Role of International Institutions - IMF

 

Role of International Institutions – IMF 

            The business across the nations are assisted and funded by the international organizations such as International Monetary Fund, World Bank and Regional Development Banks by framing economic policies and schemes for financial assistance and technical assistance. Assistance from the international organizations are substantial sources of public investment in a number of countries and such investments may help to improve the general business conditions.

International Monetary Fund:

            The IMF is the central institution of the international monetary system, established on December 27, 1945 as a result of the Bretton Woods Conference of nations and began its financial operations on March 1, 1947. It is the fund that can be tapped by members for temporary financing to address balance of payments problems and also aims to prevent crises in the system by encouraging countries to adopt sound economic policies.

Organization and Management:

    The Board of Governors, the highest authority of the governance in IMF, represented by the member countries – usually by the country’s minister of finance meets once a year at the Annual meetings of the IMF and World Bank to decide on major policy issues.

    The Executive Board, consists of 24 Executive Directors, usually meets three times a week, at the organization’s headquarters in Washington DC to discuss on day-to-day decision making, presided by Managing Director as Chairman.

    The IMF’s five largest shareholders – the United States, Japan, Germany, France and the United Kingdom – along with China, Russia and Saudi Arabia have their own seats and the rest 16 Executive Directors are elected for two-year terms by group of countries, known as constituencies.

Vision of IMF:

• Strive to promote the sustained non-inflationary economic growth that benefits all people of the world
• Center of competence for the stability of the international financial system
• Focus on its core macroeconomic and financial areas of responsibility
• Be an open institution, learning from experience and dialogue, and adapting continuously to changing circumstances

Purpose of IMF:

• Promoting the balanced expansion of world trade
• Stability of exchange rates
• Avoidance of competitive currency devaluation
• Orderly correction of a country’s balance of payments problems

Functions of IMF:

•  To provide loans to countries experiencing balance of payments problems
• To restore and rebuild the international reserves by providing financial assistance
• To help in paying for imports and exports without imposing restrictions or capital controls

Sources of Fund:

1. Quotas and Subscriptions:

    Each member is assigned a quota expressed in Special Drawing Rights (SDRs), equivalent to which every member is required to subscribe to the Fund. Quotas, that reflect the members’ economic size, are used to determine the voting power of members, their contribution to the Fund’s resources, their access to these resources, and their share in allocations of SDRs. A member is generally required to pay about 25 percent of its quota in SDRs or in currencies of other members selected by IMF; it pays the remainder in its own currency. The fund holds substantial resources in members’ currencies and SDRs, which are available to meet member countries temporary balance of needs.

2. Borrowings:

    The IMF may borrow to supplement its resources from its quotas. The IMF has two sets of standing arrangements to borrow:

• General Arrangements to Borrow (1962)
• New Arrangements to Borrow (1997)

IMF Facilities:

    IMF loans are usually provided under an arrangement, which stipulates the conditions the country must meet in order to gain access to the loan. Arrangements are based on economic programs formulated by countries in consultation with the IMF, and presented to the Executive Board in a letter of intent. All facilities are subject to market-related interest rate known as rate of charge and some carry an interest rate premium known as surcharge. The IMF has developed a number of loan instruments at concessional and non-concessional rates as follows:

Poverty Reduction and Growth Facility (PRGF):

• Financial assistance to low income countries through ESAF – Enhanced Structural Adjustment Facility, later renamed as PRGF to focus on poverty
• Interest rate: 0.5 percent
• Repayment period: 5.5 -10 years

Stand-by Arrangements (SBA):

• To address short-term balance of payment problems
• Length of facility: 12-18 months; Surcharges apply to high levels of access
• Repayment period: 2.25 – 4 years

Extended Fund Facility (EFF):

• To address more protracted balance-of-payments problems in 1974
• Length of facility: 3 years; Surcharges apply to high levels of access
• Repayment period: 4.5 – 7 years

Supplemental Reserve Facility (SRF):

• To meet a need for very short-term financing on a large scale
• Repayment period: 1-1.5 years
• Surcharge: 3-5%

Contingent Credit Lines (CCL):

• To help members prevent crises while implementing sound economic policies in 1999
• Repayment period: 1-1.5 years (same as SRF)
• Surcharge: 1.5-3.5 %

Compensatory Financing Facility (CFF):

• To assist countries experiencing either a sudden shortfall in export earnings or an increase in cost of imports
• Repayment period: 2.25 – 4 years (same as SBA)
• Length of facility: 12-18 months; No surcharge

Emergency Assistance:

• To countries that have experienced a natural disaster or emerging from a conflict
• Repayment period: 3.25-4 years

Technical Assistance:

    The IMF provides technical assistance in areas such as macro-economic policy, monetary and foreign exchange policy and systems, fiscal policy and management, external debt and macroeconomic statistics.

International Business - Multilateral Regulation of Trade and Investment under WTO

 

Multilateral Regulation of Trade and Investment under WTO

            The World Trade Organization is the only international organization dealing with the rules of trade between nations. The goal is to help producers of goods and services, exporters and importers conduct their business. The global business environment is very significantly influenced by the WTO principles and their agreements. The agreements in WTO are negotiated and signed by the bulk of the world’s nations and ratified in their parliaments. WTO, the successor to the General Agreement on Tariffs and Trade, is a facilitator and regulator of international business.

Evolution of WTO:

            The General Agreement on Tariffs and Trade, the predecessor of WTO was formed to liberalize trade in 1948 as an interim agreement to fill the gap until ITO (International Trade Organization) charter had been formed. GATT, the international trading system was guided by rules and principles agreed by the signatories of the contracting nations.

            The primary objective of GATT was to expand international trade to bring about economic prosperity by liberalizing trade. The main objectives of GATT as mentioned in its Preamble was as follows:

• Raising Standard of Living
• Ensuring full employment
• Developing full use of the resources of the world
•  Expansion of production and international trade

The conventions of GATT required that

• Any proposed change in the tariff, or other type of commercial policy of a member country should not be undertaken without consultation of other parties to the agreement
• The countries that adhere to GATT should work towards the reduction of tariffs and other barriers to international trade, which should be negotiated within the framework of GATT

GATT adopted the following principles for the realization of its objectives:

• Non-discrimination: No member country shall discriminate between the members of the GATT in the conduct of international trade
• Prohibition of Quantitative Restrictions: As far as possible GATT rules prohibited quantitative restrictions and limited restrictions on trade to the less rigid tariffs
• Consultation: GATT provided a forum for consultation to resolve disagreements and for trade negotiations  

            The first six rounds of Multilateral Trade Negotiations (MTNs) concentrated almost exclusively on reducing tariffs, while the Seventh round moved on to tackle the Non-tariff barriers. The eighth round, Uruguay round sought to broaden the scope of MTNs by including new areas such as trade in services, trade related aspects of intellectual property (TRIPs), trade related investment measures (TRIMs). Following the Uruguay round, GATT was converted from a provisional agreement into a formal international organization called World Trade Organization (WTO), the more powerful body than GATT with an enlarged role, with effect from January 1, 1995.

World Trade Organization – WTO:

            The WTO is a more powerful body with enlarged functions than the GATT and is envisaged to play a major role in the world economic affairs, with its Secretariat in Geneva, Switzerland. The objectives of WTO agreements are:

• To help trade flow as freely as possible
• To achieve further liberalization gradually through negotiation
• To set up impartial means of settling disputes

The fundamental principles, which form the foundation for the multilateral trading systems are as follows:

•  Non-discrimination
• Freer trade, predictable policies, encouraging competition
• Extra provisions for less developed countries

Salient Features of Uruguay Agreement - The WTO Agreements:

            The WTO members operate a non-discriminatory trading system that deals with their rights and their obligations. The rule book of WTO consists of agreements related to trading in goods, trade in services, relative aspects of intellectual property, dispute settlement, and trade policy reviews.

Trade in Goods: 

        This was the only concentration under the GATT, which created a forum for negotiations under lower customs duty and other trade barriers. However, on the onset of WTO, dealings with specific sectors such as agriculture and textiles, and with specific issues such as state trading, product standards, subsidies and actions taken against dumping also undertaken. 

Liberalization of trade in manufacturers:

The major liberalization in respect of trade manufacturers, regarding tariffs are done by:

• Expansion of tariff bindings
• Reduction in the tariff rates
• Expansion of duty-free access

While with respect to Non-tariff barriers, the Agreements to abolish Voluntary Export Restraints (VERs) and to phase out the Multi-fiber Arrangements (MFAs) have been regarded as a landmark achievement.

Liberalization of Trade in Agriculture:

Agreement on Agriculture, the specific agreement which provides framework for multilateral trade in agriculture, has been incorporated to establish fair and market oriented agricultural trading system with rules and disciplines such as market access, domestic support and export subsidies. The important aspects of AoA include:

• Tariffication: The replacement of existing non-tariff restrictions on trade such as import quotas by such tariffs as would substantially provide the same level of protection is known as tariffication.
• Tariff binding: Tariff binding means fixing the maximum rate of import duty, above which the country shall not raise the duty unilaterally.
• Reduction in subsidies and domestic support:  The agreement puts restrictions on the use of countervailing measures against competitor’s subsidies, which fall into the following three categories:

§  Prohibited subsidies: Those contingent upon export performance or the use of domestic instead of exported goods

§  Actionable subsidies: Those that have demonstrably adverse effects on other member countries

§  Non-actionable subsidies: Those provided to industrial research and pro-competitive to development activity to disadvantaged regions, or to existing facilities to adapt themselves to new environmental requirements.

Trade in Services: 

        Service industries such as banking, insurance, telecommunications, tourists, hotel and transport companies are allowed to do trade freely and fairly as goods under new system of principles under GATS. The General Agreement of Trade in Services with protective measures such as visa requirements, investment regulations, restrictions on repatriation, marketing regulations, restrictions on employment of foreigners, compulsions to use local facilities, extends multilateral rules and disciplines to services in different countries by four international mode of delivery of services such as cross-border supply, commercial presence, consumption abroad and movement of personnel.

    The framework of GATS includes basic obligation of all member countries on international trade in services as well as movement of workers with most favored nation (MFN) obligation that essentially prevents countries from discriminating among foreign suppliers of service and transparency requirements in which each country shall publish all its relevant laws and regulations pertaining to services.

Trade in Intellectual Property: 

        The WTO agreements related to investments in ideas and creativity states about the obtention and protection of copyrights, patents, trademarks, geographical names that are used in the identification of products, industrial designs, integrated circuit-layout designs and undisclosed information such as trade secrets. Under Uruguay Agreement, General Agreement on Trade Related Aspects of Intellectual Property Rights (TRIPs) have been formed to protect IPRs. According to WTO, the objectives of IPRs are as follows:

• Encourage and reward creative work
• Technological innovation
• Fair competition
• Consumer protection
• Transfer of technology
• Balance of rights and obligations

           Developing countries generally do not have adequate institutional mechanism and resources to properly administer IPRs regime. IPR system provides a great opportunity to developing countries to benefit from protection of indigenous property rights and traditional knowledge. There are several areas of flexibility within TRIPs that provide potential for developing countries to maximise benefits by promoting access to technology and prevailing anti-competitive abuses.

Anti-dumping measures:

        A product is regarded as dumped when its export price is less than the normal price in the exporting county. Injury is the material retardation to the establishment of an industry. The UR Agreement provides greater clarity and more detailed rules concerning the method of determining dumping and injury, the procedure to be followed in anti-dumping investigations and the duration of anti-dumping measures. Anti-dumping actions may be suspended or terminated id the exporter concerned furnishes an undertaking to revise the price to remove the dumping or the injurious effect of dumping.

Organisational Structure:

            WTO is directed by a Ministerial Conference which meets at least once every two years and its regular business is overseen by a General Council. The General Council meets several times a year in the Geneva headquarters as Trade Policy Review Body and Dispute Settlement Body. At the next level is the Goods Council, Services Council, Intellectual Property Council, that reports to the General Council. There are numerous specialized committees, working groups and working parties that deal with the individual agreements and other areas such as the development, environment, membership applications and regional trade agreements. Decisions in the WTO are made by the entire membership. All WTO members may participate in all councils, committees, etc., except Appellate Body, Dispute Settlement panels, Textiles Monitoring Body and plurilateral committees.

Benefits of WTO:

• Reduction in tariff and non-tariff barriers to trade
• Liberalization of trade and investments has resulted in increase in competition, efficiency of resource utilization, improvement in quality and productivity and acceleration of economic development
• Provides a forum for multilateral discussion of economic relations between nations 
• Settlement of trade dispute and mechanism to deal with violation of trade agreements between nations
•  Monitoring trade policies
• Technical assistance and training for developing countries

      Because of the unequal participation and lack of bargaining power, the developing countries have not been getting a fair deal from the WTO, though the rules and regulations are more transparent that makes trade harassment and unilateral actions more difficult.

International Business - Foreign Direct Investment

 

Foreign Direct Investment – Benefits and Costs

            Foreign Direct investment occurs when a firm invests directly in facilities to produce or market a good or service in a foreign country. World Investment Report defines FDI as an investment involving a long-term relationship and reflecting a lasting interest and control by a resident entity in one economy in an enterprise resident in an economy other than that of the foreign direct investor. FDI may be undertaken by individuals as well as business entities. FDI has three components: Equity Capital, Reinvested earnings and Intra-company loans. The flow of FDI refers to the amount of FDI undertaken over a given time period. This comprises capital provided by a foreign direct investor to an FDI enterprise, or capital received from an FDI enterprise by a foreign direct investor. The stock of FDI refers to the total accumulated value of foreign owned assets at a given time.

Forms of FDI:

Greenfield investments: Involves the establishment of a new operation in a foreign country

Acquisitions: Acquiring or merging with an existing firm in the foreign country

Theories of Foreign Direct Investment:

Theory of Capital Movements: The existence of perfectly competitive market, considered foreign investments as a form of factor movement to take advantage of the differential profit.

Market Imperfections Theory/ Monopolistic Advantage Theory: Foreign direct investment occurred largely in oligopolistic industries rather than in industries operating under near perfect competition.

Internalization Theory: Foreign investment results form the decision of a firm to internalize a superior knowledge. Methods of internalization includes formal ways like patents and copy rights and informal ways like secrecy and family networks.

Appropriability Theory: A firm should be able to appropriate the benefits resulting from a technology it has generated.

Location Specific Advantage Theory: Foreign investment is pulled by certain location specific advantages such as labor costs, marketing factors, trade barriers and government policies.

Eclectic Theory – John Dunning: The foreign investment by MNCs results from three comparative advantages such as location, firm and internalization. The theory failed to explain the foreign investment for acquisitions.

Knickerbocker’s Theory of Oligopolistic and Multinational Enterprise: When one firm, especially leader in an oligopolistic industry entered a market, other firms in the industry follow it to defend their market share from being taken away by the initial investor with the advantage of local production.

Benefits and Costs of FDI:

Host-Country Benefits:

Resource-transfer effects: FDI can make a positive contribution to a host economy by supplying capital, technology, and management resources that would otherwise not be available and thus boost that country’s economic growth rate.

Employment effects: FDI brings in job opportunities when a foreign multinational enterprise invest in new industry or expand the acquired enterprise either by employing a number of host country citizens.

Balance of Payments effects: If the FDI is substitute for imports of goods or services, the effect can be to improve the current account of the host country’s balance of payments.

Effect on Competition and Economic Growth: When FDI takes the form of a greenfield investment, it results in the establishment of new enterprise, increasing the number of players in a market thus increases the level of competition fostering the economic welfare of consumers by driving down prices. The long-term results would be like increased productivity growth, product and process innovations, and greater economic growth.

Host- Country Costs:

Adverse effects on Competition: When FDI takes the form of acquisition of established enterprise or merging of two or more enterprises, it would result in reduction of competition level in that market, thus creating a monopoly power for the foreign firm, reduced consumer choice and increase in price level.

Adverse effects on the Balance of Payments: The initial capital inflow that comes with the FDI must be the subsequent outflow of earnings from the foreign subsidiary to its parent company. Such outflows show up as capital outflow on balance of payments accounts. When a foreign subsidiary imports a substantial number of its inputs from abroad, which results in a debit on the current account of the host country’s balance of payments.

Effects on National Sovereignty and Autonomy: The FDI is accompanied by some loss of economic independence of the host governments that affects the host country’s economy because of loss of control over it and the lack of commitment by the foreign company.

Home-Country Benefits:

Balance of Payments effects: The home country’s balance of payments benefits from the inward flow of foreign earnings; also benefits from the demands created for home country exports of capital equipment, intermediate goods, complementary products.

Employment effects: When a foreign subsidiary creates demand for home-country exports, positive employment effects arise, thus benefiting the home country from outward FDI.

Reverse Resource-transfer effect: When the home country MNE learns valuable skills, superior management techniques and superior product and process technologies, from its exposure to foreign markets that can be subsequently transferred back to the home country, thus contributing to the economic growth rate of the home country.

Home-Country Costs:

Balance of Payments effects: The balance of payments suffers from the initial capital outflow required to finance the FDI. The current account of the balance of payments suffers if the purpose of the foreign investment is to serve the home market form a low-cost production location. The current account of the balance of payments suffers if the FDI is a substitute for direct exports.

Employment effects: When FDI is regarded as a substitute for domestic production, the result would be reduced home-country employment.

 

International Business - Balance of Payments

Balance of Payments

            Balance of Payments, according to Reserve Bank of India is a statistical statement that systematically summarizes for a specific period of time, the economic transactions of an economy with the rest of the world. International flow of goods, services and capital affect the balance of international payments and foreign exchange position of a country. The IMF describes BOP as a statistical statement for a given period showing:

• Transactions in goods and services and income between an economy and the rest of the world
• Changes of ownership and other changes in that country’s monetary gold, Special Drawing Rights (SDRs) and claims on liabilities to the rest of the world
• Unrequited transfers and counterpart entries that are needed to balance in the accounting sense, any entries for the foregoing transactions and changes which are not mutually offsetting

Importance of Balance of Payment:

• Reveals a country’s financial and economic status
• An indicator to determine whether the country’s currency value is appreciating or depreciating
• Helps the government to decide on fiscal and trade policies
• Provides information to analyze and understand the economic dealings of a country with other countries

Components of Balance of Payment:

            Balance of Payment transactions are recorded in standard double-entry book-keeping with credit and debit entries which are generally grouped under the following heads:

Current Account includes all transactions that give rise to or use of national income. This account covers all the receipts and payments made with respect to raw materials and manufactured goods; also includes receipts from engineering, tourism, transportation, business services, stocks, and royalties from patents and copyrights. It could be visible (trading in goods) or invisible trading (import/export of services such as banking, shipping, information technology, insurance), unilateral transfers or other payments/receipts.  It consists of:

• Merchandise exports and imports – Purchase and sale of goods
• Invisible exports and imports – Purchase and sale of services
• Unilateral Transfers Account – Private remittances, government grants, reparations and disaster relief
• Income receipts and Payments – Rent on property, interest on capital, and profits on investments

    When all the goods and services are combined, together they make a country’s Balance Of Trade (BOT). There is a trade deficit when imports are higher than exports and a trade surplus when exports are higher than imports.

Capital Account consists of short-term and long-term capital transactions.  The capital account is used to finance the deficit in the current account or absorb the surplus in the current account. Capital transactions include 

• loans and borrowings (both public and private sector),
• investments in the corporate stocks or real estates by non-residents,
• the purchase and sale of fixed assets,
• changes in foreign exchange reserves maintained by the central bank to control the exchange rate

Balance of Payments – Equilibrium and Disequilibrium:

            The balance of payments of a country is said to be in equilibrium when the demand for foreign exchange is exactly equivalent to the supply of it. If the demand is either surplus or deficit, the balance of payments is said to be in disequilibrium. There are a number of factors that may cause disequilibrium in the balance of payments.

• Economic factors: Large scale development expenditures, cyclical fluctuations of business activity, high aggregate demand, higher domestic prices, exhaustion of productive resources, changes in transport routes or cost, development of alternative sources of supply
• Political factors: Political instability, changes in world trade route due to war or trade agreements
• Sociological factors: Changes in tastes, preferences and fashions

            The balance of payments deficit can be corrected by adjusting the price, interest rates and income. Also, by monetary measures such as monetary expansion/contraction, devaluation and exchange control, trade measures such as export promotion and import control and by measures such as tourism development, incentives for foreign investments and remittances can be undertaken to correct the deficit in balance of payments. 

International Business - Theories of International Trade

 

Theories of International Trade

International Trade – Introduction:

            International trade refers to the exchange between people or entities in two different countries to boost their economy. An economy which has decided to embark on a program of development is required to extend its productive capacity at a fast rate. For a developing economy, developmental and maintenance imports set limits to the extent of industrialization which can be carried out in a given period. The inflow of foreign goods into the country along with them the flow of technology, the skills, speed and feed of production, the tastes and experiences will have considerable influence on domestic productions, marketing, lifestyles, and standard of living of people. The growth and pattern of international trade accounts for a major part of the international business which depends on the trading environment.

International Trade Strategy:         

            With a proper trade strategy, a business entering into global market can be successful. The selection of right trade strategy has a greater impact on the volume and composition of imports and exports, pattern of investment, direction of development, competitive and cost conditions, and consumption patterns and so on.

            An outward oriented strategy is one in which trade and industrial policies do not discriminate between production for the domestic markets and exports, or between purchase of domestic goods and foreign goods. It is a neutral strategy and is an open policy. An inward oriented strategy is characterized by bias of trade and industrial policies in favor of domestic production as against foreign trade. Protection of domestic countries from foreign competition by trade barriers, restrictions of trade by licensing or quantitative methods are some of the inward oriented strategy.

Barriers to Trade:

            Trade barriers are government induced restrictions on international trade that typically decrease overall economic potency. The countries which follow inward oriented strategy towards foreign trade use several barriers to protect domestic industries from foreign firms which includes tariff and non-tariff barriers.

Tariff barriers: These are traditional barriers that refer to the duties or taxes imposed on internationally traded goods when they cross the national borders. It aims at limiting the inward flow of products from alternative countries to safeguard the country’s own industries by creating products costlier in the country and are transparent.

·       Import tariff: Taxes levied on imports

·       Export tariff: Taxes levied on exports

·       Transit tariff: Taxes levied on goods passing through one country bound for another country

·       Ad valorem: Taxes levied as a percentage of the value of the product or service

·       Specific tariff: Taxes levied on some particular attributes of goods – weigh ad quantity

·       Combined tariff: Combination of specific and Ad valorem tariff

Non-tariff barriers: These are new protectionism measures which are not transparent and are not anchored in laws and government regulations. The developing countries use non-tariff barriers such as import licensing, import quotas, foreign exchange regulations to prevent foreign exchange outflows, whereas the developed countries to protect the domestic industries which have lost international competitiveness such as voluntary export restraint, technical barriers, minimum pricing regulations, price surveillance and so on.

·       Quotas: Numerical limits on the quantity of goods that may be imported into a country during a specified period

·       Administrative barriers: Regulatory control or bureaucratic rules designed to impair the flow of imports into a country

·       Embargoes: Complete ban on trade in one or more products with a particular country

·       Boycott: Blank prohibition on the import of all goods or services imposed by a designated country

·       Licensing: The prospective importers are required obtain a license from the licensing authorities in terms of cost, volume and product

·       Technical standards: Provisions made by governmental agencies in various countries relating to areas such as safety, pollution, technical performance and so on

Theories of International Trade:

• Theory of Mercantilism (1630) – Thomas Mun: This theory suggest that it is in the country’s best interest to maintain a surplus of trade – to export more than what it imports. By doing so, the country can accumulate more wealth and increase its prestige. Mercantilists believed that a country should increase its holdings of gold and silver by promoting exports and discouraging imports.
• Theory of Absolute Advantage (1776) – Adam Smith: According to Smith, countries should specialize in the production of goods for which they have an absolute advantage and then trade these goods for the goods traded by other countries. A country has an absolute advantage if it can produce the same quantity of goods more efficiently than any other country.
• Theory of Comparative Advantage (1817) – David Ricardo: This theory holds that a country should specialize in the production and export of a commodity in which it possesses the greatest relative advantage. Ricardo argued that it makes sense for a country to specialize in the production od those goods that it produces efficiently and to buy the goods that it produces less efficiently from other countries.
• Theory of Reciprocal Demand (1844) – John Stuart Mill: This theory suggests that the equilibrium trade terms are decided by the equation of reciprocal demand which encompasses the relative strength and demand for every other’s product in terms of their own product.
• Factor Proportions theory (1919) – Heckscher-Ohlin: According to them, each country should produce and export that commodity which primarily involves the factor of production abundantly available within the particular country. By factors of production they meant land, labor and capital on a basic level and on a more complex level, such factors as management, technological skills and specialized distribution networks.
• Leontiff Paradox (1953): Wasily – Leontiff tested the validity of Heckscher-Ohlin theory based on the US export of labor-intensive goods and outlined that the factor proportions are not homogeneous and they differ along parameters other than relative abundance.
• Product Lifecycle theory (1960s) – Raymond Vernon: The PLC theory seeks to explain how a company will begin by exporting its products and eventually undertake foreign direct investment, as the product moves through its life cycle. This theory looks at the potential export possibility of a product in four discrete stages in its life cycle which includes innovation, growth, maturity and decline.
• Country Similarity theory (1961) – Steffan Linder: This theory proposed that consumers in countries that are in the same or similar stage of development would have similar preferences. Also, this theory states that most trade in manufactured goods will be between countries with similar per capita incomes, and intra industry trade will be common.
• New Trade theory (1970s and 1980s): The new trade theory states that there are gains to be made from specialization and economies of scale, the first movers into any market can create entry barriers to others, and governments may have a role to play in assisting its home-based firms. The theory emphasizes productivity rather than a country’s resources, it is in line with the theory of comparative advantage but at odds with the factor factor endowments model.
• Global Strategic Rivalry Theory(1980s) – Paul Krugman and Kelvin Lancaster: The theory focused on MNCs and their efforts to gain a competitive advantage against other global firms in their industry.
• Diamond theory of national advantage (1990) – Michael Porter: It refers to the factors responsible for maintaining a nation’s competitive advantage. According to Porter, a firm’s competitive advantage stems from factor conditions, demand conditions, strategy and rivalry and related and supporting industries.

International Business - Managing Business in Globalization Era

 

Managing Business in Globalization Era

            Globalization refers to the integration of markets in the global economy, leading to the interconnectedness of national economies through global networks of trade, capital flows, and the rapid spread if technology and global media. Globalization has been accompanied by the creation of new institutions to work across borders and has led to renewed attention to long established international inter-governmental institutions: the UNO, the ILO and the WHO

Characteristics of Globalization:

1.    Greater trade in goods and services between nations

2.    Transfer of capital

3.    Development of global brands

4.    Spatial Division of Labor

5.    High level of labor migration

6.    Increase in spending on investment, infrastructure and innovation across the world

International Business:

            Globalization makes the business increasingly global even for domestic firms. National economies are becoming more and more interdependent and integrated and the world economy and business are becoming more and more globalized, driven by the economic liberalizations. International business refers to buying and selling of the goods and services across the borders. It encompasses activities of different nature such as trading, manufacturing and marketing, sourcing and marketing, production and so on.  

Drivers and Restrainers of Globalization:

            The main factors which motivate firms to go international are classified as push and pull factors. Pull factors are those forces of attraction which pull the business to the foreign markets such as relative profitability and growth prospects. Push factors refers to the compulsions of the domestic market such as saturation of the market. The important forces that drive globalization are as follows:

• Liberalization and Privatization which leads to the surge in cross border mergers and acquisitions and foreign direct investments resulting in a greater global economic integration
• Multinational companies that link their resources and objectives with world market
• Technological breakthroughs have facilitated in fostering business through reduced transportation and communication costs
• The proliferation of regional integration schemes enhanced the trade between the nations with increased cross-border investments and financial flows
• Economies of scale and knowledge transfers with proper utilization of resource among nations drives company towards exploring an opportunity in global market

            Besides these forces, government policies and controls, social and political opposition against foreign business, factors within organization that restricts globalization, restrain the globalization.

The special problems in International Business are as follows:

• Political and legal differences
• Cultural differences
• Economic differences
•  Differences in the currency unit and language
• Differences in the marketing infrastructure
• Trade and investment restriction
•  High costs of distance
•  Differences in business practices

Internationalization stages:

Basically, a company goes into the following stages on its decision to go global:

• Purely Domestic Company
• Domestic Company with some foreign business
•  International business
• Multinational/Global Company
• Transnational Company

Modes of Entry in International Business:

1.    Exporting Modes: The process of selling goods and services produces in one country to another country either directly or indirectly or through intra-corporate transfers. Strategies such as increasing the average unit value realization, increasing the quantity of exports, exporting new products result in increase of export earnings.

2.    Contractual Modes: Contractual entry modes are found in case of intangible products such as technology, patents, copyrights and so on. These modes can be categorized as follows:

v Licensing: A firm in one country (the licensor) permits a firm in another country (the licensee) to use its intellectual property. The monetary benefit to the licensor is the royalty or fees which the licensee pays.

v Franchising: A form of licensing in which a parent company (the franchiser) grants another independent entity (the franchisee) the right (name, production and marketing technology) to do business in a prescribed manner.

v Contract Manufacturing: A company doing international marketing contracts with firms in foreign countries to manufacture or assemble the products while retaining the responsibility of marketing the product.

v Management Contracting: The supplier brings together the package of skills that will provide an integrated service to the client without incurring the risk and benefit of ownership.

v Turnkey Contracts: An agreement by the seller to supply a buyer with a facility fully equipped and ready to be operated by the buyer’s personnel who will be trained by the seller.

3.    Fully Owned Manufacturing Facilities: Companies with long term interest in the foreign market invest in owning a manufacturing facility which comes with advantage of complete control over production and costing associated with the risk of technological and human resources and production bottlenecks.

4.    Foreign Direct Investments: It refers to direct investment in a production unit in a foreign country.

v Greenfield investments – Venturing into a new product with new operational facilities.

v Brownfield investments – Investing in an existing facility to start its operations in the foreign country.

5.    Mergers and Acquisitions: These are defined as consolidation of companies either by combining two companies or acquiring of one company by another which are either hostile or friendly. These are of horizontal, vertical and conglomerate types done by either stock or asset purchase. The reason behind Mergers and Acquisitions are reaping of synergistic advantage, overnight growth of organization, risk immunization, tax savings, diversification and so on.

6.    Joint Venture: An entity formed between the two or more parties to perform the economic activity together. The parties work on creating a new entity to share in the revenues, expenses and control of the enterprise.

7.    Strategic Alliance: This enables companies to increase resource productivity and profitability by avoiding unnecessary fragmentation of resources and duplication of investment that seeks to enhance the long-term advantage of the firm by forming alliance with its competitors, existing or potential in critical areas, instead of competing with each other. This is particularly important for technology acquisition and overseas marketing

          The choice of the most suitable alternative is based on the relevant factors related to the company and the foreign market. A company may or may not use the same strategy for all the foreign markets or for all the products. There are some conditions to be satisfied on the part of the domestic economy and the government as well as the forms for successful globalization of the business which includes business freedom, required facilities, government support and global orientation of strategies. The intent of globalization is efficiency improvement and market optimization taking advantages of the global environment.