Unit 1-Globalisation- Introduction and OverviewIntroduction:-

National economies – Moving from being self contained entities to being part of interdependent, integrated global economic systems – globalisation is enabling the transition.

World trade has grown faster than world output Nations have become interdependent – An economic slowdown in South east Asia affects USA

and Japan WTO calls for even lower tariffs After collapse of communism (end of 1980s)- country after country is adopting capitalism Countries opting for free market economies are privatising state owned enterprises,

deregulating markets, increasing competition and welcoming investment Lee Hong Koo, Prime Minister of South Korea in the mid 1990s sees it differently: ‘We didn’t

realize that the victory of the Cold War was a victory for market forces above politics…Golden StraitJacket

Globalization - Cross-border exchanges of goods, services, capital and technologiesDefinition:

A shift toward a more integrated and interdependent world economy - An economic/social and cultural phenomenon?

The movement towards the expansion of economic and social ties between countries through the spread of corporate institutions and the capitalist philosophy that leads to the shrinking of the world in economic terms.

Golden Straitjacket (Thomas Friedman- journalist) citizens able to chose from variety of competing pension options including foreign-run pension

and mutual funds deregulate economy to promote domestic competition eliminate government corruption, kickbacks and subsidies

Thomas Friedman - ‘As your country puts on the Golden Straitjacket, two things tend to happen: your economy grows and your politics shrinks.’

Implications:- The increasing reliance of economies on each other The opportunities to be able to buy and sell in any country in the world

The opportunities for labour and capital to locate anywhere in the world Domestic companies feel threatened Workers in US are afraid of losing jobs The growth of global markets in finance

Integration of economies:- Made possible by:

◦ Technology◦ Communication networks◦ Internet access◦ Growth of economic cooperation – trading blocs (EU, NAFTA, etc.)◦ Collapse of ‘communism’◦ Movement to free trade

The globalization of markets refers to the merging of historically distinct and separate national markets into one huge global market place

Tastes and preferences of consumers in different countries are converging – Firms like Coca-cola, starbucks, Mcdonald’s sell their pdts worldwide

Attending lectures by a British professor teaching in an American University via a web-conference in NUS

Size of the company is no limiting factor – Internet helps small companies market their pdts.

Globalization of production refers to the sourcing of goods and services from locations around the globe to take advantage of national differences in the cost and quality of factors of production

Cost- reduction is the objective A typical MNC sources its spares and components from different countries that the final product

loses its country affinity and is a global product

Key Driving Forces of Globalization:-Emergence of global institutionsAs markets globalise institutions are needed to help, manage and regulate and police the global market place.

GATT WTO – primarily responsible for policing the world trading system. 148 member countries that collectively account for 97% of world trade are WTO members IMF and World Bank were created in 1944 by 44 nations that met at Bretton Woods Task of IMF – to maintain order in the international monetary system Task of World Bank – to promote economic development by extending low interest loans to

cash strapped countries United Nations – Established in the yr 1945 by 51 countries committed to preserving peace

through international cooperation and collective securityDevelopments in transportation and communications

◦ Transport systems are the means by which people, products and materials are transferred from one place to another

◦ Communication systems are the means by which information is transmitted from place to place in the form of ideas, instructions and images

◦ Improvements in transport technology has “shrunk” the world◦ 19th century steam engine 20th century jet engine, large ocean-going vessels move

people◦ Containerisation moves goods fast and cheap over long distances (ships trucks)

Communication◦ Faster and more convenient communication◦ People all over the globe can communicate via telephone, e-mail, fax, video

conferencing, etc◦ Satellite technology allows for simultaneous communication◦ Optical fibre systems can transmit large amounts of information and very high speeds

Internet◦ Internet has enabled consumers to access information instantly, conveniently and

efficiently◦ Internet has transferred the way people communicate, do business, obtain information

and purchase goods and services2) Transnational Companies TNCs set up operations in different parts of the world because:

◦ Sourcing for new markets◦ Increased international economies of scale◦ Production of different parts for products and assembly done in a variety of countries ◦ Lowering cost of production◦ Greater employment opportunities

Impact of Globalizations:-Economic Impact

Improvements in Standards of Living Increased Competitions among Nations

◦ Investment and Market◦ Talent◦ Widening Gap between the rich and poor

Improvements in Standards of Living◦ As countries trade and open their doors to foreign investment, they earn more revenue

As a result, their citizens benefit from a higher standard of living Free trade allows for a larger variety of foreign goods for the consumer to

choose from Better quality of life

◦ Increased Competition Among Nations◦ Investment and Market

Globalisation means more competition as TNCs source for the cheapest places to lower their cost of production

Governments have to compete with each other to attract these foreign corporations to invest

When China opened its doors to foreign investment in the 1970s, industrial cities like Suzhou, Wuxi and Dalian were formed

◦ Investment and Market

Competition for markets and investment is intense Countries that are better able to offer incentives to investors will be more

successful in attracting investment and markets This results in further growth for the country when infrastructure is more

developed◦ Talent

Highly skilled people are in high demand all over the globe Globalisation allows people to move freely from one country to another in

search of employment Advanced economies with stable or shrinking populations seek new talent pools Emerging economies seek back their best and brightest E.g. India’s Brain Drain (e.g. Computer)

Widening Income Gap between the Rich and the Poor◦ Rapid development in developed countries and the spread of poverty in others◦ Developed countries experience rapid income growth as they own most of the

manufacturing activities ◦ Dominance of global trade by the rich, northern hemisphere countries continues◦ These developed countries and their TNCs are able to attract investments, skilled labor

and resources away from poor areas◦ However, Developing Countries face trade restrictions put up by Developed Countries◦ They are not capable of manufacturing better quality goods that fetch higher prices ◦ Poorer nations are only attractive for labor-intensive and low-cost ventures◦ The rich developed countries prosper with better opportunities while the poor

developing countries face economic uncertainties like retrenchment◦ Widening income gap can lead to social problems, increasing tension between the rich

and the poorSocial Impact

Increased Awareness of Foreign CultureTravel, the Internet, mass media (products of globalization allow you to learn moreLoss of Local Culture

◦ Global (Western) brands dominate consumer markets in developing countries◦ Creation of homogenous culture across the world◦ Spread of pop culture and erosion or loss of local culture◦ Negative influence of youth◦ Enforced beliefs

Environmental Degradation:-Concerns: Depletion of natural resources by TNCs

Concern over profits vs. protection of the environmentLack of funds to implement environmental protection

◦ Deforestation and Related Problems Rainforests cut to make way for development Rainforests cut down for industries, agriculture, housing, forestry, cattle

ranches Planting of cash crops

Projects to achieve higher level of economic development Soil erosion, extinction of flora and fauna, flooding Loss in tourism Water pollution

◦ Global Warming Large amount of greenhouse gases produced by increased usage of airplanes

and ships Factories and transportation also emit greenhouse gases, contributing to the

increase in world average temperature.◦ Environmental Management

Greater awareness Sustainable development is the key to further growth Source for alternative energy

Key Issues:◦ Damage to the environment?◦ Exploitation of labour? ◦ Monopoly power◦ Economic degradation◦ Non-renewable resources◦ Damage to cultures

Accountability of Global businesses?

Increased gap between rich and poor fuels potential terrorist reaction Ethical responsibility of business? Efforts to remove trade barriers

Unit 2- Regional Economic Integeration:-Regional economic integration refers to agreements between countries in a geographic region to reduce tariff and nontariff barriers to the free flow of goods, services, and factors of production between each other.While regional trade agreements are designed to promote free trade, there is some concern that the world is moving toward a situation in which a number of regional trade blocks compete against each other.

LEVELS OF ECONOMIC INTEGRATIONThere are five levels of economic integration:

Free trade area Customs union Common market Economic union Political union

An Economic Union involves the free flow of products and factors of production between member countries and the adoption of a common external trade policy, but it also requires a common currency, harmonization of members’ tax rates, and a common monetary and fiscal policy

A Political Union occurs when a central political apparatus coordinates the economic, social, and foreign policy of the member states

THE CASE FOR REGIONAL INTEGRATIONThe case for regional integration is both economic and political.

The Economic Case for Integration The Political Case for Integration Impediments to Integration

Case against Regional Economic Integration Regional economic integration only makes sense when the amount of trade it creates exceeds

the amount it diverts Trade creation occurs when low cost producers within the free trade area replace high cost

domestic producers Trade diversion occurs when higher cost suppliers within the free trade area replace lower cost

external suppliers Economic and Political case for integeration:-Economic

Stimulates economic growth in countries Increases FDI and world production Countries specialize in those goods and services efficiently produced Additional gains from free trade beyond the international agreements such as GATT and WTO

Political Economic interdependence creates incentives for political cooperation

This reduces potential for violent confrontation Together, the countries have more economic clout to enhance trade with other countries or

trading blocsImpediments

Integration is hard to achieve and sustain Nation may benefit but groups within countries may be hurt Potential loss of sovereignty and control over domestic issues

Case Against Integration:-

Economists point out that the benefits of regional integration are determined by the extent of trade creation, as opposed to trade diversion

Trade creation occurs when high cost domestic producers are replaced by low cost producers within the free trade area

Trade diversion occurs when lower cost external suppliers are replaced by higher cost suppliers within the free trade area

EU:There are two trade blocks in Europe: the European Union (EU) and the European Free Trade Association. (the EU currently has 25 members; the EFTA has 4). Of the two, the EU is by far the more significant, not just in terms of membership, but also in terms of economic and political influence in the world economy.

Evolution of the European Union Political Structure of the European Union The Single European Act The Establishment of the Euro Enlargement of the European Union Product of two political factors:

Devastation of WWI and WWII and desire for peace Desire for European nations to hold their own, politically and economically, on the

world stage 1951 - European Coal and Steel Community. 1957- Treaty of Rome establishes the European Community 1994 - Treaty of Maastricht changes name to the European Union

European council Heads of state and commission President resolves policy issues and sets policy direction

European Commission 20 Commissioners appointed by members for 4 year terms Proposing, implementing, and monitoring legislation

European parliament 630 directly elected members Propose amendments to legislation, veto power over budget and single-market

legislation, appoint commissioners Court of justice Council of ministers

The Single Europe Act:- This act committed member countries to work toward the establishment of a single market by

December 31, 1992 The act was born out of:

Frustration among members of the European Community regarding the barriers to the free flow of trade and investment between member countries

A need to harmonize the wide range of technical and legal standards for doing business

The Delors Commission proposed that all impediments to the formation of a single market be eliminated and the Act was enacted in 1987

Objectives: Remove frontier controls “Mutual recognition” of product standards Open public procurement to non-nationals Lift barriers to banking and insurance competition Remove restrictions on foreign exchange transactions

Euro:- In December 1991, EC members signed a treaty (the Maastricht Treaty) that committed them to

adopting a common currency by January 1, 1999.14 The euro is now used by 12 of the 25 member states of the European Union; these 12 states are

members of what is often referred to as the euro zone. T he 10 countries that joined the EU on May 1, 2004, will adopt the euro when they fulfill certain

economic criteria—a high degree of price stability, a sound fiscal situation, stable exchange rates, and converged long-term interest rates.

The current members had to meet the same criteria. Three long-term EU members, Great Britain, Denmark, and Sweden, are still sitting on the sidelines.

By mid-2002, all prices and routine economic transactions within the euro zone were in euros. Benefits:

Savings from using only one currency Easy to compare prices, resulting in lower prices Forces efficiency and slashing costs Creates liquid pan-Europe capital market Increases range of investments for individuals and institutions As of 2004, Euro strong against the dollar and expected to rise

Costs: Countries lose monetary policy control European Central Bank controls policy for the “Euro zone” EU is not an “optimal currency area” Country economies are different Euro puts the economic cart before the political horse Strong Euro (2004) makes it harder for Euro zone exporters to sell their goods

Enlargement of EU:- One major issue facing the EU over the past few years has been that of enlargement

Has become a possibility since the collapse of communism at the end of the 1980’s By the end of the 1990’s 13 countries had applied to become EU members

In December 2002 the EU formally agreed to accept the applications of 10 countries, which resulted in:

The EU expanding to include 25 states The addition of 75 million citizens to the EU Created a single continental economy with a GDP close to 11 trillion Euros

To qualify for EU membership applicants must: Privatize state assets

Deregulate markets Restructure industries Tame inflation Enshrine complex EU laws into their own systems Establish stable democratic governments Respect human rights

REGIONAL ECONOMIC INTEGRATION IN THE AMERICASRegional economic integration is on the rise in the Americas. The North American Free Trade Agreement (NAFTA) is the most significant attempt. Other efforts include the Andean group and MERCOSUR. In addition, there are plans to establish a hemisphere-wide Free Trade Area of the Americas (FTAA).

The North American Free Trade Agreement

The Andean Community MERCOSUR Central American Common Market, CAFTA and CARICOM Free Trade Area of the Americas

The North American Free Trade Agreement (NAFTA) was ratified by the governments of the United States, Canada, and Mexico in 1993; it became law January 1, 1994

The contents of NAFTA includes the following Over 10 year period: tariffs reduced (99% of goods traded) Removal of most barriers on cross border flow of services Removal of restrictions on FDI except in certain sectors

Mexican railway and energy US airline and radio communications Canadian culture

Protection of intellectual property rights Applies national environmental standards Establishment of commission to police violations

NAFTA Results:- Recent surveys indicate that NAFTA’s overall impact has been small but positive

From 1993 to 2004, trade between NAFTA’s partners grew by 250 percent Canada’s trade with NAFTA partners increased from 70% to more than 80% of all

Canadian foreign trade Mexico’s trade with NAFTA partners increased from 66% to 80% of all Mexican foreign

trade All countries experienced strong productivity growth The United States has lost 110,000 jobs per year due to NAFTA

Many economists dispute this figure because more than 2 million jobs a year were created in the US during the same time period

The most significant impact of NAFTA has not been economic, but political NAFTA helped create the background for increased political stability in Mexico

Andean Community:- Bolivia, Chile, Ecuador, Colombia, and Peru signed an agreement in 1969 to create the Andean

Pact The Andean Pact was largely based on the EU model, but was far less successful at achieving its

stated goals By the mid-1980s, the Andean Pact had all but collapsed and had failed to achieve any of its

stated objectives Nearly failed. Rejuvenated in 1990 in the Galapagos Declaration

Five current members include Bolivia, Ecuador, Peru, Colombia, and Venezuela Objectives included the establishment of a free trade area by 1992, a customs union by

1994, and common market by 1995 Operates as a customs union currently

Mercosur:- Originated in 1988 as a free trade pact between Brazil and Argentina The pact expanded in March 1990 to include Paraguay and Uruguay These countries have:

A combined population of 200 million An average annual growth rate of 3.5% for GDP

MERCOSUR countries have significant trade diversion issues

Other Hemisphere Associations:- Central American Common Market

1960s: Costa Rica, El Salvador, Guatemala, Honduras, Nicaragua. Collapsed in 1969

CARICOM 1973: English-speaking Caribbean countries 19__1: Failed for third time to establish common external tariff

Free Trade Area of the Americas Talks scheduled for January 2005 did not occur Two stumbling blocks include intellectual property rights and reductions in agriculture

subsidiesRegional Economic Integration Elsewhere:-Various efforts at economic integration are taking place in other parts of the world.

Association of Southeast Asian Nations Asia Pacific Economic Cooperation Regional Trade Blocs in Africa

ASEAN:- Created in 1967 Objective to achieve free trade between member countries and achieve cooperation in their

industrial Brunei, Indonesia, Laos, Malaysia, the Philippines, Myanmar, Singapore, Thailand, and Vietnam Progress limited by Asian financial crisis of the 90’s

Asia Pacific Economic Cooperation:- Founded in 1990 to ‘promote open trade and practical economic cooperation’

‘Promote a sense of community’ 18 members 50% of world’s GNP 40% of global trade

Despite slow progress, if successful, could become the world’s largest free trade area

Regional Trade Blocs in Africa African countries have been experimenting with regional trade blocs for half a century; there are

now 9 trade blocs on the continent Progress toward the establishment of meaningful trade blocs has been slow In 2001 Kenya, Uganda, and Tanzania committed themselves to relaunching the East African

Community trade bloc 24 years after it collapsed The intent is to establish a customs union, regional court, legislative assembly, and a

political federation Many of these groups have been dormant for years. Significant political turmoil in

several African nations has persistently impeded any meaningful progress. Also, deep suspicion of free trade exists in several African countries. The argument most frequently heard is that because these countries have less

developed and less diversified economies, they need to be “protected” by tariff barriers from unfair foreign competition.

Implications for Managers:- Opportunities: Creation of single markets

Protected markets, now open Lower costs doing business in single market

Threats: Differences in culture and competitive practices make realizing economies of scale

difficult More price competition Outside firms shut out of market EU intervention in mergers and acquisitions

Unit 3- FDI

Foreign direct investment (FDI) occurs when a firm invests directly in new facilities to produce and/or market in a foreign country

– the firm becomes a multinational enterprise– FDI can be in the form of

• greenfield investments - the establishment of a wholly new operation in a foreign country Greenfield operation - mostly in developing nations

Mergers and acquisitions with existing firms in foreign country:• quicker to execute• foreign firms have valuable strategic assets• believe they can increase the efficiency of the acquired firm• more prevalent in developed nations

• The flow of FDI - the amount of FDI undertaken over a given time period • Outflows of FDI are the flows of FDI out of a country• Inflows of FDI are the flows of FDI into a country

• The stock of FDI - the total accumulated value of foreign-owned assets at a given time • Both the flow and stock of FDI have increased over the last 30 years

• Most FDI is still targeted towards developed nations • United States, Japan, and the EU

• but, other destinations are emerging• South, East, and South East Asia especially China • Latin America • India

What are the patterns of FDi:-• The growth of FDI is a result of

1. A fear of protectionism - want to circumvent trade barriers2. political and economic changes - deregulation, privatization, fewer restrictions on FDI3. new bilateral investment treaties - designed to facilitate investment 4. the globalization of the world economy - many companies now view the world as their

market5. need to be closer to their customers

• Gross fixed capital formation - the total amount of capital invested in factories, stores, office buildings, and the like

1. the greater the capital investment in an economy, the more favorable its future prospects are likely to be

• So, FDI is an important source of capital investment and a determinant of the future growth rate of an economy

What is the source of FDI:-• Since World War II, the U.S. has been the largest source country for FDI

– the United Kingdom, the Netherlands, France, Germany, and Japan are other important source countries

– together, these countries account for 60% of all FDI outflows from 1998-2010Why do firms choose acquisition versus greenfield investments:-

• Most cross-border investment is in the form of mergers and acquisitions rather than greenfield investments

– between 40-80% of all FDI inflows per annum from 1998 to 2009 were in the form of mergers and acquisitions

• but in developing countries two-thirds of FDI is greenfield investment because there were fewer target companies

• Firms prefer to acquire existing assets because – mergers and acquisitions are quicker to execute than greenfield investments– it is easier and perhaps less risky for a firm to acquire desired assets than build them

from the ground up– firms believe that they can increase the efficiency of an acquired unit by transferring

capital, technology, or management skillsWhy FDI??Why does FDI occur instead of exporting or licensing?

1. Exporting - producing goods at home and then shipping them to the receiving country for sale – exports can be limited by transportation costs and trade barriers – FDI may be a response to actual or threatened trade barriers such as import tariffs or

quotasFDI is more attractive when transportation costs or trade barriers make exporting unattractive.Management Focus: Foreign Direct Investment by Cemax explores why foreign direct investment made more sense for the Mexican cement maker than exporting. For Cemax, exporting is too costly.

Why Choose FDI?2. Licensing - granting a foreign entity the right to produce and sell the firm’s product in return for

a royalty fee on every unit that the foreign entity sells

A firm will favor FDI over licensing when it wishes to maintain control over its technological know-how, or over its operations and business strategy, or when the firm’s capabilities are simply not amenable to licensing.

• Internalization theory ( market imperfections theory) - compared to FDI licensing is less attractive

– firm could give away valuable technological know-how to a potential foreign competitor– does not give a firm the control over manufacturing, marketing, and strategy in the

foreign country – the firm’s competitive advantage may be based on its management, marketing, and

manufacturing capabilitiesWhat is the Pattern of FDi:-Why do firms in the same industry undertake FDI at about the same time and the same locations?

• Knickerbocker - FDI flows are a reflection of strategic rivalry between firms in the global marketplace

– multipoint competition -when two or more enterprises encounter each other in different regional markets, national markets, or industries

– With regard to horizontal FDI, market imperfections arise in two circumstances:– when there are impediments to the free flow of products between nations which

decrease the profitability of exporting relative to FDI and licensing

– when there are impediments to the sale of know-how which increase the profitability of FDI relative to licensing

• Vernon - firms undertake FDI at particular stages in the life cycle of a product

Radical View:-• Marxist view: MNE’s exploit less-developed host countries

– Extract profits– Give nothing of value in exchange– Instrument of domination, not development– Keep less-developed countries relatively backward and dependent on capitalist nations

for investment, jobs, and technology• By the end of the 1980s radical view was in retreat

– Collapse of communism – Bad economic performance of countries that embraced the radical view– Strong economic performance of countries who embraced capitalism rather than the

radical view• a growing belief by many of these countries that FDI can be an important source of technology

and jobs and can stimulate economic growth– in retreat almost everywhere

Free Market View and Pragmatic Socialism:-• Nations specialize in goods and services that they can produce most efficiently• Resource transfers benefit and strengthen the host country• Positive changes in laws and growth of bilateral agreements attest to strength of free market

view• embraced by advanced and developing nations including the United States and Britain,

but no country has adopted it in its purest form• All countries impose some restrictions on FDI

Theoretical Approaches to FDi:-• Pragmatic nationalism - FDI has both benefits (inflows of capital, technology, skills and jobs) and

costs (repatriation of profits to the home country and a negative balance of payments effect)

• FDI has benefits and costs• Allow FDI if benefits outweigh costs

– Block FDI that harms indigenous industry– Court FDI that is in national interest

• Tax breaks• Subsidies

– DP World and the United States explores the reaction to the bid by DP World, a Dubai-based ports operator, to acquire P&O, a British firm that runs a network of global marine terminals. An acquisition of P&O would give DP World management of six U.S. ports. While the Bush administration claimed the acquisition posed no threat to national security, several prominent U.S. Senators raised concerns about the acquisition. Ultimately, DP World pulled out of the deal, but stated that it would look for alternative ways to enter the U.S. market.

– India – FDI in retail (impact on kirana stores)– Recently, there has been a strong shift toward the free market stance creating– a surge in FDI worldwide – an increase in the volume of FDI in countries with newly liberalized regimes

Pattern of FDI:-• FDI is expensive because a firm must bear the costs of establishing production facilities in a

foreign country or of acquiring a foreign enterprise.• FDI is risky because of the problems associated with doing business in another culture where the

rules of the game may be different.• But, why is it profitable for firms to undertake FDI rather than continuing to export from home

base, or licensing a foreign firm? • Shift to services• location-specific advantages - that arise from using resource endowments or assets that are tied

to a particular location and that a firm finds valuable to combine with its own unique assets• externalities - knowledge spillovers that occur when companies in the same industry locate in

the same area How does FDI benefit the Host Country:-

• There are four main benefits of inward FDI for a host country 1. Resource transfer effects - FDI brings capital, technology, and management resources 2. Employment effects - FDI can bring jobs3. Balance of payments effects - FDI can help a country to achieve a current account surplus4. Effects on competition and economic growth - greenfield investments increase the level of

competition in a market, driving down prices and improving the welfare of consumers– can lead to increased productivity growth, product and process innovation, and greater

economic growth Costs of FDI to Host Country:-

• Inward FDI has three main costs:1. Adverse effects of FDI on competition within the host nation

– subsidiaries of foreign MNEs may have greater economic power than indigenous competitors because they may be part of a larger international organization

2. Adverse effects on the balance of payments

– when a foreign subsidiary imports a substantial number of its inputs from abroad, there is a debit on the current account of the host country’s balance of payments

3. Perceived loss of national sovereignty and autonomy– decisions that affect the host country will be made by a foreign parent that has no real

commitment to the host country, and over which the host country’s government has no real control

FDI Benefit to Home Country:-• The benefits of FDI for the home country include1. The effect on the capital account of the home country’s balance of payments from the inward

flow of foreign earnings2. The employment effects that arise from outward FDI 3. The gains from learning valuable skills from foreign markets that can subsequently be

transferred back to the home countryCosts of FDI to Home Country:-

1. The home country’s balance of payments can suffer– from the initial capital outflow required to finance the FDI– if the purpose of the FDI is to serve the home market from a low cost labor location– if the FDI is a substitute for direct exports

2. Employment may also be negatively affected if the FDI is a substitute for domestic productionBut, international trade theory suggests that home country concerns about the negative

economic effects of offshore production (FDI undertaken to serve the home market) may not be valid– may stimulate economic growth and employment in the home country by freeing

resources to specialize in activities where the home country has a comparative advantage

How does Government influence FDI:-• Governments can encourage outward FDI

– government-backed insurance programs to cover major types of foreign investment risk• Governments can restrict outward FDI

– limit capital outflows, manipulate tax rules, or outright prohibit FDI • Governments can encourage inward FDI

– offer incentives to foreign firms to invest in their countries• gain from the resource-transfer and employment effects of FDI, and capture FDI

away from other potential host countries• Governments can restrict inward FDI

– use ownership restraints and performance requirementsThe rationale underlying ownership restraints is twofold:

• first, foreign firms are often excluded from certain sectors on the grounds of national security or competition

• second, ownership restraints seem to be based on a belief that local owners can help to maximize the resource transfer and employment benefits of FDI for the host country

How do International Instituions Influence FDI:-• Until the 1990s, there was no consistent involvement by multinational institutions in the

governing of FDI

• Today, the World Trade Organization is changing this by trying to establish a universal set of rules designed to promote the liberalization of FDI

What does FDI mean for Managers?• Managers need to consider what trade theory implies about FDI, and the link between

government policy and FDI• The direction of FDI can be explained through the location-specific advantages argument

associated with John Dunning– however, it does not explain why FDI is preferable to exporting or licensing, must

consider internalization theory

• A host government’s attitude toward FDI is important in decisions about where to locate foreign production facilities and where to make a foreign direct investment

– firms have the most bargaining power when the host government values what the firm has to offer, when the firm has multiple comparable alternatives, and when the firm has a long time to complete negotiations

Unit 4:- International Trade TheoriesWhy international trade Theory:-

International Trade takes place because of the variations in productive factors in different countries.

The variations of productive factors cause differences in price in different countries and the price differences are the main cause of international trade

International trade occurs because individuals, businesses and governments in one country want to buy goods and services produced in another country.

Countries trade with each other to obtain things that are of better quality, less expensive or simply different from what is produced at home

Instead of trying to produce everything by themselves, countries often concentrate on producing things that they can produce most efficiently.

International trade is the system by which countries exchange goods and servicesEconomic Gains from Trade:-

Efficient use of productive factors: All countries are not equally endowed with natural resources

international trade enables a country to produce only those goods in which it has a comparative advantage or an absolute advantage and import the rest from other countries

It leads to international specialisation or division of labour, which, in turn, enables efficient use of the productive factors with minimum wastages.

Equality in commodity and factor prices: International trade leads to an equality of the prices of internationally traded goods and productive factors in all the trading regions of the world (if free trade prevails)

The increase that trade can bring to the total amount of goods and services available to the national population (increased consumption argument)

Mercantilism:- not a full-blown trade theory an economic policy of governmental accumulation of wealth, in the form of gold bouillon for:

domestic control investment international expansion

reflects the era of nation-building and the shifting of European political power from feudal lords and the church to national sovereigns;

reflects and supports the principal source of wealth – trading The trade-policy implication of this economic policy was the generation of a national trade

surplus, paid for by accumulation of gold reserves. Some of this gold found its way to overseas investment by the sovereign.

Absolute Advantage:- “It is the maxim of every prudent master of the family, never attempt to make at home what it

will cost him more to make than buy … What is prudent in the conduct of every family can scarce be folly in that of a great kingdom If a foreign country can supply us with a commodity cheaper than we ourselves can make it, better buy it of them …”

Adam Smith 1776 Adam Smith argued that the wealth of nations depends upon the goods and services

available to their citizens, rather than the gold reserves held by the sovereign. Maximizing this availability depends, first, on putting all resources to use, and then, on the

ability -- to obtain goods and services from where they are produced most cheaply (because of “natural”

or “acquired” advantages)

Comparitive Advantage:- "A country … enabled to manufacture commodities with much less labour that her

neighbours may, in return for such commodities, import a fraction of the corn required for its consumption, even if … corn could be grown with much less labour than in the country from which it was imported."

David Ricardo

• Gains from trade – Potential world production is greater with free trade • Trade is a positive sum game in which all countries that participate realise economic

gains• Countries have comparative advantage in goods for which the opportunity cost of production is

relatively low• That is, those that can be produced by giving up relatively little in production of other

goods

Assumptions:- A Simple world in which only two goods exist No transportation costs exist Exchange rates not considered Resources are mobile between production of various goods We have assumed constant returns to scale

We have assumed that a country has fixed set of resources and free trade does not alter the available resources

Extension of Ricardian Model:- Immobile Resources : Resources cannot be shifted from the production of one product to

another Diminishing Returns to Specialisation Dynamic effects and Economic growth: The efficiency of labour and capital could increase with

free trade. The PPF could therefore shift upward indicating increased efficiency due to the benefits of free trade

Samuelson: In the case of rich countries, free trade relocates production facilities to low cost developing countries that could result in loss of jobs. The decrease in the prices of goods does not really offset the loss of jobs

According to Goldman Sachs, countries that have opted for free trade have also experienced high growth rates

Production Possibility Frontier Under Diminishing Retunrs:-

Influence of Free trade on PPF

Heckscher Ohlin Theory:- Ricardo stressed labor productivity and argued differences in labour productivity between

nations is the basis of trade Swedish economicsts Eli Heckscher and Bertil Ohlin argued that comparative advantage arises

from differences in factor endowments

Nations have varying factor endowments and countries will export those goods that intensely and efficiently makes use of abundant factors available internally

China – abundant availability of low cost labour (hence exports low cost manufacturing goods) US is an exporter of agricultural goods – due to availability of arable land

Leontief Paradox Leontief postulated that since US was relatively abundant in capital compared to other nations,

the US would be an exporter of capital intensive goods and importer of labour intensive goods Leontief observed that US exports were less capital intensive than labour intensive – Paradox Possible Explanation: US has a special advantage in producing new pdts with innovative

technology Production of these products may shift to developing nations because of low cost labour US may begin to import these goods and start producing other innovative products on which it

can charge a high price Ricardo’s Comparative cost theory gives a suitable answer to the Leontief Paradox.

Product Life Cycle Theory:- Pdts like mass produced automobiles, TV, instant cameras, photo copiers, PCs) were first

developed by US firms and sold in the US mkts Raymond Vernon , postulated that such innovative products enter maturity stage, due to

increased demand (mass production) they move to low cost (low labor cost) countries and from here get imported to US. US companies producing such products also move their production facilities to low labor cost countries

The demand for most US pdts tend to be on non-price factors. US thus focuses on developing other new products. They exports these new products to other

developed countries like Japan, European countries where acceptability is highEvaluation of PLC theory:-

PLC theory seems to give an accurate explanation of international trade Xerox – originally exported photocopiers from US to Japan and other advanced countries As demand began to grow in these countries Xerox entered into JVs to set up production in

Japan (Fuji-Xerox) and Great Britain (Rank Xerox) As patents expired, more competitors started entering, US exports of copiers decreased and US

eventually became an importer of copiersNew Trade Theory developed after 1970s

In industries with high fixed costs: Specialization increases output, The ability to achieve economies of scale increases through exporting Learning effects are high.

These cost savings come from “learning by doing”New Trade Theory Applications:-

In many industries, world demand will support few competitors Successful firms may emerge because of “First-mover advantage”

First movers capture economies of scale before other entrants and benefit from a low cost structure (Airbus has first mover advantage over late entrants like Boeing)

Role of the government becomes significant (Boeing and Airbus received subsidies from their governments)

learning effects are high. These are cost savings that come from “learning by doing”. First movers have this advantage

Some argue that it generates a need for government intervention and strategic trade policy

National COmpetitve Advantage:-Porters Diamond:-Porter’s 1990 study tried to explain why a nation achieves international success in a particular industry and identified attributes that promote or impede the creation of competitive advantage.

The theory attempts to analyze the reasons for a nations success in a particular industry Porter studied 100 industries in 10 nations

postulated determinants of competitive advantage of a nation were based on four major attributes

Factor endowments Demand conditions Related and supporting industries Firm strategy, structure and rivalry

Success occurs where these attributes exist. More/greater the attribute, the higher chance of success The diamond is mutually reinforcing

Factor Endowments:- Factor endowments:- A nation’s position in factors of production such as skilled labor or

infrastructure necessary to compete in a given industry Basic factor endowments : Natural resources Climate Geographic location Demographics

While basic factors can provide an initial advantage they must be supported by advanced factors to maintain success

Advanced factor endowments : Are the result of investment by people, companies, government and are more likely to lead to competitive advantage

Communications skilled labor research Technology Education If a country has no basic factors, it must invest in advanced factors

Demand Condition:- Demand:

creates capabilities creates sophisticated and demanding consumers Demand impacts quality and innovation

Related and supporting Industries:- Creates clusters of supporting industries that are internationally competitive Must also meet requirements of other parts of the Diamond

Firm Strategy Structure and rivalry:- Long term corporate vision is a determinant of success Management ‘ideology’ and structure of the firm can either help or hurt you Presence of domestic rivalry improves a company’s competitiveness

Porter’s theory should predict the pattern of international trade that we observe in the real world

Countries should be exporting products from those industries where all four components of the diamond are favorable, while importing in those areas where the components are not favorable

Implications for business:- Location implications:

Disperse production activities to countries where they can be performed most efficiently

First-mover implications: Invest substantial financial resources in building a first-mover, or early-mover advantage

Policy implications: Promoting free trade is in the best interests of the home-country, not always in the best

interests of the firm, even though, many firms promote open markets

Unit 5:-The Foreign Exchange Market The foreign exchange market is simply a market for converting the currency of one country into

that of another country, and an exchange rate is the rate at which one currency is converted into another.

Second, it’s used to provide some insurance against foreign exchange risk, or the adverse consequences of unpredictable changes in exchange rates.

The exchange rate is the rate at which one currency is converted into another Events in the foreign exchange market affect firm sales, profits, and strategy

When do firms use foreign exchange market:- International companies use the foreign exchange market when

the payments they receive for exports, the income they receive from foreign investments, or the income they receive from licensing agreements with foreign firms are in foreign currencies

they must pay a foreign company for its products or services in its country’s currency Third, it might be used for short term money market investments. If a company has a

sum of money that it wants to invest for a few months, it might find that interest rates are higher in foreign locations than at home.

Fourth, firms that engage in currency speculation where they move funds from one currency to another in the hopes of making a profit use the foreign exchange markets.

How can firms hedge against foreign exchange market:- The foreign exchange market provides insurance to protect against foreign exchange risk - the

possibility that unpredicted changes in future exchange rates will have adverse consequences for the firm

A firm that insures itself against foreign exchange risk is hedging To insure or hedge against a possible adverse foreign exchange rate movement, firms engage in

forward exchanges - two parties agree to exchange currency and execute the deal at some specific date in the future

Sometimes, companies can be caught off guard when they don’t hedge their currencies. Hedging against adverse exchange rate movements is an important part of an international firm’s financial strategy – Volkswagen case

Difference between spot rates and forward rates The spot exchange rate is the rate at which a foreign exchange dealer converts one currency

into another currency on a particular day. Eg - when you’re on a trip to Germany and you change dollars for euros, you’ll get the spot rate for the day.

spot rates change continually depending on the supply and demand for that currency and other currencies

A forward exchange rate is the rate used for hedging in the forward market rates for currency exchange are typically quoted for 30, 90, or 180 days into the future

if you know you’re going to need 200,000 yen in 30 days to pay for some components (imports), rather than taking the chance that the rate might change over the 30 days, you might enter into a forward agreement to buy the yen now and lock–in the rate, and pay for them in 30 days when your need them.

Currency Swap:- A currency swap is the simultaneous purchase and sale of a given amount of foreign exchange

for two different value dates Swaps are transacted

between international businesses and their banks

between banks between governments when it is desirable to move out of one currency into another for

a limited period without incurring foreign exchange rate risk Nature of foreign exchange market:-

The foreign exchange market is a global network of banks, brokers, and foreign exchange dealers connected by electronic communications systems

the most important trading centers are London, New York, Tokyo, and Singapore the market is always open and currencies are traded somewhere in the world—it never

sleepsDo exchange rates differ between markets:-

High-speed computer linkages between trading centers mean there is no significant difference between exchange rates and there is a single market for currencies betw’n trading centres

If exchange rates quoted in different markets were not essentially the same, there would be an opportunity for arbitrage - the process of buying a currency low and selling it high an d when all dealers do so the gap between the markets would quickly close.

Most transactions involve dollars on one side—it is a vehicle currency along with the euro, the Japanese yen, and the British pound

In other words, if you have won, but you need yen, you might first convert your won into dollars and then the dollars into yen.

How are exchange rates determined:- Exchange rates are determined by the demand and supply for different currencies The bigger question then becomes what affects the supply and demand for a currency? Three factors impact future exchange rate movements

1. A country’s price inflation 2. A country’s interest rate3. Market psychology

How do prices influence exchange rates The law of one price states that 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

if you can buy a pair of jeans in New York for $75, then you should be able to buy the same type of jeans in London for the same price after you’ve converted your dollars to pounds.

Purchasing power parity theory (PPP) argues that given relatively efficient markets (markets in which few impediments to international trade and investment exist) the price of a “basket of goods” should be roughly equivalent in each country

predicts that changes in relative prices will result in a change in exchange rates if our basket of goods is a Big Mac, we should be able to buy a Big Mac in New York, and

then take the same amount of money, convert it to yen, and buy a Big Mac in Japan, or convert the money to pounds, and buy a Big Mac in London, and so on. If you can’t, then you know that one of the currencies is undervalued or overvalued!

How do interest rates influence exchange rates:- The International Fisher Effect states that for any two countries the spot exchange rate should

change in an equal amount but in the opposite direction to the difference in nominal interest rates between two countries

, in countries where inflation is expected to be high, interest rates will be high as well, in order to encourage investors to keep their money in the market. Otherwise, investors would simply shift their money elsewhere.

If there are no restrictions on capital flows, real interest rates must be the same everywhere, or an arbitrage situation would exist. In other words, if the real interest in France was 10 percent, but in the U.S., the real interest rate was just 6 percent, investors would borrow “cheap” dollars to invest in France. This would bring the value of the dollar up, and consequently push the real interest rate in the U.S. up. In other words: (S1 - S2) / S2 x 100 = i $ - i ¥

where i $ and i ¥ are the respective nominal interest rates in two countries (say US and Japan), S1 is the spot exchange rate at the beginning of the period and S2 is the spot exchange rate at the end of the period

How does investor psychology influence exchange rate:- The bandwagon effect occurs when expectations on the part of traders turn into self-fulfilling

prophecies - traders can join the bandwagon and move exchange rates based on group expectations

1992 when George Soros, a well known international financier, made a huge bet against the British pound. He borrowed billions of pounds, and sold them for German marks. This helped push down the value of the pound on foreign exchange markets, and many other investors jumped on the bandwagon and sold pounds as well. Another situation where bandwagon effects were important in the Country Focus on the 1997 fall of the Korean Won.

government intervention can prevent the bandwagon from starting, but is not always effective

Should companies use exchange rate forecasting services:- There are two schools of thought

1. The efficient market school argues that forward exchange rates do the best possible job of forecasting future spot exchange rates, and, therefore, investing in forecasting services would be a waste of money

An efficient market is one in which prices reflect all available information if the foreign exchange market is efficient, then forward exchange rates should be

unbiased predictors of future spot rates Most empirical tests confirm the efficient market hypothesis suggesting that companies should

not waste their money on forecasting services 2. The inefficient market school argues that companies can improve the foreign exchange

market’s estimate of future exchange rates by investing in forecasting services and therefore forecasting service can be valuable.

An inefficient market is one in which prices do not reflect all available information in an inefficient market, forward exchange rates will not be the best possible predictors

of future spot exchange rates and it may be worthwhile for international businesses to invest in forecasting services

However, the track record of forecasting services is not good How are exchange rates predicted:-

There are two schools of thought on forecasting1. Fundamental analysis draws upon economic factors like interest rates, monetary policy,

inflation rates, or balance of payments information to predict exchange rates2. Technical analysis charts trends with the assumption that past trends and waves are reasonable

predictors of future trends and waves Are all currencies freely convertible:-Up until now, we’ve assumed that a currency can always be converted to another currency. But, sometimes currencies can’t be changed easily.

A currency is freely convertible when a government of a country allows both residents and non-residents to purchase unlimited amounts of foreign currency with the domestic currency

A currency is externally convertible when non-residents can convert their holdings of domestic currency into a foreign currency, but when the ability of residents to convert currency is limited in some way

A currency is nonconvertible when both residents and non-residents are prohibited from converting their holdings of domestic currency into a foreign currency

Most countries today practice free convertibility, although many countries impose some restrictions on the amount of money that can be converted the domestic currency is rapidly losing value perhaps because of hyperinflation or other economic concerns

Countries limit convertibility to preserve foreign exchange reserves and prevent capital flight - when residents and nonresidents rush to convert their holdings of domestic currency into a foreign currency

When a country’s currency is nonconvertible, firms may turn to countertrade - barter like agreements by which goods and services can be traded for other goods and services

What do exchange rates mean for managers:-Managers shl’d understand the influence of exchange rates on the profitability of trade and investment deals because an adverse shift in the

value of a currency can make a deal that appeared profitable, a bad choice. Managers need to consider three types of foreign exchange risk1. Transaction exposure - the extent to which the income from individual transactions is affected

by fluctuations in foreign exchange values includes obligations for the purchase or sale of goods and services at previously agreed

prices and the borrowing or lending of funds in foreign currencies – imports become costlier if currency depreciates

2. Translation exposure - the impact of currency exchange rate changes on the reported financial statements of a company

concerned with the present measurement of past events - Many American companies with operations in Europe were able to benefit from translation exposure between 2002 and 2004, when the rising euro increased dollar profits.

gains or losses are “paper losses” –they are unrealized3. Economic exposure - the extent to which a firm’s future international earning power is affected

by changes in exchange rates concerned with the long-term effect of changes in exchange rates on future prices,

sales, and costs This is concerned with the long-term effect of changes in exchanges rates on future prices, sales,

and costs. Many American firms were affected by this type of exposure in the 1990s when the rise in the

dollar made it difficult to be globally competitive, Hpw can mangers minimize exchange rate risk:-

To minimize transaction and translation exposure, managers should 1. Buy forward2. Use swaps3. Lead and lag payables and receivables

lead strategy - attempt to collect foreign currency receivables early when a foreign currency is expected to depreciate and pay foreign currency payables before they are due when a currency is expected to appreciate

lag strategy - delay collection of foreign currency receivables if that currency is expected to appreciate and delay payables if the currency is expected to depreciate

Lead and lag strategies can be difficult to implement To reduce economic exposure, managers should1. Distribute productive assets to various locations so the firm’s long-term financial well-being is

not severely affected by changes in exchange rates2. Ensure assets are not too concentrated in countries where likely rises in currency values will

lead to damaging increases in the foreign prices of the goods and services the firm produces In general, managers should 1. Have central control of exposure to protect resources efficiently and ensure that each subunit

adopts the correct mix of tactics and strategies2. Distinguish between transaction and translation exposure on the one hand, and economic

exposure on the other hand3. Attempt to forecast future exchange rates

4. Establish good reporting systems so the central finance function can regularly monitor the firm’s exposure position

5. Produce monthly foreign exchange exposure reports

Unit -6-Political economy of international trade Free trade occurs when governments do not attempt to restrict what its citizens can buy from

another country or what they can sell to another country While many nations are nominally committed to free trade, they tend to intervene in

international trade to protect the interests of politically important groupsThe main instruments of trade policy are:

Tariffs Subsides Import Quotas Voluntary Export Restraints Local Content Requirements Administrative Polices Antidumping Policies

Tariffs are taxes levied on imports that effectively raise the cost of imported products relative to domestic products

Specific tariffs are levied as a fixed charge for each unit of a good imported Ad valorem tariffs are levied as a proportion of the value of the imported good Tariffs increase government revenues, provide protection to domestic producers against foreign

competitors by increasing the cost of imported foreign goods, and force consumers to pay more for certain imports

So, tariffs are unambiguously pro-producer and anti-consumer, and tariffs reduce the overall efficiency of the world economy

Subsidies are government payments to domestic producers Consumers typically absorb the costs of subsidiesSubsidies help domestic producers in two ways: they help them compete against low-cost foreign imports they help them gain export markets

Import Quotas and voluntary export restraints:- Import quotas directly restrict the quantity of some good that may be imported into a country Tariff rate quotas are a hybrid of a quota and a tariff where a lower tariff is applied to imports

within the quota than to those over the quota Voluntary export restraints are quotas on trade imposed by the exporting country, typically at

the request of the importing country’s government A quota rent is the extra profit that producers make when supply is artificially limited by an

import quota Import quotas and voluntary export restraints benefit domestic producers by limiting import

competition, but they raise the prices of imported goods Local Content Requirements:-

A local content requirement demands that some specific fraction of a good be produced domestically

Local content requirements benefit domestic producers, but consumers face higher prices

Administrative trade polices are bureaucratic rules that are designed to make it difficult for imports to enter a country

These polices hurt consumers by denying access to possibly superior foreign products

Antidumping policies:- Dumping refers to selling goods in a foreign market below their costs of production, or selling

goods in a foreign market below their “fair” market value Dumping enables firms to unload excess production in foreign markets Some dumping may be predatory behavior, with producers using substantial profits from their

home markets to subsidize prices in a foreign market with a view to driving indigenous competitors out of that market, and later raising prices and earning substantial profits

Antidumping polices (or countervailing duties) are designed to punish foreign firms that engage in dumping and protect domestic producers from “unfair” foreign competition

Case of government intervention:-Arguments for government intervention:

Political arguments are concerned with protecting the interests of certain groups within a nation (normally producers), often at the expense of other groups (normally consumers)

Economic arguments are typically concerned with boosting the overall wealth of a nation (to the benefit of all, both producers and consumers)

Political arguments for free trade:-Political arguments for government intervention include:

protecting jobs protecting industries deemed important for national security retaliating to unfair foreign competition protecting consumers from “dangerous” products furthering the goals of foreign policy protecting the human rights of individuals in exporting countries

Protecting jobs and industries is the most common political reason for trade restrictions Usually this results from political pressures by unions or industries that are "threatened" by

more efficient foreign producers, and have more political clout than the consumers that will eventually pay the costs

Industries such as aerospace or electronics are often protected because they are deemed important for national security

Retaliation:- When governments take, or threaten to take, specific actions, other countries may remove

trade barriers If threatened governments don’t back down, tensions can escalate and new trade barriers may

be enacted

Protecting consumers Governments may intervene in markets to protect consumers

Furthering Policy Objectives:- Foreign policy objectives can be supported through trade policy Preferential trade terms can be granted to countries that a government wants to build strong

relations with Trade policy can also be used to punish rogue states that do not abide by international laws or

norms However, it might cause other countries to undermine unilateral trade sanctions The Helms-Burton Act and the D’Amato Act, have been passed to protect American companies

from such actions

Protecting Human Rights:- Trade policy can be used to improve the human rights policies of trading partners However, unless a large number of countries choose to take such action, it is unlikely to be

successful Some critics have argued that the best way to change the internal human rights of a country is

to engage it in international trade The decision to grant China MFN status in 1999 was based on this philosophy

Economic Arguments for Interventions:-Economic arguments for intervention include:

the infant industry argument strategic trade policy

The infant industry argument suggests that an industry should be protected until it can develop and be viable and competitive internationally

The infant industry argument has been accepted as a justification for temporary trade restrictions under the WTO

However, it can be difficult to gauge when an industry has “grown up” Critics argue that if a country has the potential to develop a viable competitive position its firms

should be capable of raising necessary funds without additional support from the government

Strategic trade policy suggests that in cases where there may be important first mover advantages, governments can help firms from their countries attain these advantages

Strategic trade policy also suggests that governments can help firms overcome barriers to entry into industries where foreign firms have an initial advantage

Revised case for Free trade:-Restrictions on trade may be inappropriate in the cases of:

Retaliation and Trade War Domestic Politics

Retaliation and trade war:-

Paul Krugman argues that strategic trade policies aimed at establishing domestic firms in a dominant position in a global industry are beggar-thy-neighbor policies that boost national income at the expense of other countries

Countries that attempt to use such policies will probably provoke retaliationDomestic policies

Krugman argues that since special interest groups can influence governments, strategic trade policy is almost certain to be captured by such groups who will distort it to their own ends

From Smith to the great depression:- Until the Great Depression of the 1930s, most countries had some degree of protectionism The Smoot-Hawley tariff was enacted in 1930 in the U.S creating significant import tariffs on

foreign goods Other nations took similar steps and as the depression deepened, world trade fell further

1947-79: GATT, Trade Liberalization, And Economic Growth:- After WWII, the U.S. and other nations realized the value of freer trade, and established the

General Agreement on Tariffs and Trade (GATT) The approach of GATT (a multilateral agreement to liberalize trade) was to gradually eliminate

barriers to trade 1980-1993: Protectionist Trends

In the 1980s and early 1990s, the world trading system was strained Japan’s economic strength and huge trade surplus stressed what had been more equal trading

patterns, and Japan’s perceived protectionist (neo-mercantilist) policies created intense political pressures in other countries

Persistent trade deficits by the U.S., the world’s largest economy, caused significant economic problems for some industries and political problems for the government

Many countries found that although limited by GATT from utilizing tariffs, there were many other more subtle forms of intervention that had the same effects and did not technically violate GATT

The Uruguay Round And The World Trade Organization The Uruguay Round of GATT negotiations began in 1986

The talks focused on several areas: Services and Intellectual Property -going beyond manufactured goods to address trade issues related to services and intellectual

property, and agriculture The World Trade Organization -it was hoped that enforcement mechanisms would make the WTO a more effective policeman

of the global trade rules The WTO encompassed GATT along with two sisters organizations, the General Agreement on

Trade in Services (GATS) and the Agreement on Trade Related Aspects of Intellectual Property Rights (TRIPS)

WTO: Experience To Date Since its establishment, the WTO has emerged as an effective advocate and facilitator of future

trade deals, particularly in such areas as services So far, the WTO’s policing and enforcement mechanisms are having a positive effect Most countries have adopted WTO recommendations for trade disputes In 1997, 68 countries that account for more than 90% of world telecommunications revenues

pledged to open their markets to foreign competition and to abide by common rules for fair competition in telecommunications

102 countries pledged to open to varying degrees their banking, securities, and insurance sectors to foreign competition

The agreement covers not just cross-border trade, but also foreign direct investment The 1999 meeting of the WTO in Seattle was important not only for what happened between

the member countries, but also for what occurred outside the building Inside, members failed to agree on how to work toward the reduction of barriers to cross-

border trade in agricultural products and cross-border trade and investment in services Outside, the WTO became a magnet for various groups protesting free trade

The Future Of The WTO: Unresolved Issues And The Doha RoundThe current agenda of the WTO focuses on:

the rise of anti-dumping policies the high level of protectionism in agriculture the lack of strong protection for intellectual property rights in many nations continued high tariffs on nonagricultural goods and services in many nations The WTO is encouraging members to strengthen the regulations governing the imposition of

antidumping duties The WTO is concerned with the high level of tariffs and subsidies in the agricultural sector of

many economies TRIPS obliges WTO members to grant and enforce patents lasting at least 20 years and

copyrights lasting 50 years The WTO would like to bring down tariff rates on nonagricultural goods and services, and reduce

the scope for the selective use of high tariff rates The WTO launched a new round of talks at Doha, Qatar in 2001 The agenda includes: cutting tariffs on industrial goods and services phasing out subsidies to agricultural producers reducing barriers to cross-border investment limiting the use of anti-dumping laws

Ubit 6:- national deifferebce-political

Political economy of a nation - how the political, economic, and legal systems of a country are interdependent

they interact and influence each other they affect the level of economic well-being in the nation Political system - the system of government in a nation

Political systems have two dimensions: the degree of collectivism versus individualism, and the degree of democracy versus totalitarianism.

These dimensions are interrelated; systems that emphasize collectivism tend towards totalitarianism, while systems that place a high value on individualism tend to be democratic.

It is possible to have democratic societies that emphasize a mix of collectivism and individualism.

It is possible to have totalitarian societies that are not collectivist. The Opening Case: The Polish Surprise explores how Poland has successfully weathered the

recent global financial and economic crisis. After decades of Communist rule, the country embraced democracy and market based economic ideals. In addition, Poland implemented privatization policies and welcomed FDI.

Collectivism stresses the primacy of collective goals over individual goals can be traced to the Greek philosopher, Plato (427-347 BC) The needs of society as a whole are generally viewed as being more important than

individual freedoms Today, collectivism is equated with socialists (Karl Marx 1818-1883)

advocate state ownership of the basic means of production, distribution, and exchange manage to benefit society as a whole, rather than individual capitalists

Socialism:- In the early 20th century, socialism split into1. Communism – socialism can only be achieved through violent revolution and totalitarian

dictatorship. This system reached its high point in the 70s

in retreat worldwide by mid-1990s Communism was swept out of Eastern Europe by a bloodless revolution of 1989 China – freedom in economic but not political space

1. Social democrats – socialism is achieved through democratic means – eg. India & Brazil, some European nations in the past

In many countries state ownership of means of production lead to inefficiency and ran counter to public good

retreating as many countries move toward free market economies – Eg. India –(free mkt economy since 1990) state-owned enterprises have been privatized

Individualism:- Individualism refers to philosophy that an individual should have freedom in his own economic

and political pursuits

The welfare of the society is best served by letting people pursue their own economic-self interest.

Individual, economic and political freedoms are the ground rules on which a society should be based.

can be traced to Greek philosopher, Aristotle (384-322 BC) individual diversity and private ownership are desirable- public ownership receives little

care as against indiv’l ownership implies democratic political systems and free market economies Individualism was refined in the work of number of British followers like David Hume,

Adam Smith and JS Mill. In recent times Nobel prize winning economists like Milton Friedman, James Buchanan

have championed this philosophy. Democracy

Democracy - a political system in which government is by the people, exercised either directly or through elected representatives

usually associated with individualism pure democracy is based on the belief that citizens should be directly involved in

decision making most modern democratic states practice representative democracy where citizens

periodically elect individuals to represent them The safeguards of democracy are – 1. an individual’s right to expression, opinion and

organisation2. free media 3. Regular elections in which individuals are allowed to vote 4. universal

adult suffrage 5. limited terms for elected representatives 5. a fair court system that is independent from the political system 6. a non-political state bureaucracy 8. a nonpolitical police force and armed service

9. relatively free access to state information

Totalitarianism - form of government in which one person or political party exercises absolute control over all spheres of human life and prohibits opposing political parties

Totalitarianism denies its citizens all of the constitutional guarantees asserted by representative democracies.

Communist: a version of collectivism that believes that socialism can be achieved through collective dictatorship – China, Vietnam, Laos, Cambodia, North Korea

Theocratic: Found in States where political power is monopolized by a party, group or individuals that governs according to religious principles

Tribal totalitarianism – found in states where a political party that represents the

interests of a particular tribe monopolizes power This system was observed in African countries like Zimbabwe, Tanzania, Uganda and Kenya. Right wing totalitarianism: It permits individual economic freedom but restricts political

freedom. Most nations that adopted this system had a hostility towards socialist or communist ideas

Eg. Fascist regimes of Germany, until early 1980’s right-wing dictatorships were common throughout Latin America. Also in Several Asian countries.

, China has seen a move toward greater individual freedom in the economic sphere, but the government is still a totalitarian dictatorship.

Political ideology and economic systems:-Political ideology and economic systems are connected

countries that stress individual goals are likely to have market based economies in countries where state-ownership is common, collective goals are dominant

Democracy and individualism go hand in hand, as do the communist version of collectivism and totalitarianism.

Tribal Totalitarianism: This system was observed in African countries like Zimbabwe, Tanzania, Uganda and Kenya.

It occurs when a political party that represents a particular tribe monopolizes power.

Economic system:- There are three types of economic systems1. Market economies - all productive activities are privately owned and production is determined

by the interaction of supply and demand government encourages free and fair competition between private producers

Production is determined by the interaction of supply and demand and signaled to producers through the price system.

For a market to work in this manner there must be no restrictions on supply. A restriction on supply occurs when a market is monopolized by a single firm. In such circumstances, rather than increase output in response to increased demand, a monopolist might restrict output and let prices rise.

Command economies - government plans the goods and services that a country produces, the quantity that is produced, and the prices at which they are sold

all businesses are state-owned, and governments allocate resources for “the good of society”

because there is little incentive to control costs and be efficient, command economies tend to stagnate

Consistent with the collectivist ideology, the objective of a command economy is for government to allocate resources for “the good of society.” In addition, in a pure command economy, all businesses are state owned.

3. Mixed economies - certain sectors of the economy are left to private ownership and free market mechanisms while other sectors have significant state ownership and government planning

governments tend to own firms that are considered important to national security India has a mixed economy. Mixed economies were once very common throughout much of the world, although they are

becoming much less so. There was a time not too long ago when Great Britain, France, and Sweden were mixed economies, but extensive privatization has reduced state ownership of businesses in all three.

Legal system - the rules that regulate behavior along with the processes by which the laws are enforced and through which redress for grievances is obtained

the system in a country is influenced by the prevailing political system Legal systems are important for business because they

define how business transactions are executed identify the rights and obligations of parties involved in business transactions A country’s laws regulate business practice, define the manner in which business

transactions are to be executed, and set down the rights and obligations of those involved in business transactions.

Differences in legal system can affect the attractiveness of a country as an investment site

Totalitarian states generally restrict private enterprise and the governments with a political philosophy of individualism tend to be pro-private enterprise and pro-consumer There are three types of legal systems

1. Common law - Common law evolved in England over hundreds of years. based on tradition, precedent, and custom

Tradition refers to a country’s legal history Precedent to cases that have come before the court in the past Customs to the ways in which laws are applied in specific situations

It is now found in most of Great Britain’s former colonies, including the USWhen law courts interpret common law, they do so with regard to these characteristics. This gives a common law system a degree of flexibility that other systems lack because it allows the judge to interpret the law.2. Civic law - based on detailed set of laws organized into codes. More than 80 countries, including Japan, France, Russia, operate within a civil law system A civil law system tends to be less adversarial than a common law system, since the judges rely upon detailed legal codes rather than tradition, precedent and custom which they interpret. Judges under a civil law system have less flexibility than those under a common law system. Theocratic law - law is based on religious teachings – Islamic law, Hindu law

Islamic Law:- Legal system in many Middle Eastern countries Based on the sharia - a comprehensive code governing Muslim conduct in all areas of life

Koran and Sunnah–- Holy Book Based on life, sayings, and practices of Muhammad Identifies forbidden practices “haram” Any Westerner doing business in Malaysia in the Middle East should have, at

minimum, a rudimentary understanding of Islamic law and its implications for commercial activities.

Brewers, for example, must refrain from advertising beer on billboards or in local-language newspapers.

To the devout muslim acceptance of interest payment is seen as a grave sin

How are contracts enforced in different legal system:-

Contract - document that specifies the conditions under which an exchange is to occur and details the rights and obligations of the parties involved

Contract law is the body of law that governs contract enforcement under a common law system, contracts tend to be very detailed with all contingencies

spelled out under a civil law system, contracts tend to be much shorter and less specific because

many issues are already covered in the civil code This suggests that it is more expensive to draw up contracts in a common law

jurisdiction, and that resolving contract disputes can be a very adversarial process in common law systems.

Which country law should be applied in dispute:- The United Nations Convention on Contracts for the International Sale of Goods (CIGS)

establishes a uniform set of rules governing certain aspects of the making and performance of everyday commercial contracts between buyers and sellers who have their places of business in different nations

Ratified by the U.S. and about 70 countries By adopting CIGS, a nation signals to other adopters that it will treat the convention’s

rules as part of the law Thus if a country has ratified CIGS, it applies, unless parties concerned have opted out of

it but, many larger trading nations including Japan and the U.K. have not agreed to the

provisions of CIGS and opt for arbitration instead When firms do not opt for CIGS, they opt for arbitration by a recognised arbitration

court to settle disputesHow are property rights and corruption related:-Property rights - the legal rights over the use to which a resource is put and over the use made of any income that may be derived from that resource

Resources include land, buildings, equipment, capital, mineral rights, businesses, and intellectual property (such as patents, copyrights and trademarks

Countries differ significantly in the extent to which their legal system protects property rights. (The law and its enforcement)

Property rights can be violated in two ways- private and public actionPrivate action : theft, piracy, blackmail by private groups –Russia – in the chaotic period following collapse of communism – successful corporate had to pay protection money to mafia

In the United States the Foreign Corrupt Practices Act was passed during the 1970s following revelations that U.S. companies had bribed government officials in foreign countries in an attempt to win lucrative contracts.

The Foreign Corrupt Practices Act makes it illegal for U.S. companies to bribe foreign government officials to obtain or maintain business over which that foreign official has authority

Requires publicly held companies to institute internal accounting controls that would record all transactions

However the law uses languages that allows for exceptions known as facilitating or expediting payments to Facilitate or expedite routine government action The law distinguishes payment made to maintain business and facilitate performance

Property rights:-Public action - legally - ex. excessive taxation, requiring expensive licenses or permits from property holders taking assets into state ownership without compensation illegally - corruption- taking bribes or blackmailing Corruption – Ferdinand Marcos of Philippines, President Suharto in Indonesiahigh levels of corruption reduce foreign direct investment, the level of international trade, and the economic growth rate in a country

Intellectual Property:- Intellectual property - property that is the product of intellectual activity – computer software,

new drugs Intellectual property must be registered in each country where business is conducted Can be protected using1. Patents – exclusive rights for a defined period to the manufacture, use, or sale of that invention2. Copyrights – the exclusive legal rights of authors, composers, playwrights, artists, and publishers

to publish and disperse their work as they see fit3. Trademarks – design and names by which merchants or manufacturers designate and

differentiate their productsInfringement of IPR:-

Counterfeiting—unauthorized copying and production of a product Associative counterfeit/imitation—product name differs slightly from a well-known brand Piracy—unauthorized publication or reproduction of copyrighted work

How can ipr be protected:- Many countries participate in international conventions designed for mutual recognition and

protection of intellectual property rights World Intellectual Property Organization Paris Convention for the Protection of Industrial Property

To avoid piracy, firms can stay away from countries where intellectual property laws are lax file lawsuits lobby governments for international property rights agreements and enforcement

Product safety and liability:- Product safety laws set certain standards to which a product must adhere Product liability involves holding a firm and its officers responsible when a product causes injury,

death, or damage There are both civil and criminal product liability laws. Civil laws call for payment and monetary

damages. Criminal liability laws result in fines or imprisonment. Both civil and criminal liability laws are probably more extensive in the United States than in any other country

liability laws tend to be less extensive in less developed nationsWhy is it important:-

Country differences in product safety and liability laws raise an important ethical issue for firms doing business abroad. When product safety laws are tougher in a firm’s home country than in a foreign country and/or when liability laws are more lax, should a firm doing business in that foreign country follow the more relaxed local standards or should it adhere to the standards of its home country?

Does the high cost of liability insurance in the U.S. make American companies less competitive

Is it ethical to follow host country standards when product safety laws are stricter in a firm’s home country than in a foreign country?

Is it ethical to follow host country standards when liability laws are more lax in the host country?

How Can Managers Determine A Market’s Overall Attractiveness? The overall attractiveness of a country as a potential market and/or investment site for an

international business depends on balancing the benefits, costs, and risks associated with doing business in that country

Other things being equal, more attractive countries have democratic political institutions, market based economies, and strong legal systems that protect property rights and limit corruption

The International Monetary System

The international monetary system refers to the institutional arrangements that countries adopt to govern exchange rates. There are international agreements that govern exchange rates

A floating exchange rate system exists when a country allows the foreign exchange market to determine the relative value of a currency – US, EU, Japan and UK

a dirty float exists when a country tries to hold the value of its currency within some range of a reference currency- China- Yuan is allowed to float against a basket of currencies within tight limits

A fixed exchange rate system exists when countries fix their currencies against each other European Monetary System (EMS)

A pegged exchange rate system exists when a country fixes the value of its currency relative to a reference currency – Mexico, Lativia and many countries had pegged their currency with reference to US dollar

The gold standard refers to a system in which countries peg currencies to gold and guarantee their convertibility

the gold standard dates back to ancient times when gold coins were a medium of exchange, unit of account, and store of value –

payment for imports was made in gold or silver - possible becos transactions were less

Post industrialisation gold standard was established payment was made in paper currency which was linked to gold at a fixed rate in the 1880s, most nations followed the gold standard

$1 = 23.2 grains of “fine” (pure) gold the gold par value refers to the amount of a currency needed to purchase one ounce of

gold Under the gold standard, each currency was linked to a fixed amount of gold. The exchange rate between currencies then, was based on the gold par value, or the amount of

a currency needed to purchase one ounce of gold. In other words, if you had dollars, and needed francs, you would convert your dollars to gold at

the rate of 23.22 grains of gold per dollar, and then convert the gold to francs at the franc/gold rate.

Why did gold standard make sense? The great strength of the gold standard was that it contained a powerful mechanism for

achieving balance-of-trade equilibrium for all countries - when the income a country’s residents earn from its exports is equal to the money its residents pay for imports

Eg. Well, if Japan has a trade surplus with the U.S., or exports more to the U.S. than it imports, dollars flow out of the U.S. to pay for the imports. After the Japanese exporters cash the dollars in for yen at the Japanese bank, the Japanese bank will trade them for gold with the U.S. The outflow of gold from the U.S. will reduce the U.S money supply and increase Japan’s money supply causing higher prices in Japan and lower prices in the U.S.

The gold standard worked well from the 1870s until 1914 but, many governments financed their World War I expenditures by printing money and

so, created inflation Then, in an effort to encourage exports and domestic employment, countries started to

devalue their currencies. People lost confidence in the system

demanded gold for their currency putting pressure on countries' gold reserves, and forcing them to suspend gold convertibility

By 1939, the gold standard was deadWhat was Bretton woods system

The great strength of the gold standard was that it contained a powerful mechanism for achieving balance-of-trade equilibrium for all countries - when the income a country’s residents earn from its exports is equal to the money its residents pay for imports

Eg. Well, if Japan has a trade surplus with the U.S., or exports more to the U.S. than it imports, dollars flow out of the U.S. to pay for the imports. After the Japanese exporters cash the dollars in for yen at the Japanese bank, the Japanese bank will trade them for gold with the U.S. The outflow of gold from the U.S. will reduce the U.S money supply and increase Japan’s money supply causing higher prices in Japan and lower prices in the U.S.

The gold standard worked well from the 1870s until 1914

but, many governments financed their World War I expenditures by printing money and so, created inflation

Then, in an effort to encourage exports and domestic employment, countries started to devalue their currencies.

People lost confidence in the system demanded gold for their currency putting pressure on countries' gold reserves, and

forcing them to suspend gold convertibility By 1939, the gold standard was dead

What Institutions Were Established At Bretton Woods? The Bretton Woods agreement also established two multinational institutions – IMF1. The International Monetary Fund (IMF) to maintain order in the international monetary system

through a combination of discipline and flexibility requiring fixed exchange rates stopped competitive devaluations and brought stability

to the world trade environment fixed exchange rates imposed monetary discipline on countries, limiting price inflation in cases of fundamental disequilibrium, devaluations were permitted the IMF lent foreign currencies to members during short periods of balance-of-

payments deficit, when a rapid tightening of monetary or fiscal policy would hurt domestic employment

a rigid policy of fixed exchange rates would be too inflexible in a more global world - the IMF created a fund using contributions from members that gave it the ability to lend foreign currencies to members to tide them over during short term balance of payments deficits

2. World bank – to promote general economic development3. The World Bank to promote general economic development - also called the International Bank

for Reconstruction and Development (IBRD) - initially designed to lend money to help rebuild Europe, but shifted its role to helping Third World nations after the Marshall Plan was implemented.

Countries can borrow from the World Bank in two ways under the IBRD scheme, money is raised through bond sales in the international capital

market1. borrowers pay a market rate of interest - the bank's cost of funds plus a margin

for expenses. through the International Development Agency, an arm of the bank created in 1960 -

raises money through subscriptions from wealthy members like the U.S. 4. IDA loans go only to the poorest countries which have 50 years to repay at a 1 percent per year

rate of interest.Why Did The Fixed Exchange Rate System Collapse?

Bretton Woods worked well until the late 1960s It collapsed when huge increases in welfare programs and the Vietnam War were financed by

increasing the money supply and causing significant inflation- This led to a deterioration of the U.S. foreign trade position, and speculation that the dollar would have to be devalued.

under the Bretton Woods system, devaluing the dollar meant that all other currencies would have to be revalued—a prospect that wasn’t appealing to other countries that would see the price of their products rise relative to American products!

In 1971, President Nixon announced that the dollar would no longer be convertible to gold, and that a 10 percent tariff on all imports would be implemented unless countries agreed to revalue their currencies.

The dollar was eventually devalued by about 8 percent, but problems continued to persist. The U.S. continued to expand its money supply, run high trade deficits, and experience high inflation.

The Bretton Woods system was only viable when the U.S. inflation rate was low, and the U.S. did not run a balance of payments deficit, and so it collapsed, and currencies began to float against each other.

Other countries increased the value of their currencies relative to the U.S. dollar in response to speculation the dollar would be devalued

However, because the system relied on an economically well managed U.S., when the U.S. began to print money, run high trade deficits, and experience high inflation, the system was strained to the breaking point – the U.S. dollar came under speculative attack

What Was The Jamaica Agreement? After the collapse of Bretton Woods, IMF members got together in 1976 in Jamaica to formalize

the new floating exchange rate system. Under the Jamaica Agreement, floating rates were deemed acceptable gold was abandoned as a reserve asset, IMF quotas, or the amounts that countries contributed to the IMF, were increased. The rules that were agreed on then, are still in place today

What Has Happened To Exchange Rates Since 1973? Since 1973, exchange rates have been more volatile and less predictable than they were

between 1945 and 1973 because of the 1971 oil crisis the loss of confidence in the dollar after U.S. inflation in 1977-78 the 1979 oil crisis the rise in the dollar between 1980 and 1985 the partial collapse of the European Monetary System in 1992 the 1997 Asian currency crisis that saw various Asian currencies lose between 50 and 80

percent of their value!

Which Is Better – Fixed Rates Or Floating Rates? Floating exchange rates provide1. Monetary policy autonomy

removing the obligation to maintain exchange rate parity restores monetary control to a government - the government could choose to expand the money supply to encourage people to buy more (stimulate dd, I and employment) without worrying about maintaining parity.

2. Automatic trade balance adjustments - For example, if a country is running a trade deficit, buying more than it sells, the outflow of money will eventually lead to a depreciation of its currency. This depreciation will make its goods cheaper in foreign markets, and imports more expensive, and the trade deficit should eventually correct itself.

3. Under the Bretton Woods System Devaluation is possible only with the permission of IMF

But, a fixed exchange rate system 1. Provides monetary discipline

ensures that governments do not expand their money supplies at inflationary rates2. Minimizes speculation

speculation that occurs with floating exchange rate regimes can cause currency fluctuations. the dollar fluctuated sharply in the 1980s, and critics of floating regimes argue that this was the result of speculation not comparative inflation rates or trade deficits.

For companies, this uncertainty makes planning more challenging3. Reduces uncertainty

promotes growth of international trade and investment the lack of connection between trade balances and exchange rates. Finally, advocates of floating exchange rates argue that floating rates help adjust trade

imbalances Critics claim trade deficits reflect the balance between savings and investment in a country.

Who Is Right?

There is no real agreement as to which system is better A fixed exchange rate regime modeled along the lines of the Bretton Woods system will not

work But a different kind of fixed exchange rate system might be more enduring and might foster the

kind of stability that would facilitate more rapid growth in international trade and investment

What Type of Exchange Rate System Is In Practice Today? Various exchange rate regimes are followed today

14% of IMF members follow a free float policy 26% of IMF members follow a managed float system 28% of IMF members have no legal tender of their own the remaining countries use less flexible systems such as pegged arrangements, or

adjustable pegs

What Is A Pegged Rate System? A country following a pegged exchange rate system, pegs the value of its currency to that of

another major currency popular among the world’s smaller nations adopting a pegged exchange rate regime can moderate inflationary pressures in a

countryWhat Is A Currency Board?

Countries using a currency board commit to converting their domestic currency on demand into another currency at a fixed exchange rate

the currency board holds reserves of foreign currency equal at the fixed exchange rate to at least 100% of the domestic currency issued

the currency board can issue additional domestic notes and coins only when there are foreign exchange reserves to back them

What Is The Role Of The IMF Today? IMF was originally established to help maintain the exchange rate system that was set at Bretton

Woods. Today, the IMF focuses on lending money to countries in financial crisis - For example, the IMF

lent money to several Asian countries in 1997. A currency crisis occurs when a speculative attack on the exchange value of a currency

results in a sharp depreciation in the value of the currency, or forces authorities to

expend large volumes of international currency reserves and sharply increase interest rates in order to defend prevailing exchange rates

A banking crisis refers to a situation in which a loss of confidence in the banking system leads to a run on the banks, as individuals and companies withdraw their deposits

A foreign debt crisis is a situation in which a country cannot service its foreign debt obligations, whether private sector or government debt

What Was The Mexican Currency Crisis Of 1995? The Mexican currency crisis of 1995 was a result of - high Mexican debts, a pegged exchange

rate that did not allow for a natural adjustment of prices Mexico’s pegged currency was the result of its 1982 financial crisis that had required an IMF

bailout. The IMF believed that the peg was necessary to limit growth in the money supply and to contain inflation.

However, by the mid-1980s, producer prices had risen significantly in Mexico without a corresponding adjustment in the exchange rate - Mexico’s trade deficit was $17 billion, and investors, reassured by the government’s pledge to maintain the peg, poured money into the country.

Eventually though, currency traders concluded that a devaluation of the peso was necessary, and began to dump the currency.

The government, after initially trying to maintain the exchange rate, suddenly devalued the peso, which combined with other selling, added up to a 40 percent drop in value!

At this point, the IMF stepped in to provide assistance and help the country get back on track. To keep Mexico from defaulting on its debt, the IMF created a $50 billion aid package

required tight monetary policy and cuts in public spending

What Was The Asian Currency Crisis? The 1997 Southeast Asian financial crisis was caused by events that took place in the previous

decade including1. An investment boom - fueled by huge increases in exports fueling a boom in

commercial and residential property, industrial assets, and infrastructure. 2. Excess capacity - investments were based on projections of future demand conditions,

resulting in excess capacity3. High debt - investments were supported by dollar-based debts4. Expanding imports – caused current account deficits

By mid-1997, several key Thai financial institutions were on the verge of default - They had made loans to companies that weren’t being repaid, making it difficult to meet their own debt obligations.

The value of the baht dropped by 55 percent! speculation against the baht and short selling began Initially, the Thai government tried to defend its currency, but then more or less gave

up, and allowed the baht to float against the dollar.Thailand abandoned the baht peg and allowed the currency to float

The IMF provided a $17 billion bailout loan package required higher taxes, public spending cuts, privatization of state-owned businesses,

and higher interest rates

Speculation caused other Asian currencies including the Malaysian Ringgit, the Indonesian Rupaih and the Singapore Dollar to fall

These devaluations were mainly driven by excess investment, high borrowings, much of it in dollar denominated debt, and a

deteriorating balance of payments position The IMF provided a $37 billion aid package for Indonesia

required public spending cuts, closure of troubled banks, a balanced budget, and an end to crony capitalism

The IMF provided a $55 billion aid package to South Korea required a more open banking system and economy, and restraint by chaebol

How Has The IMF Done? By 2008, the IMF was committing loans to 65 countries in economic and currency crisis All IMF loan packages require a combination of tight macroeconomic policy and tight monetary

policy However, critics worry

the “one-size-fits-all” approach to macroeconomic policy is inappropriate for many countries

the IMF is exacerbating moral hazard - when people behave recklessly because they know they will be saved if things go wrong

the IMF has become too powerful for an institution without any real mechanism for accountability

But, as with many debates about international economics, it is not clear who is right What Does The Monetary System Mean For Managers?

Managers need to understand how the international monetary system affects1. Currency management - the current system is a managed float - government intervention can

influence exchange rates speculation can also create volatile movements in exchange rates while exchange rate movements can be difficult to predict, they can have a significant

impact on business.2. Business strategy - exchange rate movements can have a major impact on the competitive

position of businesses need strategic flexibility to avoid economic exposure Some foreign suppliers decided that rather than risk trying to pass the effects of the

declining dollar on to consumers in the form of higher prices, they’d simply accept a smaller profit margin instead.

3. Corporate-government relations - businesses can influence government policy towards the international monetary system

companies should promote a system that facilitates international growth and development

Exporters in the U.S. for example, have lobbied for devaluations in the dollar to make exports more attractive in foreign markets.