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1.

What are the various method to entry in the foreign


market?

Ans:

The decision of how to enter a foreign market can have a significant


impact on the results. Expansion into foreign markets can be achieved via
the following four mechanisms:

• Exporting
• Licensing
• Joint Venture
• Direct Investment

Exporting

Exporting is the marketing and direct sale of domestically-produced goods


in another country. Exporting is a traditional and well-established method
of reaching foreign markets. Since exporting does not require that the
goods be produced in the target country, no investment in foreign
production facilities is required. Most of the costs associated with
exporting take the form of marketing expenses.

Exporting commonly requires coordination among four players:

• Exporter
• Importer
• Transport provider
• Government

Licensing

Licensing essentially permits a company in the target country to use the


property of the licensor. Such property usually is intangible, such as
trademarks, patents, and production techniques. The licensee pays a fee
in exchange for the rights to use the intangible property and possibly for
technical assistance.

Because little investment on the part of the licensor is required, licensing


has the potential to provide a very large ROI. However, because the
licensee produces and markets the product, potential returns from
manufacturing and marketing activities may be lost.
Joint Venture

There are five common objectives in a joint venture: market entry,


risk/reward sharing, technology sharing and joint product development,
and conforming to government regulations. Other benefits include political
connections and distribution channel access that may depend on
relationships.

Such alliances often are favorable when:

• the partners' strategic goals converge while their competitive goals


diverge;
• the partners' size, market power, and resources are small compared
to the industry leaders; and
• partners' are able to learn from one another while limiting access to
their own proprietary skills.

The key issues to consider in a joint venture are ownership, control, length
of agreement, pricing, technology transfer, local firm capabilities and
resources, and government intentions.

Potential problems include:

• conflict over asymmetric new investments


• mistrust over proprietary knowledge
• performance ambiguity - how to split the pie
• lack of parent firm support
• cultural clashes
• if, how, and when to terminate the relationship

Joint ventures have conflicting pressures to cooperate and compete:

• Strategic imperative: the partners want to maximize the advantage


gained for the joint venture, but they also want to maximize their
own competitive position.
• The joint venture attempts to develop shared resources, but each
firm wants to develop and protect its own proprietary resources.
• The joint venture is controlled through negotiations and
coordination processes, while each firm would like to have
hierarchical control.

Foreign Direct Investment

Foreign direct investment (FDI) is the direct ownership of facilities in the


target country. It involves the transfer of resources including capital,
technology, and personnel. Direct foreign investment may be made
through the acquisition of an existing entity or the establishment of a new
enterprise.

Direct ownership provides a high degree of control in the operations and


the ability to better know the consumers and competitive environment.
However, it requires a high level of resources and a high degree of
commitment.

The Case of EuroDisney

Different modes of entry may be more appropriate under different


circumstances, and the mode of entry is an important factor in the
success of the project. Walt Disney Co. faced the challenge of building a
theme park in Europe. Disney's mode of entry in Japan had been licensing.
However, the firm chose direct investment in its European theme park,
owning 49% with the remaining 51% held publicly.

Besides the mode of entry, another important element in Disney's


decision was exactly where in Europe to locate. There are many factors in
the site selection decision, and a company carefully must define and
evaluate the criteria for choosing a location. The problems with the
EuroDisney project illustrate that even if a company has been successful
in the past, as Disney had been with its California, Florida, and Tokyo
theme parks, future success is not guaranteed, especially when moving
into a different country and culture. The appropriate adjustments for
national differences always should be made.

Comparision of Market Entry Options

The following table provides a summary of the possible modes of foreign


market entry:

Comparison of Foreign Market Entry Modes

Conditions Favoring
Mode Advantages Disadvantages
this Mode
Exporting Limited sales potential in Minimizes risk and Trade barriers &
target country; little investment. tariffs add to costs.
product adaptation
required Speed of entry Transport costs

Distribution channels close Maximizes scale; Limits access to local


to plants uses existing information
facilities.
High target country Company viewed as
production costs

Liberal import policies an outsider

High political risk


Import and investment
barriers
Lack of control over
Minimizes risk and
use of assets.
Legal protection possible in investment.
target environment.
Licensee may become
Speed of entry
competitor.
Licensing Low sales potential in
target country. Able to circumvent
Knowledge spillovers
trade barriers
Large cultural distance
License period is
High ROI
limited
Licensee lacks ability to
become a competitor.
Import barriers

Large cultural distance Overcomes


ownership Difficult to manage
Assets cannot be fairly restrictions and
priced cultural distance Dilution of control

High sales potential Combines resources Greater risk than


Joint of 2 companies. exporting a &
Ventures Some political risk licensing
Potential for learning
Government restrictions on Knowledge spillovers
foreign ownership Viewed as insider
Partner may become
Local company can provide Less investment a competitor.
skills, resources, required
distribution network, brand
name, etc.

Import barriers Greater knowledge of


local market Higher risk than other
modes
Small cultural distance
Can better apply
Direct specialized skills Requires more
Assets cannot be fairly resources and
Investme priced commitment
nt Minimizes knowledge
spillover
High sales potential May be difficult to
manage the local
Can be viewed as an resources.
Low political risk insider

Feedback
2. What are various environmental factors that affect
International Business?

Ans:
A company that chooses to implement an international project is obligated
to conduct a thorough research in order to understand if such project is
viable and can be brought to life in a certain country. Numerous factors
have to be taken into consideration and investigated; it has to be done
objectively from the point of view of the host country in which business
will be performed. Thus the home company can ensure the realization of
the project in specified terms with regards to projected profits and
spending funds.

While analyzing foreign environment companies have to pay close


attention to various factors that will effect, or help if used efficiently,
future success of business in a new economy. First of all it is necessary to
carefully examine the firm’s competitive position and understand if a
project is able to bring profit in the global industry. Adequate financial
resources, successful global ventures in the past, risk levels that a
company is able to undertake and growing international demand are
those few questions that need to posed before a firm can make any
projections as to doing business abroad. There are also factors that are
directly connected to specific projects and situations and that influence
the outcome of the venture and have to be considered.

In case when a company is ready to start international project in terms of


its internal situation, it has to study issues and challenges that are caused
by macro economical and other environmental factors. Legal and political
factors are essential for the implementation of the project abroad and
each country has its own laws and regulations that could be of negative or
positive influence which greatly depends on the nature of business.
Economic condition of the host county is a core issue in deciding where
and when project will be carried out and if it is feasible at all. Such
environmental issues as GDP, inflation fluctuations and population growth
have to be considered in order to comprehend conditions in which
business will operate. Infrastructure and geography are among other
factors that will affect the project or not allow its execution in case a host
county has severe weather conditions or undeveloped infrastructure; for
instance unpaved roads and no electrical power can easily fail the project
in the very beginning and thus knowing such conditions is necessary.
Security of the country in which project will be developed is essential as
well, people make things happen and if they are in a dangerous
environment it is priory impossible to do business. Workers who are
knowledgeable about cultural differences in a host country are more likely
to perform successfully as traditions and holidays can play a huge role in
certain marketing campaigns and serve for the good image of the
company.

Working in a foreign country requires a great deal of preparation and


assessment of all possible differences that the business is about to
encounter. As was already said, major role in deciding whether or not the
project will be successful is comprehending macro environment of a new
country. Studying its economical condition, security levels and
infrastructure system is a core competence of a company who wants to be
more successful that its competitors. In case when all of those factors are
studied and considered advantageous for a new enterprise, it is important
to bear in mind that cultural differences can make all efforts void. Thus
businesses must attentively analyze what changes have to be made in the
business plan and what people are best suit for its implementation. Often,
companies hire professionals already experienced in such ventures with
foreign education who speak two or more languages. Those intermediaries
who are familiar with host country’s traditions and have social
connections are great helpers in establishing a good image of the
company abroad and in avoiding mistakes in a setting up period.

Selecting and training employees for the international project is very


important for the future success of the company. Culture shock and
coping with it are issues that have to be addressed to potential workers.
Consequently firms need to inform and train employees on how to cope
with cultural diversities and benefit from them to better manage in the
new environment.

Feedback
3. Give ten reasons why FDI is beneficial to developing
Economy?

Ans:

Foreign direct investment (FDI) was founded by Aziz Mahdi and is a


measure of foreign ownership of productive assets, such as factories,
mines and land. Increasing foreign investment can be used as one
measure of growing economic globalization.

A foreign direct investor may be classified in any sector of the


economy and could be any one of the following:

 an individual;
 a group of related individuals;
 an incorporated or unincorporated entity;
 a public company or private company;
 a group of related enterprises;
 a government body;
 an estate (law), trust or other societal organisation; or
 any combination of the above.
Foreign direct investment (FDI) policies play a major role in the economic
growth of developing countries around the world. Attracting FDI inflows
with conductive policies has therefore become a key battleground in
the emerging markets.

Developed countries also seek to bring in more FDI and use various
policies and incentives to attract overseas investors, particularly for
capital-intensive industries and advanced technology.

The primary aim of these policies is to create a friendly business


environment where foreign investors feel comfortable with the legal and
financial framework of the country, and have the potential to reap profits
from economically viable businesses. The prospect of new growth
opportunities and outsized profits encourages large capital inflows across
a range of industry and opportunity types.

IN INDIA
(FDI) in India has played an important role in the development of the
Indian economy. FDI in India has - in a lot of ways - enabled India to
achieve a certain degree of financial stability, growth and development.
This money has allowed India to focus on the areas that may have needed
economic attention, and address the various problems that continue to
challenge the country.

India has continually sought to attract FDI from the world’s major
investors. In 1998 and 1999, the Indian national government announced
a number of reforms designed to encourage FDI and present a favorable
scenario for investors.

FDI investments are permitted through financial collaborations, through


private equity or preferential allotments, by way of capital markets
through Euro issues, and in joint ventures. FDI is not permitted in the
arms, nuclear, railway, coal & lignite or mining industries.

A number of projects have been announced in areas such as electricity


generation, distribution and transmission, as well as the development of
roads and highways, with opportunities for foreign investors.

The Indian national government also provided permission to FDIs to


provide up to 100% of the financing required for the construction of
bridges and tunnels, but with a limit on foreign equity of INR 1,500 crores,
approximately $352.5m.

Currently, FDI is allowed in financial services, including the growing credit


card business. These services include the non-banking financial
services sector. Foreign investors can buy up to 40% of the equity in
private banks, although there is condition that stipulates that these banks
must be multilateral financial organizations. Up to 45% of the shares of
companies in the global mobile personal communication by satellite
services (GMPCSS) sector can also be purchased.

By 2004, India received $5.3 billion in FDI, big growth compared to


previous years, but less than 10% of the $60.6 billion that flowed into
China. Why does India, with a stable democracy and a smoother approval
process, lag so far behind China in FDI amounts?

Although the Chinese approval process is complex, it includes both


national and regional approval in the same process.

Federal democracy is perversely an impediment for India. Local


authorities are not part of the approvals process and have their own
rights, and this often leads to projects getting bogged down in red tape
and bureaucracy. India actually receives less than half the FDI that the
federal government approves.

INVESTMENT BY NON RESIDENT INDIANS & OVERSEAS


CORPORATE BODIES

For all sectors, excluding those falling under Government approval, NRIs
(which also
includes PIOs) and OCBs (an overseas corporate body means a company
or other entity owned directly or indirectly to the extent of at least 60% by
NRIs) are eligible to bring investment through the automatic route of RBI.
All other proposals, which do not fulfil any or, all of the criteria for
automatic approval are considered by the Government through the FIPB
(Foreign Investment Promotion Board).

The NRIs and OCBs are allowed to invest in housing and real estate
development sector, in which foreign direct investment is not permitted.
They are allowed to hold up to 100 percent equity in civil aviation sector
in which otherwise foreign equity only up to 40 per cent is permitted.

BENEFITS OF FDI:

Economic growth- This is one of the major sectors, which is enormously


benefited from foreign direct investment. A remarkable inflow of FDI in
various industrial units in India has boosted the economic life of country.

Trade- Foreign Direct Investments have opened a wide spectrum of


opportunities in the trading of goods and services in India both in terms of
import and export production. Products of superior quality are
manufactured by various industries in India due to greater amount of FDI
inflows in the country.
Employment and skill levels- FDI has also ensured a number of
employment opportunities by aiding the setting up of industrial units in
various corners of India.

Technology diffusion and knowledge transfer- FDI apparently helps


in the outsourcing of knowledge from India especially in the Information
Technology sector. It helps in developing the know-how process in India in
terms of enhancing the technological advancement in India.

Linkages and spillover to domestic firms- Various foreign firms are


now occupying a position in the Indian market through Joint Ventures and
collaboration concerns. The maximum amount of the profits gained by the
foreign firms through these joint ventures is spent on the Indian market.

DISADVANTAGES OF FDI:

At times it has been observed that certain foreign policies are adopted
that are not appreciated by the workers of the recipient country. Foreign
direct investment, at times, is also disadvantageous for the ones who are
making the investmentthemselves.

Foreign direct investment may entail high travel and communications


expenses. The differences of language and culture that exist between the
country of the investor and the host country could also pose problems in
case of foreign direct investment.

Yet another major disadvantage of foreign direct investment is that there


is a chance that a company may lose out on its ownership to an overseas
company. This has often caused many companies to approach foreign
direct investment with a certain amount of caution.

At times it has been observed that there is considerable instability in a


particular geographical region. This causes a lot of inconvenience to
the investor.

CURRENT EVENTS RELATED TO FDI:

IAF Vice Chief Air Marshal P K Barbora said that private industry's
participation be increased in the defence sector and India should be "bold
enough" to allow more FDI in the area.

The Foreign Investment Promotion Board has rejected a proposal by the


Jaipur IPL Cricket Pvt to induct 100% foreign equity by issuing shares for a
non-cash consideration. While approving 17 foreign direct investment
proposals worth Rs 1,159
crore at its October 30 meet.

The FIPB, will refer foreign investments in sensitive sectors to a committee


of secretaries. The panel will have representatives from various
government departments. The crucial difference will be that the
committee will be time bound and will have specific parameters to weigh
the risks.

The Textiles Minister, Mr Dayanidhi Maran, has said there is an urgent


need to attract and sustain foreign direct investment in the textiles sector
if India is to achieve the goals of employment generation and technology
upgradation, besides attaining four per cent share in the global trade in
textiles and clothing.

Feedback:

4. Discuss the FDI climate between India, China and


Vietnam.

Ans:
FDI Climate between India, China and Vietnam
PARAMETER India

FDI IN 2008-09 23885 $

How to enter • Through financial


alliance
• Through joint
schemes and technical
alliance
• Through capital
markets, via Euro issues

• Through private
placements or
preferential allotments
Sectors in which
FDI or
100% equity is • Hotel & tourism
allowed • Trading companies Foreign
• Power generation/ Direct
transmission/distrib
Investment
ution
• Drugs & Pharma is any form
• Shipping of
• Deep Sea Fishing
• Oil Exploration investment
• Housing and Real that earns
Estate
Development interest in
• Highways, Bridges enterprises
and Ports
which
• Sick Industrial Units
• Industries Requiring function
Compulsory outside of
Licensing
• Industries Reserved the
for Small Scale domestic
Sector
100% is not • Private banking territory of
allowed (49%) the investor
• Insurance (26%)
• Telecommunication Types:
(49% / 74 %)
• Retail (51% in 1) Out
single brand) war
FDI not at all • Arms and d
allowed ammunition FDI:
• Atomic Energy An
• Coal and lignite
• Rail Transport
• Mining of metals
like iron, manganese,
chrome, gypsum, sulfur,
gold, diamonds, copper,
zinc
outward-bound FDI is backed by the government against all types
of associated risks. This form of FDI is subject to tax incentives as
well as disincentives of various forms
2) Inward FDI: Here, investment of foreign capital occurs in local
resources.
3) Vertical FDI: It takes place when a multinational corporation
owns some shares of a foreign enterprise, which supplies input for
it or uses the output produced by the MNC.
4) Horizontal FDI: It happens when a multinational company carries
out a similar business operation in different nations.

I] CLIMATE IN INDIA: Several factors being attributed to the revival in


foreign direct investments (FDI) in the country include liberal investment
policies and reforms, innovative and technologically advanced products
being manufactured in India and low cost and effective solutions. FDI
equity inflows amounting to US$ 10.532 billion were received during April-
July 2009. The largest FDI of US$ 153.31 million will be brought in by Essel
Group-promoted DTH service provider. India is targeting annual foreign
direct investments worth $50 billion by 2012. It would double the inflows
by 2017. The government has approved 17 (FDI) proposals amounting to
US$ 250.56 million. Among those projects approved were FDI applications
for steel maker ArcelorMittal and iron pipe maker Electrosteel Castings.
With the government planning more liberalisation measures across a
broad range of sectors and continued investor interest, the inflow of FDI
into India is likely to further accelerate.

II]CLIMATE IN CHINA: The top sources of FDI in China in 2008 were:


Hong Kong, the British Virgin Islands, Singapore, Japan, the Cayman
Islands, South Korea, the United States, Western Samoa, and Taiwan.

The growth rate of foreign direct investment (FDI) into China accelerated
to 23% in 2008 to $92.3 billion, according to Ministry of Commerce
statistics. According to the United Nations Conference on Trade and
Development (UNCTAD), in 2007, mainland China was the world’s sixth
largest FDI recipient, after the United States, the United Kingdom, France,
Canada, and the Netherlands. China also received the most votes in a
2007 UNCTAD poll of attractive investment destinations, followed by India,
the United States, Russia, Brazil, and Vietnam.

While FDI in China shot higher, investors continued to face a range of


potential problems that could expose them to risks in the future. Problems
foreign investors face in China include lack of transparency, inconsistently
enforced laws and regulations, weak IPR protection, corruption, industrial
policies that protect and promote local firms, and an unreliable legal
system. In 2008, China continued to lay out a legal and regulatory
framework granting it the authority to restrict foreign investment that it
deems not to be in China’s national interest. In many ways, the new rules,
codify standards and practices that China was already employing in its
existing, mandatory foreign investment approval process. Key terms and
standards in the new regulations are undefined. At the moment, China
appears to be using the rules to restrict foreign investments that are:

• intended to profit from currency speculation;


• in sectors where the government is trying to tamp down aggregate
capital inflows and inflation;
• in sectors where China is seeking to cultivate “national champions;”
• in sectors that have benefited historically from state-authorized
monopolies or from a legacy of state investment;
• in sectors deemed key to social stability, like foodstuffs and heavily
polluting industries; and
• nominally “foreign” investment that is actually Chinese capital that
has been exported and re-imported to take advantage of
preferential treatment accorded to foreigners.
Although it remains to be seen how many of these rules will be applied,
they present several concerns to foreign investors. First, they appear to
give regulators significant discretion to shield inefficient or monopolistic
enterprises from foreign competition. They are also often applied in a
manner that is not transparent. Finally, overall predictability for foreign
investors has suffered because investors are less certain that China will
approve proposed investment projects. Some areas where investment is
restricted are news agencies radio and TV transmission networks, film
production, publication and importation of press and audio-visual
products, compulsory basic education, mining and processing of certain
minerals, processing of green and “special” tea using Chinese traditional
crafts and preparation of Chinese traditional medicine

At the end of 2008, in response to the weakening economy, China


announced a stimulus package that includes fiscal stimulus, business tax
cuts, and support for priority sectors that may present foreign investors
with new opportunities. China offers preferences for investments in
sectors it seeks to develop, including transportation, communications,
energy, metallurgy, construction materials, machinery, chemicals,
pharmaceuticals, medical equipment, environmental protection, energy
conservation, and electronics. Finally, China boasts numerous national
science parks, many focused on commercializing research developed in
Chinese universities. The parks provide infrastructure, management and
funding support for start-ups across a variety of industries, and welcome
foreign firms.

Investment Guidelines

While insisting it remains open to inward investment, China’s leadership


has also stated that China is actively seeking to target investment in
higher value-added sectors, including high technology research and
development, advanced manufacturing, energy efficiency, and modern
agriculture and services, rather than basic manufacturing. China would
also seek to spread the benefits of foreign investment beyond China’s
more wealthy coastal areas by encouraging multinationals to establish
regional headquarters and operations in Central, Western, and
Northeastern China.

Distribution of Foreign Investment

The vast majority of foreign investment is concentrated in China's more


prosperous coastal areas, including Guangdong, Jiangsu, Fujian, and
Shandong provinces, and Shanghai. Foreign investment in most service
sectors lags manufacturing, mainly due to government-imposed
restrictions. China is committed to gradually phasing out barriers in many
service industries, but progress has been slow

Dispute Settlement

Foreign firms report inconsistent results with all of China’s dispute


settlement mechanisms, none of which are independent of the
government. The government often intervenes in disputes. Corruption
may also influence local court decisions and local officials may disregard
the judgments of domestic courts. Well-connected local business people
are often in a better position to win court cases than are foreign investors
and it is possible that they may use their connections to avoid prosecution
for taking illegal actions against their former foreign partners. China’s
legal system rarely enforces foreign court judgments

As the economy has slowed, there have been anecdotal reports of local
governments singling out foreign investors, clients, and partners of
Chinese businesses to repay debts incurred by local businesses

III] CLIMATE IN VIETNAM

Vietnam has seen a vertical surge in its FDI inflows in the recent years,
thus becoming the third most popular investment destination after China
and India. The Vietnamese government is also trying its best to mould the
existing policies and laws, so as to keep the capital flow coming.
Statistically speaking, the FDI pledges in Vietnam have galloped from a
meager $ 11.3 billion in 2005 to $ 50 million in 2008. This year though the
FDI flows have taken a drubbing because of the volatile economic
prevalence and thus the reluctance of the foreign majors to part with the
cash, but the experts feel that Vietnam’s identity as an investor’s heaven
is here to stay. The major factors in the country which have led,
multinationals park huge investments in the country can be tabulated as
follows-

 Availability of a young, literate and cheap workforce.


 A stable socio-political situation
 Vietnam’s professionalized investment promotion activities, policy
formulation and implementation
 Cost of land, cost of consumables, very low as compared to other
locales
On account o the above stated reasons, the FDI in Vietnam surged to a
level of $64 billion in 2008. The investments were primarily in sectors like

 Construction
 High-tech areas
 Production of electronics
 Telecommunications
thus turning Vietnam into a manufacturing hub in Asia.

In 2009, the expected inflows in the country in the form of FDI pledges are
reported to plunge drastically on account of the skepticism, on the part of
the global investors, due to the ongoing slowdown. Experts have
forecasted a figure of $ 20-25 billion for this financial year in terms of the
FDI pledges, which is a fall of above 60%. Apart from the slowdown, the
various reasons that can be attributed to the same are doubts of
Vietnam’s capability to digest such huge investment sums. The various
factors that play a role here are

 inadequate infrastructure
 Management problems
 Shortage of adequately trained human resource

This lack of absorption capability has become a huge spoilsport as it is


believed that in 2006, out of the total investment funds inflow, 60 %
remained unutilized. These trends could further intensify the dollar
shortage faced by the country, on account of hoarding by companies
expecting the dong to depreciate. Thus the need of the hour for the
government is to plan and implement policies and infrastructure
development, which will restore investor confidence in Vietnam’s
capability to absorb the incoming funds.

Feedback
5. Discuss various international trade theories.

Ans:
1. Theory of Mercantilism

1) The first theory of international trade emerged in England in the


mid-16th century. Referred to as mercantilism, its principle
assertion was 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.
2) The main tenet of mercantilism was that it was in a country’s hand
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 and prestige.
3) As the English mercantilist writer Thomas Mun put it in 1630, The
ordinary means therefore to increase our wealth and treasure is by
foreign tread, where we must ever observe this rule: to sell more to
strangers yearly than we consume of theirs in value.
4) 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 per
se. Rather, they recommended policies to maximize exports and
minimize imports. To achieve this, imports were limited by tariffs
and quotas, while exports were subsidized.
5) The classical economist David Hume pointed out an inherent
inconsistency in the mercantilist doctrine in 1752. According to
Hume, if England had a balance-of-trade surplus with France (it
exported more than it imported) the resulting inflow of gold and
silver would swell the domestic money supply and generated
inflation in England. In France, however the outflow of gold and
silver would have the opposite effect. France’s money supply would
contract, and its prices would fall. This change in relative prices
between France and England would encourage the France to buy
fewer English goods (because they were becoming more expensive)
and the English to buy more Franch goods. The result would be
deterioration in the English balance of trade and an improvement in
France’s trade balance, until the English surplus was eliminated.
6) Hence, according to Hume, in the long run no country could sustain
a surplus OD the balance of trade and so accumulate gold and silver
as the mercantilists had envisaged.
7) The flaw with mercantilism was that it viewed trade as a zero game.
(A zero-sum game is one in which a gain by one country results in a
loss by another.)

2. Absolute Advantage Theory

1) In his 1776 landmark book The Wealth of Nations, Adam Smith


attacked the mercantilist assumption that trade is a zerosum game.
2) Smith argued that countries differ in their ability to produce goods
efficiently.
3) In his time, the English, by virtue of their superior manufacturing
processes, were the world’s most efficient textile manufacturers.
4) Due to the combination of favorable climate, good soils, and
accumulated expertise, the French had the world’s most efficient
wine industry.
5) 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.
6) 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.
7) In Smith’s time, this suggested that 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.
8) 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 you should never produce goods at home that you
can buy at a lower cost from other countries.
9) Smith demonstrates that by specializing in the production of goods
in which each has an absolute advantage, both countries benefit by
engaging in trade.
10) Consider the effects of trade between Ghana and South Korea.
The production of any good (output) requires resources (inputs)
such as land, labor, and capital. Assume that Ghana and South
Korea both have the same amount of resources and that these
resources can be used to produce either rice or cocoa.
11) Assume further that 200 units of resources are available in
each country. Imagine that in Ghana it takes 10 resources to
produce one ton of cocoa and 20 resources to produce one ton of
rice. Thus, Ghana could produce 20 tons of cocoa and no rice, 10
tons of rice and no cocoa, or some combination of rice and cocoa
between these two extremes.
12) The different combinations that Ghana could produce are
represented by the line GG’ in Figure 2.1. This is referred to as
Ghana’s production possibility frontier (PPF). Similarly, imagine that
in South Korea it takes 40 resources to produce one ton of cocoa
and 10 resources to produce one ton of rice.
13) Thus, South Korea could produce 5 tons of cocoa and no rice,
20 tons of rice and no cocoa, or some combination between these
two extremes. The different combinations available to South Korea
are represented by the line KK’ in Figure 2.1, which is South Korea’s
PPF.
14) Clearly, Ghana has an absolute advantage in the production of
cocoa. (More resources are needed to produce a ton of cocoa in
South Korea than in Ghana.) By the same token, South Korea has an
absolute advantage in the production of rice.

3. Ricardian Model (Comparative Advantage Theory)

1) 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.
2) Smith’s theory of absolute advantage suggests that such a country
might derive no benefits from international trade.
3) In his 1817 book Principles of Political Economy, Ricardo showed
that this was not the case.
4) 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.
5) While this may seem counterintuitive, the logic can be explained
with a simple example. Assume that Ghana is more efficient in the
production of both cocoa and rice; that is Ghana has an absolute
advantage in the production of both products. In Ghana it takes 10
resources to produce one ton one ton of cocoa and, 13 1/3
resources to produce one ton of rice. Thus, given its 200 units of
resources, Ghana can produce 20 tons of cocoa and no rice, 15 tons
of rice and no cocoa, or any combination in between on its PPF (the
ling GG’ in figure 2.2). In South Korea it takes 40 resources to
produce one ton of cocoa and 20 resources to produce one ton of
rice. Thus South Korea can produce 5 tons of cocoa and no rice, 10
tons of rice and no cocoa, or any combination on its PPF (the link KK’
in figure 2.2).
6) Again assume that without trade, each country uses half of its
resources to produce rice and
7) half to produce cocoa. Thus, without “trade, Ghana will produce 10
tons of cocoa, and 7.5 tons of rice (point A in
8) Figure 2.2), while South Korea will produce 2.5 tons of cocoa and 5
tons of rice (point B in Figure2.2).
9) In light of Ghana’s absolute advantage in the production of both
goods, why should it trade with South Korea? Although Ghana has
an absolute advantage in the production of both cocoa and rice, it
has a comparative advantage only in the production of cocoa:
Ghana can produce 4 times as much cocoa as South Korea, but only
1.5 times as much rice. Ghana is comparatively more efficient at
producing cocoa than it is at producing rice. Without trade the
combined production of cocoa will be 12.5 tons (10 tons in Ghana
and 2.5 in South Korea), and the combined production of rice will
also be 12.5 tons (7.5tons in Ghana and 5 tons in South Korea).
Without trade each country must consume what it produces. By
engaging in trade, the two countries can increase their combined
production of rice and cocoa, and consumers in both nations can
consume more of both goods.

10) The Gains from Trade


a) Imagine that Ghana exploits its comparative advantage in the
production of cocoa to increase its output from 10 tons to 15 tons.
This uses up 150 units of resources, leaving the remaining50 units
of resources to use in producing 3.75 tons of rice (point C in fig-ure
1.2).
b) Meanwhile, South Korea specializes in the production of rice,
producing l0 tons. The combined output of both cocoa and rice has
now increased.
c) Before specialization, the combined output was 12.5 tons of cocoa
and 12.5 tons of rice. Now it is 15 tons of cocoa and 13.75 tons of
rice (3.75 tons in Ghana and 10 tons in South Korea). The source of
the increase in production is summarized in Table 2.2.
d) Not only is output higher, but also both countries can now benefit
from trade. If Ghana and South Korea swap cocoa and rice on a one-
to-one basis, with both countries choosing to exchange 4 tons of
their export for 4 tons of the import, both countries are able to
consume more cocoa and rice than they could before specialization
and trade (see Table 2.2).
e) Thus, if Ghana exchanges 4 tons of cocoa with South Korea for 4
tons of rice, it is still left with 11 tons of rice, which is 1 ton more
than it had before trade. The 4 tons of rice it gets from South Korea
in exchange for its 4 tons of cocoa, when added to the 3.75 tons it
now produces domestically, leaves it with a total of 7.75 tons of rice,
which is 25 of a ton more than it had before specialization. Similarly,
after swapping 4 tons of rice with Ghana, South Korea still ends up
with 6 tons office, which is more than it had before specialization.
f) In addition, the 4 tons of cocoa it receives in exchange is 1.5 tons
more than it produced before trade. Thus, consumption of cocoa
and rice can increase in both countries as a result of specialization
and trade.
11) The basic message of the theory of comparative advantage is that
potential’ world production is greater with unrestricted free trade
than it is with restricted trade.
12) Ricardo’s theory suggests that consumers in all nations can
consume more if there are no restrictions on trade. This occurs even
in countries that lack an absolute advantage in the production of
any good.
13) In other words, to an even greater degree than the theory of
absolute advantage, the theory of comparative advantage suggests
that trade is a positive-sum game in which all countries that
participate realize economic gains.
14) As such, this theory provides a strong rationale for
encouraging free trade. So powerful is Ricardo’s theory that it
remains a major intellectual weapon for those who argue for free
trade.
4. Heckscher-Ohlin Theory

Swedish economists Eli Heckscher (in 1919) and Bertil Ohlin (in 1933)
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. 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 also has commonsense appeal.
For example, ‘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

Using the Heckscher Ohlin theory, Wassily 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.

What is Leontief Paradox?

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.

As per 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, 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.

Example : As per the theory, United States exports commercial aircraft


and imports automobiles not because its factor endowments are
especially suited to aircraft manufacture and not suited to automobile
manufacture, but because the United States is more efficient at
producing aircraft than automobiles. A key assumption in the Heckscher-
Ohlin theory is that technologies are .the same across countries. This
may not to be the case, and differences in technology may lead to
differences in productivity, which in turn, drives international trade
patterns.

5. The Product Life Cycle Theory

Raymond Vernon initially proposed the product life-cycle theory in the


mid-1960s. Vernon’s theory was based on the observation that for most
of the 20th 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. Inaddition,
the high cost of U.S. labor gave U.S. firms an incentiveto 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
products were initially produced- in America. Apparently, the pioneering
firms believed it was better to keep production facilities close 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 obviate the need to look for low cost production sites in other
countries. Vernon went on to argue that early in the life cycle of a typical
new product, demand is starting to grow rapidly in the United States,
demand in other advance countries is limited to highincome groups. The
limited initial demand in other advanced countries does not make it
worthwhile for firms in those countries to start producing the new
product, but it does necessitate some exports from the United States to
those 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 is
over time the United States switches, from being an exporter of the
Product to an importer of product as production becomes concentrated in
lower-cost foreign locations.

Figure 2.5 shows the growth of production and consumption over time in
the United States, other advanced countries, and developing countries.

6. New Trade Theory

New Trade Theory (NTT) is the economic critique of international free


trade from the perspective of increasing returns to scale and the network
effect

1. New Trade theorists challenge the assumption of diminishing


returns to specialization used in international trade theory. It
argues that increasing returns to specialization might exist in some
industries.
2. New trade theory also argues that if the output required to realize
significant scale economies represents a substantial proportion of
total world demand for that product the world market may be able
to support only a limited number of firms based in a limited number
of countries producing that product
Example: The commercial aerospace industry, which is currently
dominated by just two firms, Boeing and Airbus, is a good example of this
theory. Economies of scale in this industry come from the ability to
spread fixed costs over a large output.

Implication:

• "NTD" was the rigor of the mathematical economics used to model


the increasing returns to scale, and especially the use of the
network effect to argue that the formation of important industries
was path dependent in a way which industrial planning and
judicious tariffs might control.
• The model they developed was highly technical, and predicted the
possibilities of national specialization-by-industry observed in the
industrial world. The story of path-dependent industrial
concentrations sometimes leads to monopolistic competition.
Econometric evidence:

• The econometric evidence for NTT was mixed, and again, highly
technical. Due to the time-scales required and the particular nature
of production in each 'monopolizable' sector, statistical judgements
have been hard to make. In many ways, there is too limited a
dataset to produce a reliable test of the hypothesis which doesn't
require arbitrary judgements from the researchers.
Japan is cited as evidence of the benefits of "intelligent" protectionism,
but critics of NTT have argued that the empirical support post-war Japan
offers for beneficial protectionism is unusual, and that the NTT argument
is based on a selective sample of historical cases. Although many
examples (like Japanese cars) can be cited where a 'protected' industry
subsequently grew to world status, regressions on the outcomes of such
"industrial policies" (including the failures) have been less conclusive

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6.Discuss the impact of WTO on India’s trade policy.

Ans:
Agreement Provisions Impact Policy issue

General Prohibits: Binding of tariff -Competition from


Agreement on -Actions of lines. (India is foreign goods.
Trade'" Tariff. Government I committed to a -This affects
(GATT) Organisations that bind tariff lines at efficacy of
distort normal 40 per cent on Reservation
-Discrimination finished goods Policy.
between and 2S per cent Need for
Member nations on intermediate Reservation Policy
-Discrimination goods. machinery to move in
between domestic and equipment; tandem with OGL
and lawfully phased reduction list, with greater
imported foreign by 2005). emphasis on
goods -Quantitative competitiveness.
restrictions of -Need to
imports to be strengthen
phased out by competitiveness
1.4.2000 (original among domestic
deadline set was SSI through
2003. but India modernisation and
has lost in the technology
Disputes development.
Settlement Case).
-Create freer
trade regime.
Agreement on Countries to -Greater India bas
valuation of follow uniform transparency amended the
Goods procedures in -Beneficial to both Customs Act in
respect of importers and conformity with
customs exporters the Agreement.
formalities.
Agreement on To check arbitrary Indian companies India does not use
Pre-shipment ways of PSI exporting to services of PSI
inspection (PSI) companies in countries using companies.
valuation of PSI companies to
goods. benefit
Agreement on -Conformity with -Indian exporters -Bureau of Indian
Technical; international to benefit. As Standards (SIS)
Barriers to Trade standards import by other conforms to
(TBT) -Checks on countries are Agreement.
misuse of subject to -SIS in conformity
mandatory mandatory with International
products product standards.
standards standards. -BIS to serve as
-Establishment of -Enquiry points enquiry point.
enquiry points help facilitation.
-Process and
production
methods can be
used to
discriminate
against Indian
exports.
Agreement on Same as above International Most of Indian
Sanitary and except that standards to be standards in
Phytosanitary countries adopted conformity with
Measure. (SPM) can deny import International
from certain standards.
region/country on
the ground of
pest I disease
Agreement on Transparency and Beneficial to small Delays, discretion
import licensing time bound businesses, as and misuse of
they are usually licensing
at the receiving procedures to be
end of restricted cut.
practices.
Rules Applicable -Allows export (to -Neutralisation of -EXIM policy
on Exports be relieved of indirect taxes provides scheme
indirect taxes good. for neutralisation
(e.g. Excise Duty). -Present schemes of incidence of
-Prohibits direct providing waiver indirect taxes
tax benefits (e.g. of (e.g. Duty
Income Tax Income Tax on drawback,
waiver on export export earnings to advance licenses
earnings). be scrapped. etc.)
-Allows levy of Would affect price -Review of direct
duties on exports competitiveness tax benefits.
Agreement on -Prohibits export -Subsidies given EXIM Policy to be
Subsidies and subsidies to small made WTO
Countervailing -Phasing out by businesses are compatible.
Measures (SCM) 2003. usually
-Permits permissible and
permissible non-actionable.
subsidies. -Importing
countries can
countervail
subsidies that are
actionable. Will
make
Indian exports
more expensive.
-Small businesses
have to become
more
competitive.
Agreement on Allows countries Helpful provision Ministry of
Safeguard to take action Commerce &
Measures against undue Industry is putting
import surge required system in
injurious to place.
domestic industry
during transition
period. Measures
can include
Quantitative
Restrictions
(QRs), duty
enhancement
beyond bound
rates etc. period
extendable
Agreement on Allows countering Helpful provision Directorate of
Anti-Dumping unfair trade Anti-Dumping
Measures (ADP) practices. established in
Ministry of
Commerce &
Industry.
Trade Related Prohibits -Affects FOREX Measures
Investment countries from position. underway to
Measures imposing -Affects terminate notified
(TRIMS) conditions such Government TRIMs such as
as localisation, foreign Dividend
export obligation Investment Balancing
on investors. Policy
-Enhances
competition to
domestic industry
Market Access Binding of tariff -Increased India followed the
Negotiations lines competition from WTO time-table in
foreign goods. terms of reduction
-Does not help and binding of
Indian exporters, tariff lines.
as tariffs in
developed
countries already
low.
-India to really
Most Favoured Nation Treatment (MFN): No discrimination between
member nations.

National Treatment: No discrimination between domestic products and


lawfully imported products.

Subsidies: Permissible - Actionable and non-actionable; non-permissible.

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7. Discuss the various organisational structure in


International Business.

Ans:

There are five types of organizational structures: International Division


Structure, International Area Structure, Global Product Structure, Global
Matrix Structure, and Global Functional Design Structure.

INTERNATIONAL AREA STRUCTURE


The one that would be optimal for a company that is just expanding is the
International Area Structure. The reason this would be optimal is because
a company is new to selling internationally. "In this organizational
structure, the company is organized into countries or geographic regions."
This would be a benefit to have the organizational in this manner because
it would allow a company to focus on the region of the world we are
selling to and tailor the needs of mobility products to that area. As a
company grows internationally we can expect to see a companies
organization grow as well.

Using the International Area Structure will allow a company to hire


managers who specialize in understanding the cultural, commercial, social
and economic conditions we wish to expand to.
By using the International Area Structure, this is going to allow the
company to adapt additional marketing strategies, without disrupting the
ones company managers have worked so hard for. In addition, "an
international firm must address its coordination needs" Meaning, a
company must link and integrate functions and activities of different
divisions of the company.

• Worldwide area structure


• Favored by firms with low degree of diversification & domestic
structure based of function
• World is divided into autonomous geographic areas
• Operational authority decentralized
• Facilitates local responsiveness
• Fragmentation of organization can occur
• Consistent with multi-domestic strategy

INTERNATIONAL DIVISION STRUCTURE


When a company has a branch that is located abroad and that abroad
company is said to be attached with the original company, then this is an
international division structure.
The abroad unit is required to control all the activities which are to be
performed internationally. It is usually based on the characteristics like a
function, product or on geography. This structure is designed do that the
multinational will have a free access to explore the resources that are
present internationally.

• Adopted in early stages of international


• business operations
• Coordinate all IB activities
• Develop international expertise & skills
• Develop a global/international mindset
• Champion of foreign business

• Favored by firms with low degree of diversification.


• Area is usually a country.
• Largely autonomous.
• Facilitates local responsiveness
GLOBAL PRODUCT STRUCTURE
The product division structure is popular with large conglomerates with
multiple, unrelated business. Under this structure different subsidiaries
pertaining to different products within the same foreign country report to
the head of different product groups at the head quarters.

The product division structure enhances coordination between different


areas for any one product line but it reduces coordination of all product
lines within each zone.

• Adopted by firms that are reasonably diversified


• Original domestic firm structure based on product division
• Value creation activities of each product division coordinated by
that division worldwide
• Help realize location and experience curve economies
• Facilitate transfer of core competencies
• Problem: area managers have limited control,
• subservient to product division managers, leading to lack of local
responsiveness
GLOBAL MATRIX STRUCTURE
Over time, we can expect to see a company grow into a Global Matrix
Structure. "In this organizational structure, the chain of command is split
between product managers and area managers." As we develop the sales
in areas of the world, we can expect to see the chain of command split
between product managers and area managers.

• Helps to cope with conflicting demands of earlier strategies


• Two dimensions: product division and geographic area
• Product division and geographic areas given equal responsibility for
operating decisions
• Problems: Bureaucratic structure slows decision making
• Conflict between areas and product divisions
• Difficult to make one party accountable due to dual responsibility

GLOBAL FUNCTIONAL DESIGN STRUCTURE


Under the functional structure, the head of functional areas, such as
production, marketing, finance and personnel, are responsible for the
worldwide operations of their own functional areas.
In certain industries like energy and mining, a variation of the
functional structure known as the process structure, which uses processes
as the basis for the structure, is common.

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