Globalization Explained PDF

Globalisation This chapter aims to introduce the concept of globalisation, the growth of multinational and multi-company supply chain operations, and the role of multinational corporations in the globalisation process. The chapter concludes with an examination of the benefits and costs of globa...

Globalisation This chapter aims to introduce the concept of globalisation, the growth of multinational and multi-company supply chain operations, and the role of multinational corporations in the globalisation process. The chapter concludes with an examination of the benefits and costs of globalisation and its overall effect on the global economy. To provide a basis for answering such questions and carrying out such inquiries, this chapter will examine the following: the meaning of globalisation, integration and interdependence measures of the extent of globalisation and the growth of international business the factors that have facilitated the globalisation process multinational supply chains the costs and benefits of globalisation 2.1 The nature of globalisation and interdependence Capital mobility: the ability to move private funds across national boundaries in pursuit of higher returns Globalisation: the growing integration of national economies to form a single interdependent global economy Globalisation of markets: the convergence of tastes and preferences across the markets of the world and global acceptance of standardised products Globalisation of production: the dispersal of the phases of production around the world by a firm to take advantage of national differences in production efficiencies Interdependence of national economies: linkage between events in one economy and outcomes in another by cross-border transactions and international flows of trade, capital and technology Transfer: the movement of scientific methods of production or distribution from one enterprise, institution or country to another CONCEPTS The world's economy is changing. It can no longer be viewed just as a patchwork of distinct national economies; increasingly, it resembles a large, single global economy. National economies, businesses and individuals around the world are becoming more closely bound together in a network of global economic linkages. These global linkages are evident in a number of ways: the availability of an increasing number of products from around the world the brand names and company names such as McDonald's, Coca-Cola and Nike that are instantly recognisable and whose products are readily available no matter where we travel -- the spread of the multinational corporation the foreign ownership of local businesses the ability of people to work at their chosen career in various locations around the world. Less obvious -- although no less significant -- indicators of global linkages include: fluctuations in domestic share prices and interest rates in line with fluctuations overseas changes to the industrial structure of economies and job losses the ebb and flow of cross-border and cross-currency loans and deposits the number of foreign students studying English or studying in English-speaking countries. Globalisation covers many more issues than simply international trade. The globalisation of the world economy is characterised by a greater degree of interdependence of national economies than that created by the links of international trade. Globalisation implies that national economies lose some of their independence and separate identities as they become Economic globalisation is the increasing convergence and interdependence of national economies. The international scope and availability of markets, distribution systems, capital, labour and technology have increased. KEY IDEA merged into one global economy. This process of globalisation occurs through a number of channels in addition to international trade. These channels include the globalisation of markets, the globalisation of production, capital mobility and technology transfers. Globalisation has become one of the economic issues of our time. It is discussed by everyone, from the citizen in the street to economists and political leaders at the highest level. Joseph Stiglitz, Nobel Prize winner in economics, says benefits of globalisation stem from 'the enormous reduction of costs of transportation and communication, and the breaking down of artificial barriers to the flows of goods, services, capital, knowledge and people across borders'. However, despite being responsible for creating prosperity, globalisation has also been blamed for climate change and environmental degradation. Globalisation is not a new concept; throughout history, there have been periods of major globalisation through military conquests, such as the spread of the Roman Empire, where new ideas and products were introduced into different regions. 2.2 The extent of globalisation Capital flow: the movement of money for the purpose of investment, trade or business production Global financial system: the global system of integrated national financial markets and institutions that provides the means for cross-border financial transactions Law of one price: a measure of economic integration based on the theory that the prices of similar products traded in linked markets should converge to the one price Trade intensity: a measure of economic integration based on the ratio of trade (the sum of exports and imports) to output CONCEPTS How integrated have economies become? The integration of economies essentially concerns the movement of products, capital and people across international borders. Measures of the extent of globalisation can therefore be derived from flows of trade, capital and labour across international borders. The extent of globalisation can be measured at two levels: the economy level and the firm level. This discussion focuses on the economy only. 2.2.1 Globalisation and the economy Two trade-related measures of the level of globalisation and the economic integration of markets in the world economy are trade intensity and the law of one price. Trade intensity Trade intensity is the ratio of trade to output. It gives a measure of the integration of product markets in the world economy. Figure 2.1 shows that world trade volume growth has generally been growing faster than world GDP growth. The ratio of trade growth to GDP growth has been remarkable, and reflects the continuing importance of globalisation. What does this all mean? It means that a greater proportion of home-based production is being directed by producers to international rather than domestic markets, and a greater proportion of domestic markets are being served by imports. Domestic producers and product markets have become more internationally oriented and integrated. In 1974, the ratio of trade to GDP in Australia was 25 per cent. In 2014 this had grown to 42 per cent. Trade intensity probably underestimates the extent of product market integration. The GDP includes many services that are non-tradeable; for example, services to the owners and occupiers of houses and office blocks and to the users of infrastructure (such as roads and bridges) are unable to be traded. Of course, the remarkable figures are those for China, South Korea and India, all of which have had remarkable growth rates and contribute much more to the world economy than they did in 1974. Law of one price Economic theory predicts that the prices of similar products in markets that are linked should converge to the one price. If they do not, people can profit by buying cheap in one market and selling for a profit in the higher-priced market. The demand and supply forces created by this profit-seeking activity in the respective markets bring the prices into line. A measure of the degree of economic integration, therefore, is to examine the extent to which the prices of internationally traded products converge across countries. There is little deviation across countries from a world price for products such as gold and oil. Applying the law of one price, the markets for these commodities are highly integrated. There remain, however, significant deviations in prices across countries for most traded goods. This is due to tariff and non-tariff barriers, transaction costs, transport costs, and lack of sufficient information by traders of regulatory, market and production conditions. The increase in the cross-border flows of long-term and short-term capital is a measure of the global integration of financial markets of economies. Growth of turnover in the global foreign exchange market and the convergence of yields and interest rates -- another application of the law of one price -- are other measures of integration. Q U E S T I O N S 1 List two trade-related ways of measuring the level of economic integration of the domestic economy and the international economy. 2 Define the term 'trade intensity'. 3 Give two examples of non-tradeables. 4 What is the difference between a good and a service? 5 What does the law of one price predict about the price of traded goods? 6 a Identify two products for which the law of one price seems to apply. b Why does the law of one price seem to work in the market for these products but not other products? Sur vey: Trade intensity Visit your local supermarket, department store or speciality store. Select a category of product; for example, a food aisle of a supermarket, the children's clothing section of a department store or the car accessories section of a hardware store. Classify the products and determine the proportions that are 'made in Australia' compared to made elsewhere in the world. Present the data in graphical form, showing the relative shares from the different categories of product. ECONOMICS IN ACTION Capital flows The integration of national financial markets into a global financial system gives firms greater access to financial services from a diverse and competitive array of providers. Investors have access to an expanded menu of capital flows and investment opportunities. As shown in Figure 2.3, finance from external sources in relation to economic activity has grown significantly over the last two decades. Trade has also grown. These two measures of globalisation complement each other. For example, if foreign direct investment (FDI) grows, one would expect to see an increase in capital goods and business services. As shown in Figure 2.3, FDI inflows alone over the past decade have grown in excess of 21 per cent per year. 1995 2000 05 10 \*Post-communist states, eastern and south-east Europe 14 Foreign direct investment Inflows, \$trn 0.5 1.0 1.5 2.0 0 Transition\* Developed Developing FIGURE 2.3 Total world FDI flows 2014 Foreign exchange turnover Another measure of financial globalisation is the average daily turnover in the foreign exchange market. Financial globalisation is, in part, a reflection of the growth of international trade and the globalisation of production. Trading in the global foreign exchange market, however, has grown faster than the growth of international trade of goods and services. According to the Bank for International Settlements, as of April 2016, average daily turnover in global foreign exchange markets is estimated at US\$5.1 trillion. Clearly, the dealings of currencies in the foreign exchange market are for purposes other than as a medium of exchange in international trade. People and institutions are looking beyond their national financial markets to the international financial market to serve their financial needs. Convergence of yields International financial transactions can be initiated from virtually anywhere in the world, at any time of the day, and can be completed at the speed of electronic data transfers. Well- informed investors will move funds around the world to capture the best yields for their investments. Consequently, according to the law of one price, the yields of offshore and onshore investments with similar risks should converge. However, because of volatility in expectations about inflation and exchange rates and associated risks, yields do not necessarily converge; but in the major financial centres such as the USA, Japan and the Euro region, we find that the yields track each other in terms of rises and falls. These parallel shifts are evidence of the merging of national financial markets into a single global financial system Global integration Which economy is more globally integrated, the Australian economy or the economy of another country of your choice, such as India or China? In order to answer this question, collect and analyse the following information for both countries: external debt as a percentage of GDP inward FDI as a percentage of gross fixed capital formation total stock of inward FDI as a percentage of GDP policy towards FDI and trade government promotion of inflow and outflows of trade and investment. Using the Internet, search publications and organisations such as World Investment Report (UNCTAD), The Globalisation of Industry in the OECD Countries (OECD), the World Bank and the IMF. Follow the links to these sites as a starting point. United Nations Conference on Trade and Development Organisation for Economic Co-operation and Development The World Bank International Monetary Fund International labour flows FDI and globalisation of markets and production generate opportunities for international migration. Career opportunities in foreign affiliates exist for expatriate managers and skilled employees. Globalisation of markets increases the number of contacts among people of different cultures. A greater understanding and sensitivity to cultural diversity would presumably encourage people to migrate internationally. An increasing level of international migration for economic motives would indicate a growing integration of economies and labour markets. Data on migration of labour for the purposes of taking up employment is difficult to obtain. Levels of immigration are dependent on numerous variables outside the control of any individual. Immigration raises many economic, political and social tensions within host countries. While there has been significant liberalisation of the barriers to international trade and capital flows, migration remains highly regulated. Labour markets therefore remain very segmented and national rather than global in scope. Q U E S T I O N S 1 Which has grown faster over the past two decades, on average: international trade flows or international capital flows? 2 Why does most of the international capital flow between the OECD countries? 3 Define the term 'foreign exchange'. 4 Why does an increase in the foreign exchange turnover point to the increasing integration of financial markets? 5 How do capital flows between nations keep movements in interest rates aligned? 6 What is the difference between permanent migration and temporary migration? 7 Explain the economic and political arguments that are frequently used to restrict permanent migration. 8 How can education be a force for globalisation? everal organisations compile a list of the world's top 100 economies. Some include country, company and city. Locate one that only includes country and company information. An Internet search of 'world top 100 economies' should result in such a list. Examine the list and answer the following: 1 How many countries make the top 100 economies? How many companies make the top 100 economies? 2 Where does Australia rank? In 2016 Australia ranked 12th. Has its position improved or declined? Why do you think that is? 3 In 2016, the USA was ranked number 1 and China number 2. Is that still the case? 4 In 2016, Walmart was the leading company, ranked 10th. Is this still the case? If not, what is the leading company now? 5 In 2016, there were 31 countries and 69 companies in the top 100 economies. What is the situation now? Why have these changes occurred? Would these changes be the result of an increase or decrease in globalisation? ECONOMICS DATA Economies of scale: cost efficiencies that are derived by producing a large volume of standardised products Host countr y: a country where a company that is based in another country has business activities Multinational corporation (MNC): An enterprise operating in several countries but managed from one (home) country; generally, any company or group that derives a quarter of its revenue from operations outside of its home country is considered a multinational corporation Parent countr y: the country where a multinational corporation is primarily based and from where major decisions are made Supply chain: the system of organisations, people, activities, information and resources involved in moving a product or service from supplier to consumer CONCEPTS A multinational corporation (MNC) is an enterprise or company that operates in more than one country, but is managed from one home country. Usually an MNC will earn at least 25 per cent of revenue from operations outside its base country. MNCs generate much of the world's FDI through subsidiary companies operating in other countries. A large proportion of MNCs have offices, branches, mines, processing plants and workers in other countries (referred to as host countries). Usually, their main headquarters are found in the parent country. An MNC is usually huge; indeed more than 60 MNCs are in the world's top 100 economies! MNCs are able to become so large and influential because of their multinational supply chains. A supply chain is a system of organisations, people, activities, information and resources involved in moving a product or service from supplier to consumer. Supply chain activities involve the transformation of natural resources, raw materials and components into a finished product that is delivered to the end customer. 459780170407014 Chapter 2 \| Globalisation Infrastructure and transport All MNCs need well-developed transport networks, without which the global supply-chain networks could not possibly continue to function. Roads, railways, ports, airports and other transport systems are crucial in moving raw materials, finished goods, parts, capital equipment and all other items in the supply chain between productive stages, the finished product and onto consumers. Efficient movement of people and freight is vital to today's global economy. Governments need to be able to supply sufficient infrastructure such as rail lines, port facilities and road development to assist economic growth. It is vital for company growth that these services are readily accessible to MNCs. Lack of paved roads, rail lines, and port facilities will encourage MNCs to seek other markets from which to obtain their products. Developed countries have no such problem generally, but less-developed countries often have to supply infrastructure before an MNC will seek to operate there. Government incentives The government of a country might offer inducements to MNCs to establish operations there. Such inducements will facilitate the growth of the MNC. They include lower taxation rates, provision of infrastructure, assistance with establishment costs, provision of essential accompanying services and regulation (or lack of regulation) of business operations. When seeking a host country, MNCs will often approach more than one country, and in a sense these countries are often competing against each other to attract MNC operations. This competition can often result in better conditions for the MNC to grow and flourish. International trade has increased so dramatically that MNCs are highly dependent on the supply chain to provide the necessary buying and selling infrastructure. The incredible growth of MNCs over the past decade has been driven largely by the effective development and implementation of global supply chains that result in multi-company and multinational supply chains. Each MNC needs to incorporate its supply chains into its overall corporate strategy, to leverage them as much as products, market participation, marketing and competitive moves to achieve global competitiveness. 2.4 Factors contributing to globalisation Comparative advantage: the ability of a nation to produce a product at a lower opportunity cost of production than another nation Competitive advantage (of a firm): a characteristic specific to a firm that makes it competitive in the market place; for example, a lower-cost producer, an established brand name or an innovative product Double taxation: the taxation of an international firm's profit in the country where it is earned and again in its home country where it is distributed Emerging market economies: developing economies that are transforming their economies to a capitalist market system; also referred to as 'transitional economies' Export-orientation strategies: strategies to encourage the expansion of domestic production for export market Import-substitution strategies: strategies aimed at replacing manufactured consumer imports with domestic production from infant industries that are protected from international competition Intellectual property: technology and knowledge assets Operational restrictions: political limitations that are placed on the way a foreign firm operates; for example, who it employs, the prices it charges and the markets it serves Transfer price: the price charged for goods by one subsidiary of a multinational corporation to another subsidiary of the same company in another country Transparency: laws and regulations that are clearly spelt-out, promptly and consistently enforced and readily accessible World Trade Organization (WTO): a multilateral organisation aimed at liberalising world trade and establishing a dispute settlement procedure Globalisation has emerged with the advent of new communication technologies, transportation technologies, the activities of the multinational corporations and the growth of worldwide consumer cultures. KEY IDEA The globalisation of the world economy and international business have been facilitated by a variety of technological, economic and political developments over the past four decades. The move to free trade is one of these factors, and this is discussed more fully in Chapter 5. 2.4.1 Technological changes Dramatic improvements in transport and communication systems mean that products, capital, people and ideas can now move faster and more cheaply internationally. Improved communication and information-processing technologies allow a firm to manage and coordinate effectively the production and marketing activities of its foreign affiliates in globally dispersed locations. These technologies have also led to the establishment of new international business opportunities, such as international call centres, the provision of international financial services, and international marketing and retailing services on the Internet. Improved transport technologies have resulted in containerisation, super-freighters, larger commercial freight jet aircraft, high-pressure pipelines and offshore oil platforms. The use of containers has given rise to a more specialised vessel: the container ship. Cheaper and faster transport enables a globally oriented firm to enjoy production and marketing efficiencies. For example, production efficiencies flow from being able to locate stages of the production process in low-cost countries, and from the economies of scale that result from the supply of a standardised product to many foreign markets from a single location. Supply chains for intermediate and finished products are, in dollar terms, shortened. Marketing efficiencies result from being able to communicate standard promotional material to dispersed markets, and distribute the products to these markets in a timely manner. 2.4.2 Resolution of global political conflicts The world economy has been divided by political conflicts. With the world facing less global conflict, and conflict limited to small regional areas, the world is now more open for international trade. Trade will increase when there is a relatively peaceful global situation, and in times of global conflict, trade will become much more restricted. 2.4.3 Changed development strategies Since the 1980s, the economies of Central and Eastern Europe, China and Vietnam have undergone significant transformation, or market reforms. In varying degrees, these economies emerged as market economies. These emerging market economies have been reintegrated with the world economy. The market mechanisms -- individualism and private enterprise, both foreign and local -- are now encouraged. The promise of improved production efficiency and higher living standards as a result of the reforms are strong incentives for international business to enter these potentially lucrative markets and establish operations. Over the two decades to the late 1990s, the economic performance of newly industrialised countries (NICs) such as the 'East Asian Tigers' (Hong Kong, Singapore, South Korea and Taiwan) pointed to a successful model of economic development. The features of this model are the promotion of manufactured exports and 'outward-looking' or export-orientation strategies in business and industry policies. This development model contrasts with the more insular, 'inward-looking' import-substitution strategies chosen by countries such as India and Australia during the 1960s and 1970s. As the lessons of the NICs are taken on board by more countries, the opportunities for international business expand. The rapid economic growth of China and India in more recent times has been a major factor in the growth of international business. 2.4.4 Trade and investment liberalisation Governments impose barriers on the free flow of trade and investment for many economic, social and political reasons. Tariffs, quotas, licences and limits to the transfers of foreign exchange are the more obvious cross-border barriers to trade and investment. Less transparent barriers are government policies and regulations that can give preferential treatment to domestic business over foreign business. Examples include government-purchasing policies, labelling regulations, health and safety standards, foreign ownership limits, and authorisation and reporting procedures. Lack of transparency adds to the uncertainty of doing business in a foreign country. International trade negotiations conducted by the World Trade Organization (WTO) have yielded some significant reductions to government-imposed barriers to trade. Most reductions relate to tariff barriers rather than non-tariff barriers. As a result of negotiations through the Uruguay and Doha Rounds, tariffs of developed countries are at historically low levels. Generally speaking, average tariff rates are less than 20 per cent in most countries, although they are often significantly higher for agricultural commodities. In the most- developed countries, average tariffs are less than 10 per cent and often less than 5 per cent. On average, less-developed countries maintain higher tariff barriers, but many countries that have recently joined the WTO have reduced their tariffs substantially to gain entry. Commitments from member countries of the WTO have also been obtained regarding the liberalisation of trade in services, the protection of intellectual property and the reduction of restrictions on FDI. FDI can be subjected to a variety of regulations, including market access restrictions, ownership restrictions, operational restrictions and administrative restrictions. The liberalisation of trade and investment flows has also occurred at the regional level. The formation of regional trading blocs such as the North American Free Trade Area and the Asia- Pacific Economic Cooperation forum, and the expansion of membership of the European Union have brought commitments from member countries to reduce barriers to international trade and investment. Australia has negotiated a number of bilateral free trade agreements, including with New Zealand, the USA, Singapore and Thailand. Double taxation treaties negotiated between countries -- that is, agreements to reduce or abolish double taxation -- are incentives to conduct international business. 2.4.5 Market potential of developing countries The potential market opportunities flowing from the successful integration of lower-income countries into the global economy are huge. By 2020, there will be major shifts in the world economic order, in which emerging economies will become more important. China will overtake the USA to become the largest world economy in the near future, and there will be more emerging economies in the top ten economies by 2020 and beyond. The rise in importance of emerging economies will have implications for global consumption, investment and the environment. Large consumer markets in emerging economies will present enormous opportunities for businesses. However, income per capita will remain higher in the advanced world. There is significant market potential for foreign businesses as they grow richer and their countries' standards of living rise. 2.4.6 Market-friendly policies Governments of developed and developing countries have moved to promote market forces and competition as the means of controlling production, directing resource allocation and promoting production efficiency. Market-friendly reforms include the privatisation of government business enterprises (GBEs) and the deregulation of financial, product and labour markets. The privatisation of GBEs in areas such as telecommunications, banks, insurance, transport, ports, and electricity and water supply has attracted FDI for two reasons: 1 Privatisation is expected to result in improved efficiency and increased investment in these essential supporting facilities and services. More efficient, reliable infrastructure means reduced costs of production, enabling the producers in these countries to be more competitive in international markets. FDI is attracted to a country with efficient, reliable infrastructure. 2 Privatisation of former government monopolies has proved an attractive target for foreign investors. For example, the privatisation of telecommunications, banking, railways, postal services, health care and mining has stimulated large foreign capital inflows to countries such as South Africa, Zambia, Brazil, the Czech Republic, Hungary and Poland. 2.4.7 MNCs An MNC that can locate its different activities in different countries according to each country's comparative advantage will achieve competitive advantage. Nations benefit not only from the free flow of trade, but also from the free flow of investment. Foreign investment has increased significantly over the past two decades. It has increased at a faster rate than foreign trade. The process of globalisation and the growth of MNCs have been the stimuli to the growth in foreign investment. As explained already, an MNC can gain a competitive advantage by locating different production activities in different countries to achieve comparative advantage. To set up a production facility in a foreign location requires investment. While such investment and the globalisation of production are beneficial to the MNC, there can also be both benefits and costs to the host country. A general concern about MNCs is their threat to the autonomy of the host country's policy makers. The actions of MNCs can undermine the political agenda of the host government when the goals of the MNC and the host government are in conflict. The MNC strategy of transfer pricing provides a specific example. Assume that an MNC has subsidiaries operating in different countries to achieve comparative advantage. Each subsidiary performs a phase in the production of a product. For example, to produce a computer, a new chip is developed in the USA, the chip is produced in Japan, electronic and electrical components are produced in Korea, the computer with all its parts imported is assembled in Thailand, and the wholesaling, marketing and distribution of the finished product is handled by a firm in Australia. To produce the computer, the MNC is buying and selling products among its own subsidiaries (and from a nation's point of view, exporting and importing). It can determine the price at which to buy and sell within its own network of subsidiaries -- the transfer price is the price at which a firm sells its products to its own subsidiaries. Through transfer pricing, an MNC can move profits around the world from high-tax nations to low-tax nations. Less tax is beneficial for the MNC, but detrimental to the economies where the subsidiaries are located. The tax revenue base is eroded and the export earnings are reduced. Companies that cannot access transfer pricing are at a competitive disadvantage. Because of the costs of foreign investment and threats of MNC dominance, host governments regulate foreign investment. In the early 1970s, there were about 7000 MNCs. Today, there are more than 100 000 MNCs, with almost 1 million subsidiaries or affiliates in all industries and all nations. Together, MNCs produce about 25 per cent of global GDP. They operate in more than one or two countries to maximise profits through generating increased sales, and obtaining inputs into the production process at a lower cost. 2.4.8 Regional trading blocs Regional trading blocs include the European Union, the Association of Southeast Asian Nations (ASEAN) and the North American Free Trade Agreement. Australia belongs to the Asia-Pacific Economic Cooperation (APEC) forum. Such trading blocs generally have reduced trade barriers between nations, encouraging more inter-nation trade and increasing global production. With fewer barriers, there has been a growth in international relations, an increase in trade, and a furtherance of the exchange of technology and other production ideas. Decisions made by governments as well as individual enterprises have a major influence on the pattern of trade. In recent times, MNCs have been particularly influential in determining the nature of trade and economic relations between nations. KEY IDEA 2.4.9 Non-government institutions The International Monetary Fund (IMF) The IMF was created in 1946 to encourage international cooperation in the monetary field and to assist in the removal of foreign exchange restrictions. In addition, it aimed to stabilise exchange rates and to facilitate a multilateral payments system between member countries. Each member, when joining, was allocated a quota based on its economic strength that determined the size of its cash subscription, its voting power and its drawing rights. The special drawing rights (SDRs) are the reserve assets upon which a nation is able to draw from when required. Participants are allocated a volume of SDRs based on their original quota as determined by the IMF. From then on, holders of SDRs may use them to obtain foreign exchange from other participating countries to redeem balances of their own currency held by other countries. Originally, the value of one SDR was directly determined by the value of the US dollar, but the value is now determined by a 'basket of currencies'. Under this method, the value of the SDR is equivalent to the sum of 16 currency components broadly weighted according to their countries' relative shares in world trade. The IMF seeks to establish monetary conditions that would foster foreign trade and investment. While not aimed specifically at MNCs, MNCs benefit from the conditions established, thus enhancing their growth. The IMF can assist by making funds available to support balance of payments issues over the short-term. Funds can also be made available to assist a structural change in the economy. If the IMF were not available, countries would be tempted to impose barriers on trade and investment. Such policies are known as 'beggar-thy- neighbour' policies. The benefits of the liberalisation of trade and investment gained through regional and multilateral cooperation and agreements would be sacrificed. The IMF closely monitors the world economic and trade situation. The WTO The WTO was established in 1995, replacing its predecessor, the General Agreement on Tariffs and Trade (GATT). From 1948, the GATT was the only international body laying down trade rules accepted by its members, which were responsible for most of the world's trade. There are currently 164 members of the WTO. The WTO covers trade in goods, services and intellectual property, and sets out rules of trade between nations that are binding on governments. A rules-based system of trade provides security and predictability for international business, including MNCs. An essential part of this system is an effective means of settling trade disputes between members, reducing the need for governments to resort to unilateral retaliation. Unilateral retaliation results in the reintroduction of barriers to trade and investment. Essentially, the WTO has three basic functions: to promote free trade as long as it has no undesirable effects, to serve as a forum for trade negotiations, and to provide the means for settling disputes. By providing a more stable trade environment, the WTO has unintentionally facilitated the growth of MNCs as part of the globalisation process. The World Bank The World Bank grew out of the establishment of the International Bank for Reconstruction and Development (IBRD), which in turn was formed under the same agreement that established the IMF. Whereas the IMF focused on short-term international financial stability, the primary role of the IBRD was to fund long-term development projects. In more recent times, its focus has been on developing countries. The World Bank is not just about providing development assistance to the governments of poorer countries. It attempts to create an environment where foreign business (including MNCs) is willing to invest in these countries and the benefits from this investment can be maximised by MNCs. To these ends, the World Bank supports projects that: invest in people through improvements in health and education protect the environment encourage and assist the development of a strong private business sector improve the efficiency, quality and reliability of government services promote reforms to allow stable macroeconomic conditions and long-term planning develop infrastructure that assists in the economic development process. Such projects can assist MNCs to operate in a country, helping them to establish themselves there and develop their business in the long-term. Q U E S T I O N S 1 Explain the definition of MNC used in this text: 'An enterprise operating in several countries but managed from one (home) country; generally, any company or group that derives a quarter of its revenue from operations outside of its home country is considered a multinational corporation.' Identify the two essential parts of this definition. 2 Why does an open economy increase GDP faster? 3 Name three Australian-owned MNCs and identify the industries and the nations in which they operate. 4 List three technological changes that have supported globalisation. 5 Explain the differences between an import-substitution strategy and an export- orientation strategy. 2.5 Forces driving globalisation Core competencies: characteristics specific to a firm that give it a sustainable competitive advantage Enhanced resource endowments: resources of a nation that are developed by investment, such as human capital and infrastructure Location economies: production and marketing conditions of a location that a firm can access to give it a competitive advantage Risk diversification: managing business risks by having multiple options, such as multiple sources of supplies, or selling in multiple markets; avoiding 'putting all one's eggs in the same basket' CONCEPTS EY IDEA The business sector is the driving force behind globalisation. The globalisation of markets and production provides an international firm with additional opportunities to achieve and protect profits and sales. These opportunities are not readily available to the purely domestically oriented firm. Many economic, political and competitive forces push and pull a firm into international business. The opportunities and threats driving a business to operate internationally flow from the following: market expansion location economies core competencies competitive strategies risk diversification government incentives. 2.5.1 Market expansion Firms are pulled abroad by the promise of rapidly expanding markets. The home market may be small, with few prospects for sustained economic growth. Small markets can become quickly saturated and very competitive because market growth by one firm will be at the expense of competitors' shares. Australian firms are located close to the rapidly growing and populous economies of South and East Asia. As GNP per capita increases and the standard of living rises for a significant proportion of the population in these countries, viable market opportunities arise. Firms can exploit economies of scale with access to larger international markets. They can spread the high fixed costs of capital equipment, research and development (R&D), and advertising and distribution expenditures over a greater volume of output for a global market. The average fixed cost for each unit produced is reduced, and the firm's competitiveness is improved. 2.5.2 Location economies Relocating production facilities to a foreign site may keep a firm internationally competitive. It may be more profitable to serve the home, the local domestic and other foreign markets from this location. Taking advantage of location economies -- the respective natural and enhanced resource endowments of foreign countries and regions -- reduces costs. Such resource endowments include an abundant supply of skilled labour, extensive R&D activities, well-established technological networks, and efficient and reliable infrastructure (such as telecommunications, transport and energy supply systems). 2.5.3 Core competencies A firm competes in domestic and foreign markets based on its core competencies: characteristics unique to the firm. These characteristics allow the firm to achieve lower costs, gain higher revenues and combat the competitive forces of its rivals. There are many sources of competitive advantage: product- and process-technology patents held by the firm established brand names and reputations market intelligence a highly qualified workforce economies of scale in production and marketing exclusive access to inputs and distribution channels management skills and experience preferential treatment by governments. Going international allows a firm to develop competitive advantages, as exemplified by the location economies discussed in the previous section. There are also gains to be made from the experience of managing production and marketing facilities in different countries: the so-called 'learning curve' effects. Only by going international, however, may the firm be able to exploit its competitive advantage more fully. The domestic market may be too small and become quickly saturated. For example, a telecommunications company that has developed technology, human capital and project management skills when running the domestic nationwide telecommunications system has little opportunity to profit fully from these assets unless its operations become international. 2.5.4 Competitive strategies The threat of the loss of an existing or potential market can influence a firm to go international. Businesses will often follow major customers abroad, as a means of getting a foothold in a foreign market and also protecting an alliance with a major customer in the domestic market. When a firm is confronted with cheaper imports and cheaper domestic rivals, it can protect its domestic market share by using cheaper foreign production locations as a basis for exporting back to its domestic market. Combating international rivals in their own home markets can also divert financial and managerial resources of the rival firms from the domestic market. Establishing production facilities abroad enables a firm to protect its foreign markets by overcoming import barriers and guaranteeing essential supplies. Vertically integrating all phases of production from the supply of raw materials to the final production phase is a source of significant market power. Also, a firm that moves quickly into a foreign market gains first-mover advantages. These advantages act as barriers to entry for later potential rivals. First-mover advantages include: establishing a recognised brand name, customer loyalty and product reputation learning-curve effects, such as the managerial know-how of operating in foreign markets, making contact and building rapport with the relevant officials, and coping with local regulations and business practices establishing and monopolising distribution networks and supply chains developing excess capacity for the rapid expansion of production when confronted with potential rivals gaining access to the best customers and suppliers economies of scale. Case study: Pacific Brands moves offshore (Note: Pacific Brands is now owned by a US company.) Pacific Brands is a leading manager of consumer brands in Australia and New Zealand, marketing some of the most recognised brands in the region, including Berlei, Bonds, Clarks (children's footwear), Dunlop, Everlast, Grosby, Holeproof, Hush Puppies, KingGee, Slazenger, Sleepmaker and Tontine. Pacific Brands, formerly a division of the diversified company Pacific Dunlop, had been manufacturing many of these brands in Australia for 100 years. In 1999, the company drew up plans to outsource the production of these brands to contract manufacturers offshore. The contracting out was expected to reduce the company's workforce from 6000 to 3000. In 2014, Pacific Brands claimed to be one of Australia's largest importers of consumer goods from Asia. Pacific Brands stated that the overseas sourcing of many of its products gives it the following benefits: greater flexibility in changing designs and products a variable cost base and low cost of production greater efficiency ongoing learning curve benefits, such as: \- long-term relationships with quality suppliers accustomed to Pacific Brands requirements \- development of experienced sourcing personnel \- an established credit track record, which helps improve payment terms. Some local manufacturing of a range of products still occurs, including socks and hosiery (which are capital-intensive); new products (so that they can be manufactured and tested in the market on a trial basis); and bulky products such as furniture and mattresses (to maintain close proximity to markets). The strategy of international outsourcing was aimed at generating sustainable profit growth. There was little prospect of achieving this aim by continuing to manufacture many of the low value-added consumer brands in Australia. Questions 1 Explain 'low value-added' and 'capital-intensive' manufacturing. What resources would be used in low value-added production? 2 In which countries would Pacific Brands most likely be outsourcing the production of many of its consumer brands? 3 Why does local manufacturing of certain products in Australia remain economical? 4 What were the motives for the company moving offshore? 5 Who in Australia gains and loses from the company's decision to source products overseas? ECONOMICS IN ACTION 2.5.5 Risk diversification An international firm with production and marketing operations in several countries is able to engage in risk diversification; that is, it can reduce or manage economic and political risks. Multiple sources of essential raw materials and access to several markets reduce the political risks associated generally with political instability and with the actions of groups such as the host government, trade unions and terrorist organisations. The economic risks associated with a natural disaster or macroeconomic instability -- for example, high inflation rates, devaluing currencies or a downturn in economic activity -- are reduced by a firm operating in a number of different countries. At any one point in time, economies are at differing stages in their economic cycle of boom and recession. When faced with an economic recession in its home country, a firm with operations in several countries may be relatively protected from the recession, provided the other countries in which it operates are not also in recession. However, as the world economy becomes more integrated, there is a greater possibility that domestic economic cycles will become more directly linked, entering into periods of growth and recession at similar, if not identical, times. 2.5.6 Government incentives Host government and home government policies and regulations can act as either pull or push factors for international business. Host governments, for example, might offer incentives to attract foreign investment. Incentives include: income tax concessions and government grants favourable lending policies exemption from customs duties on the import of raw materials, technology transfer, and machinery and parts duty-free export of finished products assistance with start-up finance and rental of facilities relaxation of regulations governing pollution control, industrial relations, wages, and health and safety standards relaxation of regulations relating to local-content requirements, local ownership, remittances of profits and local employment provision of subsidised infrastructure such as energy and transport facilities. Home government policies that may induce a firm to move its operations offshore include high company tax, anti-merger competition policies, and regulations governing environmental damage and employment practices. 2.5.7 Technology transfer Technology transfer acts as a vehicle of economic integration. Technology is a key factor in the economic and social development of a country. New ideas of manufacturing methods, management structures and techniques, marketing activities and product design are transferred from one country to another. Most new technologies are developed in the R&D laboratories of the USA, Japan and Western Europe. Governments of other countries encourage foreign firms to transfer appropriate technologies to their economies. Moreover, technology represents a very significant trading opportunity. This is evident from the growth of businesses such as Google, IBM and Hewlett-Packard. Technology is transferred through a number of channels. Trade is one channel. Technology is embodied in the imports of inputs and capital goods. Exporters need to keep informed about new products or processes in order to remain internationally competitive. The contact with foreign buyers is a source of new ideas and information on competing products, and provides feedback on the performance, quality and design of products. Technology is also transferred through FDI, labour movements and licensing. Foreign firms may willingly transfer technologies and expatriate technicians and managers from their home country to a foreign country to achieve improved profitability and a competitive advantage. Using new or current technologies, production may be cheaper in a foreign location than in the home location. Firms may also believe that they can gain a competitive edge in foreign markets by supplying technologically superior products. By making new technologies, skilled labour and managers available to foreign-based affiliates, the parent company can improve the competitive potential of these affiliates. Firms will also transfer technologies in order to take advantage of the financial, tax and other inducements offered by host governments. In addition, the transfer of technology provides an alternative source of revenue when there are financial and regulatory barriers to establishing subsidiaries in foreign countries. Rather than set up its own subsidiary, a firm may license foreign firms to use its technology in return for a royalty. Trade, FDI and technology transfers are becoming more closely interconnected. Outward FDI can act either as a substitute for export trade or as a complement to it. To serve a foreign market, a firm could produce at home and export. Alternatively, it could invest in establishing a production facility in the foreign market. In this case, FDI is a substitute for exports. FDI can also promote exports, particularly the export of services. For example, the establishment of a production facility in a foreign country may require the export of high-value, technology-intensive component parts, plant and equipment from the home country. Highly skilled technicians from the home country may be needed to service this sophisticated plant and equipment. For the provision of services in a foreign country -- for example, advertising, broadcasting, banking and insurance services -- a firm will need to establish through FDI a commercial presence in the foreign country. Much technology is embodied in products, so FDI and trade are therefore channels of technology transfer. The growing interconnectedness of trade, FDI and technology transfer increases the international interdependence of national economies. The Internet, which allows for the instant transfer of information, ideas and other forms of intellectual capital, can link individuals, businesses and governments globally. It can also enable the transfer of money through e-commerce. While there is greater capacity to communicate globally, there are also significant savings to be made. The World Information Technology and Service Alliance (WITSA) estimates that the global market place for information and communications technologies was worth more than US\$4 trillion in 2010. Q U E S T I O N S 1 Give three examples each of push factors and pull factors that could encourage a firm to go into international business. 2 Describe the production advantages a firm can gain by setting up operations in a foreign country. 3 What marketing advantages can a firm gain by setting up operations in a foreign country? 4 Explain how each of the following can give a firm an international competitive advantage: established brand name, patents, highly skilled workforce and economies of scale. 5 Why would a firm strive to be the first entrant into a foreign market? Are there any risks involved in being the first mover? Explain three types of government action that could push or pull a firm into international business. 7 Describe what technology contributes to economic and social development. 8 How is technology transferred from one country to another? 9 Explain how FDI can: a substitute for exports b complement exports. 10 Outline how the trade in technology can be highly commercially beneficial. 2.1 True/False For each statement, indicate whether you consider it to be True (T) or False (F). 1 A growing proportion of international trade is intra-industry trade. 2 Globalisation has a more significant impact on the gap between high-skilled and low- skilled wages than advances in technology. 3 Globalisation ensures national independence. 4 To be labelled as a multinational company, a company must operate in at least ten countries. 5 The shift towards a more integrated and interdependent world economy is referred to as globalisation. 6 Companies hope to lower their overall cost structure or improve the quality or functionality of their product offering through globalisation of production. 7 The World Bank has focused on policing the world trading system and making sure nation-states adhere to the rules laid down in trade treaties. 8 Rivers Inc, a US-based sports apparel manufacturer, sets up a production unit in China to take advantage of the lower labour costs there. This is an example of foreign direct investment. 9 The globalisation of markets and production and the resulting growth of world trade, foreign direct investment and imports all imply that firms are finding their home markets protected from foreign competitors. 10 The expansion of world trade implies that nations are becoming less dependent on each other for important goods and services. 2.2 Terminology Select the correct term from the list below that describes each statement. A Supply chain F Globalisation B Risk diversification G Location economies C Multinational corporation (MNC) H Trade intensity D Transfer price I Competitive advantage (of a firm) E World Trade Organization (WTO) J Capital flow 1 The price charged for goods by one subsidiary of a multinational corporation to another subsidiary of the same company in another country 2 A measure of economic integration based on the ratio of trade (the sum of exports and imports) to output 3 The system of organisations, people, activities, information and resources involved in moving a product or service from supplier to consumer 4 Managing business risks by having multiple options, such as multiple sources of supplies, or selling in multiple markets; avoiding 'putting all one's eggs in the same basket' A characteristic specific to a firm that makes it competitive in the market place; for example, a lower-cost producer, an established brand name or an innovative product 6 The growing integration of national economies to form a single interdependent global economy 7 The movement of money for the purpose of investment, trade or business production 8 A multilateral organisation aimed at liberalising world trade and establishing a dispute settlement procedure 9 An enterprise operating in several countries but managed from one (home) country 10 Production and marketing conditions of a location that a firm can access to give it a competitive advantage 2.3 Multiple-choice questions Select the correct response to each of the following: 1 Globalisation of production is: A moving production offshore to achieve first-mover advantages. B moving production offshore to reduce the risk of exchange rate changes. C dispersing the different phases of production to more than one country. D dispersing the different phases of production to different foreign locations to reduce management costs. 2 Developments that have supported the expansion of international business are: A the advances in information and communications technology. B the liberalisation of trade and investment. C the privatisation of government business enterprises. D all of the above. 3 A measure of the extent of globalisation of an economy is: A the GDP per capita. B the balance of payments. C trade intensity. D market potential. 4 Factors that limit the globalisation of economies include: A cultural differences. B improved communications. C improved transport. D trade liberalisation. 5 The threat of capital flight can constrain a government's choice in setting: A a higher interest rate. B a higher tax. C higher environmental standards. D all of the above. The International Monetary Fund: A makes temporary loans of foreign currencies to member countries in financial difficulties. B rations the world's supply of loans to member countries. C controls the exchange rate of each country's currency. D none of the above. 7 Which of the following has occurred because of globalisation? A There has been an increase in financial capital flows. B The divergence in world economic systems has increased. C Global poverty has increased. D There has been a trend towards increased regulation in global markets. 8 Globalisation has resulted in: A higher economic growth worldwide. B increased trade flows worldwide. C improved living standards worldwide. D reduced environmental impact worldwide. 9 What would slow the world's globalisation process? A increases in the number of multilateral trade agreements B increases in the flow of foreign portfolio investment C increases in the volume of goods and services being traded D increases in government business regulations 10 Which of the following is not a source of potential advantage for a multinational company? A marketing advantages through the use of well-known brand names B economies of scale in research and development C tax minimisation through careful use of transfer pricing D access to cheaper labour sources within each country because multinational companies can by-pass local trade unions 11 Which of the following is not an effect of globalisation? A increased volume of foreign direct investment B increased convergence of world economies C increased levels of tariffs D increased rates of investment 12 Which of the following is not a role of the World Trade Organization? A promoting free trade B negotiating free trade agreements C resolving trade disputes D promoting international financial stability Which of the following is not an indicator of globalisation? A an increase in international trade flows B an increase of labour mobility within nations C the increase in activity in the Australian stock market D the increase in foreign direct investment 14 Which of the following organisations is most likely to act if a nation experiences a sudden financial crisis? A the World Bank B the International Monetary Fund C the World Trade Organization D the United Nations 15 Which of the following best describes an effect of globalisation? A There has been an increase in the level of global poverty. B World economic systems are growing further apart. C Foreign direct investment flows have increased. D Markets are increasingly being more regulated. 2.4 Short response questions 1 List the two essential elements of the definition of 'multinational corporation'. 2 Outline two indicators of the level of globalisation in the world. 3 Describe the role of the World Bank. 4 Describe the role of trade flows in the globalisation process. 5 Explain the role of two digital innovations in driving the process of globalisation. 6 Describe three factors that have led to the increase in global trade flows. 7 Describe three main factors contributing to the growth of multinational corporations. 8 Describe the role of the International Monetary Fund. 9 Outline three factors contributing to the growth of globalisation. 10 Explain how natural factor endowments contribute to the growth of multinational corporations. 2.5 Activities 1 Investigate the activities of five of the world's largest multinational corporations. Information on each can be obtained from the Internet by searching for the company, and by using the links provided on NelsonNet: Unilever -- the world's biggest food and soap company, with outlets in 150 countries round the world, selling products as diverse as Omo washing powder, Lipton tea, Dove soap and Magnum ice-cream Gazprom -- the biggest company in Russia and the largest gas company in the world -- and only a decade old Unilever Gazprom Levi's Shell McDonald's evi's -- the company that invented jeans and has been in business for 150 years Shell -- the energy company that operates in 140 countries and, through a chain of petrol stations, claims to run the largest retail network in the world McDonald's -- the world's best-known fast-food brand with more than 30 000 restaurants in 120 countries. 2.6 Inquiries Select one inquiry topic from the list below (or create your own) and, following a selected inquiry model such as the economic model for problem solving, conduct an inquiry that can be presented to your class. 1 Evaluate the following statement: 'Economic globalisation will inevitably result in national economies becoming subservient to multinational corporations.' 2 The process of globalisation has increased very rapidly. Are these changes occurring across the global economy or only within a region or group of economies? Are there special economic events that have caused this? Have government policies contributed to this? Who will be the winners and losers of this process? 3 Consider whether the shift towards a more integrated and interdependent global economy is a good thing. Discuss the shift from the perspectives of the consumer, the worker, the company and the environmentalist. 4 Debate one or more of the following statements. a Globalisation will inevitably see some nations deciding to amalgamate into one larger nation. b The benefits of globalisation to the world outweigh the costs of globalisation. c Multinational corporations improve a country's standard of living. d All nations benefit from globalisation. e Less-developed countries have no choice but to participate in the globalisation process. You can find answers to selected review questions within this chapter on NelsonNet. Review of Chapter 2 answers