International Business (MOD001055)
Chapter 3: International business: theory and practices
Zubair Hassan (2013): International Business-Theory and Practice. International Business
zubair@ftms.edu.my or Zubai7@gmail.com
3.1.
Introduction
This chapter covers two major components of learning objectives/outcomes that are
likely to examine via coursework or examination. This chapter will enable students to
build their knowledge on following key areas:









3.2.
Gains from trade
Sources of comparative and competitive advantage
Trade and the world economy
Barriers to trade
Protectionist policies
Regional trading arrangements
Government policies and international business
International institutions and world trade
The European Union (EU)
Gains from Trade
Gains from trade will focus on two key theories of trade:
1. Absolute advantage-Adam Smith
2. Comparative advantage-David Ricardo
3.2.1. Absolute advantage
Absolute advantage can be gained when the production of a good in country A
takes fewer units of labor than production of the good in country B.
For Smith, the organizations in each nation should specialize in producing
those things that they can do at the lowest cost. In Smith’s view, costs are
based on the value of labor, and the cost to produce a good depends on the
amount of labor to produce the good. Thus, country A has an absolute
advantage in the production of a good when it takes fewer units of labor to
produce the good than in country B. According to Smith, for the world to
benefit from absolute advantages, a country should produce goods for which it
has absolute advantage and import those goods in which it has absolute
disadvantage.
You can see the benefits from trade using absolute advantage in labor costs in
a simple example of a two-nation, two-product world. Exhibit 3.1 shows an
example of French wine production and US wheat production. For a unit of
labor, French wineries produce 15 liters of wine, three times the 5 liters
produced by US wineries. The French have an absolute advantage in wine
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Chapter 3: International business: theory and practices
Zubair Hassan (2013): International Business-Theory and Practice. International Business
zubair@ftms.edu.my or Zubai7@gmail.com
production. US farmers, however, are more efficient than French farmers at
producing wheat. They produce twice as many bushels of wheat for a unit of
labor as do the French farmers. As you can see in Exhibit 3.1, if countries
simply produce for their own consumption of wheat and wine, the total
worldwide production in our example “world” is 20 liters of wine per unit of
labor and 30 bushels of wheat with two units of labor.
Exhibit 3.1: Two-nation Wine and Wheat Production Possibilities with
without specialisation under Condition o f Absolute Advantage
What happens when we specialize?
That is, what happens if US farmers just produce wheat and French farmers
just produces wine? When the French shift their inefficient wheat production
to wine, for every freed-up unit of labor that previously produced wheat they
get 15 liters of wine. Similarly, when the US shifts its inefficient wine
production to wheat, it gets another 20 bushels of wheat. The result of this
shift in production to specialize in areas of absolute advantage is shown in the
Exhibit 3.2. Without using any more labor, total world production increases,
and if the US imports wine and the French wheat, everyone in those countries
can drink more wine and eat more bread than they did before.
Exhibit 3.2: Two-nation Wine and Wheat Production Possibilities
with specialisation under Conditions of Absolute Advantage
One of the problems of trading based on absolute advantage is that it
eliminates many potential trading partners. Although it does not seem to make
as much intuitive sense as Adam Smith’s view on trade based on absolute
advantage, David Ricardo made the insightful observation that trade can
benefit both partners even if one is more efficient in producing both goods.
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Chapter 3: International business: theory and practices
Zubair Hassan (2013): International Business-Theory and Practice. International Business
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3.2.2. Comparative advantage
Comparative advantage is said to be gained if the relative advantage in
production efficiency that a nation has internally over another.
Within any particular nation the companies and industries do some things
better than they do other things. That is, for example, one nation may be twice
as good at making computers as it is at growing corn. Another nation may be
better at growing corn than at producing computers. The principle of
comparative advantage explains how these relative differences within countries
can lead to beneficial trade between partners.
Let us look at a simple example as shown in Exhibit 3.3 to show how trade in
such a situation can work for both sides’ benefit.
Exhibit 3.3: Comparative Advantage and Opportunity Costs when One
Country has Absolute Advantage in Both Goods
In this example, we compare US and Chinese production of computers and
bicycles. Many people in the US and Europe now fear that production of many
goods will go to developing nations, with their low-cost labor and increasingly
sophisticated production technologies. However, even if, for example, the
Chinese can do most things more cheaply, the theory of comparative advantage
suggests that trade can still be beneficial to the world’s trading partners.
To illustrate the point, we arbitrarily make the Chinese television and bicycle
manufacturers more efficient than their US counterparts. For the example of
absolute advantage shown in Exhibit 3.3, we considered only labor costs and
input, but since we know that much more than labor goes into producing
something, we generalize in this example to consider broadly the input of
resources. Thus, in this illustration, the Chinese use 10 units of resources (e.g.
labor, materials, capital, machinery, etc.) to produce one computer and 2 units
of resources to produce a bicycle. In comparison, the US producers use 100
resource units for a computer and 4 units for a bicycle. The Chinese have
absolute advantage in the production of both products because they use fewer
resources.
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Chapter 3: International business: theory and practices
Zubair Hassan (2013): International Business-Theory and Practice. International Business
zubair@ftms.edu.my or Zubai7@gmail.com
Opportunity cost
Comparative advantage relates to the idea of opportunity costs. Opportunity
costs arise when the choice to produce one good requires you to give up the
opportunity to produce another good.
Thus, there is a trade-off each country makes when it decides to produce one
good in place of another. A country has comparative advantage in good A if it
has to give up producing fewer units of good B than does another country. This
means that within that country it is relatively more efficient to produce one
product than another product.
Comparative Advantage and Production Gains
The theory of comparative advantage suggests that countries should specialize
not only in those products for which they have absolute advantage but also in
those products for which they have comparative advantage. With specialization
and trade it becomes possible with comparative advantage for both trading
partners to gain.
Exhibit 3.4 show how each country could use 10,000 resource units in the
production of bicycles and computers.
Exhibits 3.4: Production and Consumption Possibilities for Computers and
Bicycles Using 10,000 Resource Units in China and the US
With no trade between the US and China, which economists call the state of
lack of trade, each country would have to produce and consume its own output.
Each country would then produce a mixture of computers and bicycles by
allocating its 10,000 resource units between the two products. The Chinese
could produce up to 1,000 computers with no bicycles or up to 5,000 bicycles
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with no computers. US manufacturers could produce up to 100 computers with
no bicycles or 2,500 bicycles without any computers. These are the extremes of
the production possibilities; more realistically, each country would produce a
mix of products depending on consumer tastes. It is unlikely that there would
be no demand for at least some bicycles or some computers in each country.
For the sake of illustration, let us assume that each country divides its 10,000
resource units equally between bicycle production and computer production.
Using the required resource units per computer and per bicycle, Exhibit 3.4
shows the production from 10,000 resource units spread equally between
products based on the required resource inputs for each country (see Exhibit
3.3 for the resource units required to produce each product). Chinese
manufacturers can produce 500 computers (5,000/10) and 2,500 bicycles
(50,000/2) in China and 50 computers (5,000/100) and 1,250 bicycles (5,000/4)
in the US.
If each country specializes in its area of comparative advantage, as shown in
Exhibit 3.4, production becomes greater in both bicycles and computers!
Unlike for absolute advantage, total specialization by each country does not
always produce more in both products.
Comparative Advantage and Consumption Gains
With the production gains, there are now 150 more computers and 250 more
bicycles available for Chinese and US American consumers. However, in order
to get these goods, China and the US must trade.
Without trade, Chinese and US consumers were limited in what they could
purchase by the range of production possibilities in the trade-offs between
computers and bicycles. Exhibit 4.4 shows the net gains in consumption
possibilities for the two-country world assuming they were divided equally
between China and the US. With trade and the right forms of specialization,
consumers in both countries now can consume more than would be possible in
a world without trade. Theoretically, at least, everyone benefits.
Free trade advocates rely heavily on the theory of comparative advantage to
offset arguments that low-cost countries such as China will eventually produce
everything, leaving the developed world with nothing but local service
industries and many lost jobs. The argument is that no country can have
comparative advantage in everything.
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Chapter 3: International business: theory and practices
Zubair Hassan (2013): International Business-Theory and Practice. International Business
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3.3.
Sources of comparative and competitive advantage
Ricardo’s theory of comparative advantage looks at the efficiency of production
primarily through labor costs as the basis of comparative advantage. However, there
are other sources of comparative advantage besides the efficiency of resource inputs.
The question is that what gives one country a comparative advantage in certain
products over other countries. Numbers of theories that have sought to answer this
question this question
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Factor endowments: Heckscher-Ohlin
Disaggregated factor endowments
Revealed comparative advantage
Competitive advantage: Porter
International product life cycle (IPLC)
3.3.1. Factor endowments: Heckscher-Ohlin
The Heckscher–Ohlin theory (HO) argues that a nation’s comparative
advantage comes from the relative abundance of its factor endowments. Factor
endowments are resources that a nation’s businesses use to produce their
products or services.
As in traditional views of comparative advantage based on the relative costs of
inputs to production, the HO theory uses the relative abundance of capital
versus labor to define comparative advantage.
There are two basic types of factor endowments. One is capital, which in
trade theory refers to inputs that go into making a product or delivering a
service, such as land, energy, machines, buildings, or tools. The other is
labor. Not all nations have equal factor endowments. For example, the US has
abundant supplies of natural resources such as land and energy. Japan has
limited factor endowments in land and natural resources such as coal.
Possible reasons for these differences in factor endowments could be:
Factors of production: such as labour, capital etc,- are hardly homogenous so
aggregate statements such ‘labour abundant’ may be relatively meaningless.
For example labour can be broken down into many different skills, capital into
different levels of technological intensity.
Products may exhibit factor intensity reversal in different countries: For
example producing certain types of car in Japan (with higher real wages) is
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likely to be more capital intensive process than producing the same car in
Spain (with lower real wages). Where substantial differences in such factor
price ratio exist, there might be factor intensity reversal, with a given product
using relatively capital intensive processes in one country but relatively labourintensive processes in another.
Factors and product markets must be competitive if differences in factor
endowments and therefore factor productivities are to be reflected in
differences in product costs.
The terms of trade between the potential exported and imported products may
lie outside the limits which would permit trade to be beneficial to both parties.
For example, the export: import price ratio maybe influenced in arbitrary ways
by unexpected fluctuations in relative exchange rates etc.
A host of other market imperfections may distort the linkage between factor
endowments, actual production costs and the relative prices at which products
are exchanged on international markets.
3.3.2. Disaggregated factor endowments
This is a more refined version of HO and tried to disaggregate the factors of
production into units that are more homogenous for purposes of comparison
between countries.
Efficiency units: here labour and capital inputs are adjusted to take account of
productivity differentials. So
Human capital: Workers can be disaggregated by level of human capital (e.g.
years of education, experience, etc) and by the type of human capital (e.g.
vocational/non-vocational, marketing/non-marketing, etc).
3.3.3. Revealed comparative advantage
The suggestion here is that the sources of comparative advantage can be
determined indirectly by observing actual trade flows between countries. For
example, it is interesting to note that in the more dynamic sectors of UK
industry, there are signs of a shift towards the higher end of the quality market
for both UK manufacturing exports and for the production of substitutes for
manufacturing imports.
3.3.4. Competitive advantage (Porter)
Michael E Porter published two articles which discussed about gaining
competitive advantage at two different levels. The first article published in
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Chapter 3: International business: theory and practices
Zubair Hassan (2013): International Business-Theory and Practice. International Business
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1980s, discussed how a company can gain competitive advantage in a
particular industry. The second article published in 1990s discussed about
gaining competitive advantage at national level. In here we are more concern
about the article published in 1990s. In this article Porter discussed about
gaining competitive advantages at corporate level and national level.
Competitive advantage: corporate level
The competitive advantages of a company are defined in terms of the
‘marginal’ company in that sector of economic activity. They are collection of
reasons that allow the more successful companies create positive added-value
in that sector of economic activity as compared to the marginal company,
which is just managing to survive. Reasons for such competitive advantages
could include some or all of the following (Wall et al, 2010, p.89):



Architecture: benefits to the company from some distinctive aspect of
the set of contractual relationships that the company has entered into
with suppliers and/or customers
Innovation: benefits to the company from being more innovative than
rivals(perhaps reinforced by legal structures, e.g. patent laws).
Incumbency advantage: benefits to the company from being an early
‘player’ in that field of activity (reputation, control over resources etc).
The essential feature about many of these sources of competitive advantage is
that they are usually temporary. Distinctive contractual relationship that prove
to be successful ( e.g. franchising arrangements) can be replicated by other
firms.
Competitive advantage: National level
This model of determining factors of national advantage has become known as
Porters Diamond. It suggests that the national home base of an organization plays an
important role in shaping the extent to which it is likely to achieve advantage on a
global scale.
In the national context, Porter has again used this perspective of a dynamic, everchanging set of competitive advantages as a basis for explaining trade patterns
between countries. Michael Porter introduced a model that allows analyzing why
some nations are more competitive than others are, and why some industries within
nations are more competitive than others are, in his book
The individual points on the diamond and the diamond as a whole affect four
ingredients that lead to a national comparative advantage. These ingredients are:
1. The availability of resources and skills,
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Chapter 3: International business: theory and practices
Zubair Hassan (2013): International Business-Theory and Practice. International Business
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2. Information that firms use to decide which opportunities to pursue with those
resources and skills,
3. The goals of individuals in companies,
4. The pressure on companies to innovate and invest
Porter’s answer is that countries produce successful firms mainly because of the
following four reasons
Figure3.1: Porter’s Diamond Model
Demand conditions
The demand conditions in the home market are important for three reasons:
1.
If the demand is substantial it enables the firm to obtain the
economies of scale and experience effects it will need to compete
globally.
2.
The experience the firm gets from supplying domestic consumers will
give it an information advantage in global markets, provided that:
3.
(a)
its customers are varied enough to permit segmentation into
groups similar to those found in the global market as a whole;
(b)
its customers are critical and demanding enough to force the
firm to produce at world-class levels of quality in its chosen products;
(c)
its customers are innovative in their purchasing behaviour and
hence encourage their firm to develop new and sophisticated products.
If the maturity stage of the plc is reached quickly and this will give
the firm the incentive to enter export markets before others do. (Product
life cycles)
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Related and supporting industries
The internationally competitive firm must have, initially at least, enjoyed the
support of world-class producers of components and related products. Moreover
success in a related industry may be due to expertise accumulated elsewhere


When local supporting industries are competitive, firms enjoy more
cost effective and innovative inputs
This effect is strengthened when the suppliers themselves are strong
global competitors
Example:
the development of the Swiss precision engineering tools industry owes
much to the requirements and growth of the country’s watch industry.
Factor conditions
These are the basic factor endowments referred to in economic theory as the
source of so called comparative advantage. Factors may be of two sorts:
1.
Basic factors such as raw materials, semi-skilled or unskilled
labour and initial capital availability. These are largely ‘natural’ and
not created as a matter of policy or strategy.
2.
Advanced factors such as infrastructure (particularly digital
telecommunications), levels of training and skill, R&D experience,
etc.
Porter argues that only the advanced factors are the roots of sustainable
competitive success. Developing these becomes a matter for government
policies



A country creates its own important factors such as skilled
resources and technological base.
The stock of factors at a given time is less important than the
extent that they are upgraded and deployed.
Local disadvantages in factors of production force innovation.
Adverse conditions such as labor shortages or scarce raw materials
force firms to develop new methods, and this innovation often leads to
a national comparative advantage.
Firm structure, strategy and rivalry
National cultures and competitive conditions do create distinctive business
focusses.

Local conditions affect firm strategy. The following factors do influence
the competitive position of MNCs in different countries.
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Chapter 3: International business: theory and practices
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o
ownership structure;
o the attitudes and investment horizons of capital markets;
o the extent of competitive rivalry;
o
the openness of the market to outside competition.
For example
German companies tend to be hierarchical. Italian companies tend to be
smaller and are run more like extended families. Such strategy and
structure helps to determine in which types of industries a nation's firms
will excel.

In Porter's Five Forces model, low rivalry made an industry
attractive. While at a single point in time a firm prefers less
rivalry, over the long run more local rivalry is better since it puts
pressure on firms to innovate and improve. In fact, high local
rivalry
results
in
less
global
rivalry.

Local rivalry forces firms to move beyond basic advantages
that the home country may enjoy, such as low factor costs.
Other events
Porter points out that countries can produce world-class firms due to two
further factors:
1.
The role of government. Subsidies, legislation and education can
impact on the other four elements of the diamond to the benefit of the
industrial base of the country. Also a government can
o
o
o
o
2.
Encourage companies to raise their performance, for example by
enforcing strict product standards.
Stimulate early demand for advanced products.
Focus on specialized factor creation.
Stimulate local rivalry by limiting direct cooperation and enforcing
antitrust regulations.
The role of chance events. Wars, civil unrest, chance factor
discoveries, etc. can also change the four elements of the diamond
unpredictably.
National competitive advantage
Successful firms from a particular country tend to have linkages between
them; a phenomenon that Porter calls clustering.
Clustering allows for the development of competitive advantage for several
reasons:
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● transfer of expertise, for example, through staff movement and contracts;
● concentration of advanced factors (e.g. telecommunications, training,
workforce);
● better supplier/customer relations within the value chain (i.e. vertical
integration).
Clustering may take place in two ways:
1. common geographical location (e.g. Silicon Valley, City of London);
2. expertise in key industry (e.g. Sweden in timber, wood pulp, woodhandling machinery, particleboard furniture).
3.3.5. International product Life Cycle
According to Wall et al (2010), patterns of products traded between countries
will be influenced by the stage of production reached in the international life
cycle of variety of knowledge-intensive products.
The new product stage will typically occur in the innovating country but then
the balance between production and consumption may shift geographically as
different stages of the product life cycle are reached.
Figure 3.2: International product life cycle for knowledge intensive
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Chapter 3: International business: theory and practices
Zubair Hassan (2013): International Business-Theory and Practice. International Business
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Products
Wall et al (2010, p.92) discussed each of the diagrams above as follows:
New product stage: here production is concentrated in the innovating country,
as is market demand. A typical scenario for this stage would be where the
relatively low output is sold at premium prices to a price-inelastic domestic
market segment. There may be a small amount of production via subsidiaries
in ‘other advanced countries’ but little or none in the LDCs.
Mature product stage: both production and consumption typically continue to
rise in the innovative country, with scale economies beginning to reduce costs
and price to a new, more price sensitive mass market segment. Exports to
other countries become a higher proportion of total sales. Output of generic
products also rises in the ‘other advanced countries’, via the output of
subsidiaries or of competitors in these countries which have the knowledgeintensive capability of developing close substitutes. These countries typically
import a higher proportion of their sales from innovating country, as do the
LDCs.
Standardised product stage: at this stage the technology becomes more
widely diffused and is often largely ‘embodied’ in both capital equipment and
process control. Low-cost locations become a more feasible sources of quality
supply in this stage, often via MNE outsourcing and technology transfer.
LDCs may even become net exporters to the innovating country and to other
advanced countries.
3.4.
Trade and the world economy
The rapid growth of world trade over the last century reflects, at least in part, the fact
that nations have become more interrelated as they have attempted to gain the
benefits of free trade.
3.4.1. Types of Trade flows
A distinction is frequently made between inter-and intra industry trade
Inter-industry trade refers to situations where a country exports products that
are fundamentally different in type from those that it imports.
Intra-industry trade refers to situation where a country exports certain items
from a given product range while at the same time importing other items from
the same product range.
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Zubair Hassan (2013): International Business-Theory and Practice. International Business
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3.4.2. Intra-regional trade
It would seem natural that nations would tend to trade more with their
immediate neighbors in the first instances, thereby raising the share of the
world trade occurring between nations with specific geographic regions.
3.5.
Barriers to trade
Where one country, or trade bloc, attempts to restrict trade
with another, to protect their producers from competition.
How will we protect the national/domestic market?
1. Tariff: A tariff is a tax levied in imported goods, usually with intentions of
raising the price of imports and thereby discouraging their purchase. Additionally,
it is a source of income to the government.
2. Quota systems. A quota will restrict the imports to a particular level, and locally
produced goods will become more expensive. The government will receive
reduced tariff income.
3. Buy national campaigns. Sometimes a country will encourage its citizens to buy
locally produced goods – on other occasions it will enforce this with regulations.
A government may say that a particular product must have a certain percentage of
locally produced components or labour (as is often the case in car manufacture) or
will require fi rms to report quarterly the sources of any purchases over a certain
value, and tax them if the proportion of foreign goods is too high.
4. Customs valuations. This approach is not so common now but in the past some
govern-ments have insisted that customs duty be paid on invoice cost plus a
percentage, effec-tively increasing the cost to the importer.
5. Technical barriers. Some countries insist on over stringent standards of quality,
health and safety, packaging or size to restrict what may be imported.
Examples of technical barriers:
Germany: At one point in time, as environmental legislation Germany insisted that
foreign firms importing goods into Germany were responsible for collecting and
removing packaging from the country. This increased transport costs to such a level as to
make many such goods no longer economi-cally viable.
North America: Similarly North America introduced standards for cars requiring the
bumpers to be a particular height which was impractical for imported sub-compact cars
made by Toyota and Honda
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6. Subsidies for local manufacturers. This is particularly prevalent for agricultural
products in North America and also in the EU, where the Common Agricultural
Policy protects small farmers in the European countries. There has been an
ongoing battle between Airbus and Boeing whose respective governments have
supported the development of each new airliner with which the companies have
sought to dominate the market.
Reasons for protectionism



-
Prevent dumping
Protect infant industries (Case of Malaysia)
Protect strategically important industries (Case of Malaysia)
Maintain employment by preventing the rapid contraction of labour-intensive
industries
Reasons against Protectionism

Prospect of retaliation. The consequences of retaliation could be especially
serious for countries increasingly dependent on international trade flows
Example:
In 2007 German exports of goods and services totalled
38% of GDP, France 24%, Italy 22%, UK 19%, with
lower percentages for the export: GDP ratio in Japan
(14%), and the USA (8%) (Wall et al, 2010).

A tariff raises domestic supply at the expense of imports. If the domestic
producers cannot make such products as cheaply as overseas producers, then one
could argue that encouraging high-cost domestic production is a misallocation of
international resources.
Protectionism can erode some of the benefits of free trade
3.6.
Regional trading arrangement
There are four broad types of regional trading arrangements (RTAs).
1.
2.
3.
4.
Free trade area
Custom unions
Common markets
Economic unions
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Figure 3.3: the steps of economic integration
3.6.1. Free Trade Area:
Free trade areas are reciprocal agreements among a group of nations, usually
from one region of the world, to remove tariffs and other trade barriers (e.g.
quotas) affecting trade with each other. Each nation, however, remains free to
impose any barriers or preferential treatments to other nations outside of the
area. The most famous free trade area is the North American Free Trade
Agreement (NAFTA) between the United States, Canada, and Mexico.
3.6.2. Customs Unions
Customs unions are similar to free trade areas regarding relationships among
members. All members get the same benefits of reduced tariffs and other trade
barriers with each other. What makes customs unions different from regional
trade agreements is that country members also agree to use uniform treatment
of outsiders with regard to trade policies. This means, for example, that South
Africa and Botswana in the SACU must impose the same tariff rates or other
import restrictions on goods imported from the US or EU.
3.6.3. Common Markets
Common markets allow free movement of labor, capital, and technology across
member nations’ borders. From the strategic point of view, this allows
companies to locate any value-chain activity in any fellow common market
country without restrictions.
For example, the best available managers and workers can be hired from
anywhere within the common market and be stationed at any of the company’s
locations.
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3.6.4. Economic Unions
The economic union includes all of the integration mechanisms of a common
market but goes a step further. Member countries agree to coordinate economic
policies, which include such factors as monetary policies, taxation, and
currencies. The European Union is making strides toward becoming an
economic union as member countries adopt the use of a single currency, called
the euro (€).
3.7.
Government policies and international business
Government policies can influence international business in a variety of ways. For
example change in fiscal policies or monetary policies will influence the
macroeconomic environment in which domestic and international operates.
Some of the policies include
1. Exchange rate
2. Import protection/export protection
3. Tax policies
3.7.1. Exchange rates
Few governments can influence their exchange rates directly, via unilateral
action. More usually they can only influence such rates indirectly whether
intentionally or unintentionally.
The increasing and decreasing exchange rate may have impacts on the level of
imports and exports. This may depends on the elasticity of demand for
imports and exports.
If price elasticity of demand for UK exports is relatively elastic (greater than
one), then any rise in euro-zone prices will reduce total expenditure in euros
on those items. The fall in the euro value of UK exports will mean a still more
substantial fall in sterling turnover for UK exporters.
If price elasticity of demand for UK imports is relatively elastic, then any fall
in sterling prices will raise total expenditure in sterling on those items. This is
likely to imply a loss of turnover and market share from UK domestic
producers to euro-zones producers.
Notes compiled by Zubair
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International Business (MOD001055)
Chapter 3: International business: theory and practices
Zubair Hassan (2013): International Business-Theory and Practice. International Business
zubair@ftms.edu.my or Zubai7@gmail.com
3.7.2. Import/export protection
As discussed before governments can use variety of tax policies as import or
export barriers. The common agricultural policy (CAP) of the EU provides a
useful illustration of government-directed policies involving import
protection/export support which exert a strong influence on operations of the
farms and agri-business, both inside and outside the EU.
3.7.3. Tax policies
Various types of taxes
Direct Tax
Taxes imposed directly on
individuals or corporation
incomes
Examples:
1. Corporate profit tax
2. Income tax
(dividend, monthly
income)
Indirect Tax
Taxes imposed on expenditure
Examples:
1. Value added tax
2. Custom duties
3. Hydro carbon tax
4. Tobacco tax
5. Import duties
Advantage
Governmenyt have to collect tax
from fewer sources – there are
fewer vendors in most economies
than there are earners.
For a government there are two further decisions to been made other than
those implied in the decisions of introducing taxes.
Firstly they will need to decide
whether the majority of the tax
revenue should come from
individuals or from companies.
Secondly they will need to decide
whether how much they wish to
raise by taxing earnings compared
to the amount the wish to raise via
indirect taxation.
If government decided to
impose heavy tax on
companies to raise revenue
Difficult to attract MNC or
foreign firms to be attracted.
Existing MNC may leave the
country causing unemployment
Notes compiled by Zubair
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International Business (MOD001055)
Chapter 3: International business: theory and practices
Zubair Hassan (2013): International Business-Theory and Practice. International Business
zubair@ftms.edu.my or Zubai7@gmail.com
3.8. International institutions and world trade
In here we pay particular attention to
1. World trade organisation (WTO)
2. International Monetary Fund
3. World bank
3.8.1. World Trade Organisation (WTO)
WTO as a successor to the earlier General Agreement on Tariff and Trade
(GATT). GATT was signed in 1947 by 23 industrialised nations that include UK,
USA, Canada and France plus some other countries.
The WTO members in total account for more than 90% of the value of world
trade. The objectives of WTO are essentially same as GATT:
1. To reduce tariffs and other barriers to trade
2. To eliminate discrimination in trade
3. Contribute to the rising living standards and fuller use of world resources
WTO Principles
WTO has sought to implement a number of principles:
1. Non-discrimination among nations in terms of trade
2. Progressive reduction in tariff and non-tariff barriers
3. Solving trade disputes through consultation rather than retaliation
Perspective of WTO
There are two types of views about WTO. Some criticise WTO and its role in
world trade while others favours WTO and its role in world trade.
Critics of the WTO
Bias to “North”.
Inability to progress the Doha Round of negotiation
Undue pressure on the ‘South’
Undue emphasis on protecting trade-related aspects of intellectual property
rights
5. Undue emphasis on liberalising trade in services
6. Localisation as an alternative doctrine
1.
2.
3.
4.
Supporters of WTO
1.
2.
3.
4.
Unilateralism/bilateralism may be the alternative to multilateralism.
Absence of rules may be the alternative to imperfect WTO rules
WTO has not distorted trade patterns
WTO is taking more robust actions against trade restrictions from the ‘North’.
Notes compiled by Zubair
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International Business (MOD001055)
Chapter 3: International business: theory and practices
Zubair Hassan (2013): International Business-Theory and Practice. International Business
zubair@ftms.edu.my or Zubai7@gmail.com
5. Localisation is viewed by free-traders as diminishing the wealth of poorer
nations rather than enhancing it.
6. Reformed WTO may have much to commend it.
3.8.2. International Monetary Fund (IMF)
The IMF plays a key role in providing foreign currencies and other sources of
world liquidity to support the growth of international trade and payments. It also
provides specific packages of financial support for economics in times of need.
The latter role involves a variety of ‘stabilisation programs’, which provide
essential funding but only on conditions that countries receiving funds agree to
implement specific programmes of change agreed with the IMF.
Foreign currencies and world liquidity
1. Currency quotas: The IMF was originally set up to provide a pool of foreign
currencies, which could be used by members to ‘finance’ temporary balance
of payments deficits.
2. Quotas: these have been assigned to each country to determine its access to
foreign currency and also its voting rights within IMF.
3. Borrowing facilities: There are, however, further facilities for borrowing,
with varying degrees of strictness as to the conditions attached.





Compensatory financing facility (CEF)
Compensatory and contingency financing facility (CCFF)
Extended fund facilities (EFF)
Oil facilities
Buffer stock facility
In addition to its normal resources, the IMF has variety of other instruments
and facilities as its disposal:






Supplementary financing facility (SFF)
Enlarge access facilities
Structural adjustment facility (SAF)
Enhanced structural adjustment facility
Trust fund facility
Systematic Transformation facility
Intermediation
IMF has been an intermediary in arranging standby credits at times when
currencies have come under severe strains. These credits have not usually been
used, but have helped restore market confidence in a country’s ability to
withstand speculative pressure, which itself has often eased that pressure.
Notes compiled by Zubair
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International Business (MOD001055)
Chapter 3: International business: theory and practices
Zubair Hassan (2013): International Business-Theory and Practice. International Business
zubair@ftms.edu.my or Zubai7@gmail.com
Special Drawing Rights (SDR)
These were introduce by the IMF in 1969, both to raise the total of the world
official reserves and to serve as potential replacement for gold and foreign
currency in international monetary system.
General arrangements to borrow (GAB)
In 1962, the ten largest IMF members plus Switzerland constructed the GAB.
Each of the signatories contributed an amount of its own currency towards a fund
which stood at US$7billion in 1982. Until January 1983, the GAB had been
arrangements available only to signatories, but since then its resources have been
available to any country in need.
SWAP arrangements
In 1960s the USA instituted a system of currency swaps with other countries,
whereby each central bank agrees to lend its own currency, or to acquire
currency balances of the other, for specified time period. Although these are
relatively short-term arrangements, there is currently an additional US$30 billion
that could be added to total reserves under such scheme.
Review of the role of the IMF
Some argued that the role of IMF must be reviewed due to the criticism faced by
the stabilisation programs offered by the IMF. These criticism include
1.
2.
3.
4.
IMF programs are inappropriate
IMF programs are inflexible
IMF support has been too small, expensive and short-term
IMF is dominated by few major industrial countries
3.8.3. World Bank
The World Bank is a grouping of three international institutions, namely the
international bank for reconstruction and development (IBRD), the international
development association (IDA) and the international finance corporation (IFC).
Notes compiled by Zubair
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International Business (MOD001055)
Chapter 3: International business: theory and practices
Zubair Hassan (2013): International Business-Theory and Practice. International Business
zubair@ftms.edu.my or Zubai7@gmail.com
Reference list
Ajami, R.A., Cool, K., Goddard, G.J., Khambata, D and Sharpe, M.E. (2006). International
Business: Theory and Practice, (2nd Edition). pp. 3-19. M.E. Sharpe, Inc.
Cullen, J.B., and Parboteeah, K.P. (2010). International Business: Strategy and Multinational
Company, pp. 3-33. Routledge, 270 Madison Ave, New York, NY 10016
Katsioloudes, M.I. and Hadjidakis, S. (2007). International Business: A global perspective.
Butterworth-Heinemann /Elsevier
Wall, S., Minocha, S., and Rees, B. (2010). International Business, (3rd Edition), pp.1-36.
Prentice Hall, Financial Times. (RECOMMENDED READING)
Notes compiled by Zubair
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