Maastrict Treaty also grants citizens the right to live, work, vote, and run for election anywhere within the EU, and strengthens the power of the EUs legislative body, the European Parliament, in budgetary, trade, cultural, and health matters. In addition, a cohesion fund was created to funnel economic development aid to countries with a GDP less than 90% of the EC average. Finally, the name change mentioned earlier occurred as the EC became the EU. The most important and controversial aspect of the Maastrict Treaty was the creation of economic and monetary union (EMU) among members. The EMU created a single currency, called the euro, for the EU, and a single EU central bank. Denmark, Sweden, and the U.K. chose not to become charter members of the

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single currency bloc. The euro came into being on January 1, 1999 when the 11 charter participants irrevocably fixed the value of their national currencies to the euro. During a three- year transition period, the euro existed only as a bookkeeping currency. Actual euro coins and currency were put into circulation at the beginning of 2002. The ultimate goal of the EU, the creation of a single EU currency, implies that countries lose their ability to control their own domestic monetary supplies and economic destinies, and thus the goal has not been reached without controversy. In order to participate in the EMU, member countries met certain convergence criteria relating to inflation rates, interest rates, currency values, government budget deficits, and government debt. The Treaty for Europe (also known as the Treaty of Amsterdam), signed in 1997, allowed for a strong commitment to attack the EUs high levels of unemployment, a strengthening of the role of the EUs Parliament, and the establishment of a two-track system. The Treaty of Nice, which became effective in February of 2003, reduced the number of areas in which unanimity was required in order for new policies to be approved. The following bBox addresses the issue further.

Three Majorities Are Better than One The Treaty of Nice requires that a qualified majority can be obtained only if three conditions (the so-called triple majority) are met: (1) the decision receives a specified percentage of the votes cast by Council members. The specified percentage will range between 71 and 74 percent (depending on the number of new members admitted to the EU); (2) a majority of the member states approve the decision; and (3) the decision is approved by members who represent at least 62% of the EUs population.

Future EU Challenges. Other conflicts continue to be waged within the EU. For
example, state aid to industry has been of particular concern to members. While the EU prohibits national governments from making subsidies that result in a distortion of competition, many governments still assist domestic companies that are in danger of bankruptcy. Another controversy surrounds the question of whether and when the EU should expand its membership. At the heart of the controversy is the wider vs. deeper question. Supporters of the wider side suggest that the EU should rapidly expand its membership, even if it makes integration more difficult, while proponents of the deeper side argue that slow expansion is more appropriate. IV. OTHER REGIONAL TRADING BLOCS The success of the EU in enriching its members has spawned the development of new trading blocs. Today, nearly every continent has at least one regional trading group. Europe contains not only the EU, but also the European Free Trade Area (EFTA). Members of EFTA include Iceland, Liechtenstein, Norway, and Switzerland. The first

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three of these countries have joined with the EU to create the European Economic Area.

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The North American Free Trade Agreement

The North American Free Trade Agreement (NAFTA) was implemented in 1994 to reduce barriers to trade and investment among Canada, Mexico, and the United States. The agreement was built upon a trade agreement that had been signed between the United .States. and Canada six years earlier and upon the extensive amount of trade that already existed between the three countries. The agreement will be phased in over a 15-year period. Trade negotiators also made an effort to prevent the establishment of screwdriver plants (factories in which very little transformation of the product is undertaken) in Mexico as a means of evading U.S. and Canadian tariffs by developing detailed rules of origin defining whether a good should qualify for preferential tariff treatment or not. The text provides an example of how such a situation might occur in the auto industry. The agreement provides certain industries with special treatment, a concession that was made in order to ensure that the agreement would be accepted by the three countries. Expansion of the agreement has been endorsed by all three countries; however, the United .States. has been unable to proceed because of the lack of presidential fast-track authority, which would give the president the authority to negotiate trade treaties with other countries.

Other Free Trade Agreements in the Americas

Other free trade agreements are currently being negotiated. Mexico in particular has been active in that respect, negotiating an agreement with Chile, an agreement with Venezuela and Coluombia, and an agreement with five of its Central American neighbors. Table 10.4 provides a list of major regional trade associations .

The Caribbean Basin Initiative (CBI) to facilitate the economic development of the nations of Central America and the Caribbean Sea was initiated by the United .States. in 1983. By offering duty- free access to the United .States. for a wide range of products, the U.nited S.tates is hoping to stimulate investment by U.S. and other foreign firms in industries that do not have much of a presence in the Caribbean Basin countries. The CBI overlaps two regional free trade areas, the Central American Common Market (CACM) and the Caribbean Community and Common Market (CARICOM). Discuss Map 10.2 here. The Mercosur Accord is an agreement between Argentina, Brazil, Paraguay, and Uruguay to cut internal tariffs and establish common external tariffs. The agreement is expected to revitalize the stagnating economies of Brazil and Argentina by stimulating new flows of FDI. Response to Mercosur by businesses has been mixed. Some have quickly taken positions that allow them to capitalize on the opportunities created by the accord, while others fear an influx of cheaply made products will make it more difficult to compete. See Chapter 2s closing case for an update on Argentina. The Andean Pact was established in 1969 to promote free trade among Bolivia, Chile, Coluombia, Ecuador, and Peru. The objective of the agreement was to make these small nations competitive with the continents larger countries. Membership

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has changed over the years (Venezuela joined in 1973 and Chile dropped out in 1976), and at least for the first twenty years, the agreement was not successful. The initial lack of success of the Andean Pact has primarily been blamed on the protectionist, import-substitution policies adopted by most members, and to a lesser extent on geography problems. In 1992, following a decision to reinvigorate the agreement, the Andean nations established a customs union for most goods. Thus far, internal trade is increasing, but progress toward establishing common external tariffs has been slow. Despite setbacks, trade in the region is likely to become freer over time. Leaders of every country in the Americas (except Cuba) have pledged to create a Free Trade Area of the Americas by 2005. Trade Agreements in the Asia-Pacific Region

The Australia-New Zealand Agreement. The Australia-New Zealand Closer Economic Relations Trade Agreement (known as CER), took effect in 1983. Its goal is to expand trade and straighten links in a diverse set of areas including investment, marketing, tourism, and transport. Most analysts agree that it has been highly successful. The Association of South East Asian Nations (ASEAN) was founded in 1967 by Brunei, Indonesia, Malaysia, the Philippines, Singapore, and Thailand to promote regional political and economic cooperation. The ASEAN Free Trade Area was established to promote intra-ASEAN trade. Discuss Map 10.3 here. The ASEAN trading bloc was established for two reasons. First, a decrease in government control of national economies has stimulated local entrepreneurs and attracted FDI. Second, it is a defensive response to the growth of other regional trading blocs. The creation of the Asian Free Trade Area (AFTA) has quickly attracted the attention of firms. AFTA has three principle objectives: to liberalize trade in ASEAN, to attract foreign investors, and to adapt ASEAN to changing economic conditions. The Common Effective Preferential Tariff (CEPT) is the mechanism under which free trade will be achieved. The Asia-Pacific Economic Cooperation (APEC), started in 1989, is the primary regional vehicle for promoting open trade and practical economic cooperation. APEC currently has 21 members from around the region. The most recent meeting of the group resulted in measures to reduce both tariff and nontariff barriers for manufactured and service trade. Show Map 10.4 here. African Initiatives

Ten African nations created the South African Development Coordination Conference (SADCC) in 1980 to promote the development of their regional economy. It also has plans to develop a regional common market. The Economic Community of West African States was formed by sixteen African nations in 1975 to cooperate on regional economic development programs. The Economic Community of Central African States was established in 1983 for similar reasons. Neither initiative has shown much success, in part because of transportation problems between nations, and in part because of a lack of an economic and political system to encourage intra-bloc trade. Discuss Map 10.5 here.

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1. What does most favored nation (MFN) mean? MFN is a trading status that grants the recipient the same tariff rates as the importing country gives its preferred trading partners. All members of the WTO are expected to grant MFN status to other WTO member countries. 2. Under what conditions can WTO members not use MFN when dealing with one another? The WTO permits members to give below MFN rates in order to assist poorer countries in their development efforts. Also, lower than MFN rates are permitted within regional trading blocs such as the EU and NAFTA. 3. How does the WTO differ from GATT? The World Trade Organization has been charged with the implementation of the Uruguay Round. While GATT focused primarily on trade in goods, the WTOs scope is much broader; it will act as the worlds advocate and monitor of more open and free trade in goods, services, and technology. Moreover, unlike its predecessor, the WTO has the power to enforce its policies. 4. How do the various forms of economic integration differ? There are five forms of regional economic integration. A free trade area eliminates all barriers to trade among member countries, but allows each member to establish its own trade policies against non-members. A customs union involves free trade among member countries, and follows a common external trade policy toward non-members. A common market eliminates tariffs among member countries, follows a common external trade policy, and eliminates barriers that inhibit the movement of factors of production. In an economic union, barriers to trade among member countries are eliminated, a common external trade policy is established, factors of production move freely between countries, and economic policies are coordinated. Finally, a political union further integrates nations by encompassing complete political integration. 5. Why do free trade areas develop rules of origin? Rules of origin specify the conditions under which a good is classified as a member or a non-member good. Free trade areas develop rules of origin to prevent trade deflection from destroying their tariff policies toward non-members.

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6. What was the goal of the Treaty of Rome? The Treaty of Rome was signed in 1957 by Belgium, France, Luxembourg, Germany, Italy, and the Netherlands. Under the tTreaty, the countries agreed to create a common market by eliminating internal barriers to trade, developing common external trade policies, and improving factor mobility. 7. Describe the four major organizations governing the EU. The Council of the European Union, made up of representatives of each member country, is the EUs main decision-makingdecision making body, and because of its composition, reflects the desires of member countries to maintain sovereignty. The Commission of the EU is comprised of 17 elected representatives who focus on the interests of the EU itself, rather than the interests of individual member countries. The representatives of the European Parliament initially played a consultative role in EU policy making, but have expanded their capacity under the Maastrict Treaty. Finally, the Court of Justice interprets the meaning of EU law and ensures that EU regulations and policies are followed. 8. What are NAFTA's major provisions? Under NAFTA, tariffs will be reduced over a 15- year period, investments restrictions will be eliminated in most sectors, some white- collar movement will be allowed, other countries may enter the Area, member countries can leave after giving six6 months notice, trade disagreements will be resolved through arbitration, and snap-back tariffs will be allowed if a surge of imports hurts a domestic industry. 9. What is the Caribbean Basin Initiative? What is its goal? The Caribbean Basin Initiative facilitates the development of Central American and Caribbean Sea nations. It was initiated by the U.nited States. to stimulate investment by domestic, U.S., and other foreign firms in industries that lack a presence in the Caribbean Basin nations. 10. What efforts have South American countries made to regionally integrate their economies? Latin American nations have made various efforts to regionally integrate their economies. Mexico and Chile signed a free trade agreement in 1971. Mexico also worked with Venezuela and Coloumbia in 1971 to reduce trade barriers against each others goods. Mexico is additionally seeking free trade agreements with its five Central American neighbors. The Mercosur Accord created a customs union between Argentina, Brazil, Paraguay, and Uruguay in 1991. Finally, the Andean Pact, established in 1969, promotes free trade between Bolivia, Chile, Coluombia, Ecuador, and Peru. The agreement was expanded to customs union status in 1992.

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1. Consider the opening case in this chapter. Canadian and U.S. economies? How has Mexico's success affected the

Mexico's prosperity has benefited the United .States. and Canada. Mexico's improved economy strengthens demand for foreign goods (i.e., goods from the United .States. and Canada). Privatization has provided greater opportunities for U.S. and Canadian firm's to expand into Mexico. 2. How does the WTO affect operations of large MNCs? successful completion of the Uruguay Round? Did MNCs benefit from the

The purpose of the WTO is to eliminate, or at least minimize, barriers to trade between countries. For large multinational companies, this effort can be both advantageous and disadvantageous. Because trade barriers limit an MNCs ability to export to some markets, the elimination of trade impediments would generally be seen as advantageous. However, in some situations, MNCs are protected from foreign competition by trade barriers. If the trade barriers are eliminated, this protection would be lost, and thus, the efforts of the WTO would negatively affect a companys operations. The Uruguay round of negotiations focused on intellectual property rights (among other areas), and implemented a protection policy that will be phased in over a period of ten years. MNCs with proprietary property will clearly benefit from this policy. In addition, some MNCs will benefit from the continued effort to reduce trade barriers. 3. Should international businesses promote or fight the creation of regional trading blocs? The answer to this question depends on whether a firm is on the inside looking out, or on the outside looking in. For companies that operate in a member country, regional trading blocs offer significant opportunities associated with larger markets. However, the marketplace will probably become more competitive. Regional trading blocs are usually regarded negatively by non-member firms because they may find themselves completely shut out of a particular market. In fact, the threat of a Fortress Europe prompted many outside firms to establish operations within the EU in the late 1980s. 4. What strategies can North American and Asian firms adopt to ensure access to the enormous EU market? North American and Asian firms are in the unfortunate position of being on the outside looking in when it comes to the EU (see Discussion Question 2). To ensure access to the enormous EU market, North American and Asian firms should attempt to establish operations within the EU. The goal of this strategy is to appear to be an insider, and can therefore be accomplished either by establishing a wholly owned subsidiary, acquisition, or forming an equity-based strategic alliance. Firms that adopt a strategy of investment will avoid the risk that is associated with an export strategy of being shut out of the market. 5. Is the abandonment of import substitution policies by South American governments a necessary condition for the success of the Andean Pact and the Mercosur agreement?

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The Andean Pact and the Mercosur agreement are both examples of customs unions. A customs union involves the elimination of trade barriers between members and the establishment of a common external trade policy. A policy of import substitution implies that governments will erect trade barriers to protect certain domestic industries that without the protection would not be successful. Thus, one could argue that a country cannot successfully follow a policy of import substitution and be a member of a customs union simultaneously. 6. Of what importance are rules of origin to international businesses? Rules of origin detail the conditions under which a good is classified as a member or a nonmember good. They are important to international businesses because they determine whether a product qualifies for preferential treatment. International businesses are affected by rules of origin in at least two ways. First, they affect the cost (and strategy) of a companys products, and second, they affect the price (and strategy) of rivals products. 7. Why does the MFN principle promote multilateral, rather than bilateral, negotiations among WTO members? The MFN principle requires one nation to treat a second nation no worse than it treats any third nation. The purpose of the principle is to promote international trade and help international businesses compete in world markets by ensuring that trade is conducted in a nondiscriminatory manner. If the policy permitted bilateral trade negotiations, it would breach the basic principles behind GATT of reducing trade barriers and increasing world trade.


Essence of the exercise This exercise is designed to further the students understanding of the implications of NAFTA. The exercise requires students to identify products that have benefited from the agreement and products that face threats as a result of NAFTA. Instructors should be aware that this exercise requires a fair amount of preparation by the student. Answers to the follow-up questions. 1. Has NAFTA provided new market opportunities for some of the products you discussed? Why or why not? The exercise asks students to identify twelve different products (two products from each country that have been helped and two products from each country that have been hurt by NAFTA). Students will probably choose a wide range of products, and therefore responses will differ. Students will probably come to the conclusion that the production of products will move to the most efficient location and help or hurt a countrys production of that product accordingly.

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2. Has it increased competition from other producers? Depending on the products chosen, students may respond affirmatively or negatively. One would expect that competition will would have increased for producers whose products had been produced in all three- member countries, but not for producers who had been the sole manufacturer in the bloc.


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Have the effects of NAFTA on each product been consistent with what advocates or critics of NAFTA might have predicted? Again, the responses to this question will depend on the products chosen by the students. Students will probably identify with labors concerns about NAFTA and will argue that situations in which layoffs have occurred as a result of NAFTA are consistent with the critics of the agreement. Similarly, students will probably side with NAFTA supporters with regard to the larger market opportunities available as a result of the agreement. Other Applications After completing this exercise, students will be fairly familiar with the perspectives of both NAFTA critics and NAFTA supporters. This familiarity should provide the basis for a lively debate on the agreement. Students can be asked to volunteer to play the role of an interested party (for example, a CEO in a labor intensive firm, a CEO in a capital intensive firm, a blue collar worker, a white collar worker, a local supplier, a local bank, and so forth) in a debate on the agreement.

Will Whirlpool Clean Up in Europe? The closing case details the moves that Whirlpool is making in Europe to capitalize on the benefits of the common market. Key Points

White goods makers (producers of appliances such as refrigerators, dishwashers, and ovens) are looking forward to the creation of common market in Europe with anticipation because they hope that it will end, or at least minimize, the differences between the various country markets for their goods. Producers believe that the EUs harmonization of product standards will allow it to standardize its output, and minimize the current situation in which products must be customized for each market. Whirlpool, the largest white goods manufacturer in the world, is particularly interested in capitalizing on the changes that are occurring within the EU. The company believes that it can turn the cost savings that result from producing and marketing a more standardized product into added value for its European customers, and in doing so, create a competitive advantage for itself. Whirlpools purchase of Netherlands-based Philips Industries white goods operations was its initial step in conquering the European market. In addition, the company has developed a strategy whereby it targets various segments of the market with different brands. Its market is segmented according to income level. Whirlpool has also consolidated its national sales offices into five regional operations. It anticipates this will help it cut costs and enhance productivity and allow for pan-European promotional campaigns. The centralization of Whirlpools

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European operations has facilitated technology transfer between its North American and European operations. Logistics, information technology, and consumer services operations have also been centralized to capitalize on the advantages of the EU. Manufacturing has been reorganized so that production of different appliances is concentrated in certain areas. Although these strategy changes appear to be working, they are working slowly, and the company has seen its European revenues increase by only 13% since 1990. Other companies, including Swedens Electrolux, have already followed Whirlpools lead, and are making similar strategic changes. Case Questions 1. What are the advantages of consolidating production of product lines at single factories in the EU? What are the disadvantages? The elimination of national borders within the EU allows a company to achieve significant economies of scale by consolidating production of product lines at single factories. Companies producing at single locations can reduce the overhead associated with multiple production sites in terms of machinery, inventory, raw materials, and labor. In addition, single location production may better promote the use of cross-functional teams at the design stage than would a multiple production location system. Some disadvantages of single location production include problems associated with strikes or other factory slowdowns that could significantly affect the output of the company in question. Companies with multiple production locations facing similar slowdowns may have the option of shifting production to an alternate location. In addition, companies employing a single production location system may tend to emphasize standardization where it is not appropriate.

2. Should Whirlpool continue to produce and market its three product lines
(Bauknecht, Whirlpool Philips, and Ignis) whicthath will span the entire white goods market, or should it focus on one market niche? Most students will probably argue that Whirlpool should continue with its strategy of producing and marketing its three product lines because the strategy acts as a hedge against economic cycles. It should also be pointed out that this strategy does not prevent Whirlpool from standardizing various internal components among the three lines and in doing so, capturing significant economies of scale. However, some students may argue that by producing products that span the entire white goods market, Whirlpool is taking the chance that its premium line will not be perceived to be as upscale as that of a firm that is only known for its premium line. Whirlpools current use of three brand names may prevent this misperception from taking place, but if it continues to move toward using the Whirlpool name on all of its products, it may run into difficulties. Some students may also argue that Whirlpool may actually cannibalize its own sales if consumers believe that one Whirlpool product is as good as the next (and thus, do not purchase the Bauknecht line).

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3. What benefits will Whirlpool gain by broadening the Whirlpool brand name from a North American brand to a global brand? Whirlpool can expect to gain numerous benefits by broadening its Whirlpool brand name from a North American brand name to a global brand name. Certainly, promotional campaigns will be facilitated by the use of a single brand name, as will the manufacturing process. In addition, Whirlpool may be able to create global brand recognition similar to that of Coca-Cola or McDonalds that would facilitate further global expansion. However, it is important to note that a disadvantage of creating a brand name is that a problem (for example, poor quality) will be carried to other countries that share the brand name. Teaching Note: Instructors may want to explore the case of Nissan with regard to brand name. Nissan initially entered the U.S. market using the brand name Datsun. Later, Nissan began the process of extending the Nissan name to the U.S. market by labeling its cars and advertisements with both the Datsun name and the Nissan name. Today, Nissan markets all of its cars with the Nissan name.

4. In light of the aggressive responses of Electrolux and Bosh Siemens Hausgerate,

should Whirlpool revise or abandon its European sStrategy? Whirlpool's strategy is basically sound. The consolidation of the European market does allow for the economies of scale Whirlpool is seeking. However, consumer tastes still vary across Europe. Some adjustments to Whirlpool's strategy may be necessary, -- perhaps focusing more directly on the low cost segment. However, given the size of the EU market, Whirlpool must remain a player. 5. Do you think it is possible to design and sell the same basic appliances around the world? Most students will probably agree that it is not possible to sell the same basic appliances around the world, if for no other reason than the fact that voltage requirements differ around the world. Beyond this basic difference, however, are the cultural dissimilarities that would make it difficult to successfully sell the same appliance around the world. The case provides some examples of how certain countries prefer certain features in washing machines. A company that tried to meet all of the different preferences with one product would probably end up producing an average product that pleased no one. There is, however, room for some standardization. Whirlpool, for example, produces many of its products with the same internal components, but customizes the outward features to meet local preferences. 1 Additional Case Application Case question 5five presents an opportunity for an interesting debate. Instructors can assign students to argue for one side (standardization) or the other (localization), and ask students to prepare for the debate by finding examples of firms that follow either a strategy of standardization or localization. Since students will probably focus on products in their debate, instructors may wish to introduce the

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idea of services, and raise the question of whether services offer greater or fewer possibilities for standardization.

Chapter 10: International Cooperation Among Nations Suggestions on incorporating the Multimedia exploration into the lesson plan The key objectives of Chapter 10 are: Understanding the importance of GATT and WTO. Discussing the different forms of economic integration between countries. Understanding the major trading blocs in todays world economy.

The following are some suggestions on how best to utilize the CultureQuest materials to achieve these objectives.


The chapter includes three active media hangers, called CultureQuest Insight Into, on the three key topic areas: culture, business, geography & history. In this chapter all three focus on Mexico. For each Active Media lesson, assign your students to review the online materials that include additional video and discussion of the respective topic. They will need to review this online material in order to answer the test questions as well as participate in suggested activities and discussion noted later in this section. Review the case in the text at the end of the chapter and use it as an example to initiate additional discussion and activities


Additional Exercises 1. Student Activity and Discussion: After the students have read the chapter end case and reviewed the online materials, discuss the following questions and statements.

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With the focus on outsourcing and manufacturing overseas, do you think maquiladoras are helpful to the Mexican economy? The American economy? How do you think the maquiladoras are impacted by Mexican culture? American culture? How might this impact foreign companies operating in Mexico at the maquiladoras?

2. Team Activity and Discussion: Group students into teams of 2-3. Have each team select an American company with operations in Mexico. Research the following: How do the Mexican and American operations differ and how are they similar? Discuss how cultural nuances between the countries impact how the company operates.

Additional test questions on this information can be found in the Test Item File.

Chapter 10: Test Questions 1. Which of the following best describes maquiladoras? a. b. c. d. Large Mexican business conglomerates Production facilities located in Mexico just south of the border with the U.S. Tasty tequila based drinks None of the above.

B. Maquiladoras are manufacturing or production facilities based in Mexican border towns. Most are run by North American, Asian and European multinational companies. 2. True or False. NAFTA has a significant impact on Mexicos economy and its business practices. True. The North American Free Trade Agreement (NAFTA) has added to the U.S.s alreadystrong influence on Mexicos corporate and business practices. In particular, competitiveness and efficiency have become higher priorities, although company owners and managers still like to surround themselves with people they know and groom their sons and sometimes their daughters to be their successors. American influence is also pervasive in the products and services offered throughout Mexico.

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3. True or False. Business in Mexico is based more on the merits of the deal and relationships do not matter much. False. Long-term relationships are still the foundation on which trust is established and business is built. In Mexico, patience and the willingness to wait are still highly valued and necessary in business transactions. This is slowly changing, spurred in part by an aggressive cadre of young professionals who pursued graduate education in the United States. 4. Discuss local opposition to Mexicos economic policies. The political situation in the state of Chiapas has received widespread media attention. This rural region in southern Mexico is home to extremely poor Maya, Chol, Zoque, and Lacandn Indians. Chiapas is now the poorest Mexican state with the richest natural resources, including oil, minerals, and electrical power. The people in Chiapas have more in common with their Central American neighbors, with whom they share many physical, linguistic, and cultural characteristics. In January 1994, the day the North American Free Trade Agreement (NAFTA) officially took effect, a group of Indian peasants, commanded by Subcomandante Marcos, rose up in armed rebellion. This was shocking not only to Mexicos leadership but to the international community. The unrest in Chiapas stems from longstanding economic and social injustice in the region and from the Indians isolation and exploitation by the local oligarchy of landowners and mestizo bosses (caciques). Since 1994, the group, calling itself the Zapatista National Liberation Army (Ejrcito Zapatista de Liberacin Nacional, or EZLN), has engaged in only a smattering of guerrilla activities in Chiapas, around San Cristobal de las Casas and Ocosingo. However, using a combination of strategies, including effective use of the Internet, Marcos and the Zapatistas have continued to increase awareness about the plight of Mexicos indigenous peoples. Equally important, the Zapatistas have opened a debate about the national legitimacy of the PRI, particularly its use of fraud, bribes, and other corrupt tactics to control and win elections at national, state, and local levels. Among the concerns are the PRIs authoritarianism, repression of opposition groups, and increasing alliance with and dependence on the U.S. government. The Mexican government has indicated that improving the social conditions in the region is a high priority. However, only partial accords have been reached between the government and the peasants. At the same time, the army continues to exert tight control over the state, particularly in and around towns where residents are known to support the rebels. The low standard of living in Chiapas, and of Indians throughout Mexico, remains a significant challenge for the Mexican government. In the years following the Chiapas uprising, poverty in southern Mexico has risen to about 40 percent.

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CASE 1ONE: Regulatory Warfare This closing case focuses on the Kodak and Fuji battle for world market share. Both companies feel that the other is operating unfairly and have led various campaigns in an effort to undermine each others market positions. Key Points

Kodak and Fuji are engaged in a bitter fight to dominate the world film market. At the present time, Kodak has 70% of the U.S. market, 11% of the Japanese market, and 36% of the market outside Japan and the United .States. In contrast, Fuji owns 67% of its home market, 11% of the U.S. market, and 31% of the market outside the United .States. and Japan.

Fuji was able to gain its large marketshare in Japan because of high tariffs. Today, however, the tariffs have been eliminated, and strangely enough, it is the United .States. that now has a higher tariff in place. Despite the elimination of the Japanese tariff, Kodak strongly feels that its poor position in the Japanese market is the result of trade barriers rather than lack of effort on its part.

The United .States. supports Kodaks assertion, citing that Japans government has promoted exclusive wholesaling arrangements that favor Fuji, has hindered the growth of large discount stores that would stock foreign goods, and has restricted the use of price competition and price promotion that would allow Kodak to underprice Fuji. Kodak also filed a dumping charge against Fuji that resulted in antidumping levies. However, the tactic may have backfired on Kodak, because now Fuji has expanded its U.S. manufacturing operations and is in a position not only to avoid the U.S. tariff on imported film, but also to respond to changes in the U.S. market. Fuji is actively fighting Kodak, arguing that the Japanese market is more open than the U.S. market. It notes that Afga has been successful in attaining 5% of the Japanese market since 1990. Fuji also contends that Kodak encourages U.S. retailers to carry only the Kodak brand. The war between the two companies is far from over. Kodak recently spent millions filing a complaint with the World Trade Organization (WTO) that the Japanese government had undertaken covert measures to restrict access to the Japanese film market. The WTO rejected the claim, but in the process required Japan to rebut the complaint on a case-by case point. Kodak feels that although the case was rejected, it was still a valuable process because Japan was forced to make

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promises to the WTO that should improve its chances for success in the Japanese market. Case Questions 1. Fujis success seems to be a good example of the application of the infant industry argument for intervening in free trade. Do you think that Fuji would have been able to dominate Japans film market if Japan had not imposed tariffs on photo film? Most students will probably agree that Fuji would have had a far more difficult battle to gain marketshare in Japan without the trade barriers to protect its efforts. However, students will probably point out that Fuji must be doing something right since it has been able to grab a large share of the world market as well. Kodak, in contrast, might be seen by some students as an example of a company that was enjoying a near-monopoly position for too long, and was finally caught off-guard. Many students may suggest that consumers are much better off as a result of Fujis presence in the world film market. 2. Kodaks strategy seems to be to use the regulatory process to accomplish what it has not been able to do through normal competitive processes. Do you agree with this strategy? Are there dangers to it? Many students may see Kodaks position as a cop-out one. It may appear that anytime things do not go the Kodak way, the company immediately files some sort of complaint. Students may feel that the company would be better served if it devoted more attention to its product and consumers instead. Students may contend that had Kodak been focused on the consumer from the start, it might not find itself in its current position of constantly defending its marketshare. 3. Consider Fujis argument that it does to Kodak in Japan what Kodak does to it in the U.S. market. If true, does this weaken Kodaks case? While the current situation between the two companies is representative of a tit-fortat war, most students will probably agree that Fuji benefited tremendously from the very high tariffs that the Japanese government put in place on imported film. Without these tariffs, Fuji would have had a much more difficult time securing its leadership position in its domestic market. 4. How significant for Kodak is the Japanese governments pledge to not stand in the way of price competition? Some students will probably suggest that this pledge will mean an end to Kodaks claims of unfair competition. Others, however, will probably suggest that Kodak will simply find another reason for its lack of success in Japan, and that the company will not capitalize on the opportunity. Students taking this perspective will probably suggest that Kodak has made the decision, knowingly or not, to fight its battles with Fuji via official complaint rather than a better marketing mix.

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CASE TWO: Nike Inc.: Developing an Effective Public Relations Strategy This case describes the difficulties Nike faced in protecting its corporate image in the face of mounting criticism against how Asian workers were being treated in plants producing goods under contract for Nike. Key Points:

Nike came under criticism for long hours, low pay, abusive managers, and harsh working conditions at Nike-e aligned factories in China and Indonesia. Nike initially ignored the criticism, pointing out that the factories were not their responsibility (Nike subcontracted out the production of the shoes). A Nike senior executive stated, "We don't pay anyone at the factories, and we don't set policy within the factories." Criticism continued to mount and Nike developed a Code of Conduct for subcontractors, and later a Manufacturing-Environment-Safety-Health (MESH) program. Neither program satisfied Nike's critics.

Nike commissioned a report by Andrew Young (former U.S. Ambassador to the UN) that claimed Nike was doing a reasonably good job of protecting workers, but the report was criticized as not being sufficiently objective. A critic stated that "Nike has spent millions of dollars buying off major athletes -- now it's bought off Andrew Young." Nike continues to struggle with these criticisms and has been unable to protect its corporate image. Case Questions: 1. What can Nike's Corporate Responsibility team do to improve Nike's public image? This is the proverbial $64 question. Nike has tried almost everything, yet has been unable to shake its negative image. Publicizing subcontractors that have been dropped because of their inappropriate practices might help demonstrate Nikes commitment to factory workers. Of course, by dropping a subcontractor, Nike would be responsible for putting many Asian workers out of a job. Students should be encouraged to think creatively. Perhaps instead of continuing to dwell on the Asian factory issue, a campaign should be launched showing Nike's corporate responsibility in other areas, such as philanthropy. 2. Why have Nike's attempts to date to address its critics been unsuccessful? Nike's "bottom line" has not yet been seriously affected and one might construe that as a limited success in Nike's handling of this issue. However, Nike's attempts to put the issue behind it have all failed. The failure is in part due to the nature of the issue. Any attempt to address it simply brings the plight of the Southeast Asian

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worker back to the public eye. Indeed, there is not a whole lot Nike can do to have a significant impact on working conditions in Asia. There is truth to Nike's position that "multinational factories had a responsibility to pay competitive wages but not to change the living standards of a nation." However, the high price of Nike's shoes makes the factory conditions and wages paid all the more troublesome. 3. What damage, if any, has been done to Nike? Has Nike reacted appropriately? Has it overreacted? Underreacted? It is difficult to offer precise answers to these questions. There is a lot of room for interpretation and the instructor should build on that ambiguity to promote a lively class discussion. There has been some damage to Nike's image, but competitors have failed to capitalize on it thus far. Given the widespread use of subcontracting in the athletic footwear industry, Nike's competitors probably have no better trackrecord than Nike and will be hesitant to use Nike's image problems to their advantage (lest the public eye turn on them instead). Hindsight suggests that Nike's early dismissal of the issue was a fatal error. Had they not adopted an "its not my problem" attitude initially, their later attempts to improve factory conditions would have been more credible. It could well be argued that originally Nike underreacted and is now having a hard time undoing the damage. 4. Many of Nike's competitors subcontract production to Asian factories similar to those used by Nike. Why was Nike singled out by human rights and labor rights activists? Activists typically single out industry leaders, since they are most visible and well known. Nike's high profile made them a natural target. Nike was also a likely target because of the visibility of its athlete spokespersons and the huge endorsement contracts awarded by Nike. The contrast between multimillion dollar contracts with Michael Jordan and the plight of the Indonesian factory worker played dramatically in the public eye -- as did the contrast between what Nike charged customers for its shoes compared to what factory workers were paid to produce them. 5. What responsibility does Nike have to the workers in the factories of its subcontractors? What wage rates should it require them to pay their workers? Nike makes the decision as to what firms should be enlisted as subcontractors for Nikes manufacturing. By simply hiring the lowest bidder without considering the bidders treatment of its employees, Nike indirectly promotes poor working conditions. At the very least, in order to protect its reputation, Nike should make sure that workers in the factories of its subcontractors are treated fairly and make a competitive wage. Students may debate the appropriate wage from a variety of perspectives. In the end, it is likely that they will agree that wages should be at least average for the country where the work is taking place. Some students will argue that Nike should show leadership in social responsibility and require that subcontractors pay at least a living wage regardless of what other firms in the area may be paying.

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CASE THREE: The Second Cultural Revolution This case describes the impact of the Internet on China and the Chinese governments reaction to the threats it poses. The case is used to highlight political risk issues (discussed in Chapter 3). Key Points: The Internet is an especially challenging development for the Chinese government because of its attempt to control the information that reaches the Chinese people.

On the other hand, the Chinese government recognizes the importance of the Internet and the need for Chinese experts in Internet -related software and hardware development. So, the Chinese government wants to restrict Internet use, while it would also like its people to be proficient in it. The Chinese government has approved a number of measures that restrict foreign ISPs (Internet Service Providers) operations in China and that protect government monopolies in the industry. The Chinese government has also attempted to limit western influence by promoting the Linux operating system over products offered by Microsoft. The government seems to have a clear anti-western bias in regulations concerning information technology and the Internet. Case Questions: 1. Characterize the types of investments that are most vulnerable to political risk. Characterize those that are least vulnerable. On a scale of 1 to 10, with 10 being the highest, how vulnerable are dot-com investments to political risks? The level of risk is associated with the level of investment. Generally speaking, dotcom investments (though very risky as far as business propositions) are not more susceptible to political risk than other investments. A 3 or 4 ranking would not be unreasonable. However, if the student is thinking specifically of China, the political risk ranking would be considerably higher. Dot-com investments may or may not require a large investment in specific iInternet-related assets located in China. The more assets located in China, the higher the risk, especially given the Chinese governments history of controlling information flows. 2. Assume you are the CEO of a North American dot-com company. Perform a political-risk assessment for your companys entrance into the Chinese market. What information would you need to conduct the study? What factors would you consider?

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As the text notes, what and how much information a firm needs to assess political risk will depend on the type of business and the length of the commitment. In China, you would face ownership risk, operating risk, transfer risk, macropolitical risk, and micropolitical risk. Business -related laws in China change frequently and the ones currently on the books may or may not be enforced. On the positive side, the Chinese government seems to be stable. Ultimately, the question boils down to whether the potential benefits are large enough to warrant the necessary risks. Given the size of the Chinese market for Internet- related services (as well as its recent growth), foreign companies may be willing to cope with a significant amount of risk. 3. What strategies would you adopt to reduce your vulnerability to political risk in China? Intels decision to locate in Hong Kong seems like a good strategy. Hong Kong, though a part of China, operates with greater freedom from government interference. Students will likely suggest the use of local partners in a venture as another way of reducing political risk. Gradually increasing investment in China might reduce political risk in the near future, but it may also handicap the firm in the long run. 4. Do you think the Chinese government will be successful in controlling the use of the Internet and minimizing Western influences in China? This, of course, requires speculation. Students should be evaluated on how well they support whatever position they select. Most students will probably say that eventually, attempts to control Internet use and Western influence will fail and history is probably on their side. The Chinese government has chosen to open up its economy and it will be difficult to maintain an open economy with significant opening of information flows and communications across countries. 5. What will be the impact of the governments efforts on the global competitiveness of Chinas high-tech industries? Repressive efforts such as those described in the case will tend to reduce Chinas long- term competitiveness in high-tech industries.

Resources for additional information NAFTA Secretariat Information on NAFTA; Topics related to NAFTA & democracy, health, investment, environment, etc.; copy of NAFTA law United States Mexico Chamber of Commerce; Information on USMexico relations (economy, NAFTA, government, links); Information on Free Trade Agreements and related topics

International Cooperation Among Nations > 167 Definition of NAFTA with a link to the European Union, member countries and their relations Trade policy: on the slow track Foreign Policy in focus; Key problems, problems with current US policy, toward a new foreign policy European Union website The European Union and Latin America business news for Latin America Latin trade news site Latin America news and up-to-date headlines

Resources for additional information NAFTA Secretariat Information on NAFTA; Topics related to NAFTA & democracy, health, investment, environment, etc.; copy of NAFTA law United States Mexico Chamber of Commerce; Information on US-Mexico relations (economy, NAFTA, government, links); Information on Free Trade Agreements and related topics Definition of NAFTA with a link to the European Union, member countries and their relations Trade policy: on the slow track Foreign Policy in focus; Key problems, problems with current US policy, toward a new foreign policy European Union website The European Union and Latin America business news for Latin America Latin trade news site Latin America news and up-to-date headlines