BUSA4000 Global Business Challenge 5 Notes PDF

**BUSA4000** **Global Business** **Challenge 5. Government Intervention in IB** **LEARNING OBJECTIVES** 1. **Model the effects of different tariff rates and other non-tariff barriers to trade and investment on the cost of doing business in international markets** 2. **Formulate strate...

**BUSA4000** **Global Business** **Challenge 5. Government Intervention in IB** **LEARNING OBJECTIVES** 1. **Model the effects of different tariff rates and other non-tariff barriers to trade and investment on the cost of doing business in international markets** 2. **Formulate strategic responses to specific government intervention tools** 3. **Assess the cost of doing business in specific countries based on membership in trade blocks, preferential trade arrangements, and other regional integrations areas.** **Challenge 5. How can firms implement strategic responses to host & home country government intervention in international business?** **Protectionism** refers to national economic policies designed to restrict free trade and protect domestic industries from foreign competition. Government intervention arises typically in the form of **tariffs** (e.g. duty), **nontariff trade barriers** (e.g. quota)*,* and **investment barriers** (target FDI). **Rationale for government intervention** Governments impose trade and investment barriers to achieve political, social, or economic objectives. Such barriers are either defensive or offensive: **◘ Defensive** barriers safeguard industries, workers, special interest groups, protect infant industries and to promote national security (export controls). **◘** **Offensive** barriers pursue a strategic or public policy objective, such as increasing employment or generating taxes. **Instruments of government intervention** Governments also impose *regulations* and *technical standards*, as well as *administrative* and *bureaucratic procedures*. Countries may also impose currency controls to minimize international withdrawal of national currency. *FDI* and *ownership restrictions* ensure that the nation maintains partial or full ownership of firms within its national borders. Governments also provide subsidies, a form of payment or other material support. Foreign governments may offset foreign subsidies by imposing countervailing duties. With dumping, a firm charges abnormally low prices abroad. A government may respond to dumping by imposing an antidumping duty. Governments support domestic firms by providing investment incentives and biased *government procurement* *policies*. **Consequences of government intervention**: **◘ *Economic freedom*** - the extent of government intervention in the national economy, assessed using the Heritage Foundation's Index of Economic Freedom. The Simon Fraser Institute in Canada provides a similar index. **◘** Government intervention and trade barriers may disproportionately impact developing economies and low-income consumers because countries in for example Africa, Bangladesh, Pakistan, and India are taxed at relatively unjustly higher levels. **◘** Government intervention can also offset such harmful effects (e.g. subsidies). **Evolution of government intervention: Intervention has a long history.** ◘ **1800s-** (late) many countries imposed substantial protectionism. ◘ **1930s-** countries reduced trade barriers worldwide. ◘ **Import substitution** -Latin America- delayed countries' eventual transition to free trade. ◘ **Industrialization-** Following World War II, Japan embarked on export-led development. ◘ **Protectionist policies**- India ◘ **1980s** - China had limited foreign involvement until then. ◘ **General Agreement on Tariffs and Trade (GATT) -** the most important development for reducing trade barriers of the last several decades ◘ **1995**- replaced by the **World Trade Organization (WTO)** ◘ The 150 members of the WTO account for nearly all world trade. **Intervention and the global financial crisis** ◘ Crisis impetus- inadequate regulation in the banking/ finance sectors ◘ Response- new government regulations and increasing protectionism to safeguard jobs, wages, and protect domestic industries via subsidies ◘ Ripple Effect- Government reforms transcend beyond the banking and financial areas. **How should firms respond to government intervention?** ◘ Firms should first undertake research to understand the extent and nature of trade and investment barriers abroad. ◘ When trade barriers are substantial, FDI or joint ventures to produce products in target countries are often the most appropriate entry strategies. ◘ Where importing is essential, the firm can take advantage of foreign trade zones, areas where imports receive preferential tariff treatment. ◘ Management should try to obtain a favorable export classification for the firm's exported products- being familiar with the **harmonized code schedules,** which provide a standardized directory for applicable tariffs. ◘ Government assistance in the form of subsidies and incentives helps reduce the impact of protectionism. ◘ Firms sometimes lobby the home and foreign governments for freer trade and investment. ** Regional integration** involves groups of countries forming alliances to promote free trade, cross-national investment, and other mutual goals. **** This integration results from **economic blocs**, in which member countries agree to eliminate tariffs and other restrictions on the cross-national flow of products, services, capital, and, in more advanced stages, labor, within the bloc. ** S**tages of regional integration: ◘ **Free trade area**, in which tariffs and other trade barriers are eliminated ◘ **Customs union**, a free trade area in which common trade barriers are imposed on nonmember countries ◘ **Common market**, a customs union in which factors of production move freely among the members ◘ **Economic union**, a common market in which some economic policies are harmonized among the member states ◘ **Political union** does not yet exist **** There are roughly 200 economic integration agreements in the world. **** The European Union (**EU**) is the most advanced of these, comprising 28 countries in Europe. ** T**he most notable bloc (free-trade-area) in the US Mexico Canada Agreement (USMCA)- consisting of Canada, Mexico, and the U.S. ** Countries pursue regional integration because:** ◘ It contributes to corporate and industrial growth, economic growth, better living standards, and higher tax revenues for the member countries. ◘ It increases market size by integrating the economies within a region. ◘ It increases economies of scale and factor productivity among firms in the member countries and attracts foreign investors to the bloc. ◘ It also increases competition and economic dynamism within the bloc, and increases the bloc's political power. Success factors for regional integration: ◘ Countries that are relatively similar in terms of culture, language, and economic and political structures. ◘ Countries that are geographically close to each other. **Ethical dilemmas of regional integration:** ◘ Regional integration simultaneously leads to *trade creation*, whereby new trade is generated among the countries inside the bloc, and *trade diversion*, in which member countries discontinue some trade with countries outside the bloc. ◘ It can reduce global free trade, particularly when member countries form a customs union that results in substantial trade barriers to countries outside the bloc. ◘ When economic blocs involve many countries of various sizes, regional integration can concentrate power into large firms and large nations inside the bloc. ◘ Regional integration results in economic restructuring, which may harm particular industries and firms. ◘ When a country joins an economic bloc, it must relinquish some of its autonomy and national power to the bloc's central authority. Individual countries risk losing some of their national identity **Consequences of regional integration:** **GOVERNMENT INTERVENTION IN INTERNATIONAL BUSINESS** Governments intervene in trade and investment to achieve political, social, or economic objectives. Barriers benefit specific interest groups, such as domestic firms, industries, and labor unions. **Government Intervention Rationale:** Job creation by protecting industries from foreign competition; support homegrown industries/firms. GOVERNMENT FREE INTERVENTION TRADE Government intervention is at odds with *free trade*, the unrestricted flow of products, services, and capital across national borders. Market liberalization and free trade foster economic growth and improved living standards. Economists have long argued that *free trade* is good for the world: resources are efficiently employed; living standards increased and value chain activities exploited. Research suggests a strong positive relationship between market openness (unimpeded free trade) and economic growth. **RATIONALE FOR GOVERNMENT INTERVENTION: FOUR REASONS** There are four main motives for government intervention: +-----------------------------------------------------------------------+ | **(1)** **Generate revenue** | | | | **Example**- the "Hamilton Tariff," enacted July 4, 1789, was the | | second statute passed by the newly founded United States, providing | | revenue for the federal government. | | | | Today, Ghana and Sierra Leone generate more than 25% of their total | | government revenue from tariffs. | +=======================================================================+ | **(2)** **Ensure citizen safety, security, and welfare** | | | | **Example**- governments pass laws to prevent importation of | | harmful products such as contaminated food. | +-----------------------------------------------------------------------+ | **(3)** **Pursue economic, political, or social objectives** | | | | In most cases, tariffs and similar forms of intervention are | | intended to promote job growth and economic development. | +-----------------------------------------------------------------------+ | **(4)** **Serve company and industrial interests** | | | | Governments may devise regulations to stimulate development of | | home-grown industries. | +-----------------------------------------------------------------------+ **DEFENSIVE RATIONALE** **Four major defensive motives:** **\[1\] PROTECTION OF THE NATIONAL ECONOMY** **Proponents Argue:** Firms in advanced economies cannot compete with those in developing countries that employ low-cost labor, thus governments should impose trade barriers to block low-priced imports. Fear is that advanced-economy manufacturers will be undersold, wages will fall, and home country jobs will be lost. **Critics Argue:** Protectionism is at odds with the theory of comparative advantage, which argues for *more* international trade, not less- b/c trade barriers interfere with country-specific specialization of labor, thus blocking the opportunity for superior living standards. Blocking imports reduces the availability and increases the cost of products sold in the home market. Protectionism may trigger retaliation, where foreign governments impose their own trade barriers, reducing sales prospects for exporters **\[2\] PROTECTION OF AN INFANT INDUSTRY** Emerging industry firms may lack experience, technological expertise and economies of scale. Therefore, an infant industry may need protection from foreign competitors, e.g. temporary trade barriers on foreign competitors Infant industry protection has allowed some countries to develop modern industrial sectors **Examples**- **Japan** became extremely competitive in global automobiles **South Korea** achieved great success in consumer electronics. **U.S.** government imposed tariffs on the import of inexpensive Chinese-made solar cells to protect the emerging U.S. solar power industry. **Challenges-** Difficult to remove- industry owners and workers tend to lobby to preserve government incentives indefinitely. Infant industries (especially in Latin America, South Asia, and Eastern Europe) have remained dependent on government protection for prolonged periods. Industry inefficiencies result in higher taxes and higher prices for the products produced by the protected industry. **\[3\] NATIONAL SECURITY** Countries impose trade restrictions on products viewed as critical to national defense and security, such as military technology and computers. Trade barriers can help retain domestic production in security-related products- computers, weaponry, and certain transportation equipment. **Example-** ◘ **Russia** blocked a bid by Siemens (German engineering giant) to purchase the Russian turbine manufacturer OAO Power Machines, due to national security. **Export controls**- governments manage/prevent the export of certain products or trade with specific countries. **Examples-** ◘ Many countries do not allow the export of plutonium to North Korea because it can be used to make nuclear weapons. ◘ The U.S. generally blocks exports of nuclear and military technology to countries it deems state sponsors of terrorism, such as Iran, and Syria. **\[4\] NATIONAL CULTURE AND IDENTITY** Governments seek to protect certain occupations, industries, and public assets that are considered central to national culture and identity- restrict/prohibit certain imports- **Examples-** ◘ **U.S.** opposed Japanese investors' purchase of the Seattle Mariners baseball team, Pebble Beach golf course in California, and New York's Rockefeller Center- because these are viewed as part of the national heritage. ◘ **France** does not allow significant foreign ownership of its TV stations because of concerns about foreign influences on French culture. ◘ **Switzerland** imposed trade barriers to preserve its long-established tradition in watch making. ◘ **Japanese** restrict the import of rice because this product is central to the nation's diet and food culture. **OFFENSIVE RATIONALE** **Two offensive categories:** **\[1\] NATIONAL STRATEGIC PRIORITIES** Intervention encourages the development of industries that bolster the nation's economy. This is a *proactive* variation of the infant industry rationale, related to national industrial policy. Countries with many high-tech or high-value-adding industries---such as information technology, pharmaceuticals, car manufacturing, or financial services---create better jobs and higher tax revenues than economies based on low-value-adding industries---such as agriculture, textile manufacturing, or discount retailing. **Examples**- Germany, South Korea, Japan, Norway---devise policies that promote the development of more desirable industries. Implementation: Deciding which industries to support is challenging because it is difficult to predict which industries will produce comparative advantages. Poor choices may result in continuous subsidization of underperforming industries. **\[2\] INCREASING EMPLOYMENT** Import barriers may be imposed to protect employment in designated industries. By insulating domestic firms from foreign competition, national output is stimulated, leading to more jobs in the protected industries. Most effective- import-intensive industries that employ much labor to produce normally imported products. **Example-** A joint venture between Shanghai Automotive Industry Corporation (SAIC) and Volkswagen created jobs in China. **INSTRUMENTS OF GOVERNMENT INTERVENTION** **Tariffs** **Export tariffs**- taxes on products exported by domestic firms **Example-** Russia charges a duty on oil exports, intended to generate government revenue and maintain higher oil stocks within Russia. **Import tariff** (most common) - tax levied on imported products. **Ad valorem** **tariffs** are assessed as a percentage of the value of the imported product. **Specific tariff**---a flat fee or fixed amount per unit of the imported product---based on weight, volume, or surface area (such as barrels of oil or square meters of fabric). **Revenue tariff** - intended to raise revenue for the government, e.g. taxing cigarette imports. **Protective tariff** - protects domestic industries from foreign competition. **Prohibitive tariff** - is so high that no one can import any of the items. **Harmonized code (harmonized tariff)** -- tariffs determined according to this synchronized worldwide system that classifies products according to 8,000 unique codes and assigns standardized tariffs accordingly Developing economies- tariffs are common. Advanced economies- tariffs still provide a significant source of revenue. **Nontariff Trade Barriers** ** Government policies that restrict trade without imposing a direct tax or duty - quotas, import licenses, local content requirements, government regulations, and administrative or bureaucratic procedures** ** The use of nontariff barriers has grown substantially in recent decades- they are easier to conceal from the WTO and other monitoring organizations.** **Quotas** restrict the physical volume or value of products that firms can import into a country. The **upside** is that domestic producers are protected from cheaper imports, giving them a competitive edge over foreign producers. The **downside** is that domestic consumers and producers of certain types of products pay more for the product. It also means that firms that manufacture products containing the higher-priced product can save money by moving production to countries that do not impose quotas or tariffs on this product. **Voluntary export/import restraints** (VERs/VIRs) are voluntary quotas imposed by governments whereby firms agree to limit exports/imports of certain products. **Example-** EU impounded the Chinese-made clothing when China exceeded the voluntary import quotas it had negotiated with the EU; millions of Chinese-made garments piled up at European ports/borders; European retailers were challenged having ordered their clothing inventory several months in advance. **Import license** - government permission to import, which restricts imports similarly to quotas- a costly, complicated, bureaucratic process in some countries **Note:** Different from *licensing* a strategy for entering foreign markets in which one firm allows another the right to use its intellectual property in return for a fee. Governments sell import licenses to firms on a competitive basis or on a first-come, first-served basis - a process that discriminates against smaller firms, which typically lack the resources to purchase the licenses. **Examples-** ◘ **Russia-** a complex web of licensing requirements limits imports of alcoholic beverages. ◘ **India**- until the 1990s, the government imposed the "license raj," an especially elaborate system of licenses that regulated establishing/running businesses in the country. **Local content requirements** stipulate that production must include a certain percentage of local value added production, i.e. locally produced. These are usually imposed in economic bloc countries, such as the European Union and USMCA. The so called "**rules of origin requirement**" specifies that a certain proportion of products and supplies, or of intermediate goods used in local manufacturing, must be produced within the bloc. **Government regulations and technical standards** include safety regulations for motor vehicles and electrical equipment, health regulations for hygienic food preparation, labeling requirements that indicate a product's country of origin, technical standards for computers, and bureaucratic procedures for customs clearance. ** Examples** of protecting domestic firms by imposing red tape for foreign firms: ◘ **European Union** strictly regulates genetically modified (GM); a policy that blocks some food imports into Europe from the U.S. b/c GM food regulations are relatively lax in the U.S. ◘ **China** requires foreign firms to obtain special permits to import GM foods. ◘ **Chinese** government clashed with **Google** when it refused to censor its Web search and news services in mainland China. The government has historically censored material it considers subversive, which has hindered Google's attempts to enter China's huge Internet market. ** Administrative or bureaucratic procedures** that hinder the activities of importers or foreign firms ** Examples-** ◘ **India**- business sector is burdened by countless regulations, standards, and administrative hurdles at the state and federal levels. ◘ **Mexico**- government imposed bureaucratic procedures led United Parcel Service to temporarily suspend its ground delivery service across the U.S.- Mexican border. ◘ **U.S.** barred Mexican trucks from entering the U.S. on the grounds that they were unsafe. ◘ **Saudi Arabia**- every foreign business traveler to the Arab kingdom must hold an entry visa that can be obtained only by securing the support of a Saudi sponsor - a citizen who vouches for the visitor's actions- very difficult to get. **Investment Barriers** In order to bypass tariffs, firms may enter countries via FDI, yet be subject to ownership restrictions. Globally, FDI and ownership restrictions are common in industries such as broadcasting, utilities, air transportation, military technology, and financial services, as well as industries that involve major government holdings, such as oil and key minerals. ** Examples**- ◘ **Mexico**- government restricts FDI by foreign investors to protect its oil industry, which is deemed critical to the nation's security. ◘ **Canada**- government restricts foreign ownership of local movie studios and TV networks to protect its indigenous film and TV industries from excessive foreign influence. ◘ **Services** sector - FDI and ownership restrictions are particularly burdensome because services usually cannot be exported and providers must establish a physical presence in target markets. Smuggling may be an unintended consequence. **Currency controls** **** Restrictions on the outflow of hard currency (such as the U.S. dollar, the euro, and the yen), or the inflow of foreign currencies **** These controls are used to conserve valuable hard currency, reduce the risk of capital flight, and are particularly common in developing countries. ** Dual official exchange rates-** Some countries employ a system of offering exporters a relatively favorable rate to encourage exports, while importers receive a relatively unfavorable rate to discourage imports. ** Help and Hinder-** Currency controls favor companies when they export their products from the host country but harm those that rely heavily on imported parts and components. ** Repatriation** of profits-- restrictions on revenue transfer from profitable operations back to the home country. ** Example-** ◘ **Venezuela-** currency controls have led to a shortage of dollars and other hard currencies. Multinational firms avoid doing business in Venezuela because strict currency rules limit the amount of profits they can take out of the country or limit their ability to receive payment for imports at reasonable prices. Venezuela imposed the controls to keep imports inexpensive and retain a base of hard currencies in the country. **Subsidies and Other Government Support Programs** ** Subsidies -** Monetary or other resources that a government grants to a firm or group of firms, intended to encourage exports or to facilitate the production and marketing of products at reduced prices, to ensure the involved firms prosper. ** Examples-** Cash disbursements, material inputs, services, tax breaks, infrastructure construction, and inflated government contracts. ** Examples-** ◘ **France**- government provided large subsidies to Air France, the national airline. ◘ **European** government support of Airbus, the leading European manufacturer of commercial aircraft ◘ **China-** Many leading corporations, such as China Minmetals (\$39 billion annual sales) and Shanghai Automotive (\$34 billion annual sales), are state enterprises wholly or partly owned by the Chinese government, which provides these firms with huge financial resources. ** Critics** -- **unfair advantages**- subsidies artificially reduce the cost of business for the recipient. The WTO **prohibits** subsidies when it can be proven that they hinder free trade. ** Example-** ◘ **India-** government provides massive subsidies to state-owned oil companies, which allows them to offer gasoline at very low prices. Foreign MNEs such as Royal Dutch Shell cannot operate profitably at such prices and consequently avoid doing business in that market. ** Subsidies** encourage overproduction, which lower domestic food prices, making agricultural imports from developing countries less competitive. ** Difficult to Define-** when a government provides land, infrastructure, telecommunications systems, or utilities to corporate park firms, this is technically a subsidy- yet many would argue that this is just an appropriate public function ** European** and **U.S**. governments provide agricultural subsidies to supplement the income of farmers and help manage the supply of agricultural commodities. ** Countervailing duties -** government retaliation against foreign subsidies by imposing a duty on imported products to offset subsidies in the exporting country. ◘ The duty cancels out the effect of the subsidy. ** Dumping** - subsidies may allow a manufacturer to engage in **dumping**, which is charging an unusually low price for exported products, typically lower than that for domestic or third-country customers, or even lower than manufacturing cost. ** Example** - The EU subsidy to sugar producers allows EU farmers to dump massive amounts of sugar at artificially low prices onto world markets, making them the largest exporters of sugar- without the subsidies Europe would be one of the world's biggest sugar importers. **** Dumping is against WTO rules because it amounts to unfair competition, **but it is hard to prove.** **** A large MNE that charges very low prices could conceivably drive competitors out of a foreign market, thereby achieving a monopoly, and later raise its prices. ** Antidumping duty** - a tax imposed on products deemed to be dumped and causing injury to producers of competing products in the importing country. **** The WTO allows this practice. ** Examples of indirect government subsidies-** support home country businesses by funding R&D initiatives, granting tax exemptions, and offering business development services, such as market information, trade missions, and privileged access to key foreign contacts. ** Investment incentives**- related to subsidies- transfer payments or tax concessions made directly to individual foreign firms to entice them to invest in the country. ** Examples-** **◘ Hong Kong** government put up most of the cash to build the Hong Kong Disney Park ([park.hongkongdisneyland.com]). While the theme park and facilities cost about \$1.81 billion, the government provided an investment of \$1.74 billion to Walt Disney to develop the site. **◘** Austin, Texas and Albany, New York competed to have the Korean manufacturer Samsung Electronics ([[www.samsung.com]](http://www.samsung.com)) build a semiconductor plant in their regions. Austin offered \$225 million worth of tax relief and other concessions in its successful bid to attract Samsung\'s \$300 million plant, estimated to create nearly 1,000 new jobs locally. **◘ Macedonia** entices MNEs with incentives such as low corporate taxes, immediate access to utilities and transportation, and financial support for training workers ([[www.investinmacedonia.com]](http://www.investinmacedonia.com)). **◘** 1990s- **Germany** encouraged foreign firms to invest in the economically disadvantaged East German states by providing tax and investment incentives. **◘** 1990s- **Ireland** achieved an economic renaissance through proactive promotion of Ireland as a place to do business. Targeting foreign firms in the high-tech sector---including medical instruments, pharmaceuticals, and computer software- foreign firms were offered preferential corporate tax rates of 12%. ** Government procurement policies** support domestic industries and constitute an indirect form of nontariff trade barrier*.* **** Government procurement policies restrict government-funded purchases to home-country suppliers. ** Example**- Several governments require that air travel purchased with government funds be with home-country carriers. **** Government procurement policies are common in countries with large public sectors, such as China, Russia, and various Middle Eastern countries. ** U.S.** - government agencies favor domestic suppliers unless their prices are higher than foreign suppliers. ** Japan**- government agencies often do not even consider foreign bids, regardless of pricing. ** Effects**- Government Intervention may be measured by a nation's ***Ease of Doing Business***, an index developed by the World Bank that ranks 189 countries. **** A **high ease** of doing business ranking means the country's regulatory environment is business-friendly; very conducive to starting and operating a company there. ** *Ease of Doing Business* Index** **10** **variables are rated per country for a total ranking index:** Starting a business Dealing with construction permits Getting electricity Registering property Getting credit Protecting minority investors Paying taxes Trading across borders Enforcing contracts Resolving insolvency **Ethical Concerns** **** Government intervention and trade barriers disproportionately impact developing economies and low-income consumers because countries such as Bangladesh, Pakistan, India, Cambodia and Africa- where clothing and shoe exporters are concentrated- are taxed at relatively higher levels than UK imports- U.S. import tariffs on clothing and shoes exceed 20%. ****The tariffs that confront less-developed economies are often several times those faced by the richest countries. **** Government intervention can also offset harmful effects- create or protect jobs: **◘ Example-** Globalization has affected thousands of European workers whose jobs have been shifted to other countries with lower labor costs. The European governments have provided subsidies for the unemployed, aimed at retraining workers to upgrade their job skills or find work in other fields. **HOW FIRMS CAN RESPOND TO GOVERNMENT INTERVENTION** **** Firms must cope with protectionism and other forms of intervention- impractical to avoid markets with high trade and investment barriers or excessive government intervention. **Strategies for Managers** **** Emerging markets, e.g. China, India, and countries in Africa, Asia, Latin America, are characterized by extensive trade barriers and never-ending government intervention. **** Despite the challenges, firms target emerging markets and developing economies because they promise significant long-term potential. **(1) RESEARCH TO GATHER KNOWLEDGE AND INTELLIGENCE** **** Firms should first undertake research to understand the extent and nature of trade and investment barriers abroad. **** Scan the business environment to identify the nature of government intervention, plan market-entry strategies and host-country operations, and capitalize upon government support opportunities. **** Review return-on-investment criteria to account for the increased risk/cost of trade and investment barriers ** Example-** EU is devising new guidelines that affect firms in areas ranging from product liability laws to standards for investment in European industries. **(2) CHOOSE THE MOST APPROPRIATE ENTRY STRATEGIES** ** Exporting**- Tariffs and most nontariff trade barriers ** FDI** - Investment barriers **** Most firms choose exporting as their initial entry strategy. However, if high tariffs are present, managers should consider other strategies, such as FDI, licensing, and joint ventures that allow the firm to operate directly in the target market, avoiding import barriers. **◘ Example-**Taiwan's **Foxconn**, a contract manufacturer for Apple and other electronics firms, built a factory in **Brazil** to avoid the high import tariffs. **** Even FDI can be impacted by tariffs- if it requires importing raw materials and parts to manufacture finished products in the host country. **** Tariffs often vary with the *form* of an imported product. **◘** Companies often ship manufactured products "knocked-down" and assemble them in the target market. **◘** In countries with relatively high tariffs on imported personal computers, importers often bring in the parts and assemble the computers locally. **◘ Example-** BMW ships automobiles knocked-down to Brazil, India, Russia, Thailand, and other emerging markets to avoid paying higher tariffs. In Brazil, the average tariff on imported cars is about 35 percent, compared to 15 to 20 percent for unassembled parts and components. Upon arriving in Brazil, the knocked-down cars are assembled in local factories and sold to consumers. BMW could ship finished vehicles to such countries, but the tariff on parts and components is lower. By doing final assembly in Brazil and other emerging markets, BMW avoids paying higher tariffs. **(3) TAKE ADVANTAGE OF FOREIGN TRADE ZONES** **** Governments establish foreign trade zones (FTZs; *free trade zones* or *free ports*) in an effort to create jobs and stimulate local economic development. **** Products brought into an FTZ are not subject to duties, taxes, or quotas until they, or the products made from them, enter into the non-FTZ commercial territory of the country where the FTZ is located. **** Firms use FTZs to assemble foreign dutiable materials and components into finished products, which are then re-exported. **** Firms may use FTZs to manage inventory of parts, components, or finished products that the firm will eventually need at some other location. ** Example-** Japanese carmakers store vehicles at the port of Jacksonville, Florida, without having to pay duties until the cars are shipped to U.S. dealerships. **** FTZs exist in more than 75 countries, usually near seaports or airports. **** The U.S. is home to several hundred FTZs used by thousands of firms. **** Located on the Atlantic side of the Panama Canal, the Colon Free Zone ([[www.colonfreezone.com]](http://www.colonfreezone.com)) is an enormous FTZ where products are imported, stored, modified, repacked, and re-exported without being subject to tariffs or customs regulations. ** Example-** A successful experiment with FTZs has been the ***maquiladoras***---export-assembly plants in northern Mexico along the U.S. border that produce components and finished products destined for the U.S. - e.g. clothing, furniture, car parts, electronics, etc. **** Now under USMCA (US Mexico Canada Agreement), the collaboration enables firms from the U.S., Asia, and Europe to tap low-cost labor, favorable duties, and government incentives, while serving the U.S. market. **** Maquilas account for about half of Mexico's exports **(4) SEEK FAVORABLE CUSTOMS CLASSIFICATIONS FOR EXPORTED PRODUCTS** **** Reduce exposure to trade barriers by classifying products according to the appropriate harmonized product code. **** Since many products can be classified in several categories, ensure that the exported products are classified under the lowest tariff code. ** Example-** Some telecommunications equipment can be classified as electric machinery, electronics, or measuring devices. **** Manufacturers may also modify the exported product in a way that classifies it according to the lowest tariff code, thereby minimizing trade barriers. ** Example-** South Korea faced a quota on the export of non-rubber footwear to the U.S. - by shifting manufacturing to rubber-soled shoes, Korean firms greatly increased their footwear exports **(5) TAKE ADVANTAGE OF INVESTMENT INCENTIVES AND OTHER GOVERNMENT SUPPORT PROGRAMS** **** Government assistance in the form of subsidies and incentives is another strategy for reducing the cost of trade and investment barriers. ** Examples-** **◘** **Mercedes**- built a factory in Alabama, it benefitted from reduced taxes and direct subsidies provided by the Alabama state government. **◘** **Siemens**- built a semiconductor plant in Portugal; it received subsidies from the Portuguese government and the EU. These incentives covered nearly 40% of Siemen's investment and training costs. **◘** Governments in Europe, Japan, and the U.S. increasingly provide incentives to companies that set up shop within their borders **** Incentives also include reduced utility rates, employee training programs, tax holidays, and construction of new roads and communications infrastructure. **(6) LOBBY FOR FREER TRADE AND INVESTMENT** Increasingly, nations are liberalizing markets in order to create jobs and increase tax revenues. **** Firms can lobby foreign governments to lower trade and investment barriers. **** Foreign firms often hire former government officials to help lobby their former colleagues ** Examples-** **Japanese-** have achieved much success in reducing trade barriers by lobbying U.S. and European governments. **China-** domestic and foreign firms lobby the government to relax protectionist policies and regulations that make China a difficult place to do business. Foreign firms often hire former Chinese government officials to help lobby their former colleagues. **** The private sector lobbies federal authorities to undertake government-to-government trade negotiations, aimed at lowering barriers. **** Private firms bring complaints to world bodies, e.g. the WTO, to address unfair trading practices of key international markets. **REGIONAL INTEGRATION AND ECONOMIC BLOCS** Governments play an important role in facilitating: **Regional economic integration** (regional integration), refers to the growing economic interdependence that results when two or more countries within a geographic region form an alliance aimed at reducing barriers to trade and investment. ** Example-** European Union (EU) formation- regional integration increases economic activity and makes doing business easier among nations within the alliance. Economic bloc members are at a minimum parties to free trade agreement. **Free trade agreement-** formal arrangement between two or more countries to reduce or eliminate tariffs, quotas, and barriers to trade in products and services **50%** (**more than**) of world trade today is under some form of (bloc) preferential trade agreement. **Premise-** **mutual advantages** for cooperating nations within a common geography, history, culture, language, economics, and/or politics The free trade that results from economic integration helps nations attain higher living standards by encouraging specialization, lower prices, greater choices, increased productivity, and more efficient use of resources. **Regional Economic Integration Bloc or Economic Bloc**- a geographic area that consists of two or more countries that agree to pursue economic integration by reducing tariffs and other restrictions to cross-border flow of products, services, capital, and, in more advanced stages, labor. ** Examples of Regional Integration-** European Union (EU) US Mexico Canada Agreement (USMCA)- Canada, Mexico, and the U.S. ** Example- EU** ◘ More advanced economic bloc ◘ Permits the free flow of capital, labor, and technology among their member countries ◘ Harmonizing **monetary policy** (to manage the money supply and currency values) and **fiscal policy** (to manage government finances, especially tax revenues) **** Still, recent crises in Greece, Italy, Spain, and Portugal, and general discord among EU members, are challenging the progress of regional integration in Europe. **INTERNATIONAL BUSINESS CONTINUUM- TWO EXTREMES:** **Levels of Regional Integration** **Free Trade Area** The simplest and most common arrangement, in which member countries agree to gradually eliminate formal barriers to trade in products and services within the bloc, while each member country maintains an independent international trade policy with countries outside the bloc. ◘ **Example- USMCA** The free trade area emphasizes the pursuit of comparative advantage for a group of countries rather than for individual states. Local content requirements- if unmet, products subject to tariffs imposed on non-member countries. **Customs Union** **Second** level of regional integration- similar to a free trade area except that the member states harmonize their external trade policies and adopt *common* tariff and nontariff barriers on imports from nonmember countries ◘ **Example- MERCOSUR** (Argentina, Brazil, Paraguay, and Uruguay). The adoption of a common tariff system means that an exporter outside MERCOSUR faces the *same* tariffs and nontariff barriers when trading with *any* MERCOSUR member country. **Common Market -- (Single Market)** **Third** stage of regional integration- trade barriers are reduced or removed, common external barriers are established and products, services, and *factors of production* such as capital, labor, and technology are allowed to move freely among the member countries. Like a customs union - common trade policy with nonmember countries is also established. ◘ **Example- EU** Reduced/eliminated restrictions on immigration and the cross border flow of capital A worker from an EU country has the right to work in other EU countries, and EU firms can freely transfer funds among their subsidiaries within the bloc. **Challenges:** ◘ Require substantial cooperation from the member countries on labor and economic policies. ◘ As labor and capital can flow freely inside the bloc, benefits to individual members vary, because skilled labor may move to countries where wages are higher and investment capital may flow to countries where returns are greater. **Example- Germany**: influx of workers from Poland and the Czech Republic, because these workers can earn substantially higher wages in Germany than they can at home. **Economic Union**- **(Monetary Union- sometimes)** **Fourth stage** of regional integration- member countries enjoy all the advantages of early stages, but also strive to have common fiscal and monetary policies. **At the extreme**- ◘ Identical tax rates ◘ Fixed exchange rates ◘ Free currency convertibility among member states ◘ Free movement of capital **Standardization**- ◘ Helps eliminate discriminatory practices that might favor one member state over another. ◘ Through greater mobility of products, services, and production factors, an economic union enables firms within the bloc to locate productive activities in member states with the most favorable economic policies. ◘ **Example- the EU** **Monetary unions**: ◘ EU has made great strides toward this. Nineteen EU countries have established a *monetary union* with a single currency, the euro. ◘ European financial institutions can establish EU branches and offer banking & insurance services far easier with a monetary union and the euro. ◘ The single currency enables easier trading and investment for European firms doing business within the union. **Economic unions**: ◘ Member countries strive to eliminate border controls, harmonize product and labeling standards, and establish region-wide policies for energy, agriculture, and social services. ◘ Also members standardize laws and regulations regarding competition, mergers, and other corporate behaviors, and harmonize professional licensing procedures. **Political Union**: **(ultimate)** ◘ Perfect unification of all policies by a common organization- submersion of all separate national institutions ◘ **Example**- Remains an ideal, yet to be achieved. **ADVANTAGES AND IMPLICATIONS OF REGIONAL INTEGRATION** Economic integration contributes to corporate and industrial growth, to economic progress, better living standards, and higher tax revenues for the member countries. Nations seek at least **four objectives** in pursuing regional integration: **EXPAND MARKET SIZE** Regional integration greatly increases the scale of the marketplace for firms inside the economic bloc. Consumers also gain access to a wider selection of products and services. **Examples-** ◘ Belgium has a population of just 10 million; the EU gives Belgian firms free access to a total market of roughly 500 million buyers. ◘ The German insurance firm Allianz considers Europe as one large marketplace. ◘ Under USMCA, Canadian firms gained access to the much larger markets of Mexico and the U.S. **ACHIEVE SCALE ECONOMIES AND ENHANCED PRODUCTIVITY** Expansion of market size within an economic bloc gives member country firms the opportunity to increase the scale of operations and gain economies of scale in production and marketing. Internationalization inside the bloc helps firms learn to compete more effectively outside the bloc as well. Labor and other inputs are allocated more efficiently among the member countries- leading to lower prices for consumers. **ATTRACT DIRECT INVESTMENT FROM OUTSIDE THE BLOC** Foreign firms prefer to invest in countries that are part of an economic bloc because factories that they build within the bloc receive preferential treatment for exports to other member countries. **Examples**- General Mills, Samsung, and Tata- invested heavily in the EU to take advantage of Europe\'s economic integration. By establishing operations in a single EU country, these firms gain free trade access to the entire EU market. **ACQUIRE STRONGER DEFENSIVE AND POLITICAL POSTURE** Strengthen member countries relative to other nations and world regions- this was one of the motives for initially creating of the European Community (precursor to the EU), whose members sought to fortify their mutual defense against the expanding influence of the former Soviet Union. For some, the EU is one way Europe counterbalances the power and international influence of the U.S. Countries are more powerful when than cooperate than individually. **MANAGERIAL IMPLICATIONS OF REGIONAL INTEGRATION** Broader challenges of regional integration are trade creation, trade diversion, sacrifice of autonomy, the failure of small or weak firms, and job loss. ** Four Strategic Implications of Regional Economic Integration:** **INTERNATIONALIZATION BY FIRMS INSIDE THE ECONOMIC BLOC** Regional integration pressures firms to internationalize into neighboring countries within the bloc. The elimination of trade and investment barriers presents new opportunities to source input goods from foreign suppliers within the bloc. Competitive advantages gained from internationalizing within the bloc may be leveraged to internationalizing outside the bloc. **RESTRUCTURING OF OPERATIONS** Managers develop strategies and value-chain activities suited to the region as a whole, rather than to individual countries. **Rationalization** is the process of restructuring and consolidating company operations that managers often undertake following regional integration- goal: reducing redundancy and increasing efficiencies. Goal - reduce redundancy & costs and increase the efficiencies through economies of scale. Rationalization becomes an attractive option because, as trade and investment barriers decline, the firm that formerly operated factories in each of several countries reaps advantages by consolidating the factories into one or two central locations inside the economic bloc. **Example-** **Caterpillar**, the U.S. manufacturer of earth-moving equipment, undertook a massive program of modernization and rationalization at its EU plants to streamline production, reduce inventories, increase economies of scale, and lower operating costs. Rationalization may be applied to value chain-functions such as manufacturing, distribution, logistics, purchasing, and R&D. **Example**- creation of an economic bloc eliminates the need to devise separate distribution strategies for individual countries. Instead, firms are able to employ a more global approach for a larger marketplace, generating economies of scale in distribution. **REGIONAL PRODUCTS AND MARKETING** **Standardization** of products and services- firms prefer standardized merchandise in their various markets- easier and much less costly. In more advanced stages of regional integration, member countries tend to harmonize product standards and commercial regulations, and eliminate trade barriers and transportation bottlenecks. As conditions in the member countries become similar to each other, companies can increasingly standardize their products and marketing. **Example**- J. I. Case Company, a manufacturer of agricultural machinery once produced 17 versions of the Magnum model of farm tractors to comply with varying national regulations. The harmonization of EU product standards allowed the firm to standardize its tractor, and produce only a handful of models appropriate for serving the whole EU market. **INTERNATIONALIZATION BY FIRMS FROM OUTSIDE THE BLOC** Regional integration and large multi-country markets are attractive to firms from outside the bloc. The most effective way for a foreign firm to enter an economic bloc is to establish a physical presence via FDI. Foreign firms tend to avoid exporting as an entry strategy because economic blocs erect trade barriers against imports from outside the bloc. A production facility, marketing subsidiary, or regional headquarters anywhere inside a bloc affords the outsider access to the entire bloc and to advantages enjoyed by local firms based inside the bloc. **Examples-** with the EU formation, Britain has become the largest recipient of FDI from the United States. U.S. firms choose Britain as the beachhead to gain access to the massive EU market. In a similar way, European firms have established factories in Mexico to access countries in the USMCA bloc.