2The Global Economy

Learning Objectives

• Distinguish among the basic theories of world trade: absolute advantage, comparative advantage, and competitive advantage.

• Discuss the pros and cons of global outsourcing.• List and explain the principal parts of the balance-of-

payments statement. • Describe how and why exchange rates fluctuate.• List and describe the major agencies that promote

world trade, as well as those that promote economic and monetary stability.

• Describe common trade restrictions and explain their impact on international marketers.

• Compare the four different forms of economic integration.

Chapter Overview

• International trade overview• Basic theories of world trade• Balance of payments• Exchange rates• International agencies for promoting economic and

monetary stability• Protectionism and trade restriction• Economic integration as a means of promoting trade• The globalization controversy

Basic Theories of World Trade

Absolute advantage• Trade is based on each country selling what

it is best at producing

Comparative advantage• Trade can occur between two countries

even if one of the countries has no absolute advantage in any product

Competitive Advantage

Michael Porter argues that the theory of comparative advantage is limited by its focus on the elements of production:

– Land – Labor– Natural resources– Capital

Theory of Competitive Advantage

• Elements of production• Nature of domestic demand• Presence of appropriate suppliers or

related industries• The conditions in the country that

govern how companies are created, organized, and managed

• Nature of domestic rivalry

Global Outsourcing

• Technology has created a global market for skilled workers

• No national winners or losers

• Losses and benefits accrue differently to different groups

Balance of Payments

• (BOP): an accounting record of the transactions between the residents of one country and the residents of the rest of the world over a given period of time

Exchange Rates

An exchange rate measures the value of one currency in terms of another currency

US $ = 0.5 £

One currency can appreciate or depreciate against another

US $ = 0.75 £US $ = 0.30 £

Determined by Supply and Demand

• Imports/exports

• Inflation rate

• Investors and speculators

• Government actions

Soft Currencies

• Currencies of smaller, less developed countries

• Rates can be determined by the governments of these countries

• Governments must eventually respect supply and demand; currencies often face significant devaluations

Currency Fluctuations: Impact on Export Markets

When the currency of a foreign market devalues against an exporter’s home currency, marketers must consider 2 options:

• Raise prices in the export market in order to preserve margins - Can your brand command a higher price?

• Keep prices steady in hopes of sustaining or increasing market share- Cost containment might help to maintain margins somewhat

• The devaluation of a foreign market currency against the home currency will translate into lower earnings in the home currency

• Similarly, licensing and franchising fees from that export market will translate into lower amounts when translated into the home currency

Currency Fluctuations: Impact on Foreign Earnings

Currency Fluctuations: Reevaluating Market Participation

• Sometimes exporters decide to leave markets if a devaluation causes their products to be priced out of that market

• However, such a currency devaluation makes buying foreign-market assets cheaper in the home currency

Agencies Promoting Economic and Monetary Stability

• International Monetary Fund– Prevention of economic instability in

emerging markets

• World Bank– Long-term loans to developing countries

• Group of 7(8)– Finance ministers/Central Bank governors

of USA, Japan, Germany, France, Britain, Italy, Canada (Russia)

Protectionism and Trade Restrictions

• Tariffs

• Quotas

• Orderly marketing arrangements (voluntary export restrictions)

• Non-tariff barriers

General Agreement on Tariffs and Trade (GATT)

• Formed in 1947 by 23 nations

• Offers Reciprocity and reduction or elimination of duties between members.

• Non discrimination– Most favored nation (MFN) status

• Helped simplify trade documentation

• Replaced in 1996 by the World Trade Organization

World Trade Organization

• Created as final act of GATT• Based in Geneva with 153 member countries• Members agree to a set of rules to improve

world trade• WTO is forum to resolve trade disputes• Unlike GATT, WTO decisions can only be

overturned by consensus and not by vetoThe website is: http://www.wto.org

World Bank

• Provides financial and technical assistance to developing countries

• Founded in 1944 in Washington, D.C.• Main mission to fight poverty• Provides low interest loans, no interest

loans, and guarantees local government bonds.

• Contributes to global sustainability and care for the environment

Different Types of Regional Economic Integration

• Free Trade Area

• Customs Union

• Common Market

• Complete Economic Integration

Free Trade Area

• Two or more countries agree to eliminate trade barriers and tariffs between their countries

• Countries continue to have individual agreements with other countries

• The North American Free Trade Agreement is between Mexico, Canada, and the U.S. The website: www.naftanow.org

Customs Union

• A trade agreement between 2 or more countries

• Elimination of the internal barriers and tariffs

• Establishment of common external barriers and tariffs to other countries

• Mercosur, referred to as the Southern Common Market, includes the countries of Argentina, Brazil, Paraguay and Uruguay

Common Market

• Elimination of the internal barriers and tariffs between 2 or more countries

• Establishment of common external barriers to trade

• Free movement of the factors of production, including labor, capital and information

• The European Union is a common market