International Trade Theory MGMT 350 PDF

***Chapter 6 International Trade Theory*** ***Mercantilism***: advocates government involvement in trade surplus -- export more than import - Flaw views trade as a zero-sum game (one country losses by another) ***Absolute advantage theory***: Adam Smith's theory where countries should specializ...

***Chapter 6 International Trade Theory*** ***Mercantilism***: advocates government involvement in trade surplus -- export more than import - Flaw views trade as a zero-sum game (one country losses by another) ***Absolute advantage theory***: Adam Smith's theory where countries should specialize in producing goods and services where they have absolute advantage - Unrestricted free trade; both countries benefit from specialization and trade C***omparative advantage theory***: Ricardo focuses on differences in labor productivity; countries specialize in what they can produce most efficiently and buy what it produces less efficiently from other countries, even if it can produce the goods more efficiently themselves - Unrestricted free trade - Positive-sum game where all participants have economic gains - Assumes constant returns to specialization; more realistic to assume diminishing returns - Not all resources are the same quality - Different goods use different proportions of resources - Resources don't always move easily from one activity to another - Political opposition to free trade from those whose jobs are most at risk - Dynamic gains: - *Increase a country's stock of resources* as increased supplies of labor and capital from abroad become available within the country - *Increase the efficiency* with which a country uses its resources - PPF shifts outward - Free trade agreement between rich country poor country Samuelson critique: - Historically, benefits wealthy countries ***Hecksher-Ohlin theory***: focuses on factors of production - Comparative advantage arises from differences of which a country is endowed with resources - Export goods that make intensive use of factors that are locally abundant - Import goods that make intensive use of factors that are locally scarce - Unrestricted free trade - *Leontief Paradox*: questioned validity of theory; U.S. exports were less capital intensive than U.S. imports P***roduct life-cycle theory***: focuses on production location changes as products become more widely accepted - most new products were developed and sold in the U.S. - Over time demand grows in other countries, product becomes standardized, and price is a competitive weapon - Other countries can then produce at a lower cost limiting the potential for U.S. export - Historically accurate, now ethnocentric and dated N***ew trade theory***: focuses on first-mover advantages - Economic and strategic advantages to the first to enter market - Scale based cost advantage, later entrants struggle to match - Justify limited gov intervention for certain export-oriented industries - Cost reduction with large scale production - Without trade, goods produced and scale of production limited by the size of the market - Low volume, high costs - With trade, individual national markets combine into one large world market - Each nation has increased variety and lower cost of goods ***Porter's Diamond Theory***: four broad attributions of a nation shape the environment in which local firms compete 1. *Factor endowments*: a. Basic: Natural resources, climate, location, demographic b. Advanced: communication infrastructure, skilled labor, research facilities, tech i. Investments by people, companies, and gov 2. *Demand conditions*: c. Competitive advantage if domestic consumers are sophisticate and demanding 3. *Related and supporting industries*: d. Investments in advanced factors of production by related and supporting industries can help the industry achieve a strong competitive international position e. Successful industries in a country tend to be grouped into clusters of related industries 4. *Firm strategy, structure, and rivalry*: f. Different countries have different management ideologies that may or may not help build national competitive advantage g. Strong association between vigorous domestic rivalry and the creation and persistence of competitive advantage in an industry - two additional variables, chance and government, can influence the diamond - (factor endowments) subsidies, policies towards capital markets, policies toward education, (domestic demand) local product standards/regulations, (firm rivalry) capital market regulation, tax policy, and antitrust laws ***Chapter 8 Foreign Direct Investment*** ***Flow of FDI***: the amount of FDI undertaken over a given time period ***Stock of FDI***: total accumulated value of foreign-owned assets at a given time ***Outflows***: flows of FDI out of a country ***Inflows***: flows of FDI into a country - Trends in FDI - Growing more than world trade or output - Circumvents trade barriers - Driven by political and economic changes - Shift towards democratic institutions and free market economies - Globalization has positive effect on it - Direction of FDI - U.S. is a target of FDI inflows - Why? Because of large and wealthy domestic markets, dynamic and stable economy, and favorable political environment - Inflows towards developing nations and transition economies, like China - Source of FDI - U.S. largest source of FDI since WWII - 60% of all FDI outflows from 2000-2020 come from: - U.S., U.K., France, Germany, Japan, and the Netherlands - China has been a major investor in less developed nations ***Greenfield investments***: establishes a new operation in a foreign country ***Acquisitions:*** Quicker to execute, acquire valuable strategic assets, increase efficiency of acquired unit by transferring capital, tech, or management skills - **Why FDI**? - Alternatives are exporting and licensing; FDI is expensive and risky in comparison - Exporting limitations: - Transportation costs and trade barriers - Imports limited through quotas and tariffs, exports limited through costs; therefore, boosting attractiveness of FDI and licensing - Licensing limitations: - ***Internalization theory***: licensing gives away tech know to foreign competitors, doesn't give tight control over operations in foreign countries, and competitive advantage is based on non-amendable capabilities like management, marketing, and manufacturing - Advantages of FDI: - Unattractive transportation costs and trade barriers of exporting - Control over tech know-how, operations, and business strategy - When capabilities are not amendable to licensing - **Strategic behavior view of FDI** - Relationship between FDI and oligopolistic industries - ***Oligopoly***: an industry with a limited number of large firms - Interdependence between firms creates imitative behavior - Imitative behavior also occurs in FDI - ***Multipoint competition***: when two or more enterprises encounter each other in different regional or national markets ***Eclectic Paradigm***: determines if foreign investment is a good idea based on ownership, location, and internalization advantages ***Radical View***: multinational enterprises (MNEs) are an instrument of imperialist domination - Marxist political and economic theory - Influential from 1945-80s; No longer widely accepted ***Free Market View:*** international production should be distributed among countries according to the theory of competitive advantage - FDI benefits both the source country and host country ***Pragmatic Nationalism***: pursue policies designed to maximize the national benefits and minimize the national costs - Aggressively courts FDI in national interest **Benefits and Costs of FDI** - Host-Country benefits - Capital, tech, and management resources - Job opportunities that wouldn't be there otherwise - Balance of payments tracks payments to and from other countries - Current account tracks exports and imports - Current account deficit is when a country imports more than it exports - Countries want current account surplus (exports more than it imports) - FDI does this because it is a substitute for imports, and uses foreign subsidiary to export to other countries - Greenfield investments increase number of players in a market, stimulates investments, and lowers prices - Host-Country costs - Adverse effects on competition - Subsidiaries of foreign MNEs have greater economic power than local competitors - Greenfield investments should increase competition, but not as clear with an acquisition - May be neutral effect; could create a monopoly - Adverse effects on balance of payments - Outflow of earnings to parent company (capital outflow) - Imports of substantial inputs from abroad (debit on current account - Loss of economic independence - Home-Country benefits - Balance of payments benefits from the inward flow of foreign earnings - Positive employment because of demand for home country exports - MNE learns valuable skills from foreign markets that can be transferred back to the home country - Home-Country costs - Initial capital outflow needed to finance FDI - Current account suffers if the purpose of FDI is to serve home market from a low-cost production location - Current account suffers if FDI is a substitute for direct exports - Employment suffers when FDI is substitute for domestic production **Government Policy Instruments and FDI** - Home-Country Policies - Encouraging outward FDI - Government-backed insurance programs - Government loans - Elimination of double taxation of foreign income - Host country's relaxing restrictions on FDI - Restricting outward FDI - Limited capital outflows - Manipulate tax rules - Prohibit investment for political reasons - Host-Country Policies - Encouraging outward FDI - Incentives such as tax concessions, low-interest loans/grants, or subsidies - Restricting inward FDI - Ownership restraints - Performance requirements - World Trade Organization 1995 - Multinational agreements to liberalize trade in telecommunications and financial services ***Chapter 10 The Foreign Market Exchange*** ***Currency conversion*** - Convert payments received for its exports, income received from foreign investments, or income received from licensing agreements with foreign firms - Make payment to a foreign company for its products or services in its country's currency - Invest cash for short terms in foreign money markets - Engage in currency speculation (buying and selling currencies in hopes of profiting from currency changes **Functions of Foreign Exchange Markets** Insuring Against Foreign Exchange Risk - ***Spot exchange rates***: rate at which a foreign exchange dealer converts one currency into another currency on a particular day - Change continually - Value determined by supply and demand - ***Foreign exchange rates***: when two parties agree to exchange currency and execute the deal at some specific date in the future - Exchange rates governing such future transactions are forward exchange rates - Usually quoted for 30, 90, and 180 days - ***Currency swaps***: simultaneous purchase and sale of a given amount of foreign exchange for two different value dates - Transacted between international businesses and their banks, between banks, and between governments - Common type: spot against forward ***Law of one price***: In competitive markets free of transportation costs and barriers to trade, identical products sold in different countries must sell for the same price when their price is expressed in terms of the same currency ***Purchasing power parity***: comparison of prices of identical products determines the real or PPP exchange rate; the price of a "basket of goods" should be roughly equivalent in each country - ***Big Mac index***: an informal way of measuring PPP between countries by using the price of a Big Mac (converted to USD) as a benchmark to reflect local cost of ingredients, wages, etc. **Money supply and exchange rates** Money supply and price inflation - The growth rate of a country's money supply determines its likely future inflation rate - ***Inflation***: when money supply increases faster than output increases - Increase in money supply makes int easier to borrow, increases demand for goods and services - A country with high inflation rate will see depreciation in its currency exchange rate - ***Hyperinflation***: an explosive and seemingly uncontrollable price inflation in which money loses value very rapidly **Prices and Exchange Rates** ***Empirical tests of PPP theory***: exchange rates are determined by relative prices; changes in relative prices result in a change in exchange rates - Not a strong predictor of short-run movements in exchange rates of five years or less - Best predicts exchange rate changes for countries with high rates of inflation and underdeveloped capital markets - ***Purchasing power parity puzzle***: failure to find link between inflation rates and exchange rates - Reasons for failure: - Assumes no transportation costs or barriers to trade - Price discrimination by dominant enterprises - Governments attempt to influence the value of their currencies **Interest rate and exchange rates** - ***Interest rates***: reflect expectations about likely future inflation rates - Fisher effect ***Investor psychology***: emotional and cognitive factors that influence the decision-making process of investors - Neither PPP theory nor international Fisher effect is good at predicting short-term movements in exchange rates - Reason for this failure is the impact of investor psychology on short-run exchange rate movements - ***Bandwagon effect***: traders move like a herd ***Efficient market schools***: when prices reflect all available public information - FWD exchange rates should then be unbiased predictors of future spot rates - Inaccuracies will be random ***Inefficient market schools***: when prices do not reflect all available public information - FWD exchange rates will not be the best possible predictors of future spot exchange rates **Three forms of convertibility**: 1. ***Free convertible***: government allows both residents and nonresidents to purchase unlimited amounts of foreign currency 2. ***Externally convertible***: only residents can convert their holdings of domestic currency into foreign currency without any limitations 3. ***Nonconvertible*** ***Limiting convertibility***: governments limit convertibility to preserve their foreign market reserves - Companies work around it through countertrade, barter-like agreements ***Chapter 12 The Global Capital Market*** **Functions of global capital market** - ***Market makers***: financial service companies that connect investors and borrowers, either directly or indirectly - Commercial banks perform indirect functions - Investment banks perform direct functions **Capital Market Loans** - ***Equity loans***: made when a corporation sells stock to investors - ***Debt loans***: requires corporations to repay a predetermined portion of the loan amount at regular intervals regardless of how much profit it is making **Benefits of global capital markets** - Attractions - Borrower's Perspective: Lower Cost of Capital - ***Cost of capital***: price of borrowing money - Domestic capital market -- higher cost of capital - Global capital market -- lower cost of capital - Investor's Perspective: Portfolio Diversification - Wider range of investment opportunities - Diversify portfolio internationally, reducing risk - ***Systemic risk***: movement in a stock's portfolio's value that are attributable to macroeconomic forces affecting all firms in an economy - Risk reducing effects would be greater except for the volatile exchange rates associated with the floating exchange rate regime - Growth of global capital market - 24-hour trading - Deregulation in 70s - Response to development of eurocurrency market - Increasing acceptance of free market ideology - Risks - Individual nations vulnerable to speculative capital flows - Could destabilize national economies - "Hot money" = short term capital; "patient money" long term cross-border capital flows - Investors need more info about foreign assets to make global capital market work efficiently - Lack of info encourages speculative flows - Causes investors to react to dramatic events and move money too quickly - Different accounting methods make comparison difficult - 2000s had rapid movement towards harmonization of different national accounting standards ***Eurocurrency Markets*** - Eurocurrency: important and relatively low-cost source of funds for international businesses - Eurodollars account for two-thirds of all Eurocurrencies - Can be created anywhere in the world ***Advantages and drawbacks of eurocurrency markets*** - Attraction - Lack of gov regulation - Banks offer higher interest rates on Eurocurrency deposits than home currency deposits, and charge borrowers a lower interest rate - Banks have more freedom in dealings with foreign currency - Companies receive higher interest rate on deposits and pay less for loans - Drawbacks - If regulated, chance of bank failure is lower - Borrowing funds internationally can expose a company to foreign exchange risk ***Global bond market*** - Fixed-rate bond: most common type that receives a fixed set of cash payoffs - International bonds: foreign bonds sold outside the borrower's country and are denominated in the currency of country where it's issued - Attractions - Absence of regulatory interference - Outside regulatory domain of any single nation - Less strict disclosure requirements than most domestic bond markets ***Global equity market*** - National equity markets historically separated by regulatory barriers - Difficult to take capital out of a country and invest it elsewhere - Corporations lacked ability to list shares on stock markets outside their home nations - Difficult to attract equity capital from foreign investors - Consequences of international equity investment: - Internationalization of corporate ownership - Companies historically rooted in one nation are listing stock in equity markets of other nations ***Chapter 17 Global Production and Supply Chain Management*** **Objectives of supply chain** - Ensure total cost from raw materials to finished goods is as low as possible - To increase product/service quality by establishing process-based quality standards and eliminating defective raw material, component parts, and products from manufacturing process and supply chain ***Six Sigma*:** Statistically based philosophy that aims to reduce defects, boost productivity, eliminate waste, and cut costs throughout company - Total quality management - Especially helpful for structuring global processes for multinational corporations ***ISO 9000***: a set of international standards that leads to a certification process that quality standards are met - Management attention on improving quality of products and processes - Required by European Union **Where to produce** ***Country factors***: political and economic systems, culture, and relative factor costs differ from country to country - Location economies, formal/informal trade barriers, transportation costs, rules/regulations, exchange rate movements ***Minimum efficient effect***: a technological factor that refers to the level of output at which most plant-level scale economies are exhausted ***Product features***: includes universal needs; and value-to-weight ratio (influences transportation costs) ***Make-or-buy decisions***: made at strategic and operational levels; strategic levels focus on long-term, operational focus on short-term - "Make decisions" can result from issues of product success, specialized knowledge, strategic fit, specialized design/production - Based on cost and production capacity, and inventory planning ***Reverse Logistics***: process of planning, implementing, and controlling the efficient, cost-effective flow of raw materials, in-process inventory, finished goods, and related information from the point of consumption to the point of origin for the purpose of recapturing value or proper disposal - Goal to optimize after-market activity - Important part of global supply chain ***Global purchasing coordination***: shared decision making creates a more integrated, coherent, efficient, and effective global supply chain - Operational objectives of responsiveness, variance reduction, inventory reduction, shipment consolidation, quality, life-cycle support ***Chapter 19 Global Human Resource Management*** ***Staffing policy***: selecting individuals who have the skills requires to do particular jobs - Tool to develop and promote the desired corporate culture of the firm **Ethnocentric, Polycentric, and Geocentric Approaches** - ***Ethnocentric approach***: key management positions are filled by parent-country nationals - Host country lacks qualified individuals - Best way to maintain a unified corporate culture - Firm believes best way to transfer core competencies is to transfer parent-country nationals who have knowledge of that competency to the foreign operation - Limits advancement opportunities for host-country nationals - Creates resentment, lower productivity, and increased turnover - ***Cultural myopia***: inability to see people from other cultures as acting in a normal way according to their own culture - ***Polycentric approach***: host-country nationals are recruited to manage subsidiaries, while parent-country nationals occupy key positions at corporate headquarters - Less likely to have cultural myopia - Less expensive - Less opportunities for host-country nationals to gain experience outside their country, cannot progress beyond senior positions at subsidiary - Lack of integration between corporate headquarters and foreign subsidiaries - ***Geocentric approach***: seeks the best people for key jobs throughout the organization, regardless of nationality - Best use of firm's human resources - Builds cadre of international executives who feel at home working in many cultures - Creates value in the firm - Reduces cultural myopia and enhances local responsiveness - Expensive to implement ***Expatriate managers***: work for home country but live in host country; used by ethnocentric and geocentric staffing policies ***Expatriate failure***: premature return from foreign posting and high resignation rates; high costs - Reasons - Inability of spouse to adjust - Manager's inability to adjust - Family problems - Manager's personal or emotional maturity - Inability to cope with larger overseas responsibilities ***Expatriate selection***: improving selection procedures reduces expatriate failures - Four dimensions of success prediction - Self-orientation (e.g. self-confidence) - Others-orientation (e.g. language skills) - Perceptual ability (e.g. empathy) - Cultural toughness ***Training vs. development***: training gives expatriate managers skills for the foreign posting; development intends to develop the manager's skills over his or her career with the firm **Expatriate training** - ***Cultural training:*** seeks to foster an appreciation for the host country's culture, history, politics, economy, religion, and social and business practices - Familiarization trip to host country to ease culture shock - ***Language training:*** exclusive reliance on English diminishes an expatriate manager's ability to interact with host-country nationals - Willingness to communicate in language of host country improves effectiveness - ***Practical training:*** aimed at helping expatriate manager and family ease themselves into day-to-day life in the host country - Support network of friends; often an expatriate community ***Repatriation of expatriates***: return of expatriates to home country; final link in integrated process - Challenges with returners not having a job that uses their new skills; programs for reintegration back into work life in home-country's organization **Performance appraisal problems** - Host and home managers subject to unintentional bias - Reducing bias - Give more weight to onsite manager's appraisal than to offsite manager's appraisal - Consult home-office manager before onsite manager completes formal termination eval ***Expatriate pay***: includes base salary, foreign service premium, allowance of various types, tax differentials, and benefits - Allows expatriates to have same standard of living they would have at home plus financial inducement - Base salary same range as similar position in home country - Foreign service premium for working outside their country of origin - Allowance includes comp for hardship, housing, cost of living, and education - May have to pay income tax to both home and host country gov - Benefits are the same as home **Organized labor** - Concerns - Company can counter its bargaining power with the power to move production to another country - Company will keep highly skilled tasks in its home country and farm out low-skilled tasks to foreign plants - Power reduction in attempting to import home country employment practices and contractual agreements ***Diversity workshops***: overcome subconscious biases and stereotyping that may lead to discrimination against minority employees ***Chapter 20 Accounting and Finance in International Business*** ***Accounting Standards***: rules for preparing financial statements; define what is useful accounting information ***IFRS*** (International Financial Reporting Standards) vs ***GAAP*** (Generally Accepted Accounting Principles) - IFRS - Compliance is voluntary; developed standards for firms seeking stock listings in global markets - May replace GAAP in U.S. **Exchange Rate Changes and Control Systems** ***Lessard-Lorange Model***: Three exchange rates can be used to translate foreign currencies into corporate currency - Initial rate - Projected rate - Ending rate ***Internal forward rate***: refers to a company-generated forecast of future spot rates ***Transfer price***: the price at which goods are transferred between subsidiary companies in a multinational firm - International businesses often manipulate transfer prices to minimize their worldwide tax liability, minimize import duties, and avoid government restrictions on capital flows ***Separation of subsidiary and manager performance***: the evaluation of a subsidiary should be kept separate from the evaluation of its manager - Manager's evaluation should consider how hostile or benign the country's environment is - Managers should be evaluated in local currency terms after necessary allowances (tax rates, inflation rates, exchange rates, etc.) ***Capital budgeting***: used to quantify the benefits, costs, and risks of an investment; enables managers to compare different investment alternatives within and across countries - Process - Estimate the cash flows associated with project over time - Discount to determine their net present value using an appropriate discount rate - If the net present value of the discounted cash flows is greater than zero, the firm should go ahead with the project ***Political risk*** - Political change may result in the expropriation of foreign firm' assets - Political and social unrest may also result in economic collapse, can render firm's assets worthless - Increased tax rates, imposition of exchange controls that limit or block a subsidiary's ability to remit earnings to its parent company, the imposition of price controls, and government interference in existing contracts - Uncertainty ***Economic risk*** - Biggest problem arising from mismanagement is inflation - Long-run relationship between a country's relative inflation rate and changes in exchange rates - Not totally reliable relationship ***Transaction costs***: commissions to foreign exchange dealers; various costs of exchange - ***Transfer fee***: bank charge for moving cash from one location to another - ***Bilateral netting***: settlement in which the amount one subsidiary owes another can be cancelled by the debt the second subsidiary owes the first - ***Multilateral netting***: technique used to reduce the number of transactions between subsidiaries of the firm **Cash Flow After Multilateral Netting**  ***Tax havens***: offers foreign businesses and individuals minimal or no tax liability, along with a politically and economically stable environment - Minimizes tax liability - Allows international businesses to avoid or defer income taxes by establishing a wholly owned, nonoperating subsidiary in the tax haven ***Transfer prices*** - Firms can reduce tax liability by using transfer prices to shift earnings - Firms can move funds out of a country where significant currency devaluation is expected - Firms can move funds from a subsidiary to the parent company (or a tax haven) when financial transfers in form of dividends are restricted or blocked by host-country government policies - Firm can use to reduce import duties when ad valorem tariff is in force ***Fronting loans***: loan between parent and its subsidiary channeled through a financial intermediary, usually a large international bank - Can circumvent host-country restrictions - Can provide tax advantages ***Unbundling***: mix of techniques to transfer funds across borders