Global Business Management
(MGT380)
Lecture #31
Revision
International Business Environment
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International business
Differentiating feature of GB (Political & legal
differences; cultural; economic; currency;
restrictions; cost of distance)
What are the Forces of GB (Profit, growth, domestic
market constraints; competition; government
policies)
4-types of International orientations (Ethnocentrism;
polycentrism; regiocentrism; geocentrism)
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Globalization stages(Purely domestic firm, small
foreign activity, International company,
Multinational, transnational)
Drivers: Liberalization, Technology (Death of
distance, no boundaries), MNCs, WWW, Product
development costs, Competition, Regional
integration, Leverage-advantages by
experience(experience transfer, economy of scale,
resource utilization, global strategy)
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Restraining forces: External and Internal
International business decision making: 1. need to
see objectives, resources, market potential,
environmental factors 2. market selection 3. entry
mode 4.Int structure decision
Business Environment (domestic, international,
global), self-reliance criterion
Culture: Integrated system of learned behaviour
patterns that characteristics of the members of any
given society
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High-context Vs Low-context culture
Elements of culture
 Language
 Religion
 Manners
and customs
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Values are shared beliefs or group norms within the
society and attitudes are evaluations of alternatives
based on values.
Material element: It refers to the impact of
technology, and as a result how a society organizes
its activities (Economic infrastructure, social
infrastructure, financial infrastructure). Cultural
convergence
Each culture has clear statement for what is
acceptable and what is not
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Education plays an important role in passing on and
sharing of culture
Two types of knowledge (i) Objective/factual:
communication, education, R&D (ii) Experimental: by
involving oneself in new culture
Culture life styles can be classified into four
dimension: Individualism, Power distance,
Uncertainty avoidance, Masculinity
International Trade & Investment
Policies
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Rationale of trade policies
 The
domestic policy actions of most governments aim to
increase the standard of living of citizens and to
improve the quality of life, and to achieve full
employment.
 These policies goals and international trade relates
indirectly.
 Each country develops its own domestic policy, which
varies, may cause conflict. E.g., Cattle, Cars
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ITO, GAAT (Most Favored Nation clause), WTO
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Three major changes have occurred over time in the
global policy environment:
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a reduction of domestic policy influence;
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a weakening of traditional international institutions
Focus was shifted towards non-tariff barriers which are more
complex
 Right to establishment within countries without personal presence
 Disputes in areas like agriculture or intellectual property rights
protection continue to rise.
 Inclusion of ‘social causes’ such as labour laws, competition,
emigration
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Sharpening of the conflict between industrialized and
developing nations.
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Trade restrictive measures:
 Tariffs
are taxes on the value of imported goods
 Quotas are restrictions on the no of foreign products
that can be imported
 Non-tariff barriers include testing, certification, simply
bureaucratic hurdles which result in restricting imports.
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Anti-dumping law, Nontariff barriers (preference to
domestic bidders, incompatibility of international
standards) and tightening market access
Effects: high cost, shift of product/mode, efficiency
loss
Politics and Law
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The Home-Country Perspective, Host Country
Political and Legal Environment, International
Relations and Laws
Major areas of governmental activity that are of
concern to the international business manager:
 Embargoes
and Sanctions
 Export Controls
 Regulation
of International Business Behavior
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Sanctions and Embargoes: Refers to Gov actions
that distorts free flows of trade in goods/services
for political purpose rather than economic purpose.
Export Controls: Most countries have export control
system designed to deny or at least delay the
acquisition of strategically important goods rivals.
 Steps:
 Should
a given product be exported?
 To a given country?
 For use by a given firm?
 Collapse
of Soviet Union and Eastern Block
 Focus is shifted to third world countries
 Loosing bond between allied nations
 Availability of technology from other resources
 Speed of change and rapid dissemination of information
and innovation around the world. The issue of equipment
size
Regulating International behaviour through
boycotts, anti-trust laws, bribery, general
acceptable standards and ethics
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Political Action and Risk:
 Confiscation: The government takeover of a firm
without compensation to the owners.
 Expropriation: A form of government takeover in which
the firm’s owners are compensated.
 Domestication: The government demands transfer of
ownership and management responsibility.
 Intellectual property right: Risk of loosing their core
competitive edge.
Economic risk: currency control, taxes, prices control
Political risk: ownership, operating and transfer risks
Managing risk, & legal systems(code and common)
International Trade Theory
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Free trade refers to a situation where a government
does not attempt to influence through quotas or
duties what its citizens can buy from another country
or what they can produce and sell to another
country.
The Pattern of International Trade are difficult to
explain
Mercantilism makes a crude case for government
involvement in promoting exports and limiting
imports
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In 1776, Smith suggested that countries differ in
their ability to produce goods efficiently. A country
has an absolute advantage in the production of a
product when it is more efficient than any other
country in producing it.
According to Ricardo’s theory of comparative
advantage, it makes sense for a country to
specialize in the production of those goods that it
produces most efficiently and to buy the goods that
it produces less efficiently from other countries, even
if this means buying goods from other countries that
it could produce more efficiently itself.
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Assumption of competitive advantage theory: The simple example of
comparative advantage makes a number of assumptions: only two
countries and two goods; zero transportation costs; similar prices and
values; resources are mobile between goods within countries, but not
across countries; constant returns to scale; fixed stocks of resources; and
no effects on income distribution within countries.
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The Samuelson Critique: Samuelson argues that 1) Resources do not
always move freely from one economic activity to another. 2) the ability
to offshore services jobs that were traditionally not internationally mobile
may have the effect of a mass inward migration into the United States,
where wages would then fall.
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Studies exploring the relationship between trade and economic growth
suggest that countries that adopt a more open stance toward international
trade enjoy higher growth rates than those that close their economies to
trade. Trade increase stock of resources, Trade increase the
efficiency(technology, competition, economy of scale)
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Heckscher and Ohlin argued that comparative advantage arises from
differences in national factor endowments . Relative not Absolute.
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In 1953, Wassily Leontief postulated that since the U.S. was relatively
abundant in capital compared to other nations, the U.S. would be an
exporter of capital intensive goods and an importer of labor-intensive
goods. However, he found that U.S. exports were less capital intensive than
U.S. imports (exporting labor-intensive).
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In the mid-1960s, Raymond Vernon proposed the product life-cycle theory
that suggested that as products mature both the location of sales and the
optimal production location will change affecting the flow and direction of
trade.
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Economies of Scale, First Mover Advantages, and the Pattern of Trade
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Porter’s 1990 study tried to explain why a nation achieves international
success in a particular industry and identified four attributes that promote
or impede the creation of competitive advantage:
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Factor Endowments: A nation's position in factors of production can lead to
competitive advantage, natural resources or human capital
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Demand Conditions: The nature of home demand for the industry’s product or
service influences the development of capabilities. Sophisticated and demanding
customers pressure firms to be competitive.
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Relating and Supporting Industries: The presence supplier industries and related
industries that are internationally competitive can spill over and contribute to other
industries
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Firms strategy, structure, and rivalry: The conditions in the market determining how
companies are created, organized, and managed and nature of domestic rivalry.
FDI
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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: acquisitions or mergers with
existing firms in the foreign country
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The flow of FDI refers to the amount of FDI undertaken over a
given time period
The stock of FDI refers to the total accumulated value of
foreign-owned assets at a given time
Gross fixed capital formation - the total amount of capital
invested in factories, stores, office buildings, and the like
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FDI has grown more rapidly than world trade and world output
 firms still fear the threat of protectionism
 democratic political institutions and free market economies have
encouraged FDI
 globalization is forcing firms to maintain a presence around the world
There are several reasons for this pattern.
1) Firms are worried about protectionist measures, and see FDI as a way of
getting around trade barriers. 2) Changes in the economic and political
policies of many countries have opened new markets to investment.
Think, for example of the changes in Eastern Europe that have made it
possible for foreign firms to expand there. 3)Third, many firms see the
world as their market now, and so are expanding wherever they feel it
makes sense. Spain’s Telefonica is pursuing opportunities in Latin
America and in Europe. 4) Many manufacturers are expanding into
foreign countries to take advantage of lower cost labor, or to be closer
to customers, and so on. China has become a hot spot for firms that are
attracted to the country’s low wage rates, and large market.
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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 skills
Export/ License vs. FDI
Internalization theory suggests that licensing has three major
drawbacks compared to FDI i) firm could give away valuable technological
know-how to a potential foreign competitor. RCA (US firm) licensed its colortechnology to Japanese firms to Sony. (ii) does not give a firm the control over
manufacturing, marketing, and strategy in the foreign country (iii) the firm’s
competitive advantage may be based on its management, marketing, and
manufacturing capabilities. Toyota competitive advantages (management &
process capabilities) embedded in its culture
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Why do firms in the same industry undertake FDI at about the
same time and the same locations?
Knickerbocker : Suggests that firms follow their domestic
competitors overseas. FDI flows are a reflection of strategic
rivalry between firms in the global marketplace; More
pertinent in Oligopolistic market. For example: Toyota and
Nissan responded to investment of Honda; Electrolux did in
response of G.E and Whirlpool.
Vernon - firms undertake FDI at particular stages in the life
cycle of a product; Xerox; This theory is did well to explain
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When demand of country support the production and shift
production to low-cost markets when competition is high
It fails to explain that why firm do FDI when export/license is
profitable (because of economies of scale)
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According to Dunning’s eclectic paradigm- it is important to
consider: 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. Electrolux in China, externalities - knowledge
spillovers that occur when companies in the same industry
locate in the same area. Firms willing to take advantage of
low-cost labor/natural resources/ technology they go
accordingly. Silicon Valley in CA.
How does a government’s attitude affect FDI?
1. Radical view (traces its roots to Marxist political and
economic theory). This perspective argues that the MNE is an
instrument of imperialist domination and a means of exploiting
host countries for the benefit of their capitalist-imperialist home
countries. Socialists and Nationalists , world is changing
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Free market perspective which argues that international
production should be distributed among countries according to
the theory of comparative advantage. This perspective
suggests that countries specialize in the production of the
goods they can produce most efficiently and trade for
everything else. It then follows, that FDI will actually increase
the overall efficiency of the global economy. Not fully
embraced.
In the middle of the continuum is pragmatic nationalism which
argues that FDI has both benefits and costs. Benefits include
things like inflows of capital, technology, skills, and jobs, while
costs include the repatriation of profits and negative balance
of payments effects. Pragmatic nationalism suggests that FDI
should only be allowed if the benefits outweigh the costs.
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Host country benefits: Resource transfer effects we’ve actually already talked a bit about this.
Remember that FDI can benefit a country by
bringing in capital, technology, and management
skills helping the country to increase its economic
growth.
Bring jobs. Well cited example is
FDI helps BOP in two ways:
 FDI
is substitute for imports of goods/services, it increases
CA. For instance, Japanese FDI in EU and USA.
 When MNCs export product to other countries
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FDI affects competition and economic growth: If FDI is in the
form of greenfield investment, competition will increase in a
market. This should drive down prices and benefit consumers.
More competition also promotes increased productivity,
innovation, and then, economic growth.
There are three main costs of inward FDI. 1. Adverse effect on
competition: subsidiaries of foreign MNE’s might end up having
greater economic power than indigenous competitors. It gives
the negative effects on competition. 2. Negative effects on the
balance of payments. When it comes to the balance of
payments, host countries worry that along with the capital
inflows that come will the FDI, will be the capital outflows that
occur when the subsidiary repatriates profits to the parent
company. Some countries actually limit the amount of profits
that can be repatriated to limit the negative effects of this.
Host countries are also concerned that some subsidiaries import
a substantial number of their inputs.
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Loss of national sovereignty and autonomy: Sometimes host
governments worry that they may lose some economic
independence as a result of FDI. They worry that since foreign
companies have no particular commitment to the host country,
they won’t really worry about the consequences of their
decisions on the host country. Loss of economic independence.
The effect on the capital account of the home country’s
balance of payments, the employment effects that arise from
outward FDI when importing parts, the gains from learning
valuable skills from foreign markets that can subsequently be
transferred back to the home country. Reverse resourcetransfer.
The home country’s balance of payments can suffer and
employment.
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Well, there are various ways that home and host
countries can encourage or discourage FDI (ownership
and performance restraints)
Decision to export/license/FDI
Regional integration
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Regional economic integration - agreements between countries
in a geographic region to reduce tariff and non-tariff barriers
to the free flow of goods, services, and factors of production
between each other
regional trade blocs compete against each other
Levels of integration
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A free trade area eliminates all barriers to the trade of goods and
services among member countries
A customs union eliminates trade barriers between member countries
and adopts a common external trade policy, Andean Community
(Bolivia, Columbia, Ecuador, and Peru)
A common market has no barriers to trade between member
countries, a common external trade policy, and the free movement of
the factors of production
4.
5.
An economic union has the free flow of products and factors
of production between members, a common external trade
policy, a common currency, a harmonized tax rate, and a
common monetary and fiscal policy, European Union (EU),
Euro since January 2001
A political union involves a central political apparatus that
coordinates the economic, social, and foreign policy of
member states, the EU is headed toward at least partial
political union, and the U.S. is an example of even closer
political union
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All countries gain from free trade and investment
 regional economic integration aims to exploit the gains from
free trade and investment; Trade theories, +sum game,
Linking countries together, making them more dependent on
each other; creates incentives for political cooperation and
reduces the likelihood of violent conflict, Wars; gives countries
greater political clout when dealing with other nations; If no. of
countries involve is higher it would be difficult
Forerunner was the European Coal and Steel Community
(1951); The European Economic Community (1957); The Single
European Act (1987); The European Council- European
Commission (responsible for proposing EU legislation)European Parliament- Court of Justice-
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Benefits of the euro
savings from having to handle one currency, rather than
many, Travelers. $40 billion/year
 it is easier to compare prices across Europe, so firms are
forced to be more competitive
 Cost of production reduce
 gives a strong boost to the development of highly liquid
pan-European capital market like NASDAC
 increases the range of investment options open both to
individuals and institutions
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Benefits of the euro
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savings from having to handle one currency, rather than many, Travelers.
$40 billion/year
it is easier to compare prices across Europe, so firms are forced to be
more competitive
Cost of production reduce
gives a strong boost to the development of highly liquid pan-European
capital market like NASDAC
increases the range of investment options open both to individuals and
institutions
Benefits of the euro
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loss of control over national monetary policy
EU is not an optimal currency area (they have different wage rate, tax
rate, business cycle, effects of shocks)
Shifting the economic affects to other countries
Political influence; Fortress Europe
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The North American Free Trade Area includes the United States, Canada,
and Mexico
 abolished tariffs on 99% of the goods traded between members
 removed barriers on the cross-border flow of services
 protects intellectual property rights
 removes most restrictions on FDI between members
 allows each country to apply its own environmental standards
 establishes two commissions to impose fines and remove trade privileges
when environmental standards or legislation involving health and safety,
minimum wages, or child labor are ignored
Benefits of all countries
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The Andean Pact -formed in 1969 using the EU model between Bolivia,
Chile, Ecuador, Colombia, Peru
MERCOSUR-originated in 1988 as a free trade pact between Brazil and
Argentina; was expanded in 1990 to include Paraguay and Uruguay and
in 2005 with the addition of Venezuela
Talks began in April 1998 to establish a Free Trade of The Americas (FTAA)
by 2005, Brazil and US have their concerns
The Association of Southeast Asian Nations (ASEAN, 1967)-currently
includes Brunei, Indonesia, Malaysia, the Philippines, Singapore, Thailand,
Vietnam, Myanmar, Laos, and Cambodia
An ASEAN Free Trade Area (AFTA) between the six original members of
ASEAN came into effect in 2003, ASEAN and AFTA are moving towards
establishing a free trade zone
The East African Community (EAC) was re-launched in 200
Foreign exchange market
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The foreign exchange market
1. is used to convert the currency of one country into the currency of
another 2. provides some insurance against foreign exchange risk the adverse consequences of unpredictable changes in exchange rates
The exchange rate is the rate at which one currency is converted into
another
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
 they have spare cash that they wish to invest for short terms in money
markets. E.g. if interest rates are higher in foreign locations than at
home.
 they are involved in currency speculation - the short-term movement of
funds from one currency to another in the hopes of profiting from shifts in
exchange rates
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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
using a forward exchange rate.
The spot exchange rate is the rate at which a foreign exchange dealer
converts one currency into another currency on a particular 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
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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
The foreign exchange market is a global network of banks, brokers, and
foreign exchange dealers connected by electronic communications systems
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; Vehicle-currency.
Exchange rates are determined by the demand and supply for different
currencies
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Three factors impact future exchange rate movements
1.
A country’s price inflation
2.
A country’s interest rate
3.
Market psychology
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
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Jacket Price in US and Pakistan should be same
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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
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A positive relationship exists between the inflation rate and the level of
money supply
When the growth in the money supply is greater than the growth in output,
inflation will occur
Supply of money -> Demand -> Inflation -> buying power (PPP)->
Currency
This Relationship is formulized by Irvin Fisher and is known as The Fisher
Effect . Which states that country’s nominal exchange rate is the sum of
required real rate of interest and expected rate of inflation over the
period of time
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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
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
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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
 Jacket Price in US and Pakistan should be same
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
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
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

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
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A positive relationship exists between the inflation rate and the level of
money supply
When the growth in the money supply is greater than the growth in output,
inflation will occur
Supply of money -> Demand -> Inflation -> buying power (PPP)->
Currency
This Relationship is formulized by Irvin Fisher and is known as The Fisher
Effect . Which states that country’s nominal exchange rate is the sum of
required real rate of interest and expected rate of inflation over the
period of time
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1.
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There are two types of school of thoughts: 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
The inefficient market school argues that companies can improve the
foreign exchange market’s estimate of future exchange rates by investing
in forecasting services
Fundamental analysis draws upon economic factors like interest rates,
monetary policy, inflation rates, or balance of payments information to
predict exchange rates; Technical analysis charts trends with the
assumption that past trends and waves are reasonable predictors of
future trends and waves
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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
Buy forward; Use swaps; Lead and lag payables and
receivables
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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
Thank you