International Business Environment 2024-2025 Lecture 2 PDF

International Business Environment 2024-2025 Lecture 2. REVIEW Global business environment Measuring country & market competitiveness Entering foreign markets Assoc. prof. Tamara Pavasović Trošt Sources Hamilton and Webster textbook, Part 1 Brooks textbook, chapters 1 and 2 Gaspar et al. ch. 8...

International Business Environment 2024-2025 Lecture 2. REVIEW Global business environment Measuring country & market competitiveness Entering foreign markets Assoc. prof. Tamara Pavasović Trošt Sources Hamilton and Webster textbook, Part 1 Brooks textbook, chapters 1 and 2 Gaspar et al. ch. 8 2 Outline I. Review: Basics of IB Measuring impact of environmental factors The global business environment International trade (Lecture 4) Analyzing global industries Analyzing industry competition II. Analzying and assessing markets Market analysis Market structure types Measuring market concentration Assessing country attractiveness, getting data III. Models of internationalization Theories of internationalization Entering foreign markets, market entry strategies Standardization vs. localization (adaptation) vs. glocalization 3 Review of IB: Understanding the international business environment Definitions ❖ Environment = the totality of external environmental forces which may influence any aspect of organizational activity Environmental Dynamism = refers to the rate and quantity of changes that occur in the environment. Environmental Complexity = refers to how many variables are present in the environment. If there are multiple variables present in an environment, this will yield greater environmental complexity and thus increased environmental uncertainty. 5 Dynamism and complexity Source: Johnson et al. (2008) 6 Definitions Macro-environmental uncertainty: uncertainty in the organization’s general environment, including political, regulatory, statutory, and economic conditions. Competitive uncertainty: inability to establish the intensity of competition in the industry in the future, the relative powers of competitors, their future courses of action, and strategies. Market (and demand) uncertainty: stems from lack of clarity in the dynamics of the market and their effects on the organization’s operations, and demand and supply conditions in the industry. Technology uncertainty: uncertainty pertaining to change in the industry’s technological resources and capabilities. Source: Jabnoun et al., ASQ 7 Classification of environmental forces PEST, PESTLE: Macroeconomic environment 8 PEST vs. SWOT 9 Example 10 Interpretation or reality? ❖ Organizations and their employees assist in the “creation” of their own business environment ▪ Actual nature of environment both human interpretation and “hard reality” ▪ Different organizations in the same industry view environmental forces differently ▪ Organizations filter and interpret incoming information about the environment ▪ Managerial cognition, organizational culture, and politics, all influence this process ❖ Managers 'perception of their environment may have a greater influence on organizational decision-making and strategic direction than does objective information. 11 Interpretation or reality? ❖ Factors affecting individual and organizational perception of external environment: ▪ Characteristics of individuals Background, education, duration of employment within the organization, culture, personality (e.g. tolerance for ambiguity) ▪ Organizational culture ▪ Organizational politics, structures and control mechanisms ▪ History and development of an organization ▪ Industrial sectors and their norms 12 Impact analysis ▪ Effective way of forecasting the effect of environmental changes on organizations - ascertain a series of potential environmental changes - assess the probable effect of these changes ▪ Effect of change is first assessed as either positive (+) or negative (-); strength is indicated by ++, +++ ▪ Can be done at the business level or at the industry level - at the industry level – assess effects of environmental change upon its competitors (e.g., are some better prepared than others? Will some be more or less affected by a realignment of exchange rates? 13 Impact analysis: Business 14 Impact analysis: truck industry Source: Brooks et al. (2011), p. 22 15 Review of IB: The global business environment Globalization examples Collapse in US housing market → nationalization of banks in UK Earthquake in Japan → increase in price of computer chips and fall in stock markets worldwide Expansion of Chinese economy → unemployment among Dell employees in the USA Bali terrorism attack → less American tourists in UK ✓ Events in one part of the world have a major impact in others ✓ Business operates in a world where globalization is happening at an accelerating rate ✓ Globalization confronts businesses with opportunities and threats 17 Globalization - The creation of linkages or interconnections between nations - Understood as a process in which barriers (physical, political, economic, cultural) separating different regions of the word are reduced or removed (liberalization), stimulating exchanges in goods, services, money, and people ✓ “the widening, deepening, and speeding up of worldwide interconnectedness in all aspects of contemporary social life, from the cultural to the criminal, the financial to the spiritual” (Held et al. 1999) ▪ economic, political, cultural, social life are all affected by globalization 18 Globalization’s pervasiveness ❖ Globalization influences culture through transfer of knowledge, ideas, and beliefs across national borders - mass media (television, film) - diets, food (e.g. Macdonaldization) - education (Erasmus, ECTS) - sport - health - crime (pornography, prostitution, illegal substances, money laundering, human trafficking) - religion 19 But… ✓ Most global trade and investment takes still place within and between four economic blocs: - Western Europe (EU member states) - NAFTA (USA, Canada, Mexico) - Japan - China ✓ 60% of EU trade takes place between member states 20 Drivers of globalization Political/regulatory Technological Economic 21 Drivers of globalization – Political/Regulatory Steps to REMOVE barriers to trade: - GATT, WTO - Free trade area: member states agree to remove tariffs and quotas on goods from other members, members have freedom to set the level of tariff imposed on imports of goods from non-members - Customs union: like a free trade area, but members agree to levy a common tariff on imports of goods from non-members - Common market: like a customs union, but member states agree to allow free movement of goods, services, capital, and labor (e.g. EU) Regional trade area (RTO): e.g. NAFTA, ASEAN, Mercosur Export processing zone (EPZ): MNCs can invest, produce, and trade under favorable conditions; given financial incentives to invest, allowed to import goods and produce out free of tax. 22 Drivers of globalization – Technological ❖ Improvements in communications (Internet…) - Modern communications technology makes it easier to control foreign operations - Allows migrants to maintain links with countries of origin - Integrates world’s financial markets (monitoring of movements in share prices, interest rates, and currency rates) - e.g. India – call center jobs ❖ Reductions in transport costs - Goods and people are able to travel long distances quickly and at low cost 23 Drivers of globalization – Economic ▪ Desire to cut costs: finding markets with lower energy or labor costs (e.g. relocation of manufacturing to countries with low labor costs) ▪ Competition: pushes firms to reduce product lines and to expand globally to seek saving: economies of scale in R&D, manufacturing, marketing ▪ Saturated domestic markets: firms outgrow their domestic market, must seek opportunities beyond their domestic borders (e.g. Ikea) ▪ Growth of global customers: global customers need basic supplies of input materials, global financial and accounting services, global hotel chains (standard product of consistent quality, lower purchase costs, lower administration costs) 24 Barriers to globalization Government Technical regulation regulation Cultural and geographic distance 25  Barriers to globalization – Government regulation ▪ Tariffs and subsidies ▪ Foreign aid with strings attached – promotes interests of donor country, not best value for recipient country ▪ Controls on capital – controls on inflows or on outflows of FDI and FII (e.g. restriction on capital inflows in India, South Korea, Japan; US law preventing foreign firms buying more than 24.9% of an American airline, etc) ▪ Public procurement – government departments, public utilities in telecommunications, gas and water – large amounts of public money purchasing goods and services (10 to 25% of GDP; in EU 16%). Governments often favor domestic firms. ▪ Border and immigration controls – filling in of customs forms, checking goods at borders, visa requirements, quotas requiring employment of domestic employees, etc ✓ Protectionism: government actions and policies that restrict or restrain international trade, often with the intent of protecting local businesses and jobs from foreign competition. 26 Barriers to globalization – Technical regulation ❖ Technical standards and regulations – thousands of different technical specifications relating to goods and services which can protect domestic markets from foreign competition ❖ Protection of IP rights – countries differ in policies towards intellectual property rights- relating to new products and production processes, brand names, logos, books, films. - extent of protection and enforcement varies widely by country (e.g. counterfeiting) - lack of protection of IPRs can stunt trade and FDI in these countries 27 28 Example: health regulations 29 Example: health regulations Aflatoxins – fungi found on agricultural crops like corn; can be found in milk of cows who fed on the corn EU and Canadian standard – max 0,05 μg/Kg of aflatoxins in milk Serbian standard (also in US, China, Brazil, Mexico, Russia, etc) - max 0,5 μg/Kg After controversy in 2013, Serbia changed requirements to 0,25 – twice “harsher” than in the US and Russia, but still 5 times more lenient than in the EU (another example: listeria; thrives more in some climates than others; more problematic for international trade regulations in these countries) 30 Barriers to globalization – Cultural and geographic distance ▪ Cultural distance: differences in language, religious beliefs, race, national and regional tastes, social norms and values, and business practices – regulate what is regarded as acceptable behavior and attitudes Culture can influence consumer behavior, work culture, and business practices Some products (meat, cereals, tobacco, office machines) more sensitive than others (cameras, road vehicles, cork and wood, electricity) – Ghemawat (2000) ▪ Corruption ▪ Geographical distance: makes trade difficult, particularly for firms that are low in value but high in bulk (cement, beer), or are fragile or perishable (glass, fruit) 31 Review of IB: International trade, FDI, FII (Review in Lecture 4) 32  Indicators of globalization → Lecture 4! 1. International trade in goods and services (imports and exports) ▪ China, US, Germany and Japan – largest traders of goods (>60%) ▪ US, UK and Germany major exporters of commercial services ▪ Global recession in 2009 greatly affected both 2. Transfer of money capital from one country to another ▪ Foreign indirect investment (FII) – portfolio investment; money is used to purchase financial assets in another country ▪ Foreign direct investment (FDI) – when a firm establishes, acquires, or increases production facilities in a foreign country 3. Migration: movement of people across national borders 33 Changes to growth over time https://www.youtube.com/watch?v=fnIl212tBPk ✓ Video made in 2012, predicting changes to growth over time. How accurate is it in capturing what happened over the past decade? 34 II. Market analysis Basics ❖ Market vs. industry; how do we define a market? Deciding which goods or services to include Identifying the firms competing in the market Indicating the geographical area where those firms are competing ❖ Market structures: perfect competition to monopoly Market power, market concentration ❖ Industry analysis Porter’s 5 forces 36 Which products/services belong to a particular market? ▪ Cross-elasticity of demand: measures the response of customers when one firm changes its price - If the price of a product increases and customers switch in large numbers to cheaper products → products can be classified to the same market (e.g. BP, Esso and Shell) - Allows us to identify competitors: firms making products with a high cross-elasticity of demand are defined as being part of the same industry - Hard to measure ▪ Can also observe behavior of businesses - evidence showing businesses reacting regularly to decisions made by other firms; or identify firms whose actions about pricing and advertising is constrained by others (e.g. Easyjet, Ryanair) ▪ Not a straightforward process! - Rolls Royce and Fiat Punto – same market? 37 Identifying firms competing in the market ❖ Diversified firms – companies selling a range of goods Usually classified into several industries; companies seen as competing in various markets e.g. Whirpool, Electrolux, LG – various appliances, from washing machines to electric cookers; not substitutes The ability to source a range of products from a single company may put such firms at a competitive advantage against rivals with a limited range ❖ Vertically integrated firms – companies operating at several stages of production of a product e.g. Shell, Exxon, BP → drill for oil, refine, and sell it (3 industries: drilling, refining, retailing) e.g. 21st Century Fox → produce and distribute films 38 Clarifying the geographical boundaries ▪ Firms located in different places could be producing similar products, but are not actually competing against each other in the same geographical marketplace Geographical boundaries are determined by whether a price increase in one area attracts competition from firms elsewhere, or drives customers away to cheaper areas Southern UK – consumers get the ferry to France for cheaper alcohol and tobacco; can conclude that they are part of the same geographical market ▪ Geographical distance: Cost of transporting goods from one area to another might not be economical Depends on transport infrastructure – fragmented or integrated markets ▪ Firms might try to purposely keep markets separate (e.g. VW in Southern Germany vs. Northern Italy) 39  Market structures Type of market Number of firms Barriers to entry Nature of structure product Perfect Very many None Homogenous competition Monopolistic Many None Heterogenous competition Oligopoly Few Often high Homogenous/ differentiated Monopoly One High Unique Source: Hamilton and Webster (2015), p. 76 40  Market structures: Monopoly ▪ One firm dominates the market, usually protected from competition by high barriers to entry Controls the market and can set prices to extract maximum profit for their customers Consumers have to pay the price because they have no alternative suppliers to purchase from Monopolists are free to pursue independent pricing policy; and do not need to differentiate their products (no competition) ▪ Very few exist in real life Wrigley (owned by Mars) = 1/3 of global market; 84% of UK chewing gum Microsoft = 90% of world market for desktop operating software (but 20% if include smartphones and tablets) 41 Market structures: Natural monopoly ▪ Very high fixed costs can result in the creation of a natural monopoly E.g. gas, water, electricity, and telephone networks Rivals are deterred from entering the market by very high capital investment involved 42 Market structures: Monopolistic competition ▪ Middle ground between monopoly and perfect competition ▪ A large number of firms, no barriers to entry, and only a small degree of product differentiation ▪ e.g. corner shop or convenience store segment of the retail market; restaurants, cereal, clothing, shoes, and service industries in large cities ▪ https://www.youtube.com/watch?time_continue=1&v=aB 7O0qgp3ns 43  Market structures: Oligopoly ▪ Few firms, often protected by high entry barriers, and with ability to exercise some control over the market ▪ Market concentration of top 4 firms is over 50% of the market Most manufacturing and many service sector industries operate in oligopolistic markets E.g. cell phone service providers, airplane manufacturers (Boeing, Airbus) ▪ Firms try to differentiate their products from those of their competitions in the branding, advertising, packaging, and design of their goods and services; have to be successful in convincing consumers that their products are different e.g. Procter & Gamble spends $10 billion or 12% of sale revenues on advertising yearly, Coca Cola spends 6% of sales revenues ▪ Actions of one firm likely affect rivals’ sales, market share, and profits; and likely provoke a reaction, leading to cut-throat competition 44 45 Market structure: Oligopoly cartels ▪ In order to avoid competition, oligopolists sometimes set up cartels Aim to control competition through firms in the market agreeing to set common prices or divide market geographically among carter members Often established by firms producing undifferentiated products where buyers will go to the cheapest suppliers; when supply threatens to outstrip demand, firms fear outbreak of competition Illegal in many countries ▪ Connor (2000) – “resurgence of global price fixing”, “a global pandemic” of international cartels 17 EU steel producers found guilty of running a cartel for 18 years in which they fixed prices and shared markets Several large multinational producers of vitamins (Roche of Switzerland, BASF of Germany, Daiichi of Japan) Major airlines like British Airways, Air France, Lufthansa, and Japan Airlines – cartel to fix prices of carrying cargo 46 Market structures: Perfect competition ▪ Assumes perfect knowledge – producers and sellers are aware of profit made by other producers; buyers have knowledge of price in every section of the market Due to perfect knowledge in the market, any differences in costs will be eradicated in the long term as firms know about each other’s behavior ▪ Each firms aims to maximize its profit; in the long run, entry pushes price down to minimum point so that economic profits are zero Individual firms must accept market price Firms cannot set their own pricing policy, because price is set by the market ▪ Examples tend to be commodities – products that are the same no matter who produces it (paper clips, copy paper) also agricultural markets, free software, street food vendors 47 Measuring market concentration: Concentration Ratio (CR) ❖ The share of the largest firms in industry sales or output by value or by volume ▪ CR2 = concentration ratio for the two largest firms in the industry; CR10 = conc. ratio for largest 10 firms in the industry ▪ e.g. CR3 for global smartphone industry: - in 2014, CR3 = 44% (Samsung 25.2 + Apple 11.9 + Huawei 6.9). - In 2010, CR3 = 66% (Nokia, RIM/Blackberry, Apple) - change in competition → success of Samsung, decline of Nokia and RIM, aggressive competition from Huawei and Lenovo ▪ European Commission: CR1 > 40% indicates level of concentration that could have adverse effects on competition 48  Measuring market concentration: Hirschmann Index (HHI) ❖ The sum of squares of the individual market shares of all the firms in the market - e.g. a market containing 5 firms with market shares of 40%, 20%, 15%, 15%, and 10% = 2550 ▪ Gives proportionately greater weight to the market shares of larger firms; more accurate picture because includes all firms in the calculation ▪ Range from close to 0 (in purely competitive market) to 10,000 (in case of pure monopoly) ▪ EU Commission: HHI > 1000 in a market indicates a level of concentration that could have adverse affects on competition ▪ Geographical variation: Lenovo in 2014 had 5% of world market for smartphones, but 12% of domestic market AB InBev: 20% of world market for beer, but 70% for Brazil 49 50 Analyzing industry competition Porter’s 5 forces (Porter 2008) 52 Porter’s 5 forces: 1. Industry rivalry Competition usually happens in: Price Advertising and sales promotion Distribution Improvements in existing goods and services Introduction of completely new products Rivalry can also be a struggle for resources (natural resources, human resources) 53 Porter’s 5 forces: 1. Industry rivalry Competitive advantage can be gained through mergers and acquisitions ❖ Horizontal mergers – firms at the same stage of production of a product - Boost market share and reduce competition - E.g. Air France merger with KLM ❖ Vertical mergers – companies move closer to their suppliers of raw materials or to their final customers, guarantee supplies of materials or distribution - Allows firms to make efficiencies in the supply change, and to squeeze rivals into coming to them for supplies or distribution - E.g. Time Warner (media) merger with AOL (internet service provider) 54 Porter’s 5 forces: 1. Industry rivalry Assessing the strength of industry competition: 1) The number of competing firms – the larger the number of competitors, the more likely the competition will be fierce 2) The relative size of firms – when firms are of similar size/equal market shares, competition is stronger 3) Market growth rate – when the market is growing slowly, firms try to take market share from competitors by competing more fiercely 4) Extent of product differentiation – if firms have succeeded in convincing customers that their products are different than of their rivals, competition is less intense 5) Importance of fixed costs – firms with high fixed costs are under more pressure to sell their output in order to generate contribution to their fixed costs 55 Which firms are so successful that their brand became the generic name for the product? 56 Porter’s 5 forces: 2. Competition from new entrants Entry of new firms is a threat to established firms in the industry Low-growth industries with poor profits are unlikely to be threatened by a rush of new firms Probability of new entrants depends on the height of barriers to entry 57 Porter’s 5 forces: 2. Competition from new entrants Barriers to entry of new firms: Absolute cost barriers – the advantages which established firms have over newcomers (hotels – oceanside property; electricity generation – physical networks) Legal barriers – laws and regulations Product differentiation – new firms must convince customers that their products are significantly different from those of their competitors; large amounts of money for advertising, sales promotion, packaging Economies of scale – when an increase in the scale of the firm (small factory → large factory), leads to a fall in per-unit costs Other factors: excess capacity, declining demand, ability of established firms to freeze out new entrants by controlling supply of materials or pricing, distribution through vertical integration or long-term contracts with suppliers and customers 58 Porter’s 5 forces: 3. Threat of Substitutes ❖ Substitutes: goods or services operating in an apparently different industry, but delivering similar service to customer (e.g. Eurostar train from Paris to London is competition to EasyJet and Lufthansa) ▪ Threat is influenced by cost and ease with which customers can switch to the substitute product E.g. as oil prices increase, customers with central heating might switch to cheaper form of energy Switching could be deterred by cost, time, and inconvenience of changing equipment Switching could be deterred by confusion pricing – overwhelming customers with choices (e.g. telecommunications packages) Often difficult to estimate whether customers do see certain goods and services as being good substitutes (cross-elasticity of demand) 59 Porter’s 5 forces: 4. Customers ❖ Bargaining power of customers is determined by: ▪ Number and size of firms If small number of large firms facing large number of small customers, industry is in powerful position – losing a customer is not costly (e.g. accountancy services - PWC, KPMG, Deloitte, E&Y) If many firms have small numbers of large customers, power switches to the buyer ▪ Proportion of customer costs constituted by the product ▪ Extent of product differentiation The less differentiated the product, the easier for customers to switch to a cheaper supplier ▪ Ability of customers to integrate vertically 60 Porter’s 5 forces: 5. Suppliers ✓ (Suppliers = businesses selling inputs such as fuel, raw materials, and components to the firms in the industry) ❖ Bargaining power of suppliers Reverse of bargaining power of buyers ☺: Suppliers are sellers of inputs, customers are firms in the industry If supplier industry is dominated by a few large firms, power of suppliers will be high (can get away with price increases, reductions in quality, and worsening of terms and conditions of sale) – e.g., Intel If supplier industry is more fragmented, power of suppliers will be low, and power of customers will be high (e.g. European dairy industry – suppliers of dairy faced with smaller number of powerful customers like Tesco, Aldi and Leclerc) 61 Porter’s 6th force: 6. Complementary products ❖ Complementary products = used together by customers; do not compete with each other but operate in tandem ▪ e.g. mobile phones need service providers; cars need gas, printers need ink cartridges ▪ Microsoft and Intel “joined at the hip” – companies dependent on each other → constant conflict over who gets ‘the bigger piece of the pie’, pricing, timing of investments 62 Checklist: Analyzing an industry with the 6 Forces ✓ Are there many firms or only a few? ✓ Are firms a similar size? ✓ Is the market growing or declining? ✓ Is product differentiation important? ✓ How high are fixed costs as a percentage of total costs? ✓ Do additions to production capacity increase total industry capacity significantly? ✓ Are there any significant barriers to entry? ✓ Is there significant excess capacity in the industry? ✓ Do existing firms have the power to prevent entry? ✓ Is there significant competition from substitutes? ✓ Is there a large number of small buyers/suppliers or a few large buyers/suppliers? ✓ Does the product constitute a large proportion of supplier revenues? ✓ Do customers/suppliers have the ability to take over firms in the industry? ✓ Are firms in the industry dependent on complementary products? 63 Where to get data on industry trends and market shares? ❖ Most sources of industry/market reports are payable: Commercial companies (Statista, Bloomberg, Nielsen, Ibis, Economist Intelligence Unit) ❖ National government, agencies: National agencies, interest groups, industry associations o for reports on market shares of insurance companies/policies, Agencija za zavarovalni nadzor, Slovensko zavarovalno zdruzenje etc o for bank market shares, Bank of Slovenia, Zdruzenje bank Slovenije o for telecommunication, Agencija za komunikacijska omrežja in storitve Republike Slovenije ❖ Databases with national company data for Slovenia: GVIN, Bizi (recall SKD, NACE) 64 Assessing Country Attractiveness What makes a market attractive? ❖ Trade-off between risk and return! - Countries differ in terms of their attractiveness as a result of variations in the economic environment, growth rates, political stability, disposable income levels, available resources, government incentives, level of competition, risk associated with economic and political stability - In order to assess attractiveness, need to combine macro-economic environmental analysis (e.g. PEST) with industry-level analysis (e.g. Porter) 66 Collecting data 1 ❖ IMD World Competitiveness Yearbook – 60 of the most competitive countries according to economic performance, government efficiency, business efficiency, and infrastructure ❖ Economist Intelligence Unit (EIU) – ranks 82 countries according to the attractiveness of their business environment, covering 10 different factors: political environment, macroeconomic environment, market opportunities, policy towards free enterprise and competition, policy towards foreign investment, foreign trade and exchange controls, taxes, financing, the labor market, infrastructure ❖ Research Monitor database – through FELU library! ✓ See Seminar work for instructions and helpful links from Zhonghui 67 Collecting data 2: WEF Global Competitiveness Index ❖ World Economic Forum (WEF) Global Competitiveness Report – 12 pillars of competitiveness for 148 countries, based on Porter’s model 1. Institutions – legal framework, government attitudes to markets and freedom, excessive bureaucracy, overregulation, and corruption 2. Infrastructure – quality roads, railroads, ports, airports, electricity supply, telecommunications 3. Macroeconomy – economic stability 4. Health and primary education – healthy workforce with basic education 5. Higher education and training – higher grade skills necessary for the economy to move up the value chain 6. Goods market efficiency – sophisticated customers and competitive domestic and foreign markets 68 Collecting data 2: WEF Global Competitiveness Index 7. Labor market efficiency – flexible labor markets with appropriate reward systems 8. Financial market sophistication – with savings channeled to productive investment 9. Technological readiness – access to ICT 10. Market size – domestic and foreign markets allow economies of scale 11. Business sophistication – quality of business networks and individual firms’ operations and strategy 12. Innovation – high levels of R&D expenditure, collaboration between universities and industry, protection of intellectual property ✓ The 12 pillars are inter-dependent and reinforce each other 69 70 Collecting data 2: WEF Global Competitiveness Index ❖ The WEF identifies 3 stages of development: - Factor-driven - Efficiency-driven - Innovation-driven Based on: 1) GDP per capita 2) the share of exports of primary goods in total exports ✓ Countries with a ratio of 70% or more are factor driven 71 Collecting data 3: WB “Ease of Doing Business” Index Countries are ranked by percentile “Ease of Doing Business” index composed of various scores A huge database, new reports yearly, 155 countries included. Methodology very diverse, including interviews (perceptions!) Starting a business top 100 http://www.doingbusiness.org/rankings 72  World Bank “Doing Business” index Starting a business – Procedures, time, cost and minimum capital to open a new business Dealing with construction permits – Procedures, time and cost to build a warehouse Getting electricity – procedures, time and cost required for a business to obtain a permanent electricity connection for a newly constructed warehouse Registering property – Procedures, time and cost to register commercial real estate Getting credit – Strength of legal rights index, depth of credit information index Protecting investors – Indices on the extent of disclosure, extent of director liability and ease of shareholder suits Paying taxes – Number of taxes paid, hours per year spent preparing tax returns and total tax payable as share of gross profit Trading across borders – Number of documents, cost and time necessary to export and import Enforcing contracts – Procedures, time and cost to enforce a debt contract Resolving insolvency – The time, cost and recovery rate (%) under bankruptcy proceeding 73 World Bank “Doing Business” index https://data.worldbank.org/indicator/IC.BUS.EASE.XQ?name_d esc=true&view=map Slovenia: https://www.doingbusiness.org/content/dam/doingBusiness/ country/s/slovenia/SVN.pdf (2020 report) 74 75 Doing Business - Slovenia 76 Problem with EDB reports https://www.economist.com/finance-and-economics/2018/01/20/the-world-banks-ease-of-doing-business- report-faces-tricky-questions 77 EDB criticism 78 79 After data irregularities on Doing Business 2018 and 2020 were reported internally in June 2020, World Bank management paused the next Doing Business report and initiated a series of reviews and audits of the report and its methodology. In addition, because the internal reports raised ethical matters, including the conduct of former Board officials as well as current and/or former Bank staff, management reported the allegations to the Bank’s appropriate internal accountability mechanisms. After reviewing all the information available to date on Doing Business, including the findings of past reviews, audits, and the report the Bank released today on behalf of the Board of Executive Directors, World Bank Group management has taken the decision to discontinue the Doing Business report. The World Bank Group remains firmly committed to advancing the role of the private sector in development and providing support to governments to design the regulatory environment that supports this. Going forward, we will be working on a new approach to assessing the business and investment climate. We are deeply grateful to the efforts of the many staff members who have worked diligently to advance the business climate agenda, and we look forward to harnessing their energies and abilities in new ways.” Statement on Release of Investigation into Data Irregularities in Doing Business 2018 and 2020 (worldbank.org) 80  Collecting data 4: Other data sources - International Monetary Fund – economic and financial indicators – GDP, economic growth, inflation, government finance, population, balance of payments - OECD - UNCTAD - World Trade Organization - UK Data Service (previously ESDS, through 2012) - UK Trade and Investment - US Export.gov (for US businesses going global) - CIA World Factbook – geography, climate, infrastructure, climate, natural resources - UN International Trade Statistics Yearbook – trade statistics (info on which goods and services in each country importing from abroad) - Heritage Foundation Index of Economic Freedom – assessment of countries according to various measures of freedom (freedom to trade, freedom from tax, strength of property rights, regulation and corruption) - World Bank Global Governance Indicator – governance indicators for political stability, government effectiveness, regulatory quality, etc. 81 Collecting data 4: Other data sources on specific issues Socio-cultural aspects – various sources (European Social Survey, Schwartz's World Values Survey, Hofstede website, GLOBE project website, etc) Public opinion – Pew Research Center Expatriates – HSBC expatriate report and International Expat survey Innovation – EU Innovation Scoreboard Trade restriction and state intervention information – Global trade alerts Intellectual property – World Intellectual Property Office (WIPO) Statistics and various indicators for EU countries – EUROSTAT Corruption – Transparency International 82 Country assessment 83 Country assessment 1: Initial screening 1. Initial screening – eliminate those countries which have little chance of being markets or production sites Is there a basic demand for the company’s products? Are the basic resources required present? Is the business environment acceptable? 84 Country assessment 2: General market and site potential 2. a) General market potential assessment Market size – relative size of the overall economy; population size (# of potential customers); GDP per head and disposable income per head (purchasing power); distribution of income (spread of purchasing power). Also proxy indicators – ownership of cars, energy usage, televisions, internet usage, degree of urbanization, demographic changes Market growth – rate at which market is growing (growth in population, growth in GDP) Quality of demand – profile of customers in the market b) General site potential assessment Check whether countries have the essential resources needed to undertake production: availability of raw materials, access to labor and finance, cost of doing business (cost of labor, price of energy, price of communications and transport, tax rates); also quality of labor (availability, skill level, and productivity) 85 Country assessment 3: General business environment 3. General business environment assessment Political and legal – government regulation, government bureaucracy, law and order Economic and financial – inflation, interest rates, exchange rates, credit availability, financial stability, returns on investment Socio-cultural – affect acceptability and need for adaptation to product; terms of employment etc o Cultural: language, religion, diet, values and norms, attitudes, beliefs, customs, social relationships o Social: distribution of income, modes of employment, living and working conditions, ethnicity, degree of urbanization, availability and skill level of labor, levels of pay, working hours, level of trade unionization, demographic age/gender structure Technological – development of the infrastructure; transport and communications network, internet capacity, water supply, quality of ports/airports, electricity production and certainty of supply 86 Country assessment 4: Market assessment 4. a) Product/service market assessment – more detailed assessment within each of the selected markets; specific industry indicators – measure total market demand in a particular industry Data on: size and growth rate of market, major competitors, products, and market shares; prices, marketing and promotions of competitors; distribution networks; local standards and regulations (trademark rules and product liability); value of imports and exports of the product), tariffs and other trade regulations; local cultural factors that require product adaptation Porter’s 5/6 forces analysis of the competitive environment 87 Country assessment 4: Market assessment 4. b) Production site assessment – a more detailed analysis on doing business in the particular market: Regulations on foreign ownership of enterprises Level of development of financial system, currency used, foreign exchange controls, stock exchange; tax regulation and rates; requirements for financial reporting Investment guarantees and incentives, existence of business registration procedures Labor regulations covering expatriate employees, regulations for salaries, health and unemployment insurance payments for local and expatriate employees, min. wage requirements, entry visas and work permits, facilities available for expats Settling of disputes, regulations of intellectual property rights, competition law 88 Country assessment 5: Risk assessment 5. Undertake risk assessment ❖ Sources of risk: Natural disasters: hurricanes, earthquakes Change in political leadership or philosophy or political leadership; corrupt or weak political leadership Reliability of infrastructure Supply chain disruption Economic risks – volatility of the economy and foreign exchange problems Wars, terrorism; civil unrest between ethnic groups, races and religions; uprisings Organized crime; piracy ✓ World Bank Global Governance Indicator ✓ WEF global risk report 89  WEF Global Risks 2018 90 Country assessment 6: Market/site selection 6. Select market and/or site Compare short-listed countries by an estimate of the market share the company is likely to gain Make a grid with weights for factors important for the decision: 91 Source: https://www.slideshare.net/sunniedoll/ya-kun-kaya-toast-international-strategy III. Models of internationalization Internationalization theories 1. Uppsala or “stage” model 2. Transaction cost model 3. Network model 4. Born global model 93 Traditional models of internationalization: Uppsala 3-stage model ▪ From domestic base, firms develop gradually by exporting to another culturally and geographically similar culture ▪ Exporting initially takes place either directly through company’s own export department, or indirectly via an external export agency ▪ As overseas business expands, and with it the experience and confidence of operating in overseas markets, the firm becomes more committed to foreign activities – exporting to more distant and less culturally similar countries ▪ Success combined with greater knowledge of foreign markets leads to setting up of production facilities across the world, that can be done with partner firms through joint ventures or totally owned foreign subsidiaries 94 Traditional models of internationalization: Challenges ▪ Reality is much messier; not a simple sequential process; firms may operate different modes at the same time ▪ Different types of organization follow different processes of internationalization; process different for organizations like hotels, restaurants, accountants, retailers, management consultants ▪ Many firms are “born global” (when foreign sales account for at least 25% of the total within 3 years of its inception), take an international perspective from the outset Usually small, with limited resources but global vision; technology companies focused on market niches Companies in small, open economies (like Denmark, Sweden and Switzerland), because of limited size of domestic market and pressure from competition, are under more pressure to enter global markets quickly 95 Transaction cost model of internationalization Firms will tend to expand until the cost of organizing an extra transaction within the firm will become equal to the cost of carrying out the same transaction by means of an exchange on the open market Cost minimization explains structural decisions Firms internalize (vertically integrate) to reduce transaction costs 96  TCA model source: Hollensen 8th ed. 97 Network model of internationalization The relationships of a firm in a domestic network can be used as bridges to other networks in other countries. Geographic expansion through establishing relationships and networks of independent actors in one or several markets. Bonds could be personal, legal, economical or technical. 98  Network model example source: Hollensen 8th ed. 99 Born Global companies ❖ Organizations that experience “global from birth” – see the world as one market; typically limited adaptation. Also known as early internationalizers, international new ventures, global start-ups, or international entrepreneurs Tech companies (Skype, Spotify, Logitech, HTC) The market in the home country is not large enough to support the scale at which the firm needs to operate Most of the firm’s potential customers are foreign, multinational firms Many of the firm’s potential customers have overseas operations where they will use the firm’s products or services The firm operates in a knowledge-intensive or high-technology sector Having the most technically advanced offering in the world is key to the firm’s competitive advantage 100 Characteristics of Born Globals SMEs with less than 500 employees Annual sales under $100million Reliance on cutting-edge technology Managed by entrepreneurial visionaries 101 Example: Outfit7 2 Slovenians invested 250,000$ in 2009 to develop apps Talking Tom and Friends reached 300 million downloads 18 months after launch Sold to United Luck Consortium for over 1 billion US$ in 2017 102  Uppsala vs. Born global source: Hollensen 8th ed., m Âijö et al. 2005 103 Dimensions of internationalization Source: Welch and Loustarinen (1988) 104  source: Hollensen 8th ed. 105 Entry strategies  Entry strategies in global business Low risk and low return Wholly Export/ owned Strategic Joint Foreign Import Licensing Franchising foreign alliances ventures acquisitions business subsidiari es High risk and high return 107 108 Entry strategies: risk ❖ Variation in degrees of risk: Ownership Operation Transfer ▪ In general, the greater the risk, the greater the rewards ▪ Entrepreneurs will chose the approach that suits their risk profile ✓ Risk profile = amount of financial loss entrepreneurs are willing to take in a business 109  Export-Import business ❖ Export-import business: Low-risk business operation that involves penetrating foreign markets (by exporting) or importing merchandise at competitive prices for domestic consumption Capital is not tied up, easy to enter or exit Because it’s relatively easy to participate, competition is generally keen and profit margins not very high ▪ Existence of well-established techniques for financing trade that are aimed at facilitating trade and minimizing financial risk Exporter is assured payment will be received after the importer receives the stated merchandise (export invoices, customs clearance; bank payment clearance) ▪ Both small and large firms can conduct export-import business 20% of US international trade is conducted by small businesses, but many large corporations conduct their own import-export business ▪ Huge expansion with rise of internet and internet sales of products and services 110 Licensing ❖ Licensing = the practice in which a company or individual provides the foreign partner with the technology (patented technology, copyright, process, trademark) to manufacture and sell products or services in a target country for an annual license fee Fee could be based on percentage of final sales revenue, or number of units sold ▪ The licensor (company providing the license) must properly evaluate, understand, and trust the licensee (the overseas partner) Closer relationship than with export-import business Licensor needs to trust the licensee Involves slightly more risk: sales diversion (licensee manufactures licensed products and sells them under different brand names; loss of patent fees) Usually include penalty clauses and exit strategies 111 Franchising ❖ Franchising = the practice in which the parent firm provides specialized equipment and/or service (e.g. product specification and adaptation, pricing, promotion, and distribution strategies; training) and sometimes to fund some startup cost ▪ Franchisee pays an annual fee, usually based on sales generated and seed money given ▪ No significant capital investment abroad by parent company ▪ E.g. McDonald’s, Starbucks 112 Strategic alliances ❖ Strategic alliance = agreement between two or more firms that do not involve the creation of a separate entity with joint ownership and in which the firms stand to gain revenues and maximize profits through cooperation for a given period of time ▪ Non-equity arrangement: do not involve the creation of a separate entity with joint ownership ▪ Primarily aimed at enhancing revenues ▪ E.g. global airline industry: Star Alliance, Sky Team ▪ Challenge is that members can prematurely quit the alliance 113 International Joint Ventures ❖ IJV = a business that is jointly owned and operated by two or more firms (usually one from host country and the other from another country) that pool their resources (labor, capital, technology, management) to penetrate host country markets, generate and split profits, and share commercial risk ▪ IJV formation makes sense when capital investment needs are so large that no single company would be willing to risk all the needed funds ▪ Allow each partner to use its comparative advantage to improve the joint operation ▪ E.g. Dow Chemical (US) and Saudi Aramco (Saudi Arabia) built $20 billion bio-chemical complex in SA (Sadara Chemical) to produce plastics for high-growth markets of Asia, ME, EE, $7 billion of equity 114 Cross-border mergers and acquisitions ❖ Acquisition – purchase of established firms abroad with the goal of using the existing production, marketing, and distribution networks and of having instant access to foreign markets that fit the purchasing firm’s global strategy ✓ Acquisitions – The home country purchases the host country’s firm and implement its own international business strategy (deciding what products and services to produce, how to price and market them, how to manage the new company) ✓ Mergers – The management of both companies will play an active role in business development and execution The company being acquired should be well established and have a good reputation in the local market Relatively risky, because significant amount of capital may be required to acquire and upgrade foreign facilities; and corporate cultural differences 115 Wholly-owned subsidiaries ❖ Subsidiaries = new facilities built and operated overseas that require large investment of capital because these new establishments are tailored to the exact needs of the home country firm ▪ Building and operating of new facilities (“green field” plants) ▪ Large capital investments; high risk, high reward ▪ New subsidiaries likely to be modern, efficient, environmentally sound, designed to international standards ▪ Require major marketing efforts to penetrate the new market because of cultural differences and because the entrant is new and unknown 116 117 Standardization vs. Localization Dilemma of how to go global Why dilemmas of how to go global are so important: For many US companies, 70% of the total world market for goods and services is outside of the country - Coca Cola earns 75% of its operating income and 2/3 of profit outside of North America Must find best possible balance between standardization and localization Also called “standardization vs. adaptation”, “globalization vs. localization”, “global integration vs. local responsiveness” 119 Standardization One-size-fits-all approach: volume, cost management and efficiency Achieving maximum productivity through standardization of service product and service design and delivery achieving global economies of scale and lowest unit cost It eases efforts in content creation and management by ensuring the same content is delivered across all channels Creates a coherent and consistent global image of the firm and its products Challenges: variations across markets in consumer attitudes, competitive environments Does not allow for capitalizing on local market trends Can create negative reaction from neglecting local needs 120 Standardization Factors that boost standardization: Westernization and Americanization – it is assumed diverse publics will accept global products Convergence in customer preferences and income across target countries International brand awareness Greater globalization also brings falling costs of trade, leading to even greater cost efficiency of standardization 121 Localization Customers appreciate brands that “get” their culture; Customization adds a personal touch Respect local specifications and expectations Good local image Isn’t scalable or efficient Higher cost Time consuming Difficulty to establish proper customization strategy; risks of failure 122 Localization Forces that call for localization: Competition from successful domestic products Regulatory requirements (quality, safety, technical specifications, domestic content), e.g. EU product standards Differences in consumer preferences (e.g. culture) and income 123 Non-tariff barriers that affect localization ❖ Domestic content provisions – regulations requiring that a certain percentage of the value of imports be sourced domestically e.g. apparel imported into the US should use US cotton, or use a certain amount of American labor. Aimed to protect jobs in the home country ❖ Health and safety – food safety measures to prevent the entry of harmful pests and diseases via imported foods, animals and plans e.g. EU ban on imports of genetically modified crops and processed goods from the rest of the world 124 Adaptation → Glocalization Instead of standardization (globalization) → global localization (adaptation) or glocalization – mixing standardization and customization in a way that minimizes costs while maximizing satisfaction (segmentation!); “think globally, act locally” Can also decide what should be global versus local: - Products - Technology and inputs - Manufacturing - Brands - Marketing - Distribution - Customer service 125 Glocalization Glocalization: adaptation of international products around the particularities of a local culture in which they are sold Allows integration of local markets into world markets “The simultaneity – the co-presence – of both universalizing and particularizing tendencies.“ (Roland Robertson) While global strategy emphasizes standardization of global products, glocal strategy explains the balance that must exist between the standardization and local adaptation of business activities and products 126 Source: https://www.bu sinesstoday.in/ magazine/lbs- case- study/how- ikea-adapted- its-strategies- to-expand-in- china/story/196 322.html 127 128 Coming up next Week of Oct. 14-18: No seminars Week of Oct. 21-25: seminars in the classroom (pick any of the 3 sessions) with prof. Anastas Vangeli: how to prepare the case study Week of Oct. 28-Nov. 1: NO CLASS OR SEMINARS but Oct. 29 deadline to submit project plan (1 point) Next lectures: Lecture 3: Global financial environment (review, prof. Mojmir Mrak) Lecture 4: International trade (review, prof. Črt Kostevec) 129 International Business Environment 2024-2025 Lecture 3. Global Financial Environment prof. Mojmir Mrak  Outline Exchange Rates Foreign Exchange Market The Balance of Payments The International Monetary System and Changes in Global Economic Governance 3-2 © 2016 Pearson Education, Inc. All rights reserved. Exchange rates  Definition of Exchange Rates Exchange rate is a price of one country’s currency in units of another currency Exchange rate is often referred to as the most important „relative price“ in the economy Definitions of exchange rates – Nominal bilateral exchange rate – Real bilateral exchange rate – Effective exchange rate – Real effective exchange rate Two classifications of exchange rate regimes – De-iure classification; According to officially announced implementation (ex-ante) – De-facto classification or IMF classification; According to actual implementation of the excgange rate regime (ex-post) 3-4 © 2016 Pearson Education, Inc. All rights reserved.  IMF Classification of Currency Regimes IMF’s classification of currency regimes in effect since January 2009 Category 1: Hard Pegs – Countries that have given up their own sovereignty over monetary policy – E.g., dollarization or currency boards Category 2: Soft Pegs – AKA fixed exchange rates, with five subcategories of classification Category 3: Floating Arrangements – Mostly market driven, these may be free floating or floating with occasional government intervention Category 4: Residual – The remains of currency arrangements that don’t well fit the previous categorizations 3-5 © 2016 Pearson Education, Inc. All rights reserved.  IMF Exchange Rate Classifications 3-6 © 2016 Pearson Education, Inc. All rights reserved.  IMF Exchange Rate Classifications (cont.) 3-7 © 2016 Pearson Education, Inc. All rights reserved.  Taxonomy of Exchange Rate Regimes 3-8 © 2016 Pearson Education, Inc. All rights reserved.  Fixed Versus Flexible Exchange Rates A nation’s choice as to which currency regime to follow reflects national priorities about all facets of the economy, including: – inflation, – unemployment, – interest rate levels, – trade balances, and – economic growth. The choice between fixed and flexible rates may change over time as priorities change. 3-9 © 2016 Pearson Education, Inc. All rights reserved.  Fixed Versus Flexible Exchange Rates Countries would prefer a fixed rate regime for the following reasons: – stability in international prices – inherent anti-inflationary nature of fixed prices However, a fixed rate regime has the following problems: – Need for central banks to maintain large quantities of hard currencies and gold to defend the fixed rate – Fixed rates can be maintained at rates that are inconsistent with economic fundamentals 3-10 © 2016 Pearson Education, Inc. All rights reserved.  Fixed Versus Flexible Exchange Rates Stylized determinants for the exchange rate regime choice (which one is more appropriate?) – Size of the country (larger the country, more appropriate for flexible ER) – Openness of the country (more open the county, more appropriate for flexible ER) – Diversificantion of the economy (more diversified the country, more appropriate for flexible ER) – Trade concentration (more concentrate the trade of the country, more appropriate fixed ER) – Inflation rate differentials (larger the inflation rate differentials, more appropriate for flexible ER) – Credibility of policy makers (stronger the credibility, more appropriate for flexible ER) 3-11 © 2016 Pearson Education, Inc. All rights reserved.  Attributes of the “Ideal” Currency Possesses three attributes, often referred to as the Impossible Trinity: – Exchange rate stability – Full financial integration – Monetary independence The forces of economics do not allow the simultaneous achievement of all three The following exhibit illustrates how pursuit of one element of the trinity must result in giving up one of the other elements 3-12 © 2016 Pearson Education, Inc. All rights reserved.  The Impossible Trinity 3-13 © 2016 Pearson Education, Inc. All rights reserved.  A Single Currency for Europe: The Euro In early 1990s, the members of the European Union met at Maastricht, the Netherlands, to finalize a treaty that changed Europe’s currency future. This treaty set out a timetable and a plan to replace all individual ECU currencies with a single currency called the euro. 3-14 © 2016 Pearson Education, Inc. All rights reserved.  A Single Currency for Europe: The Euro To prepare for the EMU, a convergence criteria was laid out whereby each member country was responsible for managing the following to a specific level: – Nominal inflation rates – Long-term interest rates – Fiscal deficits – Government debt In addition, a strong central bank, called the European Central Bank (ECB), was established in Frankfurt, Germany. 3-15 © 2016 Pearson Education, Inc. All rights reserved.  Effects of the Euro The euro affects markets in three ways: – Cheaper transaction costs in the eurozone – Currency risks and costs related to uncertainty are reduced – All consumers and businesses both inside and outside the eurozone enjoy price transparency and increased price-based competition 3-16 © 2016 Pearson Education, Inc. All rights reserved.  Achieving Monetary Unification If the euro is to be successful, it must have a solid economic foundation. The primary driver of a currency’s value is its ability to maintain its purchasing power. The single largest threat to maintaining purchasing power is inflation, so the job of the EU has been to prevent inflationary forces from undermining the euro. 3-17 © 2016 Pearson Education, Inc. All rights reserved.  Emerging Markets and Regime Choices A currency board exists when a country’s central bank commits to back its monetary base – its money supply – entirely with foreign reserves at all times. This means that a unit of domestic currency cannot be introduced into the economy without an additional unit of foreign exchange reserves being obtained first. – Argentina moved from a managed exchange rate to a currency board in 1991 – In 2001, the country ended the currency board as a result of substantial economic and political turmoil 3-18 © 2016 Pearson Education, Inc. All rights reserved.  Emerging Markets and Regime Choices Dollarization is the use of the U.S. dollar as the official currency of the country. One attraction of dollarization is that sound monetary and exchange-rate policies no longer depend on the intelligence and discipline of domestic policymakers. – Panama has used the dollar as its official currency since 1907 – Ecuador replaced its domestic currency with the U.S. dollar in September 2000 3-19 © 2016 Pearson Education, Inc. All rights reserved.  Currency Regime Choices for Emerging Markets Some experts suggest countries will be forced to extremes when choosing currency regimes—either a hard peg or free-floating Three common features that make emerging market choices difficult: 1. weak fiscal, financial and monetary institutions 2. tendencies for commerce to allow currency substitution and the denomination of liabilities in dollars 3. the emerging market’s vulnerability to sudden stoppages of outside capital flows 3-20 © 2016 Pearson Education, Inc. All rights reserved.  Regime Choices for Emerging Markets 3-21 © 2016 Pearson Education, Inc. All rights reserved.  The Foreign Exchange Market  Functions of the Foreign Exchange Market The foreign exchange market is the mechanism by which participants: – transfer purchasing power between countries; – obtain or provide credit for international trade transactions; and – minimize exposure to the risks of exchange rate changes. 3-23 © 2016 Pearson Education, Inc. All rights reserved.  Structure of the Foreign Exchange Market The global foreign exchange market today is rapidly changing due to: – electronic trading platforms; – algorithmic trading programs and routines; and – increasing role of currencies as an asset class. Global trading is a 24-hour-a-day process When the Asian-based trading centers overlap, the global currency markets exhibit the greatest depth and liquidity. 3-24 © 2016 Pearson Education, Inc. All rights reserved.  Global Currency Trading: The Trading Day 3-25 © 2016 Pearson Education, Inc. All rights reserved.  Market Participants Participants in the foreign exchange market include liquidity seekers and profit seekers. Five broad categories of institutional participants operate in the market: – bank and nonbank foreign exchange dealers; – individuals and firms conducting commercial or investment transactions; – speculators and arbitragers; – central banks and treasuries; and – foreign exchange brokers. 3-26 © 2016 Pearson Education, Inc. All rights reserved.  Transactions in the Foreign Exchange Market A spot transaction is the purchase of foreign exchange with delivery and payment between banks taking place normally on the second following business day. A forward transaction requires delivery at a future value date of a specified amount of one currency for a specified amount of another currency. A swap transaction in the interbank market is the simultaneous purchase and sale of a given amount of foreign exchange for two different value dates. 3-27 © 2016 Pearson Education, Inc. All rights reserved.  Size of the Foreign Exchange Market In April 2022, a survey conducted by the Bank for International Settlements (BIS) estimated the daily global net turnover in the foreign exchange market to be $7.5 trillion. The primary driver of rapid foreign exchange growth in recent years is attributed to increasing profit seeker activity facilitated by electronic trading and access to the greater market. 3-28 © 2016 Pearson Education, Inc. All rights reserved.  Global Foreign Exchange Market Turnover, 2010-2022 3-29 © 2016 Pearson Education, Inc. All rights reserved.  Foreign Exchange Rates and Quotations A foreign exchange rate is the price of one currency expressed in terms of another currency. A foreign exchange quotation (or quote) is a statement of willingness to buy or sell at an announced rate. 3-30 © 2016 Pearson Education, Inc. All rights reserved.  Foreign Exchange Rates and Quotations Quotations may be designated by traditional currency symbols or by ISO codes All electronic trading between institutions in the global marketplace uses the three-letter ISO codes. The paper currency of most countries continues to be represented using the country’s traditional currency symbol. 3-31 © 2016 Pearson Education, Inc. All rights reserved.  Bid, Ask, and Mid-Point Quotation 3-32 © 2016 Pearson Education, Inc. All rights reserved. The Balance of Payments  The Balance of Payments BOP data is important for government policymakers and MNEs as it is a gauge of a nation’s competitiveness or health (domestic and/or foreign) For a MNE, both home and host country BOP data is important as: – An indication of pressure on a country’s foreign exchange rate – A signal of the imposition or removal of controls in various sorts of payments (dividends, interest, license fees, royalties and other cash disbursements) – A forecast of a country’s market potential (especially in the short run) 3-34 © 2016 Pearson Education, Inc. All rights reserved.  Fundamentals of BOP Accounting A BOP statement is a statement of cash flows over an interval of time. A credit is an event, such as the export of a good or service, that records foreign exchange earned—an inflow of foreign exchange to the country. A debit records foreign exchange spent, such as payments for imports or purchases of services—an outflow of foreign exchange. 3-35 © 2016 Pearson Education, Inc. All rights reserved.  Fundamentals of BOP Accounting The BOP must balance. It cannot be in disequilibrium unless something has not been counted or has been counted improperly. Therefore, it is incorrect to state that the BOP is in disequilibrium. 3-36 © 2016 Pearson Education, Inc. All rights reserved.  The Accounts of the BOP The BOP has three major sub-accounts— the current account, the capital account, and the financial account. In addition, the official reserves account tracks government currency transactions. A fifth account, the net errors and omissions account is produced to preserve the balance of the BOP. 3-37 © 2016 Pearson Education, Inc. All rights reserved.  The Current Account The Current Account includes all international economic transactions with income or payment flows occurring within one year, the current period. It consists of the following four subcategories: – Goods trade (export and import of goods) – Services trade – Primary income (Income) – Secondary income (Current transfers) The Current Account is typically dominated by the first component which is known as the Balance of Trade (BOT) 3-38 © 2016 Pearson Education, Inc. All rights reserved.  The Current Account Merchandise trade is the original core of international trade. The manufacturing of goods was the basis of the industrial revolution and the focus of the theory of comparative advantage in international trade. Declines in steel, automobiles, automotive parts, textiles, and shoe manufacturing have caused massive economic and social disruption 3-39 © 2016 Pearson Education, Inc. All rights reserved.  Balance of Payments of Slovenia: Current Account 3-40 © 2016 Pearson Education, Inc. All rights reserved.  The Capital and Financial Accounts The capital and financial accounts of the balance of payments measure all international economic transactions of financial assets. The capital account is made up of transfers of financial assets and the acquisition and disposal of nonproduced/nonfinancial assets. – Has only been introduced recently as a separate account 3-41 © 2016 Pearson Education, Inc. All rights reserved.  The Capital and Financial Accounts The financial account consists of four components—direct investment, portfolio investment, net financial derivatives, and other asset investment. Financial assets can be classified in a number of different ways including the length of the life of the asset (maturity) and the nature of the ownership (public or private). The financial account, however, uses degree of control over assets or operations to classify financial assets. 3-42 © 2016 Pearson Education, Inc. All rights reserved.  The Capital and Financial Accounts: Direct Investment This is the net balance of capital dispersed from and into the country for the purpose of exerting control over assets. The source of concern over foreign investment in any country focuses on two topics: control and profit. Some countries possess restrictions on what foreigners may own in their country. Concerns over profit stem from the same argument. 3-43 © 2016 Pearson Education, Inc. All rights reserved.  The Capital and Financial Accounts: Portfolio Investment This is the net balance of capital that flows in and out of the country, but does not reach the 10% threshold of direct investment. The purchase of debt securities across borders is classified as portfolio investment because debt securities by definition do not provide the buyer with ownership or control. Portfolio investment is motivated by a search for returns rather than to control or manage the investment. 3-44 © 2016 Pearson Education, Inc. All rights reserved.  Balance of Payments of Slovenia: Capital and Financial Account 3-45 © 2016 Pearson Education, Inc. All rights reserved.  Net Errors & Omissions/Official Reserves Accounts The Net Errors and Omissions account ensures that the BOP actually balances. The Official Reserves Account is the total reserves held by official monetary authorities within the country. These reserves are normally composed of the major currencies used in international trade and financial transactions (hard currencies). The significance of official reserves depends generally on whether the country is operating under a fixed exchange rate regime or a floating exchange rate system. 3-46 © 2016 Pearson Education, Inc. All rights reserved.  Causes of Balance of Payment Deficit and possible Responses Classification of causes for BOP disequilibrium – Short-term, temporary problems – Long-term (continuous, progressive) problems Short-term problems - important from liquidity point of view Long-term problems - important from economic development or structural point of view; two groups of causes – Structural factors – Monetary factors 3-47 © 2016 Pearson Education, Inc. All rights reserved.  Causes of Balance of Payment Deficit and possible Responses In theory, there are two mechanism for dealing with BoP disequilibrium – Financing – does not imply reallocation of resources; appropriate when causes are short-term – Adjustment – it requires reallocation of resources in the country; appropriate when BoP problems are caused by long-term, structural factors In practice, a combination of both is usually applied; their proportion depends on – Causes of balance-of-payments disequilibrium – Capacity of the country to finance the deficit – Policy choices of the authorities 3-48 © 2016 Pearson Education, Inc. All rights reserved.  International Monetary System and Changes in Global Economic Governance  Concept of an International Monetary System Main objectives of an effective international monetary system – To create conditions conducive for exchange rate stability (EXCHANGE RATE ISSUE) – To provide an effective BoP adjustment mechanism (BOP ISSUE) – To generate normal access to international liquidity that is required for BoP financing (BOP ISSUE) International monetary system is a consistent set of rules aimed at achieving the above three objectives simultaneously 3-50 © 2016 Pearson Education, Inc. All rights reserved.  Four Models for a „Good“ International Monetary System Model no. 1: Mechanism of automatic adjustment; key elements are foreign exchange supply and demand (example: gold standard before WW I) Model No. 2: (n – 1) mechanism / system; it works only in the system of fixed exchange rates (example: Bretton Woods system) Model No. 3: Coordination of economic policies; key element is exchange rate system (example: after the Bretton-Woods system) Model No. 4: Monetary union; key element is elimination of national currencies (EMU) 3-51 © 2016 Pearson Education, Inc. All rights reserved.  Evolution of the Global Monetary System 3-52 © 2016 Pearson Education, Inc. All rights reserved.  Evolution of the International Monetary System The Gold Standard (1876-1913) – Gold has been a medium of exchange since 3000 BC – “Rules of the game” were simple, each country set the rate at which its currency unit could be converted to a weight of gold – Currency exchange rates were in effect “fixed” – Expansionary monetary policy was limited to a government’s supply of gold – Was in effect until the outbreak of WWI when the free movement of gold was interrupted 3-53 © 2016 Pearson Education, Inc. All rights reserved.  Evolution of the International Monetary System The Inter-War Years & WWII (1914-1944) – During this period, currencies were allowed to fluctuate over a fairly wide range in terms of gold and each other – Increasing fluctuations in currency values became realized as speculators sold short weak currencies – The U.S. adopted a modified gold standard in 1934 – During WWII and its chaotic aftermath the U.S. dollar was the only major trading currency that continued to be convertible 3-54 © 2016 Pearson Education, Inc. All rights reserved.  Evolution of the International Monetary System Bretton Woods and the International Monetary Fund (IMF) (1944) – As WWII drew to a close, the Allied Powers met at Bretton Woods, New Hampshire to create a post-war international monetary system – The Bretton Woods Agreement established a U.S. dollar based international monetary system and created two new institutions the International Monetary Fund (IMF) and the World Bank 3-55 © 2016 Pearson Education, Inc. All rights reserved.  Evolution of the International Monetary System – The International Monetary Fund is a key institution in the new international monetary system and was created to: Help countries defend their currencies against cyclical, seasonal, or random occurrences Assist countries having structural trade problems if they promise to take adequate steps to correct these problems – The International Bank for Reconstruction and Development (World Bank) helped fund post-war reconstruction and later on general economic development 3-56 © 2016 Pearson Education, Inc. All rights reserved.  Evolution of the International Monetary System Fixed Exchange Rates (1945-1971) – The currency arrangement negotiated at Bretton Woods and monitored by the IMF worked fairly well during the post-WWII era of reconstruction and growth in world trade – However, widely diverging monetary and fiscal policies, differential rates of inflation and various currency shocks resulted in the system’s demise – The U.S. dollar became the main reserve currency held by central banks, resulting in a consistent and growing balance of payments deficit which required a heavy capital outflow of dollars to finance these deficits 3-57 © 2016 Pearson Education, Inc. All rights reserved.  Evolution of the International Monetary System – Eventually, the heavy overhang of dollars held by foreigners resulted in a lack of confidence in the ability of the US to met its commitment to convert dollars to gold – The lack of confidence forced US to suspend official purchases or sales of gold by the U.S. Treasury on August 15, 1971 – This resulted in devaluations of the dollar – Most currencies were allowed to float to levels determined by market forces as of March 1973 3-58 © 2016 Pearson Education, Inc. All rights reserved.  Evolution of the International Monetary System The Floating Era (1973-1997) – Since March 1973, exchange rates have become much more volatile and less predictable than they were during the “fixed” period – There have been numerous, significant world currency events over the past 30 years The Emerging Era (1997-present) – Emerging market economics are multiplying in number and growing in complexity – This results in a growing number of emerging market currencies 3-59 © 2016 Pearson Education, Inc. All rights reserved.  Changes in the Global Economic Governance The term economic governance describes the overall philosophy and architecture of – Economic policy-making as well as – The institutions and processes that guide the evolution of the economy The manner in which economic governance is run at a global level is unique for several reasons – Changing character of global geopolitical relations – Growing number of players involved – Broadened and deepened economic cooperation needs stronger and better economic governance 3-60 © 2016 Pearson Education, Inc. All rights reserved.  Changes in the Global Economic Governance After WW II, „rule-based“ global economic governance was put in place Globalization was a very fertile ground for its development Main features of the „rule-based“ system: – It was de-facto guaranteed by US („unipolar world“) – It was implemented through a strong role of IFIs – Its agenda was practically exclusively focus on economic issues – This was a period when the goal was to integrate China into the global economy 3-61 © 2016 Pearson Education, Inc. All rights reserved.  Changes in the Global Economic Governance Transition from „rule-based“ to „deal-based“ global economic governance is caused by several mutually reinforcing trends – Transition to an increasingly multipolar world (the growing importance of emerging economies; from G7 to G-20) – Growing geopolitical tensions (especially those ones between US and China, and recently between Russia and the West) – Negative aspects of globalization (inequality within countries and growing populism) – International organizations are not adjusted to the new reality on the ground (IMF, WTO, WB) 3-62 © 2016 Pearson Education, Inc. All rights reserved.  Changes in the Global Economic Governance Key features of „deal-based“ system …. – World is „multipolar world with IFIs marginalized – Fragile and non-transparent – Narrowly focused on national interests (economy is an instrument for achieving strategic goals) – Dependent on bargaining power …. and its consequences – Unstable international relations – Growing inequality between countries – Bad for small countries – Goal of integrating China into global economy replaced by the debate how to dis-integrate 3-63 © 2016 Pearson Education, Inc. All rights reserved. International Business Environment 2024-2025 Lecture 4. REVIEW International Trade Prof. Črt Kostevec Outline I. Why do countries trade? II. Globalization: International trade of goods and services Int‘l movement of capital (FDI, FII) Int‘l migration III. Levels of „managing“ international trade: National (gov‘t) trade policy: tariffs, non-tariff barriers Global (multilateral) trade institutions Regional economic agreements 2  Why do countries trade? Blasphemy in the 18th century the »18th Century Rule«, which was published this year in a pamphlet Considerations Upon the East-India Trade (1701) by an anonymous author. The author was later determined to be Henry Martyn (1665-1721) a Whig politician “a country should import that goods that cannot be produced at home or that can be more cheaply produced abroad “ 3  Why do countries trade? Why import? Do we (country) have a We can make it, but is product or a commodity? it being made cheaper Can we make it? somewhere else? Are they simply Do they use Are factors of Do they more productive? a different production produce Better trained, more technology? cheaper? at scale? efficient,… 4  Is int’l trade linked to economic growth? Lever and Van den Berg (2003) survey the empirical literature and summarize the result as A one percentage point increase in the growth of exports is associated with a one-fifth percentage point increase in economic growth. What would be the connecting mechanism? Knowledge transfer and learning Capacity utilization and economies of scale Competitive pressures on the import side 5 How about poverty reduction? 6 II. International trade in goods and services 7 International trade of goods and services Trade – the sale (exports) and purchase (imports) of goods/merchandise and services across national border. Product groups: a) Primary products (agricultural, fuels and mining products) b) Manufactures (iron and steel, chemicals, machinery and transport equipment, textiles, clothing and others) c) Other products Trade policy – all government actions that seek to alter the free flow of goods or services from or to a country. Sources: Gaspar et al. (2017), pp. 36-47 https://www.wto.org/english/res_e/statis_e/wts2021_e/wts2021chapter04_e.pdf 8 Value of trade of goods and services 9 Trade openess 10  Leading exporters – trade of goods 25 United States; 21,6 20 China; 14,2 15 Germany; 12,0 United Kingdom; 11,3 10 United States; 8,5 Japan; 9,2 France; 3,5 5 China; 0,9 0 China France Germany India Japan Republic of Korea United Kingdom United States 11 The issue with services 12  The issue with services Share of services in global value added (source: UNCTAD, 2024) 80 70 66,62 60 53,39 50 40 37,34 30 28,82 20 10 0 Industry Services 13 14 Exports of goods & services as % GDP latest data 15 https://www.theglobaleconomy.com/rankings/exports/  Export/GDP 2000 to 2023 (World bank data) Exports of goods and services to GDP 100 SVN; 94,15 90 80 70 HRV; 54,03 60 50 40 DEU; 47,14 30 CHN; 19,74 20 10 0 HRV DEU FRA JPN KOR CHN SVN 16  Trends in global trade – total exports of goods 2002 (left), 2012 (top right) and 2022 (bottom right) https://globaltradedata.wto.org/official-data 17  Merchandise exports and imports by region fourth quarter of 2022: a slump in goods trade (volume of world merchandise trade is anticipated to increase by 0.8% in 2023, down from the 1.7% forecast in April, the 3.3% growth is projected for 2024) first half of 2023: export growth was fastest in North America, import growth 18 was fastest in CIS, Middle East, Africa The case against free trade 19  Effect of possible trade conflict Trade conflict, where international cooperation on tariffs breaks down completely and all countries set tariffs unilaterally: WTO economists have attempted to quantify the medium- run economic impact of this wider trade conflict (Bekkers and The, 2019). Results indicate that a "worst case" scenario would lead to a decline in world GDP in 2022 of about 2% and a fall in global trade of about 17% compared to baseline projections. As comparison, global GDP declined about 2% and global trade fell about 12% in