+ All Categories
Home > Documents > IBE notes 1

IBE notes 1

Date post: 08-Mar-2015
Category:
Upload: mohanraokp2279
View: 57 times
Download: 2 times
Share this document with a friend
130
Module 1 Meaning of Multinational enterprise A multinational corporation (MNC) also called multinational enterprise (MNE), is a corporation or an enterprise that manages production or delivers services in more than one country. It can also be referred as an international corporation. The International Labour Organization (ILO) has defined an MNC as a corporation that has its management headquarters in one country, known as the home country, and operates in several other countries, known as host countries. The first modern multinational corporation is generally thought to be the Dutch East India Company. Nowadays many corporations have offices, branches or manufacturing plants in different countries from where their original and main headquarters is located. Some multinational corporations are very big, with budgets that exceed some national GDPs. Multinational corporations can have a powerful influence in local economies, and even the world economy, and play an important role in international relations and globalization. The presence of such powerful players in the world economy is reason for much controversy. Global company: A global company is the one which has either global marketing strategy or global strategy. Global company either produces in home country or in a single country and focuses on marketing these products globally, or produces the products globally and focuses on marketing these products domestically. Transnational company: A transnational company produces, markets, invests and operates across the world. It is an integrated global
Transcript
Page 1: IBE notes 1

Module 1

Meaning of Multinational enterprise

A multinational corporation (MNC) also called multinational enterprise (MNE), is a corporation or an enterprise that manages production or delivers services in more than one country. It can also be referred as an international corporation. The International Labour Organization (ILO) has defined an MNC as a corporation that has its management headquarters in one country, known as the home country, and operates in several other countries, known as host countries.

The first modern multinational corporation is generally thought to be the Dutch East India Company. Nowadays many corporations have offices, branches or manufacturing plants in different countries from where their original and main headquarters is located.Some multinational corporations are very big, with budgets that exceed some national GDPs. Multinational corporations can have a powerful influence in local economies, and even the world economy, and play an important role in international relations and globalization. The presence of such powerful players in the world economy is reason for much controversy.

Global company:

A global company is the one which has either global marketing strategy or global strategy. Global company either produces in home country or in a single country and focuses on marketing these products globally, or produces the products globally and focuses on marketing these products domestically.

Transnational company:

A transnational company produces, markets, invests and operates across the world. It is an integrated global enterprise which links global resources with global markets at profit. There is no pure transnational corporation.

Approaches to international business

Ethnocentric approach  

Definition: Ethnocentricity (ethnocentrism) is a belief in the superiority of one's own ethnic group. The firm basically believes that parent-country nationals are better qualified and more trustworthy than host country nationals.

Rationale and advantages: Experience curve effects derive from standardization of production. The firm produces in the home country initially and transfers its core competency to the host country under the guidance of expatriate managers.

Page 2: IBE notes 1

These managers have the knowledge to create value through core competencies. They also contribute to the maintenance of the corporate culture.

Problems and disadvantages: Denies advancement to host country nationals. This may breed resentment and diminish the firm's public image. Expatriate managers are expensive to maintain: they may become insular in their attitudes and be prone to cultural myopia. The latter may result in management overlooking market niche opportunities.

Polycentric approach  

Definition: Polycentricity (polycentrism) is a belief that local people know the local environment better than outsiders.

Rationale and advantages: Gives hope for profit maximization through flexibility because local managers can react quickly to market needs in the areas of pricing, production, product life cycle, and political activity. Absence of problems associated with expatriate managers including cultural myopia. Provides continuity in the management of foreign subsidiaries.

Problems and disadvantages: No synergy because there is little communication between national units. Limits experience of host nationals to their own country. Corporate headquarters may become isolated from national units and lead to lack of integration. This in turn may lead to corporate inertia.

Geocentric approach  

Definition: Geocentricity (geocentrism) is the notion that the best people should be employed, regardless of their nationality.

Rationale and advantages: Enables the firm to make best use of its human resources and builds a cadre of executives who feel comfortable working in any culture.

Ethnocentric and polycentric pressures are balanced in favor of optimizing the company's operations. The ethnocentric pressure for low cost standardized operations is satisfied because enough of the right kinds of products exist in the global customer base to permit scale economies and experience curve effects. The polycentric pressure for local responsiveness is satisfied

Page 3: IBE notes 1

because of the need to meet the distinctive characteristics which remain in every market.

Problems and disadvantages: May be contrary to host countries' desire for the MNE to employ local citizens. Expensive to implement because of the need for considerable cross-cultural training and development.

Regiocentric approach

Definition: Regiocentricity is the variation of staffing policy to suit particular geographic areas.

Rationale and advantages: Policy varied to suit the nature of the firm's business and product strategy. Allows interaction between executives because of inter-regional transfers. Shows some sensitivity to local conditions. Provides a 'stepping stone' for a firm wishing to move from an ethnocentric or polycentric approach to a geocentric approach.

Problems and disadvantages: May produce federalism at a regional (rather than a country) basis and constrains the firm from taking a global stance. May improve career prospects at the national level, but only to the regional level: staff may never attain positions at corporation headquarters

The various modes of entry in international business are:

Exporting

Turnkey projects

Licensing

Franchising

Joint ventures

Wholly owned subsidiaries

Exporting:

Many manufacturers begin their global expansion as exporters and later switch to another mode for serving a foreign market. Manufacturing in existing locations and transporting into new markets is called exporting.

Page 4: IBE notes 1

Advantages: Avoid costs of investing in new location.

Realize experience curve and location economies. By manufacturing the product in a centralized location and exporting it to other national markets, the firm may be able to realize substantial sale economies from its global sales volume.

Disadvantages: new locations may have lower manufacturing costs

High transport costs can make exporting uneconomical, particularly for bulk products.

Tariff and non-tariff barriers by the host country government can make it risky and costly.

Agents in the foreign country may not act in exporter’s best interest.

Turnkey Projects:

A project in which contractor handles every detail of the project for a foreign client, including the training of operating personnel, and then hands over the foreign clients the “key” to a plant that is ready for operation. (Setting up a new plant ready for operation). Turnkey projects are most common in the chemical, pharmaceutical, petroleum refining and metal refining industries, all of which use complex, expensive production technologies.

Advantages: This is the best way of earning greater economic returns from that asset. Obtain

returns from know-how about a complex process. Government restrictions may limit other options therefore; this strategy is best

in case where FDI is limited by government. (Middle East countries and petroleum refining.)

Lower risk if unstable economic/political situation in country

Disadvantages: The firm that enters into the turnkey deal will have no long-term interest in the

foreign country. Less potential to profit from success of plant. Creating a competitor by transferring the technical know-how to a foreign firm.

Give away technological know-how to potential competitor

Licensing:

Licensing agreement is an arrangement whereby a licensor grants the rights to intangible property to the licensee for specified time in exchange for royalties. Foreign licensee buys rights to manufacture a firm’s product. Intangible property includes patents, inventions, formulations, processes, designs, copyrights and trademarks. Originally, Fuji-Xerox joint venture started as licensing agreement with Xerox. Licensed its xerographic know-how to Fuji-Xerox. In return, Fuji-Xerox paid Xerox a royalty fee equal to 5

Page 5: IBE notes 1

percent of the net sales revenue that Fuji-Xerox earned from the sales of photocopiers based on Xerox’s patented know-how.

Advantages: The firm does not have to bear the costs and risks of investment; it is an

attractive option for firms lacking capital to develop operations overseas. Avoid political/economic problems or restrictions in a country. This is used

when a firm wishes to participate in a foreign market but is prohibited from doing so by barriers to investment.

Disadvantages: Licensing does not give a firm tight control over manufacturing, marketing and

strategy that is required for realizing experience curve and location economies. Loss of control over operations (marketing, manufacturing, strategy)

Unable to realize experience curve and locational economies

Limited in coordinating international strategy against competitors

Loss of technological know-how

Cross licensing can minimize some of the disadvantages of direct licensing if there is a potential for two-way licensing; it creates interdependencies between the parties.Meaning: Cross licensing, is an arrangement whereby a company grants the rights to intangible property to another firm for a special time in exchange for royalties and a license from the foreign partners for some of its technological know-how.

Franchising:

Franchising is similar to licensing. This tends to involve a longer-term commitments than licensing. Selling limited rights to use of a brand name and service know-how.Meaning: franchising is a specialized form of licensing in which the franchiser not only sells intangible property to the franchisee (normally trademark) but also insists that the franchisee agree to abide strict rules as to how to do the business. The franchiser will assist the franchisee to run the business on an ongoing basis. The franchiser in turn receives a royalty payment, which amounts to some percentage of the franchise’s revenues.

Advantages: Franchisor do not bear the costs and risks of investment

Avoid political/economic problems and restrictions in a country

Quicker international expansion possible

Disadvantages:

Limited in coordinating international strategy against competitors

Loss of control over quality and service

Joint Ventures:

Page 6: IBE notes 1

A joint venture is an establishment of a firm that is jointly owned by tow or more otherwise independent firms. Work with a local partner and share in the costs/profits of an operation. The most typical joint venture is a 50/50 venture, in which there are tow parties, each of which holds a 50 percent ownership stake and contributes a team of managers to share operating control, however, there are joint ventures in which tone from has a majority share and thus tighter control.

Advantages: Benefit from local firm’s knowledge about the host country’s competitive

conditions, culture, language, political systems and business systems. shared costs/risks of development

political constraints on other options

Disadvantages: Loss of control over technology to its partner.

JVs do not give the firm the tight control over subsidiaries that it might need to realize experience curve or location economies. Limited ability to realize experience curve and location economies

limited ability to coordinate international strategy against competitors

conflicts between partners over goals and objectives of the JV.

Wholly Owned Subsidiaries:

In wholly owned subsidiary, the firm owns 100 percent of the stock. Establishing a wholly owned subsidiary in a foreign market can be done in two ways. The firm can either set up a new operation in that country or it can acquire an established firm and use that firm to promote its products in the country’s market.

Advantages: Control over technological know-how ensured, especially when a firm’

competitive advantage is based on technological competence. Many high tech firms prefer this entry mode for overseas expansion.(firms in semiconductor, electronics and pharmaceuticals).

control over ability to coordinate international strategy

ability to realize location and experience economies

ability to coordinate with other subsidiaries

Disadvantages: Most costly method of serving a foreign market.

The firm entering through this mode must bear the full costs and risks of setting up overseas operations.

Selecting an Entry Mode

A brief summary of the advantages and disadvantages of each of the modes is shown.

Page 7: IBE notes 1

Mode of Entry Advantages Disadvantages

ExportingEconomies of scaleLower foreign expenses

No low cost salesHigh transportation costsPotential tariffs

Turnkey Project Access to closed marketsCompetition from local clientLoss of competitive advantage

LicensingQuick expansionLower expenses and risksLower political risk

Loss of competitive advantageLimited ability to use profits in one country to increase competition in another country

Franchising

Quick expansionLower development costs and risksLower political risk

Loss of competitive advantagePotential quality control problemsLimited ability to use profits in one country to increase competition in another country

Joint Venture

Knowledge of local marketsLower development costs and riskAccess to closed markets

Potential for conflict of interestLoss of competitive advantage

Wholly Owned Subsidiary

Maximum control over proprietary knowledge / technologyGreater strategic flexibilityEfficiencies of global production system

Large capital outlayLack of local knowledgeIncreased risk

Strategic Alliance

Access to closed marketsPooled resources increase partner’s capabilitiesComplementary skills & assets

Loss of competitive advantagePotential overestimation of partner’s capabilities

The optimal choice of entry mode for firms pursuing a multinational strategy depends to some degree on the nature of their core competency.

If a firm’s competitive advantage (its core competence) is based upon control over proprietary technological know-how, licensing and joint venture arrangements should be avoided if possible in order to minimize the risk of losing control over that technology,

Page 8: IBE notes 1

unless the arrangement can be structured in a way where these risks can be reduced significantly.

When a firm perceives its technological advantage as being only transitory, or the firm may be able to establish its technology as the dominant design in the industry, then licensing may be appropriate even if it does involve the loss of know-how. By licensing its technology to competitors, a firm may also deter them from developing their own, possibly superior, technology.

The competitive advantage of many service firms is based upon management know-how. For such firms, the risk of loosing control over their management skills to franchisees or joint venture partners is not that great, and the benefits from getting greater use of their brand names can be significant.

The greater the pressures for cost reductions, the more likely it is that a firm will want to pursue some combination of exporting and wholly owned subsidiaries. This will allow it to achieve location and scale economies as well as retain some degree of control over its worldwide product manufacturing and distribution.

Strategic Alliances

The term strategic alliances refers to cooperative agreements between potential or actual competitors

The advantages of alliances are that they facilitate entry into foreign markets, enable partners to share the fixed costs and risks associated with new products and processes, facilitate the transfer of complementary skills between companies, and help firms to establish technical standards.

The disadvantage of a strategic alliance is that the firm risks giving away technological know-how and market access to its alliance partner, while getting very little in return.

Making Alliances Work

When considering the selection of a partner, a firm must be certain that the partner is one that can help the firm achieve its goals, share the firm’s vision for the purpose of the alliances, and not act opportunistically to exploit the alliance for purely its own ends. Partner selection can be critical to success, and requires a significant investment in researching the skills and traits of potential partners.

A firm should structure the alliance to avoid unintended transfers of know-how. This can be done by walling-off (wall-off) sensitive technologies, by writing contractual safeguards into alliance agreements, by agreeing in advance to engage in reciprocal swaps of technological know-how, and by seeking credible commitments from alliance partners.

Page 9: IBE notes 1

Two of the keys to making alliances work seem to be (1) building trust and informal communications networks between partners, and (2) taking proactive steps to learn from alliance partners.

Overall, strategic alliances tend to have quite high failure rates. Many times this failure is a result of unrealistic expectations and conflicts between the partners. It should be noted, however, that just because an alliance is terminated it may not have necessarily failed -- some perfectly acceptable alliances can serve mutual interests for short periods of time where both parties benefit, and then end when the benefits no longer exceed the costs. You can draw analogies between alliances and the dating practices of people to help illustrate the benefits, costs, risks, as well as the long vs. short-term nature of the “alliances”!

Module 2

What is the meaning of Exchange Rate?

The rates applied by the Bank for converting foreign currency into Indian rupees and vice versa are known as exchange rates. In other words, exchange rate is the rate at which one currency can be exchanged for another.

What are the systems of quoting Exchange Rates?

There are two systems of quoting exchange rates:i.Direct Quotation: Where the price of foreign currency is quoted in terms of home or local currency. In this system variable units of home currency equivalent to a fixed unit of foreign currency is quoted

For Example US Dollar 1 = Rs 43.50

ii. Indirect Quotation: Where exchange rates are quoted in terms of variable units of foreign currency as equivalent to a fixed number of units of home currency.For Example US Dollar 2.30 = Rs. 100

Till 01.08.1993 banks in India were required to quote all the rates on indirect basis. From 02.08.1993 banks are quoting rates on direct basis only

Purchasing power parity

Page 10: IBE notes 1

Concept

 Let us start with a simple and familiar example. Two years back, a dollar could be used to buy 45 rupees. Today, it can buy only 39 rupees. In other words, the value of dollar fell compared to the rupee, while its value might have increased w.r.t some other currency. What explains these contrasting changes? There are many models to explain how exchange rates are determined, each highlighting some of the many factors at work.The simplest of them is called purchasing power parity. This theory states that a unit of any given currency should be able to buy the same quantity of goods in all counties. Many economists believe that purchasing power parity describes the forces that determine exchange rates in the long run.

 Purpose

 The concept of purchasing-power parity (PPP) has two applications: it was originally developed as a theory of exchange rate determination, but it is now primarily used to compare living standards across countries.

 Rationale

 The theory of purchasing power parity is based on the principle that a good must sell for the same price in all locations. Otherwise, there would be opportunities for profit left unexploited. For example, a person can buy a pen for Rs 5 in Delhi and then sell it in Bangalore for Rs 7, making a profit of Rs 2 per pen from the difference in price. The process of taking advantage of difference in prices in different markets is called arbitrage. In this example, as people took advantage of this arbitrage opportunity, they would increase the demand for pen in Delhi and increase the supply of pen in Bangalore. Thus the price of pen will rise in Delhi and fall in Bangalore. This process will continue until the prices are same in the two markets.

 Let us apply this same theory to the international markets. If a dollar (or any other currency) could buy more pens in United States than in England, international traders could make profit by buying pens in United States and selling it in England. This would drive up the price of pen in US and drive it down in UK. Conversely, if a dollar could buy more pens in UK than that in US, traders could buy pens in UK and sell it in US which could have the price effect as described above. This leads to the theory of purchasing power parity. According to this, a currency must have the same purchasing power in all countries. As the name suggests, parity means equality, and purchasing power refers to the value of money. Purchasing power states that a unit of all currencies must have the same real value in every country.

 HOW IS PPP CALCULATED?

 The simplest way to calculate purchasing power parity between two countries is to compare the price of a "standard" good that is in fact identical across countries. Every year The Economist magazine publishes a light-hearted version of PPP: its "Hamburger Index" that compares the price of a McDonald's hamburger around the world. More sophisticated versions of PPP look at a large number of goods and services. One of the

Page 11: IBE notes 1

key problems is that people in different countries consume very different sets of goods and services, making it difficult to compare the purchasing power between countries.

 Difficulties in measurement and comparisons

 Purchasing power parity provides a simple model of how exchange rates work. This theory works well for many economic phenomena. Yet this theory is not completely accurate. It means that exchange rates do not always move to ensure that a dollar has the same real value in all countries all the time. There are two main reasons why this theory does not always hold good.First, there are many goods which are not easily traded. In such cases, arbitrage would probably be too limited to eliminate the difference in prices. Thus, the deviation from purchasing power might persist.

Second, Even tradable goods are not always perfect substitutes when they are produced in different countries. For example, some consumers prefer Newport jeans and others prefer Lee Cooper. Moreover, consumer interest changes with time. If Lee Cooper suddenly becomes popular, increase in demand for Lee will go up. As a result, a dollar might then buy more Lee jeans in United States than in India. But despite the difference in prices in the two markets, there might be no opportunity for arbitrage because consumers do not view the two jeans as equivalent.

Foreign exchange market

The forex trading market is regarded as the biggest financial market. It is this market that is responsible for the trading of currencies. This is a most important function and one area that are worth getting to know more about. Very large amounts of currency are traded by large organizations such as financial institutions, multinational corporations, currency speculators, central banks and government. The foreign exchange market is regarded as the most suitable market for this trade and superior to the New York Stock Exchange (NYSE). US $ 2 trillion is handled each day by the foreign exchange market. The New York Stock Exchange handles US $ 50 billion each day. As soon as one kind of currency is traded for another kind then it regarded as foreign market exchange. This market allows for the trading of any kind of currency.

There are currencies as different from one another as the US dollar and the Swiss franc and the Japanese yen. The foreign exchange market does not cater only to the needs of the biggest institutions as was the case in previous years. Nowadays, smaller enterprises also take advantage of the foreign exchange market. In fact there are many people who use this market because it has the potential to yield good profits. This has become apparent to thousands of individuals who are taking part in the buying and selling of currencies. But it is always a good idea to have as much background information as possible in order to make informed decisions. Everybody wants to be successful. Another reason why it is preferable to have some knowledge of the foreign exchange market is because it does go up and down. This happens according to what is going on in the international market. Key investors are those who are seen as being knowledgeable about international markets. The trading is not centralized. It is possible to get

Page 12: IBE notes 1

information without much effort. If you have an interest in the foreign exchange market or want to trade then take a look at what is available online. All you would have to do is key-in the words ‘foreign exchange market’ in order to get links to a number of appropriate sites. It is not just businesses and big institutions that need to know about foreign exchange. There is a great deal of international travel that takes place. There is hardly a location where you will not see a young traveler with a backpack far from home. These people are exchanging foreign currencies all the time. Knowing how to value the currency and when to exchange can mean gaining or losing money.

The main characteristics of the foreign exchange market are summarized below.

It is a market without a trading field

The finance industry generally consists of two sets of systems, namely the operation market and the business network. Stock trading is carried out through stock exchanges, like the New York Stock Exchange and the Tokyo Stock Exchange, that are centralized business financial commodities - they consist of unified procedures and intermediaries such that the quoted price and transaction time are the same across various brokers. The investor can buy and sell their holdings through any broker, therefore the stock exchange is said to "consist of a trading market and trading field".

On the other hand, foreign exchange transactions take place without any unification of the operation market and business network. The forex market has no centralized market like a stock exchange. The foreign currency trading network has formed into a global, non-formal organization that consists of an advanced information system. Forex traders are not required to hold a membership of any organization, but must obtain their colleague’s trust and approval. The forex market therefore is said to "consist of a market but no trading field". Each day, the trading volume in the global forex market runs into several billions of U.S. dollars.

Circulation work

Due to the different geographical position of the various financial centers, the forex market operates 24 hours each working day.

Early morning 0830 (New York time) New York market opens, 0930 Chicago market opens, 1830 Sydney opens, 1930 Tokyo opens, 2030 Hong Kong and Singapore open, before dawn 1430 Frankfurt opens, and at 1530 London market opens. The forex market therefore undergoes 24 hours of uninterrupted operation, from Monday to Friday each week.

This kind of continued operation, free from any time and spatial barrier is an ideal environment for investors. For instance, a forex trader may buy the Japanese Yen in the morning at the New York market, and in the evening if the Japanese Yen rises in the Hong Kong market, the trader can sell in the Hong Kong market. The freedom to operate in multiple markets provides an enormous number of opportunities.

Page 13: IBE notes 1

Shift of Wealth

In the foreign exchange market, the exchange rate refers to the exchange ratio between the currencies of two countries. Fluctuations in the exchange rate change will cause one currency to lose its monetary value, and at the same time increase the monetary value of another currency. For instance, over 20 years ago a single US dollar bought 360 Japanese Yen, whereas at present 1 US dollar buys 110 Japanese Yen; this explains that the Japanese Yen has risen in value, and the US dollar has decreased in value (relative to the Yen). This is said to be a shift in wealth, as a fixed amount of Japanese Yen can now purchase many more goods than two decades ago.

In recent years, the size of the foreign exchange market fund has constantly increased, causing more exchange rate fluctuation every day, and urging this wealth shift to be larger.

Determinants of Exchange Rates

Numerous factors determine exchange rates, and all are related to the trading relationship between two countries. Remember, exchange rates are relative, and are expressed as a comparison of the currencies of two countries. The following are some of the principal determinants of the exchange rate between two countries. Note that these factors are in no particular order; like many aspects of economics, the relative importance of these factors is subject to much debate.

1. Differentials in inflation: As a rule of thumb, a country with a consistently lower inflation rate exhibits a rising currency value, as its purchasing power increases relative to other currencies. During the last half of the twentieth century, the countries with low inflation included Japan, Germany and Switzerland, while the U.S. and Canada achieved low inflation only later. Those countries with higher inflation typically see depreciation in their currency in relation to the currencies of their trading partners. This is also usually accompanied by higher interest rates. (To learn more, see Cost-Push Inflation Versus Demand-Pull Inflation.)

2. Differentials in interest rates: Interest rates, inflation and exchange rates are all highly correlated. By manipulating interest rates, central banks exert influence over both inflation and exchange rates, and changing interest rates impact inflation and currency values. Higher interest rates offer lenders in an economy a higher return relative to other countries. Therefore, higher interest rates attract foreign capital and cause the exchange rate to rise. The impact of higher interest rates is mitigated, however, if inflation in the country is much higher than in others, or if additional factors serve to drive the currency down. The opposite relationship exists for decreasing interest rates - that is, lower interest rates tend to decrease exchange rates. (For further reading, see What Is Fiscal Policy?)

3. Current-account deficits: The current account is the balance of trade between a country and its trading partners (see Understanding The Current Account In The Balance Of Payments), reflecting all payments between countries for goods, services, interest and dividends. A deficit in the current account shows the country is spending more on foreign trade than it is earning, and that it is borrowing capital from foreign sources to make up

Page 14: IBE notes 1

the deficit. In other words, the country requires more foreign currency than it receives through sales of exports, and it supplies more of its own currency than foreigners demand for its products. The excess demand for foreign currency lowers the country's exchange rate until domestic goods and services are cheap enough for foreigners, and foreign assets are too expensive to generate sales for domestic interests.

4. Public debt: Countries will engage in large-scale deficit financing to pay for public sector projects and governmental funding. While such activity stimulates the domestic economy, nations with large public deficits and debts are less attractive to foreign investors. What is the reason? A large debt encourages inflation, and if inflation is high, the debt will be serviced and ultimately paid off with cheaper real dollars in the future.

In the worst case scenario, a government may print money to pay part of a large debt, but increasing the money supply inevitably causes inflation. Moreover, if a government is not able to service its deficit through domestic means (selling domestic bonds, increasing the money supply), then it must increase the supply of securities for sale to foreigners, thereby lowering their prices. Finally, a large debt may prove worrisome to foreigners if they believe the country risks defaulting on its obligations. Foreigners will be less willing to own securities denominated in that currency if the risk of default is great. For this reason, the country's debt rating (as determined by Moody's or Standard & Poor's, for example) is a crucial determinant of its exchange rate.

5. Terms of trade: A ratio comparing export prices to import prices, the terms of trade is related to current accounts and the balance of payments. If the price of a country's exports rises by a greater rate than that of its imports, its terms of trade have favorably improved. Increasing terms of trade show greater demand for the country's exports. This, in turn, results in rising revenues from exports, which provides increased demand for the country's currency (and an increase in the currency's value). If the price of exports rises by a smaller rate than that of its imports, the currency's value will decrease in relation to its trading partners.

6. Political stability and economic performance: Foreign investors inevitably seek out stable countries with strong economic performance in which to invest their capital. A country with such positive attributes will draw investment funds away from other countries perceived to have more political and economic risk. Political turmoil, for example, can cause a loss of confidence in a currency and a movement of capital to the currencies of more stable countries.

Conclusion

The exchange rate of the currency in which a portfolio holds the bulk of its investments determines that portfolio's real return. A declining exchange rate obviously decreases the purchasing power of income and capital gains derived from any returns. Moreover, the exchange rate influences other income factors such as interest rates, inflation and even capital gains from domestic securities. While exchange rates are determined by numerous complex factors that often leave even the most experienced economists flummoxed, investors should still have some understanding of how currency values and exchange

Page 15: IBE notes 1

rates play an important role in the rate of return on their investments.

Hedge

What Is Hedging?

The best way to understand hedging is to think of it as insurance. When people decide to hedge, they are insuring themselves against a negative event. This doesn't prevent a negative event from happening, but if it does happen and you're properly hedged, the impact of the event is reduced. So, hedging occurs almost everywhere, and we see it everyday. For example, if you buy house insurance, you are hedging yourself against fires, break-ins or other unforeseen disasters.

Portfolio managers, individual investors and corporations use hedging techniques to reduce their exposure to various risks. In financial markets, however, hedging becomes more complicated than simply paying an insurance company a fee every year. Hedging against investment risk means strategically using instruments in the market to offset the risk of any adverse price movements. In other words, investors hedge one investment by making another.

Technically, to hedge you would invest in two securities with negative correlations. Of course, nothing in this world is free, so you still have to pay for this type of insurance in one form or another.

Although some of us may fantasize about a world where profit potentials are limitless but also risk free, hedging can't help us escape the hard reality of the risk-return tradeoff. A reduction in risk will always mean a reduction in potential profits. So, hedging, for the most part, is a technique not by which you will make money but by which you can reduce potential loss. If the investment you are hedging against makes money, you will have typically reduced the profit that you could have made, and if the investment loses money, your hedge, if successful, will reduce that loss.

How Do Investors Hedge?

Hedging techniques generally involve the use of complicated financial instruments known as derivatives, the two most common of which are options and futures. We're not going to get into the nitty-gritty of describing how these instruments work, but for now just keep in mind that with these instruments you can develop trading strategies where a loss in one investment is offset by a gain in a derivative.

Let's see how this works with an example. Say you own shares of Cory's Tequila Corporation (Ticker: CTC). Although you believe in this company for the long run, you are a little worried about some short-term losses in the tequila industry. To protect yourself from a fall in CTC you can buy a put option (a derivative) on the company, which gives you the right to sell CTC at a specific price (strike price). This strategy is known as a married put. If your stock price tumbles below the strike price, these losses will be offset by gains in the put option.

Page 16: IBE notes 1

The other classic hedging example involves a company that depends on a certain commodity. Let's say Cory's Tequila Corporation is worried about the volatility in the price of agaves, the plant used to make tequila. The company would be in deep trouble if the price of agaves were to skyrocket, which would severely eat into profit margins. To protect (hedge) against the uncertainty of agaves prices, CTC can enter into a futures contract (or its less regulated cousin, the forward contract), which allows the company to buy the agaves at a specific price at a set date in the future. Now CTC can budget without worrying about the fluctuating commodity.

If the agaves skyrocket above that price specified by the futures contract, the hedge will have paid off because CTC will save money by paying the lower price. However, if the price goes down, CTC is still obligated to pay the price in the contract and actually would have been better off not hedging.

Keep in mind that because there are so many different types of options and futures contracts an investor can hedge against nearly anything, whether a stock, commodity price, interest rate and currency - investors can even hedge against the weather.

The Downside

Every hedge has a cost, so before you decide to use hedging, you must ask yourself if the benefits received from it justify the expense. Remember, the goal of hedging isn't to make money but to protect from losses. The cost of the hedge - whether it is the cost of an option or lost profits from being on the wrong side of a futures contract - cannot be avoided. This is the price you have to pay to avoid uncertainty.

We've been comparing hedging versus insurance, but we should emphasize that insurance is far more precise than hedging. With insurance, you are completely compensated for your loss (usually minus a deductible). Hedging a portfolio isn't a perfect science and things can go wrong. Although risk managers are always aiming for the perfect hedge, it is difficult to achieve in practice.

What Hedging Means to You

The majority of investors will never trade a derivative contract in their life. In fact most buy-and-hold investors ignore short-term fluctuation altogether. For these investors there is little point in engaging in hedging because they let their investments grow with the overall market. So why learn about hedging?

Even if you never hedge for your own portfolio you should understand how it works because many big companies and investment funds will hedge in some form. Oil companies, for example, might hedge against the price of oil while an international mutual fund might hedge against fluctuations in foreign exchange rates. An understanding of hedging will help you to comprehend and analyze these investments.

Conclusion

Risk is an essential yet precarious element of investing. Regardless of what kind of investor one aims to be, having a basic knowledge of hedging strategies will lead to better

Page 17: IBE notes 1

awareness of how investors and companies work to protect themselves. Whether or not you decide to start practicing the intricate uses of derivatives, learning about how hedging works will help advance your understanding of the market, which will always help you be a better investor.

Future contract

A contractual agreement, generally made on the trading floor of a futures exchange, to buy or sell a particular commodity or financial instrument at a pre-determined price in the future. Futures contracts detail the quality and quantity of the underlying asset; they are standardized to facilitate trading on a futures exchange. Some futures contracts may call for physical delivery of the asset, while others are settled in cash.

The terms "futures contract" and "futures" refer to essentially the same thing. For example, you might hear somebody say they bought "oil futures", which means the same thing as "oil futures contract". If you want to get really specific, you could say that a futures contract refers only to the specific characteristics of the underlying asset, while "futures" is more general and can also refer to the overall market as in: "He's a  futures trader."

Currency futures

Currency futures are futures markets where the underlying commodity is a currency exchange rate, such as the Euro to US Dollar exchange rate, or the British Pound to US Dollar exchange rate. Currency futures are essentially the same as all other futures markets (index and commodity futures markets), and are traded in exactly the same way.Options

An option is a contract that gives the buyer the right, but not the obligation, to buy or sell an underlying asset at a specific price on or before a certain date. An option, just like a stock or bond, is a security. It is also a binding contract with strictly defined terms and properties.

The two types of options are calls and puts:

A call gives the holder the right to buy an asset at a certain price within a specific period of time. Calls are similar to having a long position on a stock. Buyers of calls hope that the stock will increase substantially before the option expires.

A put gives the holder the right to sell an asset at a certain price within a specific period of time. Puts are very similar to having a short position on a stock. Buyers of puts hope that the price of the stock will fall before the option expires.

Participants in the Options Market

Page 18: IBE notes 1

There are four types of participants in options markets depending on the position they take:

1. Buyers of calls2. Sellers of calls 3. Buyers of puts 4. Sellers of puts

People who buy options are called holders and those who sell options are called writers; furthermore, buyers are said to have long positions, and sellers are said to have short positions.

Module 3

Theories of international trade

The Theory of Comparative Advantage

David Ricardo, working in the early part of the 19th century, realized that absolute advantage was a limited case of a more general theory. Consider Table 1. It can be seen that Portugal can produce both wheat and wine more cheaply than England (i.e., it has an absolute advantage in both commodities). What David Ricardo saw was that it could still be mutually beneficial for both countries to specialize and trade.

Table 1

Country Wheat Wine

  Cost Per Unit In Man Hours Cost Per Unit In Man Hours

England 15 30

Portugal 10 15

Page 19: IBE notes 1

In Table 1, a unit of wine in England costs the same amount to produce as 2 units of wheat. Production of an extra unit of wine means foregoing production of 2 units of wheat (i.e. the opportunity cost of a unit of wine is 2 units of wheat). In Portugal, a unit of wine costs 1.5 units of wheat to produce (i.e. the opportunity cost of a unit of wine is 1.5 units of wheat in Portugal). Because relative or comparative costs differ, it will still be mutually advantageous for both countries to trade even though Portugal has an absolute advantage in both commodities.

Portugal is relatively better at producing wine than wheat: so Portugal is said to have a COMPARATIVE ADVANTAGE in the production of wine. England is relatively better at producing wheat than wine: so England is said to have a comparative advantage in the production of wheat.

Table 2 shows how trade might be advantageous. Costs of production are as set out in Table 1. England is assumed to have 270 man hours available for production. Before trade takes place it produces and consumes 8 units of wheat and 5 units of wine. Portugal has fewer labor resources with 180 man hours of labor available for production. Before trade takes place it produces and consumes 9 units of wheat and 6 units of wine. Total production between the two economies is 17 units of wheat and 11 units of wine.

Table 2

C o u n t r y

Production

Before Trade After Trade

Wheat Wine Wheat Wine

E n g l a n d 8 5 18 0

P o r t u g a l 9 6 0 12

T o t a l 17 11 18 12

If both countries now specialize, Portugal producing only wine and England producing only wheat, total production is 18 units of wheat and 12 units of wine. Specialization has enabled the world economy to increase production by 1 unit of wheat and 1 unit of wine.

The simple theory of comparative advantage outlined above makes a number of important assumptions:

There are no transport costs. Costs are constant and there are no economies of scale. There are only two economies producing two goods. The theory assumes that traded goods are homogeneous (i.e., identical). Factors of production are assumed to be perfectly mobile. There are no tariffs or other trade barriers.

Page 20: IBE notes 1

There is perfect knowledge, so that all buyers and sellers know where the cheapest goods can be found internationally.

Theory of absolute advantage

A country has an absolute advantage over another in producing a good, if it can produce that good using fewer resources than another country. For example if one unit of labor in India can produce 80 units of wool or 20 units of wine; while in Spain one unit of labor makes 50 units of wool or 75 units of wine, then India has an absolute advantage in producing wool and Spain has an absolute advantage in producing wine. India can get more wine with its labor by specializing in wool and trading the wool for Spanish wine, while Spain can benefit by trading wine for wool. (Adam Smith, Wealth of Nations, Book IV, Ch.2.) The benefits to nations from trading are the same as to individuals: trade permits specialization, which allows resources to be used more productively.

A country has an absolute advantage over another in producing a good, if it can produce that good using fewer resources than another country. For example if one unit of labor in India can produce 80 units of wool or 20 units of wine; while in Spain one unit of labor makes 50 units of wool or 75 units of wine, then India has an absolute advantage in producing wool and Spain has an absolute advantage in producing wine. India can get more wine with its labor by specializing in wool and trading the wool for Spanish wine, while Spain can benefit by trading wine for wool. (Adam Smith, Wealth of Nations, Book

IV, Ch.2.) The benefits to nations from trading are the same as to individuals: trade permits specialization, which allows resources to be used more productively.

The Heckscher-Ohlin Trade Theory

  The Heckscher-Ohlin theory says that two countries trade

goods with each other (and thereby achieve greater

economic welfare), if the following assumptions hold:

The major factors of production, namely labor

and capital, are not available in the same proportion in

both countries.

The two goods produced either require relatively

more capital or relatively more labor.

Labor and capital do not move between the two

countries.

Page 21: IBE notes 1

There are no costs associated with transporting

the goods between countries.

The citizens of the two trading countries have the

same needs.

  Bigger Differences - Greater Gains

 

 

 

 

 

 

 

 

Of the above conditions, the central one is the assumption

that capital and labor are not available in the same

proportion in the two countries. This condition leads to

specialization. The country with relatively more capital

specializes - but not necessarily fully - in production of

capital-intensive goods (which it exports in exchange for

labor-intensive goods) while the country with relatively

little capital specializes in production of labor-intensive

goods (which it exports in exchange for capital-intensive

goods).

According to the theory, the more different the countries

are - regarding the capital-to-labor ratio - the greater the

economic gain from specialization and trade. Example:

Imagine two countries that each produces both jeans and

cell phones. Although both countries use the same

production technologies, one has a lot of capital but a

limited number of workers, while the other country has

little capital but lots of workers.

The country that has a lot of capital but few workers can

produce many cell phones but few pairs of jeans because

cell phones are capital intensive and jeans are labor

intensive. The country with many workers but little

capital, on the other hand, can produce many pairs of jeans

but few cell phones.

According to the Heckscher-Ohlin theory, trade makes it

possible for each country to specialize. Each country

exports the product the country is most suited to produce

in exchange for products it is less suited to produce. The

country that has a lot of capital specializes in the

production of cell phones, whereas the country that has

more labor specializes in the production of jeans.

Page 22: IBE notes 1

In this case, neither country has specialized in producing more of one of the two particular products - both countries produce about the same number of jeans and cell phones.

 

Country A - having more capital than labor - has specialized in producing more cell phones. Country B - having more labor than capital - has specialized in producing more jeans. In this case, trade may benefit both countries involved.

Factor endowment theory

The MTIT is explained by Hecksher and Ohlin through Foreign Endowment. Every country has abundance in one factor. Similarly every product has different factor intensities. Then a country should produce such commodities whose factor intensity is same as its factor abundance. With this the country can claim cost   advantage   in production   and specialization. Difference in FT can be seen in different factor   availability ratios. Such difference in ratios indicates the potential of cost advantage and trade. It shows that Portugal has more of capital and England more of labor.   The difference in capital availability ratio is reflected in factor price ratio. It is because of interdependence between factor availability and factor ratios. Given  these  conditions Portugal  shall  specialize  in  capital intensive  wine  and labor intensive cloth will be produced  by England. It can be seen that   Portugal is   abundant   in capital and England

Page 23: IBE notes 1

has more of labor. Given the factor intensities it can be seen from the isoquants that cloth can   be produced   by  both  Portugal and England.

England can naturally specialize in cloth. On the other hand Portugal can produce more wine than cloth. Also it is capital intensive. Portugal specializes in wine. MT strongly suggests partial specialization.   Á country  will produce both the goods but specializes in one.

Protectionist policies

A variety of policies can be used to achieve protectionist goals. These include:

1. Tariffs: Typically, tariffs (or taxes) are imposed on imported goods. Tariff rates usually vary according to the type of goods imported. Import tariffs will increase the cost to importers, and increase the price of imported goods in the local markets, thus lowering the quantity of goods imported. Tariffs may also be imposed on exports, and in an economy with floating exchange rates, export tariffs have similar effects as import tariffs. However, since export tariffs are often perceived as 'hurting' local industries, while import tariffs are perceived as 'helping' local industries, export tariffs are seldom implemented.

2. Import quotas: To reduce the quantity and therefore increase the market price of imported goods. The economic effects of an import quota is similar to that of a tariff, except that the tax revenue gain from a tariff will instead be distributed to those who receive import licenses. Economists often suggest that import licenses be auctioned to the highest bidder, or that import quotas be replaced by an equivalent tariff.

3. Administrative Barriers: Countries are sometimes accused of using their various administrative rules (eg. regarding food safety, environmental standards, electrical safety, etc.) as a way to introduce barriers to imports.

4. Anti-dumping legislation Supporters of anti-dumping laws argue that they prevent "dumping" of cheaper foreign goods that would cause local firms to close down. However, in practice, anti-dumping laws are usually used to impose trade tariffs on foreign exporters.

5. Direct Subsidies: Government subsidies (in the form of lump-sum payments or cheap loans) are sometimes given to local firms that cannot compete well against foreign imports. These subsidies are purported to "protect" local jobs, and to help local firms adjust to the world markets.

6. Export Subsidies: Export subsidies are often used by governments to increase exports. Export subsidies are the opposite of export tariffs, exporters are paid a percentage of the value of their exports. Export subsidies increase the amount of trade, and in a country with floating exchange rates, have effects similar to import subsidies.

Page 24: IBE notes 1

7. Exchange Rate manipulation: A government may intervene in the foreign exchange market to lower the value of its currency by selling its currency in the foreign exchange market. Doing so will raise the cost of imports and lower the cost of exports, leading to an improvement in its trade balance. However, such a policy is only effective in the short run, as it will most likely lead to inflation in the country, which will in turn raise the cost of exports, and reduce the relative price of imports.

De facto protectionism

In the modern trade arena many other initiatives besides tariffs have been called protectionist. For example, some commentators, such as Jagdish Bhagwati, see developed countries efforts in imposing their own labor or environmental standards as protectionism. Also, the imposition of restrictive certification procedures on imports are seen in this light.

Further, others point out that free trade agreements often have protectionist provisions such as intellectual property, copyright, and patent restrictions that benefit large corporations. These provisions restrict trade in music, movies, drugs, software, and other manufactured items to high cost producers with quotas from low cost producers set to zero.

Arguments for protectionism

Protectionists believe that there is a legitimate need for government restrictions on free trade in order to protect their country’s economy and its people’s standard of living.

The "Comparative Advantage" argument has lost its legitimacy

The Comparative Advantage argument is used by most economists as a basis for their support of free trade policies. Opponents of these policies argue that the Comparative Advantage argument has lost its legitimacy in a globally integrated world—in which capital is free to move internationally. Herman Daly, a leading voice in the discipline of ecological economics, emphasizes that although Ricardo's theory of comparative advantage is one of the most elegant theories in economics, its application to the present day is illogical: "Free capital mobility totally undercuts Ricardo's comparative advantage argument for free trade in goods, because that argument is explicitly and essentially premised on capital (and other factors) being immobile between nations. Under the new global economy, capital tends simply to flow to wherever costs are lowest—that is, to pursue absolute advantage."

Protectionists would point to the building of plants and shifting of production to Mexico by American companies such as GE, GM, and even Hershey Chocolate as proof of this argument.

The Comparative Advantage argument is also premised on full employment. According to the Wikipedia entry on Comparative Advantage, “if one or other of the economies has less than full employment of factors of production, then this excess capacity must usually be used up before the comparative advantage reasoning can be applied”. Protectionists

Page 25: IBE notes 1

believe that this further erodes the legitimacy of the Comparative Advantage argument as a basis for determining trade policy for countries that suffer from significant unemployment or underemployment.

Domestic tax policies can favor foreign goods

Protectionists believe that allowing foreign goods to enter domestic markets without being subject to tariffs or other forms of taxation, leads to a situation were domestic goods are at a disadvantage, a kind of reverse protectionism. By ruling out revenue tariffs on foreign products, governments must rely solely on domestic taxation to provide its revenue, which falls disproportionately on domestic manufacturing. As Paul Craig Roberts notes: "[Foreign discrimination of US products] is reinforced by the US tax system, which imposes no appreciable tax burden on foreign goods and services sold in the US but imposes a heavy tax burden on US producers of goods and services regardless of whether they are sold within the US or exported to other countries."

Protectionists argue that this reverse protectionism is most clearly seen and most detrimental to those countries (such as the US) that do not participate in the Value Added Tax (VAT) system. This is a system which generates revenues from taxation on the sale goods and services whether foreign or domestic. Protectionists argue that a country that does not participate is at a distinct disadvantage when trading with a country that does. That the final selling price of a product from a non-participating country sold in a country with a VAT tax must bear not only the tax burden of the country of origin, but also a portion of the tax burden of the country were it is being sold. Conversely, the selling price of a product made in a participating country and sold in a country that does not participate, bears no part of the tax burden of the country in which it is sold (as do the domestic products it is competing with). Moreover, the participating country rebates VAT taxes collected in the manufacture of a product if that product is sold in a non-participating country. This allows exporters of goods from participating countries to reduce the price of products sold in non-participating countries.

Protectionists believe that governments should address this inequity, if not by adopting a VAT tax, then by at least imposing compensating taxes (tariffs) on imports.

Infant industry argument

Protectionists believe that infant industries must be protected in order to allow them to grow to a point where they can fairly compete with the larger mature industries established in foreign countries. They believe that without this protection, infant industries will die before they reach a size and age where economies of scale, industrial infrastructure, and skill in manufacturing have progressed sufficiently allow the industry to compete in the global market.

For example, say that investors in Ethiopia would like to start a car company. Assuming the investors were smart, educated people with knowledge of how to produce cars, an Ethiopian firm would still face practically insurmountable barriers to entering the global auto industry. Ethiopia lacks the infrastructure of parts suppliers. It lacks workers skilled in the specifics of building cars. And, an infant auto industry would have to compete for steel, glass, and other raw materials with established firms such as Toyota and Mercedes

Page 26: IBE notes 1

who purchase materials in quantities that allow established companies to receive a better price and therefore allow them to produce cars at a lower cost than the infant company.

Some might argue that trying to start an auto industry in Ethiopia is simply a bad business decision and that is certainly true, but what is true for the auto industry is true for every other industrial segment. Ethiopia would face the same barriers in trying to enter the appliance industry, the textile industry, the pharmaceutical industry, or any other established manufacturing segment. Protectionists believe that such barriers to entry are anti-competitive in the same way as monopolies and trusts are anti-competitive. Protectionists believe that Ethiopia has a right to become an industrialized nation and that its government has a right to pass protectionist legislation to insure that its infant industries have a chance to mature.

Unrestricted Trade undercuts domestic policies for social good

Most industrialized governments have long held that laissez-faire capitalism creates social evils that harm its citizens. To protect their citizens, these governments have enacted laws that restrict what companies can and can not do in pursuit of profit.

Examples are:Child Labor LawsEnvironmental Protection LawsProduct Safety LawsAnti-Trust LawsOccupational Safety LawsEqual Opportunity LawsIntellectual Property LawsCollective Bargaining LawsMinimum Wage Laws

Protectionists argue that these laws place an economic burden on domestic companies bound by these laws that put them at a disadvantage when they compete, both domestically and abroad, with goods and services produced by companies unfettered by such restrictions. They argue that governments have a responsibility to protect their corporations as well as their citizens when putting its companies at a competitive disadvantage by enacting laws for social good. Otherwise, they believe that these laws end up destroying domestic companies and ultimately hurting the citizens these laws were designed to protect.

Arguments against protectionism

Protectionism is frequently criticized as harming the people it is meant to help. Many mainstream economists instead support free trade.[1][4] Economic theory, under the

Page 27: IBE notes 1

principle of comparative advantage, shows that the gains from free trade outweigh any losses as free trade creates more jobs than it destroys because it allows countries to specialize in the production of goods and services in which they have a comparative advantage. Protectionism results in deadweight loss; this loss to overall welfare gives no-one any benefit, unlike in a free market, where there is no such total loss. According to economist Stephen P. Magee, the benefits of free trade outweigh the losses by as much as 100 to 1.

Most economists, including Nobel prize winners Milton Friedman and Paul Krugman, believe that free trade helps workers in developing countries, even though they are not subject to the stringent health and labour standards of developed countries. This is because "the growth of manufacturing — and of the myriad of other jobs that the new export sector creates — has a ripple effect throughout the economy" that creates competition among producers, lifting wages and living conditions.] Economists have suggested that those who support protectionism ostensibly to further the interests of third world workers are in fact being disingenuous, seeking only to protect jobs in developed countries. Additionally, workers in the third world only accept jobs if they are the best on offer, as all mutually consensual exchanges must be of benefit to both sides, else they wouldn't be entered into freely. That they accept low-paying jobs from first world companies shows that their other employment prospects are worse.

Alan Greenspan, former chair of the American Federal Reserve, has criticized protectionist proposals as leading "to an atrophy of our competitive ability. ... If the protectionist route is followed, newer, more efficient industries will have less scope to expand, and overall output and economic welfare will suffer." Protectionism has also been accused of being one of the major causes of war. Proponents of this theory point to the constant warfare in the 17th and 18th centuries among European countries whose governments were predominantly mercantilist and protectionist, the American Revolution, which came about primarily due to British tariffs and taxes, as well as the protective policies preceding both World War I and World War II. According to Frederic Bastiat, "When goods cannot cross borders, armies will."

Free trade promotes equal access to domestic resources (human, natural, capital, etc.) for domestic participants and foreign participants alike. Some thinkers extend that under free trade, citizens of participating countries deserve equal access to resources and social welfare (labor laws, education, etc.). Visa entrance policies tend to discourage free reallocation between many countries, and encourage it with others. High freedom and mobility has been shown to lead to far greater development than aid programs in many cases, for example eastern European countries in the European Union. In other words visa entrance requirements are a form of local protectionism.

Current world trends

Since the end of World War II, it has been the stated policy of most First World countries to eliminate protectionism through free trade policies enforced by international treaties and organizations such as the World Trade Organization. Certain policies of First World governments have been criticized as protectionist, however, such as the Common Agricultural Policy in the European Union and proposed "Buy American" provisions in economic recovery packages in the United States.

Page 28: IBE notes 1

The current round of trade talks by the World Trade Organization is the Doha Development Round and the last session of talks in Geneva, Switzerland led to an impassé. The leaders' statement in the G20 meeting in London in early 2009 included a promise to continue the Doha Round.

Protectionism after the 2008 financial crisis

Heads of the G20 at their recent London summit pledged to abstain from imposing any trade protectionist measures. Although they were reiterating what they had already committed to, last November in Washington, 17 of these 20 countries were reported by the World Bank as having imposed trade restrictive measures since then. In its report, the World Bank says most of the world's major economies are resorting to protectionist measures as the global economic slowdown begins to bite.

Modern theory of international trade

Modern theory of international trade is an extension of classical theory of international trade. The comparative cost advantage theory given by Ricardo takes into account only labor as the only productive factor of production whereas, modern theory gives equal importance to all resources.

Modern theory is given by Hecksher and Ohlin. The modern theory of international trade does not supplant classical theory but only supplements it.

Modern theory brings out certain relationships in the economic variables:

Factor availability determines the factor prices, Factor prices determine the product prices, The difference in factor prices and product prices is the basis of cost advantage

and specialization. Differences in the factor and product prices are the cause of international trade. Factors of production being immobile between countries, the factor price

differences remain. The cost advantage is sustained and trade takes place.

According to modern theory, International trade is a special case of inter regional and inter local trade. With in a country the factors are mobile and factor prices will be equal. Country as a whole will be having uniform cost advantage. Whereas, between countries, there is no factor mobility. The factor prices remain different and the cost advantage is permanent.

The modern theory is markedly different from the classical theory where it only proposes partial specialization. The classical theory advocated complete specialization. Partial specialization states that the country should produce both the goods but specializes in a

Page 29: IBE notes 1

good where it has cost advantage. This will help in sustaining the cost advantage in the long run.

Model : It is a 2x2x2 model with two countries: Portugal and England, two commodities: wine and cloth and two factors; labor and capital. The theory is explained with the help of

1. General equilibrium and 2. Factor endowment theorem

General equilibrium Analysis:

The general equilibrium analysis was originally developed by Leon Walrus. It is a case where the production equilibrium is same as the consumption equilibrium. Given closed economy in the beginning the equilibrium is found at a point where:

GEA was first used by Leon Walrus. The GE is an identity between production equilibrium and consumption equilibrium. This is a model with closed economy.

With intro of I.T the GE   will undergo a change. The international price line will be different from domestic price lines. The production equilibrium will move from T1 to T2. It can be seen that at E2 Portugal produces   large wine than its consumption. This is

Page 30: IBE notes 1

the surplus for exports. In turn Portugal will receive cloth on international price line at E3 there is an increase in the level of social gain from EIC to EIC2. I.T is a case of partial specialization where a country produces both goods but specializes in one.

International trade increases the number of goods that domestic consumers can choose from, decreases the cost of those goods through increased competition, and allows domestic industries to ship their products abroad. While all of these seem beneficial, free trade isn't widely accepted as completely beneficial to all parties. This article will examine why this is the case, and how countries react to the variety of factors that attempt to influence trade.

What Is a Tariff?

In simplest terms, a tariff is a tax. It adds to the cost of imported goods and is one of several trade policies that a country can enact.

Why Are Tariffs and Trade Barriers Used?

Tariffs are often created to protect infant industries and developing economies, but are also used by more advanced economies with developed industries. Here are five of the top reasons tariffs are used:

1. Protecting Domestic Employment - The levying of tariffs is often highly politicized. The possibility of increased competition from imported goods can threaten domestic industries. These domestic companies may fire workers or shift production abroad to cut costs, which means higher unemployment and a less happy electorate. The unemployment argument often shifts to domestic industries complaining about cheap foreign labor, and how poor working conditions and lack of regulation allow foreign companies to produce goods more cheaply. In economics, however, countries will continue to produce goods until they no longer have a comparative advantage (not to be confused with an absolute advantage).

1. Protecting Consumers - A government may levy a tariff on products that it feels could endanger its population. For example, South Korea may place a tariff on imported beef from the United States if it thinks that the goods could be tainted with disease.

2. Infant Industries - The use of tariffs to protect infant industries can be seen by the Import Substitution Industrialization (ISI) strategy employed by many developing nations. The government of a developing economy will levy tariffs on imported

Page 31: IBE notes 1

goods in industries in which it wants to foster growth. This increases the prices of imported goods and creates a domestic market for domestically produced goods, while protecting those industries from being forced out by more competitive pricing. It decreases unemployment and allows developing countries to shift from agricultural products to finished goods.

Criticisms of this sort of protectionist strategy revolve around the cost of subsidizing the development of infant industries. If an industry develops without competition, it could wind up producing lower quality goods, and the subsidies required to keep the state-backed industry afloat could sap economic growth.

3. National Security - Barriers are also employed by developed countries to protect certain industries that are deemed strategically important, such as those supporting national security. Defense industries are often viewed as vital to state interests, and often enjoy significant levels of protection. For example, while both Western Europe and the United States are industrialized, both are very protective of defense-oriented companies. This can be seen in the special treatment of Boeing (NYSE:BA) by the United States and Airbus by Europe.

4. Retaliation - Countries may also set tariffs as a retaliation technique if they think that a trading partner has not played by the rules. For example, if France believes that the United States has allowed its wine producers to call its domestically produced sparkling wines "Champagne" (a name specific to the Champagne region of France) for too long, it may levy a tariff on imported meat from the United States. If the U.S. agrees to crack down on the improper labeling, France is likely to stop its retaliation. Retaliation can also be employed if a trading partner goes against the foreign policy objectives of the government.

5. The next section will cover the various types of trade barriers and tariffs.

Types of Tariffs and Trade Barriers

There are several types of tariffs and barriers that a government can employ:

Specific tariffs Ad valorem tariffs Licenses Import quotas Voluntary export restraints Local content requirements

Specific Tariffs - A fixed fee levied on one unit of an imported good is referred to as a specific tariff. This tariff can vary according to the type of good imported. For example, a country could levy a $15 tariff on each pair of shoes imported, but levy a $300 tariff on each computer imported.

Ad Valorem Tariffs - The phrase ad valorem is Latin for "according to value", and this type of tariff is levied on a good based on a percentage of that good's value. An example

Page 32: IBE notes 1

of an ad valorem tariff would be a 15% tariff levied by Japan on U.S. automobiles. The 15% is a price increase on the value of the automobile, so a $10,000 vehicle now costs $11,500 to Japanese consumers. This price increase protects domestic producers from being undercut, but also keeps prices artificially high for Japanese car shoppers.

Non-tariff barriers to trade include:

Licenses - A license is granted to a business by the government, and allows the business to import a certain type of good into the country. For example, there could be a restriction on imported cheese, and licenses would be granted to certain companies allowing them to act as importers. This creates a restriction on competition, and increases prices faced by consumers.

Import Quotas - An import quota is a restriction placed on the amount of a particular good that can be imported. This sort of barrier is often associated with the issuance of licenses.  For example, a country may place a quota on the volume of imported citrus fruit that is allowed.

Voluntary Export Restraints (VER) - This type of trade barrier is "voluntary" in that it is created by the exporting country rather than the importing one. A voluntary export restraint is usually levied at the behest of the importing country, and could be accompanied by a reciprocal VER. For example, Brazil could place a VER on the exportation of sugar to Canada, based on a request by Canada. Canada could then place a VER on the exportation of coal to Brazil. This increases the price of both coal and sugar, but protects the domestic industries.

Local Content Requirement - Instead of placing a quota on the number of goods that can be imported, the government can require that a certain percentage of a good be made domestically. The restriction can be a percentage of the good itself, or a percentage of the value of the good. For example, a restriction on the import of computers might say that 25% of the pieces used to make the computer are made domestically, or can say that 15% of the value of the good must come from domestically produced components.

In the final section we'll examine who benefits from tariffs and how they affect the price of goods.

Who Benefits?

The benefits of tariffs are uneven. Because a tariff is a tax, the government will see increased revenue as imports enter the domestic market. Domestic industries also benefit from a reduction in competition, since import prices are artificially inflated. Unfortunately for consumers - both individual consumers and businesses - higher import prices mean higher prices for goods. If the price of steel is inflated due to tariffs, individual consumers pay more for products using steel, and businesses pay more for steel that they use to make goods. In short, tariffs and trade barriers tend to be pro-producer and anti-consumer.

The effect of tariffs and trade barriers on businesses, consumers and the government shifts over time. In the short run, higher prices for goods can reduce consumption by

Page 33: IBE notes 1

individual consumers and by businesses. During this time period, businesses will profit and the government will see an increase in revenue from duties. In the long term, businesses may see a decline in efficiency due to a lack of competition, and may also see a reduction in profits due to the emergence of substitutes to their products. For the government, the long-term effect of subsidies is an increase in the demand for public services, since increased prices, especially in foodstuffs, leaves less disposable income.

How Do Tariffs Affect Prices?

Tariffs increase the prices of imported goods. Because of this, domestic producers are not forced to reduce their prices from increased competition, and domestic consumers are left paying higher prices as a result. Tariffs also reduce efficiencies by allowing companies that would not exist in a more competitive market to remain open.

Figure 1 illustrates the effects of world trade without the presence of a tariff. In the graph, DS means Domestic Supply and DD means Domestic Demand. The price of goods at home is found at price P, while the world price is found at P*. At a lower price, domestic consumers will consume Qw worth of goods, but because the home country can only produce up to Qd, it must import Qw-Qd worth of goods.

Figure 1. Price without the influence of a tariff

When a tariff or other price-increasing policy is put in place, the effect is to increase prices and limit the volume of imports. In Figure 2, price increases from the non-tariff P* to P'. Because price increases, more domestic companies are willing to produce the good, so Qd moves right. This also shifts Qw left. The overall effect is a reduction in imports, increased domestic production and higher consumer prices. (To learn more about the movement of equilibrium due to changes in supply and demand, read Understanding Supply-Side Economics.)

Page 34: IBE notes 1

Figure 2. Price under the effects of a tariff

Tariffs and Modern Trade

The role tariffs play in international trade has declined in modern times. One of the primary reasons for the decline is the introduction of international organizations designed to improve free trade, such as the World Trade Organization (WTO). Such organizations make it more difficult for a country to levy tariffs and taxes on imported goods, and can reduce the likelihood of retaliatory taxes. Because of this, countries have shifted to non-tariff barriers, such as quotas and export restraints. Organizations like the WTO attempt to reduce production and consumption distortions created by tariffs. These distortions are the result of domestic producers making goods due to inflated prices, and consumers purchasing fewer goods because prices have increased.

Since the 1930s, many developed countries have reduced tariffs and trade barriers, which has improved global integration, as well as brought about globalization. Multilateral agreements between governments increase the likelihood of tariff reduction, and enforcement on binding agreements reduces uncertainty.

Page 35: IBE notes 1

Module 4

WTO

The World Trade Organization is an international organization which was created for the liberalization of international trade. The World Trade Organization came into existence on January 1st, 1995 and it is the successor to General Agreement on Trade and Tariffs (GATT). The World trade organization deals with the rules of trade between nations at a global level. WTO is responsible for implementing new trade agreements. All the member countries of WTO have to follow the trade agreement as decided by the WTO.

Structure of the WTO:

Following is the structure of WTO.

Highest Level: Ministerial ConferenceThe Ministerial Conference is the top most body of the WTO, which meets in every two years. It brings together all the members of WTO.

Second Level: General CouncilThe General Counsel of the WTO is the highest level decision making body in Geneva, which meets regularly to carry out the functions of WTO.

Third Level: Councils for TradeThe Workings of GATT, which covers international trade in goods, are the responsibility of the Council of Trade.

Fourth Level: Subsidiary BodiesThere are subsidiary bodies under the various councils dealing with specific subjects such as agriculture, subsidies, market access etc.

Page 36: IBE notes 1

Benefits Of WTO It helps promote peace and prosperity across the globe. Disputes are settled amicably. Rules bring about greater discipline in trade negotiations, thereby reducing

inequalities to a large extent. Free trade reduces the cost of living and increases household income. Companies have greater access to markets and consumers have wider range of

products to choose from. Good governance accelerates economic growth

How WTO Helps Developing Countries

The WTO system of principles, rules and obligations safeguards the interests of all members – including the economically least powerful – and they help governments to devise and pursue economic reform programs.

The multilateral trade framework of rules can also assist domestic policy-making. WTO rules do not prescribe a trade policy but they do help governments consolidate development policies based on open, competitive markets.

A rules-based system

'Leverage' in market access negotiations requires a large market, attractive to exporters in other countries. Many developing countries do not have this negotiating power, so agreed concepts, principles and rules of trade are especially important to them.

The WTO system combines reciprocal market access negotiation of market access with rules on non-discrimination in trade - the “Most Favored Nation” (MFN) principle. That is, market liberalization agreed between any two WTO members is extended to all members of the WTO.

For developing countries, one of the most important recent achievements of the WTO has been the strengthening of this multilateral framework of rules and agreements and their extension into new areas. WTO rules have been tightened on the use of measures that often target the exports of developing countries, including those on

subsidies countervailing and anti-dumping duties safeguard measures

The application of the WTO rules in merchandise sectors such as textiles and apparel and in agriculture - which are very important in developing country trade - has been strengthened and improved.

WTO disciplines now also cover sectors such as trade in services and trade incorporating intellectual property. As developing countries expand their imports and exports in these sectors, the new rules will help to ensure that these countries extract the greatest benefit from international trade.

Page 37: IBE notes 1

All these rules are only effective. However, if there is an efficient and fair means to settle disputes in case of a breach of obligations. The WTO Dispute Settlement Understanding provides such a framework. Developing countries are now making frequent use of the dispute settlement mechanism, bringing cases against developed and developing country members.

How the WTO supports domestic reform programs

Governments are frequently pressured to increase protection despite the additional costs this imposes on the economy overall. Taxes on imports or exports are also used by Governments as a convenient source of revenue.

The framework of rules and principles in the WTO helps to clarify the full impact of a trade policy decision, offering guidance and support for governments that choose to resist protectionist pressures in the interests of sustainable development.

Policy discretion is a two-edged sword. It can motivate politically powerful special interest groups to press for actions that are not necessarily acting in the interests of the national economy.

Political pressure may force governments to concede to the demands of these special interest groups

undermining the credibility of economic reforms discouraging both domestic and foreign investors making domestic and foreign investors hesitant to commit funds to longer-term

projects.

WTO obligations can help reform-minded governments resist protectionist pressures. The acceptance of multilateral rules and principles on trade-related policies can help a government balance special interest group demands against the advantages of compliance with liberalizing principles.

Recently, many WTO members have also chosen to bind trade liberalization in their WTO tariff schedules, greatly enhancing the credibility of their trade reform. The Uruguay Round negotiations allowed these countries to ‘count’ autonomous liberalization measures in the Round as part of their negotiating ‘coin’. The tariff bindings negotiated – in return for bindings by trading partners - helped many governments to consolidate their economic reforms.

Part of the support which the WTO rules offer governments is the assurance that trading partners, too, are bound by reciprocal obligations to reduce protection and to act fairly in their trade policies.

Some preferential treatment

Most developing countries have relied, from time to time, on special preferential access to developed country markets under the Generalized System of Preferences (GSP). These

Page 38: IBE notes 1

non-reciprocal trade preferences sometimes offered developing countries substantially better access to developed country markets than was available under bound MFN tariff rates.

But the preferences - which were not bound because they were granted unilaterally - were not secure rights and were, in any case, eroded over time as MFN tariff rates were reduced.

Offers by developing countries in the Uruguay Round to bind their tariffs have secured for them improved MFN terms of market access on a contractual - and therefore enforceable and predictable - basis.

Flexibility for developing countries

The WTO recognizes that developing countries may need more time to implement new obligations such as those adopted in the Uruguay Round. For example, developing countries have a longer period in which to implement their TRIPS obligations. Developing countries are permitted under the Uruguay Round agreements, for example, to employ certain subsidies beyond the date for their elimination from the policies of developed countries.

Many of the agreements also contain specific provisions for technical assistance for developing countries in meeting their new obligations.

The Guide contains a special section detailing the additional flexibility built-in to the WTO Agreements in recognition of the interests of developing country members.

Also, in special circumstances, developing countries are permitted by the GATT to employ policies contrary to the principles of the treaty. For example, the rules in Article XVIII of GATT permit developing countries to use quantitative restrictions that would otherwise be prohibited by GATT rules to support the establishment or the development of an industry, although the conditions under which these provisions may be used were further tightened in the Uruguay Round.

Rules covering services trade

The General Agreement on Trade in Services (GATS) extends the rules based multilateral trading system to the large and dynamic sector of services trade. The benefits for developing countries should be similar to those they have enjoyed from WTO rules on merchandise trade.

As their services infrastructure and capacity increase, developing countries will be able to take advantage of the improved access opportunities the GATS provides. Many developing countries are not currently well placed to export services, however, domestic capabilities are growing.

Developing countries will benefit from liberalization of import barriers to services trade because this will lower the input costs for their manufacturing and agricultural industries. All manufactures, for example, are likely to include components of transport (road, rail or

Page 39: IBE notes 1

air delivery) services, professional (accountancy, design, engineering), telecommunications (faxes, telephone, telex) and financial (bank credits, business loans, export or import credit) services.

Competitive supply of these services – enforced by opening domestic services markets to competitive import supply – can make an important contribution to the competitiveness of export or import competing goods.

The GATS permits Member countries, including developing countries, to negotiate the conditions of access to their markets under which foreign services suppliers may establish in their countries. These terms and conditions are bound in the schedules of the member countries concerned.

Intellectual Property rules

The Agreement on Trade-Related Aspects of Intellectual Property Rights (TRIPS) offers potential benefits for developing countries by creating a policy framework that could help promote technology transfer and foreign direct investment. Its main disciplines include non-discrimination (most-favored-nation and national treatment) and the equal application by all Members of minimum standards of protection for all categories of intellectual property rights.

The agreement also protects the interests of developing country firms as owners and exploiters of IP rights, particularly in the high-technology sector. Many developing countries were already introducing intellectual property protection regimes before the end of the Uruguay Round.

The new rules have many complex effects on trade flows. The overall impact continues to elude empirical studies. World Bank staff estimate, however, that the higher levels of protection have a ‘significantly positive’ impact on bilateral flows in non-fuels goods trade (Fink and Primo Braga – World Bank 1998).

Textiles and food trade

Despite entrenched opposition - in some of the wealthiest developed countries - to liberalization of trade in the textile, clothing, footwear and food sectors, there have been major changes in the WTO rules that apply to trade in these goods.

The new rules require the progressive elimination of the most protective trade barriers and put limits on the most trade-disruptive export policies in these sectors. But actual reductions in protection have so far been small.

In textiles and clothing trade, the phase-out of the quantitative import barriers sanctioned by the Multi-Fibre Arrangement – leaving only tariff protection for domestic markets - represents a fundamental change in protection policy. Developing countries are expected, eventually, to be the biggest beneficiaries of changes in trade flows, investment and the location of production that will result.

Page 40: IBE notes 1

In the agricultural sector, developing countries will be among the primary beneficiaries of the reduction of both border-protection and the value and quantity of subsidized exports. The increase in minimum access to agricultural markets provided in the Uruguay Round Agriculture Agreement has given developing country food exporters some additional opportunities.

The special interests of the food importing countries – whose import prices could be affected by the Agreement - have been recognized in a Ministerial Decision which provides for potential access to special multilateral financial assistance. Many of these food-deficit countries, however, also have substantial domestic food production. Given the right policy settings, producers in food-deficit countries should benefit from any increase in world prices, leading to higher levels of domestic production and lower national food deficits. For more on this subject, see the topic on the Agriculture Agreement.

It is expected that, because of the relatively small predicted changes in agricultural prices, the welfare effects for least developed and net-food-importing countries will be small, relative to GDP.

A recent assessment by World Bank staff of the welfare effects for least-developed and net food-importing countries as a result of the Uruguay Round Agriculture Agreement, found that:

Changes in welfare are significantly affected by the structure of trade and distortions in the domestic economy. For example, in many least-developed countries, governments tend to tax producers heavily and subsidize food prices, particularly for urban consumers. Imported foods are commonly sold at prices well below world prices reducing the production incentives for domestic farmers.

Although developing economies may suffer from any increases in world prices for food products following cuts to export subsidies, terms-of-trade losses are small in relation to total GDP. Only in a small number of countries is the estimated welfare change greater than one per cent of GDP.

The effects of domestic economic distortions (such as subsidies for urban consumers) are significantly larger than the terms-of-trade changes. In some cases, the distortion effects oppose the terms-of-trade effects and are large enough to offset the terms-of-trade loss.

In short, removing policy distortions could convert a small loss in terms-of-trade to potential gains.

CURRENT ISSUES IN WTO

Page 41: IBE notes 1

GMOs are created by transferring genetic material from one organism to another. This process is called genetic engineering, or biotechnology. Although the transfer of genetic material has long occurred through selective breeding and other techniques, new technologies permit more controlled transfers, and transfers of genes from completely unrelated species. Although citizens and governments in different countries all want to ensure that these GMOs do not pose a threat to human health or the environment, they do not agree on the best way to protect against these potential threats.

Trade problems arise when countries have different regulations regarding the testing and approval procedures necessary to place GMOs and their products on the market, or when they disagree about labeling and identification requirements. Some countries ban imports and sales of GMOs and their products altogether. In other countries, a large part of the production of some crops, such as maize or soybeans, is from genetically modified seeds, and is mixed with non-modified varieties during storage, transport and processing. These countries argue it would be unnecessary and very costly to keep GMOs separate, and consider that labeling requirements or import bans are unnecessary trade barriers.

So far, no trade dispute over GMOs has been examined by a WTO dispute settlement panel. Several WTO agreements could apply to the topic, including SPS, but also the TBT Agreement, the Agreement on Trade-Related Aspects of Intellectual Property Rights (TRIPs) and the GATT. An international agreement on living modified organisms, the Biosafety Protocol, was negotiated in the year 2000 under the Convention on Biodiversity of the United Nations. GMOs and SPS 

Under what circumstances does the SPS Agreement apply to GMOs? According to the definition of an SPS measure, the agreement applies to measures taken

to protect: from:

human or animal life

risks arising from additives, contaminants, toxins or disease-causing organisms in their food, beverages, feedstuffs;

human life plant- or animal-carried diseases (zoonoses);

animal or plant life

pests, diseases, or disease-causing organisms;

a country damage caused by the entry, establishment or spread of pests.

In the discussion of GMOs, the first and last definitions seem relevant, i.e. protection from food safety risks and invasive species risks from genetically modified plants. In the case of food safety, however, the SPS Agreement applies to risks from additives, contaminants, toxins or disease-causing organisms, and it is not clear if potential risks from GMO foods fit into one of those categories. If the SPS Agreement did apply, regulations on GMOs would have to conform to the provisions of the Agreement, such as scientific risk assessment and least trade restrictive measures.

Page 42: IBE notes 1

Countries could also argue that relevant scientific evidence is insufficient, and adopt a provisional measure according to Article 5.7, based on the available pertinent information. They would then be obliged to actively seek the additional information needed for a more objective risk assessment, and to review the measure within a reasonable period of time. What might be “reasonable” would have to be determined on a case-by-case basis.

The SPS Committee has not discussed GMOs in any detail. However, the United States circulated a paper in June 2000 which pointed out the lack of consistency in notifications. Some countries notified GMO-related regulations under SPS, others under TBT, and sometimes under both. Thailand has also brought to the Committee’s attention Egypt’s restrictions on its canned tuna, allegedly because of concerns that the tuna was canned in genetically modified soy oil, and in September 2000 requested official consultations with Egypt.  

Other WTO Agreements 

To the extent that the SPS Agreement did not apply to GMO regulations, the TBT Agreement may apply. The TBT Agreement allows governments to take measures if they have a legitimate objective, such as protecting health or the environment. TBT measures should not be more trade-restrictive than necessary. In addition, the TBT Agreement does not allow for discrimination between like products. If a panel were established, it would thus have to decide whether the measure had a legitimate objective, whether it was more trade-restrictive than necessary, and whether GMOs and their products were substantially the same as their non-modified counterparts. In the case of processed foods, for example mayonnaise containing oil from modified soybeans, the “like product” consideration might be difficult. The TBT Committee has discussed GMOs mostly in relation to labeling requirements.

The TRIPs Agreement requires countries to provide a minimum level of protection for certain intellectual property rights. However, only new inventions have to be patentable, not discoveries. Even where a patent is granted, the government can still regulate or ban a product from sale. With respect to GMOs, countries may exclude from patentability plants and animals as well as essentially biological processes for the production of plants and animals. However, they must provide protection for microorganisms and non-biological and microbiological processes. The TRIPs Agreement also allows temporary exclusion from patentability when necessary to protect human, animal or plant life or health or to avoid prejudice to the environment. The TRIPs Agreement would normally not be invoked in a conflict regarding market access for GMOs, but it might be invoked in a dispute on intellectual property protection related to GMOs.

Finally, Article XX of GATT provides for exceptions from GATT rules in order to protect health or the environment. Here, again, the issue of “like” products would arise. In addition, a country would have to show that it is necessary to violate the GATT to achieve the desired health or environmental protection.

Page 43: IBE notes 1

In preparations for the Ministerial Conference in Seattle in 1999, several Members proposed the establishment of a working group in the WTO to study GMOs. This group might examine GMOs and their relationship with the different WTO Agreements, and evaluate the need for further action. However, no such working group has been established, and since the Seattle Ministerial at the end of 1999, the issue has not been discussed. In the context of the negotiations on agriculture which began in 2000, the United States has submitted a proposal (G/AG/NG/W/15) calling for disciplines to ensure that processes covering trade in products developed through new technologies are transparent, predictable and timely. GMOs and the “Three Sister Organizations” 

The three sister organizations have begun work on GMOs, and any standards, recommendations and guidelines they develop will be international standards in the sense of the SPS Agreement.

Codex has established an ad hoc task force on foods derived from biotechnology. The task force is developing general principles for risk analysis for GM foods, and specific guidance on risk assessment. It is also examining the analytical methods available for detection of GMOs in foods. To support the work of the task force, there has been a joint FAO/WHO expert consultation on safety aspects of genetically modified foods of plant origin in May/June 2000, and further expert consultations are planned on the safety of genetically modified foods from animals and micro-organisms, plus a working group on testing methods.

Some of the standards developed by the OIE deal with diseases that have human health and biosafety significance. These standards are approved by the OIE member countries and published in the OIE International Animal Health Code. The OIE also publishes the Manual of Standards for Diagnostic Tests and Vaccines. A few of the tests and vaccines use genetically modified organisms. The OIE has had a working group on biotechnology since 1996.

The IPPC has formed an open-ended working group on phytosanitary aspects of GMOs, biosafety and invasive species. It will develop standards for risk analysis as applied to environmental hazards. The Cartagena Protocol on Biosafety 

In January 2000, negotiations on a Biosafety Protocol, under the Convention on Biological Diversity of the United Nations, were completed in Montreal. The protocol lays down rules for international trade in living modified organisms, or LMOs. LMOs are basically GMOs that have not been processed, and that could live if introduced into the environment, such as seeds.

Under the protocol, a country which wants to export LMOs for “intentional introduction into the environment” (such as seeds for planting) must seek advance informed agreement from the importing country before the first shipment takes place. Exports of LMOs which are to be used for food, feed or processing do not have to go

Page 44: IBE notes 1

through advance informed agreement; rather, trading partners will inform each other of their policies through a “biosafety clearing-house”. The protocol provides for decisions to be based on risk assessment. Under certain circumstances, importers can ask the exporter to carry out the risk assessment. In addition, the protocol contains provisions related to identification of LMOs in international trade.

If a dispute is brought to the WTO, the panel can only judge compliance with WTO Agreements. In doing so the Cartagena Protocol would presumably be taken into account as a relevant international treaty. The relationship of the protocol with the SPS Agreement and other international agreements is not clear.

European Union

The European Union (EU) is an economic and political union of 27 member states, located primarily in Europe. Committed to regional integration, the EU was established by the Treaty of Maastricht in 1993 upon the foundations of the European Communities.[8] With over 500 million citizens, the EU combined generated an estimated 28% share (US$ 16.5 trillion) of the nominal and about 21% (US$14.8 trillion) of the PPP gross world product in 2009.

The EU has developed a single market through a standardised system of laws which apply in all member states, ensuring the free movement of people, goods, services, and capital. It maintains common policies on trade, agriculture, fisheries and regional development. Sixteen member states have adopted a common currency, the euro, constituting the Eurozone.

The EU has legal personality and enacts legislation in justice and home affairs, including the abolition of passport controls by the Schengen Agreement between 22 EU and 3 non-EU states and guaranteeing a European area of freedom, security and justice.It is able to conclude treaties with foreign countries and has devised the Common Foreign and Security Policy and the Common Security and Defence Policy, thus developing a limited role in European defence and foreign policy. It has diplomatic missions and delegations established around the world and has representation at the World Trade Organization, G8, G-20 major economies and at the United Nations.

As an international organisation, the EU operates through a hybrid system of supranationalism and intergovernmentalism. In certain areas, decisions are made through negotiation between member states, while in others, independent supranational institutions are responsible without a requirement for unanimity between member states. Important institutions of the EU include the European Commission, the Council of the European Union, the European Council, the Court of Justice of the European Union, and the European Central Bank. The European Parliament is elected every five years by member states' citizens, to whom the citizenship of the European Union is assured.

Page 45: IBE notes 1

The EU traces its origins from the European Coal and Steel Community formed among six countries in 1951 and the Treaty of Rome formed in 1957 by the same states. Since then, the EU has grown in size through enlargement, and in power through the addition of policy areas to its remit.

ASEAN

Since its start about a decade ago, the partnership between India and the Association of South East Asian Nations (ASEAN) comprising Brunei, Cambodia, Indonesia, Laos, Malaysia, Myanmar, the Philippines, Singapore, Thailand and Vietnam has been developing at quite a fast pace.

India became a sectoral dialogue partner of ASEAN in 1992. Mutual interest led ASEAN to invite India to become its full dialogue partner during the fifth ASEAN summit in Bangkok in 1995. India also became a member of the ASEAN Regional Forum (ARF) in 1996. India and ASEAN have been holding summit-level meetings on an annual basis since 2002.

In October 2009, India signed a Free Trade Agreement (FTA) with the ASEAN members in Thailand. Under the ASEAN-India FTA, ASEAN member countries and India will lift import tariffs on more than 80 per cent of traded products between 2013 and 2016.Also, tariffs on sensitive goods will be reduced to 5 per cent in 2016, while tariffs will be maintained on up to 489 very sensitive items. India and ASEAN are currently negotiating agreements on trade in services and investment. The services negotiations are taking place on a request-offer basis, wherein both sides make requests for the openings they seek and offers are made by the receiving country based on the requests. There are four meetings scheduled between January and July and the deal is expected to be finalized by August 2010.

India has made requests in a number of areas including teaching, nursing, architecture, chartered accountancy and medicine as it has a large number of English speaking professionals in these areas who can gain from job opportunities in the ASEAN region. India is also keen on expanding its telecom, IT, tourism and banking network in ASEAN countries.

TRADE

The deepening of ties between India and ASEAN is reflected in the continued buoyancy in trade figures. The ASEAN is India's fourth-largest trading partner after the EU, US and China. In 2008-09 India's exports to ASEAN totaled US$ 19.14 billion, an increase of 16.62 per cent. During April-June 2009, India exported goods worth US$ 4.41 billion to ASEAN.

India imported goods worth US$ 26.20 billion in 2008-09 from ASEAN. During the period April-June 2009, India's imports totaled US$ 6.24 billion.

Singapore

Page 46: IBE notes 1

The growing bilateral economic relationship is reflected in the rapidly rising bilateral trade between Singapore and India. Singapore continues to be the single largest investor in India amongst the ASEAN countries with FDI inflows into India and the second largest amongst all countries, rising to US$ 3.45 billion in 2008-09. FDI inflows from Singapore between April-December 2009 stood at US$ 1.70 billion, taking the cumulative inflows in the April 2000-December 2009 period to US$ 9.51 billion.

The total bilateral trade during 2008-09 was US$ 16.1 billion, an increase of 3.86 per cent over US$ 15.5 billion in 2007-08.

ICICI Bank is all set to become the second Indian financial institution to get a full-fledged banking license in Singapore, which will allow it to set up branches, ATMs, take deposits and disburse loans like a local bank. State Bank of India is already a fully-recognized bank in Singapore.

Malaysia

The bilateral economic relationship between India and Malaysia has been steadily moving ahead. Malaysia has been a huge source of FDI for India. In fact, Malaysia is the twenty-fourth largest overall investor and second largest investor among ASEAN countries with a total inflow of US$ 244.45 million during the April 2000-December 2009 period.

Bilateral trade among the two countries amounted to US$ 10.5 billion during 2008-09. During the same period, US$3 8.7 million worth of Malaysian investments in India were primarily in sectors like construction, real estate and business services.

NAFTA

The North American Free Trade Agreement (NAFTA) was signed by Canada, Mexico, and the United States in December 1992, and came into effect on January 1st, 1994. The NAFTA is precedent-setting in that it establishes a free trade area among developed and developing countries.

The agreement seeks to promote free trade in goods and services and increase investment not only by eliminating tariff protection and reducing non-tariff barriers, but also by introducing GATT plus trade and investment-related disciplines. The NAFTA builds on the bilateral Canada-U.S. Free Trade Agreement (CUSFTA) which came into effect on January, 1989. Major advances in the NAFTA over the CUSFTA include the substantially expanded coverage of government procurement (to services and construction), intellectual property and investor's rights (introducing binding investor-state arbitration), as well as more stringent rules of origin.

Two side agreements signed in 1993 address cooperation on labor (NAALC) and the environment. These side agreements will allow the imposition of fines and trade sanctions to enforce national standards under certain circumstances.

Major trade components of the NAFTA include:

Page 47: IBE notes 1

General: (a) Tariffs and Quotas: All U.S., Canadian, and Mexican tariffs and quotas will be

phased out over 15 years; (b) Rules of Origin: Goods made with materials or labor from outside North

America qualify for NAFTA treatment only if they undergo "substantial transformation" within a member country;

Sector-Specific: (a) Autos: Tariffs will be eliminated after eight years for autos only if a certain

percentage of costs are comprised of North American materials or labor. The requirement that U.S. auto manufacturers produce in Mexico in order to sell there will be lifted after 10 years;

(b) Textiles and Apparels: Strict rules will eliminate tariffs only for goods made from North American-spun yarn or from fabric made from North American fibers. Quotas can be reimposed temporarily if imports cause "serious damage" to domestic industry;

(c) Agriculture: About half of the existing tariffs and quotas will be eliminated immediately; however those for politically sensitive crops, such as U.S. corn sold to Mexico or Mexican peanuts, sugar and orange juice sold to the U.S., will be gradually phased out over the maximum period of 15 years.

Institutions

Various institutions will facilitate the implementation of the agreement. The Free Trade Commission, composed of cabinet-level representatives of each member country, will meet at least once a year to oversee the performance and evolution of NAFTA. In particular, it will supervise dispute resolution and the work of the nearly 40 committees and working groups set up under the NAFTA. At the Commission's first ministerial meeting in January of 1994, it was agreed that an International Coordinating Secretariat be established in Mexico City, with a U.S. Executive Director. This decision has yet to be implemented.

For some people, NAFTA clearly has been a success. This should not be a surprise inasmuch as it was designed to bring extraordinary government protections to a specific set of interests-investors and financiers in all three countries who search for cheaper labor and production costs. From that perspective, increased gross volumes of trade and financial flows in themselves testify to NAFTA's achievements.

But most citizens of North America do not support themselves on their investments. They work for a living. The overwhelming majority has less than a college education, has little leverage in bargaining with employers, and requires a certain degree of job security in order to achieve a minimal, decent level of living. NAFTA, while extending protections for investors, explicitly excluded any protections for working people in the form of labor standards, worker rights, and the maintenance of social investments. This imbalance inevitably undercut the hard-won social contract in all three nations.

As the three reports in this paper indicate, from the point of view of North American working people, NAFTA has thus far largely failed.

Page 48: IBE notes 1

These reports, based in part on more comprehensive labor market surveys in all three countries,1 show that the impact on workers in each nation has been different according to their circumstances. For example, given their respective sizes, the impact of economic integration has been inevitably greater in Canada and Mexico than in the United States. But despite this, there are striking similarities in the pattern of that impact.

In the United States, as economist Robert Scott details, NAFTA has eliminated some 766,000 job opportunities-primarily for non-college-educated workers in manufacturing. Contrary to what the American promoters of NAFTA promised U.S. workers, the agreement did not result in an increased trade surplus with Mexico, but the reverse. As manufacturing jobs disappeared, workers were downscaled to lower-paying, less-secure services jobs. Within manufacturing, the threat of employers to move production to Mexico proved a powerful weapon for undercutting workers' bargaining power.

Was U.S. workers' loss Mexican workers' gain? While production jobs did move to Mexico, they primarily moved to maquiladora areas just across the border. As Carlos Salas of La Red de Investigadores y Sindicalistas Para Estudios Laborales (RISEL) reports, these export platforms-in which wages, benefits, and workers' rights are deliberately suppressed-are isolated from the rest of the Mexican economy. They do not contribute much to the development of Mexican industry or its internal markets, which was the premise upon which NAFTA was sold to the Mexican people. It is therefore no surprise that compensation and working conditions for most Mexican workers have deteriorated. The share of stable, full-time jobs has shrunk, while the vast majority of new entrants to the labor market must survive in the insecure, poor-paying world of Mexico's "informal" sector.

As Bruce Campbell of the Canadian Centre for Policy Alternatives reports, Canada's increased market integration with the United States began in 1989 with the bilateral Free Trade Agreement, the precursor to NAFTA. While trade and investment flows increased dramatically, per capita income actually declined for the first seven years after the agreement. Moreover, as in Mexico and the United States, Canadians saw an upward redistribution of income to the richest 20% of Canadians, a decline in stable full-time employment, and the tearing of Canada's social safety net.

This continent-wide pattern of stagnant worker incomes, increased insecurity, and rising inequality has emerged at a time when economic conditions have been most favorable for the success of greater continental integration. The negative effect of increasing trade and investment flows has been obscured by the extraordinary consumer boom in the United States, especially during the period from 1996 through the summer of 2000. The boom, driven by the expansion of domestic consumer credit and a speculative bubble in the stock market, spilled over to Canada and Mexico. Their economies have now become extremely dependent on the capacity of U.S. consumers to continue to spend in excess of their incomes. As the air seeps out of that bubble, the cost of those nations' reliance on the U.S. consumer market is becoming apparent.

The current imbalanced structure of NAFTA is clearly inadequate for the creation of an economically sustainable and socially balanced continental economy. The experience suggests that any wider free trade agreement extended to the hemisphere that does not

Page 49: IBE notes 1

give as much priority to labor and social development as it gives to the protection of investors and financiers is not viable. Rather than attempting to spread a deeply flawed agreement to all of the Americas, the leaders of the nations of North America need to return to the drawing board and design a model of economic integration that works for the continent's working people.

SAARC

The South Asian Association for Regional Cooperation (SAARC) comprises Bangladesh, Bhutan, India, the Maldives, Nepal, Pakistan and Sri Lanka. SAARC is a manifestation of the determination of the peoples of South Asia to work together towards finding solutions to their common problems in a spirit of friendship, trust and understanding and to create an order based on mutual respect, equity and shared benefits. The main goal of the Association is to accelerate the process of economic and social development in member states, through joint action in the agreed areas of cooperation.

EVOLUTION

The idea of regional cooperation in South Asia was first mooted in November 1980. After consultations, the Foreign Secretaries of the seven countries met for the first time in Colombo, in April 1981. This was followed, a few months later, by the meeting of the Committee of the Whole, which identified five broad areas for regional cooperation. The Foreign Ministers, at their first meeting in New Delhi, in August 1983, formally launched the Integrated Programme of Action (IPA) through the adoption of the Declaration on South Asian Regional Cooperation (SARC).

At the First Summit held in Dhaka on 7-8 December 1985, the Charter establishing the South Asian Association for Regional Cooperation (SAARC) was adopted.

OBJECTIVES

The objectives, principles and general provisions, as mentioned in the SAARC Charter, are as follows :

- To promote the welfare of the peoples of South Asia and to improve their quality of life;

- To accelerate economic growth, social progress and cultural development in the region and to provide all individuals the opportunity to live in dignity and to realize their full potentials;

- To promote and strengthen collective self-reliance among the countries of South Asia;

- To contribute to mutual trust, understanding and appreciation of one another's problems;

- To promote active collaboration and mutual assistance in the economic, social, cultural, technical and scientific fields;

- To strengthen cooperation with other developing countries; - To strengthen cooperation among themselves in international forums on matters of

common interests; and

Page 50: IBE notes 1

- To cooperate with international and regional organizations with similar aims and purposes.

PRINCIPLES- Cooperation within the framework of the Association is based on respect

for the principles of sovereign equality, territorial integrity, political independence, non-interference in the internal affairs of other states and mutual benefit.

- Such cooperation is to complement and not to substitute bilateral or multilateral cooperation.

- Such cooperation should be consistent with bilateral and multilateral obligations of the member states.

- Decisions at all levels in SAARC are taken on the basis of unanimity. - Bilateral and contentious issues are excluded from its deliberations.

INTEGRATED PROGRAMME OF ACTION (IPA)

The IPA is a key component of the SAARC process and includes twelve agreed areas of cooperation, each being covered by a designated Technical Committee.

In response to the emphasis given by successive Summits on the need to further consolidate and streamline IPA and to make it more result oriented, a comprehensive set of guidelines and procedures was adopted in 1992 for the rationalization of SAARC activities. As a result of this, there is now a greater focus on activities that would bring tangible benefits to the people of South Asia.

The Secretary-General reports on the progress in the implementation of IPA to the Standing Committee, both at its inter-Summit and pre-Summit Sessions.

The Standing Committee has also taken the initiative to review the institutional mechanisms and activities of the Association, including, the evaluation of the functioning of the Technical Committees, amalgamation/alteration of their mandate and also a review of the role of the Secretariat.

Technical committee1. Agriculture (TC01)

Agriculture was among the original five areas identified for fostering regional cooperation. The first meeting of TC01 was held in 1983. Subsequently, Forestry was also included in the work of the Technical Committee. TC01 was instrumental in the setting up of SAARC Agricultural Information Centre (SAIC) at Dhaka in 1988 - the first SAARC regional institution.

Member states have been exchanging Germplasm, Breeding Materials on Livestock and Fishery in accordance with the quarantine regulations in force in their respective countries. Prototypes of Farmtools and Equipment have been exchanged for trial and adaptation. Activities for Improved Livestock through Exchange of Animals, Frozen Semen and Vaccine have also been undertaken. The responsibility of compiling lists of institutions and disciplines capable of offering training in member countries has been

Page 51: IBE notes 1

entrusted to SAIC. Rice and Wheat-breeding Programmes for enhancing productivity have been conducted while Multilocation trials for various crops are being undertaken.

Regular meetings of Counterpart Scientists is a very important feature of the Committee's programmes. The list of Counterpart Scientists in the twelve agreed areas of crops and disciplines have been finalized for networking. These are : Rice (Millet); Wheat; Oilseeds; Horticulture (Potato) Vegetables and Fruits; Fisheries; Forestry; Transfer of Technology; Livestock (Animal Health and Production); Farm Machinery and Implements; Post Harvest Technology; Agriculture Economics & Policies and Soils. Progress has been made towards establishing a network on Amelioration of Problem Soils.

The programme for the 1990s focuses on Genetic Engineering and Bio-Technology (for crop and livestock improvement, agricultural and horticultural development, embryo transfer technology for livestock and conservation of endangered germplasm); Homestead Vegetable Production; Food Availability and Nutritional Balance; Data Base on Technology and Training facilities in agricultural science within the SAARC countries; and meeting of the Expert Group on Crop Diseases. Two important project proposals namely

i) Promotion of the "Bio-Villages, and

(ii) Reaching the Million - Training of Farmers and Farm Women by 2000 A.D. have recently been completed and future course of action on these proposals is underway.

2. Communications (TC02)

TC on Telecommunications and TC on Postal Services both established in 1983 which had hitherto functioned separately were amalgamated into a single TC on Communications with effect from 1993.

With a view to bringing about an over-all improvement in the postal services in the region, the work programme in this sector included training, seminars, workshops study tours etc.

Training programmes were held for First and Middle Level Officers and for Trainers as well as in Philately, International Postal Services, International Mail Accounting and Routing, Postal Management Services and Post Office Savings Banks. Seminars / Workshops were organized on Postal Operation and future challenges, Mechanization of Postal Operations, Agency functions, Financial Services, Caring for Customer, Expedited Mail Service (EMS), Circulation System of EMS and Postal Marketing.

Study tours on Agency Services, Safety and Security of Postal Articles, Postal Services in Hilly or Rural Areas and New Mail and Financial Service in Pakistan were undertaken to gain first-hand knowledge of problems and plans for improvement of postal services.

Since 1985, Letter Writing Competitions have been held annually. Studies had been undertaken on Productivity Measurement Techniques applied in postal operations, Postal Delays in SAARC region, Integration of Postal Services with rural development and

Page 52: IBE notes 1

Concessional Mail Tariff and Mail Transmission. Other activities undertaken include issuance of commemorative stamps, postage stamp displays and philatelic exhibitions.

Within the overall objective of providing telecommunication services to majority of the rural population by the year 2000, TC02 has focused on efforts to promote technological and human resource development and management. There has been substantial progress in implementing the recommendations for the establishment of ISD, automatic telex, and bureau fax facilities, improvement of inter-country links, introduction of common collection charges and media independent tariff, adoption of SDR as common accounting unit and off-peak period tariff.

Short-term activities in Telecommunications include Seminars/Workshops on Data Transmission, Digital Switching, Network Management, Operations, Software maintenance, Trends in External Plants practice, Adoption of new technologies in rural telecommunication system, Transition from analogue to digital transmission, improvement of quality services in telecommunications, IDR satellite technology and improvement of rural telecommunications.

Training courses have also been held on new technologies for maintenance of switching systems, software development, financial management, packet switch data network and NEAX 61.

3. Education, Culture and Sports (TC03)

TC on Education (established in 1989) and TC on Sports, Arts and Culture (established in 1983) were amalgamated into a single TC on Education and Culture with effect from 1993. TC03 was renamed in 1995 as TC on Education, Culture and Sports.

The priority themes identified for cooperation in the field of Education are Women and Education; Universal Primary Education; Literacy, Post Literacy and Continuing Education; Educational Research; Science and Technical Education, Education for the Underserved Areas and Distance Education. The nominations of Nodal Agencies for each of the priority themes have been completed and appropriate Action Plans are being prepared.

Short-term activities in the field of Education include, Expert Group Meetings; Workshops/Seminars on the priority themes; Modernization of Curriculum; Environmental Education including Population Education; Planning and Management of Education, Teacher Training, Higher Education and Book Production and Marketing.

TC03 is also engaged in the improvement and expansion of the SAARC Chairs, Fellowships and Scholarships Scheme. Nodal Points for networking arrangement for sharing information on Mass Literacy Programmes have been identified. The modalities and operational framework for this purpose are being prepared.

Short term activities in the field of Culture include six South Asian Archaeological Congresses; one History Conference; Workshops / Training / Seminars on Conservation of Wall Paintings, Documentation of Musical and Oral Traditions, Archives and Photographic Exhibitions of Monuments, National Heritage and an Expert Group

Page 53: IBE notes 1

Meeting on Preservation of Monuments and Archival Materials. In the field of Arts and Exhibition of Handicrafts; Workshops on Sea Based Crafts and Artisans at Work; and SAARC Painters Camp have been held.

As part of the regional cooperation activities in Sports, Coaching Camps / Clinics have been conducted in Table Tennis, Squash, Hockey, Basketball, Swimming, Athletics and Volleyball. Training of Experts in Sparktaid has been conducted. Basketball and Football Tournaments and SAARC Marathons have been organized.

4. Environment (TC04)

The Third SAARC Summit (Kathmandu, 1987) decided to commission a study on "Causes and Consequences of Natural Disasters and the Protection and Preservation of the Environment". National Studies were undertaken and subsequently consolidated into a Regional Study, which was approved by the Sixth SAARC Summit (Colombo, 1991).

The recommendations of the above Regional Study were considered by the Committee on Environment (February 1992), which identified, for immediate action, measures for strengthening the environment management infrastructure; programmes on environmentally sound land and water use planning; research and action programme on mountain development in the Himalayan Region; coastal zone management programme; a SAARC forestry and watershed programme; programme on energy and environment; pollution control and hazardous waste management programme; a SAARC cooperative programme for biodiversity management; peoples participation in resource management; information exchange on low cost and environmentally sound habitat technologies; establishment of a SAARC relief and assistance mechanism for disaster and regional cooperation on the development of modern disaster warning systems.

A special session of the Committee on Environment (November 1992) met to evolve specific programme activities and modalities to implement the above measures.

The Fourth SAARC Summit (Islamabad, 1988) decided that a joint study be undertaken on "Greenhouse Effect and its Impact on the Region". National Studies prepared by member states were consolidated into a regional study, which was approved by the Seventh SAARC Summit (Dhaka, 1993).

The Committee on Environment was designated as the Technical Committee on Environment and included within its purview, "Greenhouse Effect and its Impact on the Region". It began functioning from January 1, 1993.

TC04 has identified measures for immediate action from among the recommendations and decided on a number of modalities for their implementation. These include, improving climate monitoring capability through networking arrangement and through SAARC Meteorological Research Centre (SMRC); developing climate change and sea-level rise scenario through country specific studies and sharing of information data in this respect; making available to member states expertise on climate research and monitoring Greenhouse Gases emission; identification of training and research institutions and

Page 54: IBE notes 1

ongoing programmes; exchange of information and data; exchange of experience on strategies for developing, mitigating and adaptive responses to climate change.

TC04 also covers topics such as Approaches to Environmental Legislations, Regulations and Standards in SAARC countries; Rehabilitation of Degraded Lands; Training Course on Wetlands Assessment and Management; Workshop on Alternate/Renewable Energy and Workshop of SAARC National Experts on Climate Change. The urgent need to establish a networking approach through identified nodal points/institutions has also been stressed.

A SAARC Environment Ministers Conference was held in New Delhi in April 1992 to evolve a joint position on the issues related to the UN Conference on Environment and Development (UNCED). SAARC also presented a common position paper to the Fourth World Conference on Natural Disaster Reduction (Yokohama, May 1994).

TCs on Environment and Meteorology will be merged and designated as TC on Environment and Meteorology with effect from 1 January 1996.

5. Health and Population Activities (TC05)

Health and Population Activities was one of the original five areas of cooperation identified by member states. The First Meeting of TC05 was held in 1984.

The primary focus of TC05 has been on children, population welfare and policy, maternal and child health, primary health care, disabled and handicapped persons, control and eradication of major diseases in the region such as malaria, leprosy, tuberculosis, diarrhea diseases, rabies, AIDS, and iodine deficiency disorder.

Important activities undertaken by TC05 include the setting up of the SAARC Tuberculosis Centre (STC), in Kathmandu in 1992, devising a standard Format for preparing the Annual Review of the Situation of Children in the SAARC region; establishment of networking arrangements for training, research and eradication of malaria and regional approach for combating major diseases in the region. A Directory of training programmes in six priority areas, i.e. malaria, tuberculosis, leprosy, diarrhea diseases, human rabies and maternal and child health have been prepared and circulated. In addition, several status papers on important subjects relating to health have been circulated among member states.

The Second SAARC Summit (Bangalore, 1986) decided that the survival, protection and development of Children should be given highest priority and directed that annual reviews be undertaken on the situation of children in SAARC countries. Such annual reviews for the years 1993 and 1994 have been completed by TC05 based on annual country reports submitted by member states. These annual reviews have indicated, inter-alia, reduction of infant mortality and significant progress in the immunization program for children in the region.

TC05 will be renamed as TC on Health, Population Activities and Child Welfare with effect from 1 January 1996.

Page 55: IBE notes 1

6. Meteorology (TC06)

Meteorology was also one of the five areas of cooperation initially identified by member states. The first meeting of TC06 was held in 1984. Since its inception, the Committee has been involved in organizing seminars/workshops in areas such as Joint Inter-Comparison of Barometers, Meteorological Instruments, Agricultural Meteorology, Numerical Weather Prediction, Crop-Weather relationship and Crop-Yield Forecast, Long Range Weather Forecasting, Radar Meteorology etc. Training programs have been conducted on Meteorological Tele-communications, Management and Establishment of National Data Centers, Monsoon Forecasting etc. State-of-the-art Reports on Western Disturbances, Tropical Cyclones including Prediction of Recurvature, Thunder Storms, Long Range Forecasting of Monsoon Rain, Short Range Prediction of Monsoon and Norwesters, Tornadoes and Water Sprouts, have been completed. Expert panels have been convened on specialized fields such as Agro-meteorology; Climatology and Data Exchange; and Instrumentation.

An Annual Regional Award is given to a young scientist or a group of scientists for a research paper on meteorological topics to encourage research in the field of Meteorology. Another Award has been introduced since 1995 for senior scientists to encourage research work in the field of Meteorology.

The programmes for 1990s identified by the Committee include, the establishment of National Data Centers, conducting studies on Meteorological aspects of Environment Pollution, establishment of Port Meteorological Offices for obtaining Data from Ocean areas. TC06 has also identified long-term measures, such as creation of a Regional Data Bank, Organization of Research Flight Facilities for probing cyclones, networking for Drifting and Anchored Buoys in Oceanic Regions, Environmental Pollution Monitoring stations, Preparation of Atlases of Meteorological Parameters and Familiarization with Computer Technology as needed for meteorological research, including visits to computer centers and cost of consumable.

TCs on Meteorology and Environment will be merged and designated as TC on Environment and Meteorology with effect from 1 January 1996.

7. Prevention of Drug Trafficking and Drug Abuse (TC07)

Since its establishment in 1987, TC07 has implemented a number of programmes in law enforcement, prevention, treatment and rehabilitation as essential elements of a coordinated regional strategy in combating drug trafficking and drug abuse. It contributed significantly towards the finalization of the SAARC Convention on Narcotic Drugs and Psychotropic Substances in November 1990, which came into force in September 1993 upon its ratification by all member states.

Cooperation among Drug Law Enforcement Agencies and Officers is being developed through short-term activities such as Seminars and Training Courses. Nodal Agencies in member states have been nominated to exchange information and intelligence on drug offences. The SAARC Drug Offences Monitoring Desk (SDOMD) has been established in Colombo to collate, analyze and disseminate information on drug offences. Efforts are afoot for further strengthening SDOMD.

Page 56: IBE notes 1

In the field of demand reduction, short-term activities such as workshops/ seminars held so far have focused on the role of media in drug abuse prevention, community mobilization against drug abuse, preventive education, school curriculum development, treatment and relapse prevention and exchange of information on indigenous and innovative methods of treatment. A networking arrangement among Nodal Institutions in drug abuse prevention is being established.

Meetings of selected NGOs involved in Drug Abuse Prevention have been held. A Directory of such Organizations has been compiled in order to promote greater interaction among them. The Colombo Plan Bureau's Project Proposal and the establishment of working relations between SAARC and the Colombo Plan Bureau were approved by the Twentieth Session of the Standing Committee. This will promote and encourage cooperation among NGOs in SAARC countries involved in anti-narcotics activities.

Efforts have been directed at promoting SAARC member states' accession to the relevant UN Conventions, conclusion of Regional and Drug Convention and harmonization and consolidation of national drug laws. A Memorandum of Understanding for cooperation between SAARC and the United Nations International Drug Control Programme (UNDCP) has been signed.

BRIC

In economics, BRIC (typically rendered as "the BRICs" or "the BRIC countries") is a grouping acronym that refers to the related economies of Brazil, Russia, India, and China.The BRIC countries met for their first official summit on 16 June 2009, in Yekaterinburg, Russia, with Luiz Inácio Lula da Silva, Dmitry Medvedev, Manmohan Singh, and Hu Jintao, the respective leaders of Brazil, Russia, India and China, all attending.The core focus of the summit was related to improving the current global economic situation and discussing how the four countries can better work together in the future, as well as a more general push to reform financial institutions. There was also discussion surrounding how developing nations, such as those members of BRIC, could be better involved in global affairs in the future. In the aftermath of the summit the BRIC nations suggested that there was a need for a new global reserve currency that is 'diversified, stable and predictable'. The statement that was released stopped short of making a direct attack on the perceived 'dominance' of the US dollar, something which the Russians have been critical of; however, it still led to a fall in the value of the dollar against other major currencies.

The foreign ministers of the BRIC countries had met previously on May 16, 2008 also in Yekaterinburg.

One week prior to the summit, Brazil offered $10 billion to the International Monetary Fund. It was the first time that the country had ever made such a loan. [ Brazil had previously received loans from the IMF and this announcement was treated as a significant demonstration of how Brazil's economic position had changed. China also announced plans to invest a total of $50.1 billion and Russia planned to invest $10 billion.

Page 57: IBE notes 1

Summit Date Host country Host leader Location held1st June 16, 2009  Russia Dmitry Medvedev Yekaterinburg2nd April 16, 2010  Brazil Luiz Inácio Lula da Silva Brasília3rd TBA  China Hu Jintao Beijing

A criticism is that the BRIC projections are based on the assumptions that resources are limitless and endlessly available when needed. In reality, many important resources currently necessary to sustain economic growth, such as oil, natural gas, coal, other fossil fuels, and uranium might soon experience a peak in production before enough renewable energy can be developed and commercialized, which might result in slower economic growth than anticipated, thus throwing off the projections and their dates. The economic emergence of the BRICs will have unpredictable consequences for the global environment. Indeed, proponents of a set carrying capacity for the Earth may argue that, given current technology, there is a finite limit to how much the BRICs can develop before exceeding the ability of the global economy to supply.

Page 58: IBE notes 1

Module 5

Corporate Social Responsibility – a definition:

A responsible business is achieving commercial success in ways that honor ethical values and respect people, communities and the natural environment. These businesses minimize any negative environmental and social impacts and maximize the positive ones.

Approaches There are several approaches to Corporate Social Responsibility (CSR) The Three-P Approach to CSR:

o Level 1: Principles of social responsibility o Level 2: Processes of social responsiveness o Level 3: Products (or Outcomes) as they relate to the firm's societal

relationships

We need to adopt these as appropriate for our business. For many of us we will only work at level one with some elements of level 2.

What does a sustainable and responsible company look like?

It is run for and can be seen to be run for the benefit of profit, people and planet. It integrates responsible business practice so that it is built in to business purpose

and strategy rather than being a bolt-on to business operations. Employees value it as a great place to work. Customers and suppliers value it as a good business to do business with. The community values it as a great neighbor. Investors and financiers value it as worth investing in. It has a good health and safety record. It has environmentally friendly premises.

 Keeping it simple and adding value:

11 simple things you can do today to apply CSR principles to your business 1. Recycle printer and toner cartridges – or use continuous ink systems 2. Buy and use fair trade products – tea, coffee, etc 3. Buy materials and from suppliers that use sustainable sources 4. Look at how your staff travel to work – walk, drive, bus, cycle etc

Page 59: IBE notes 1

5. Ensure Lights, computers and other equipment are switched off when not in use 6. Pay staff, suppliers and creditors on time 7. Turn the heating or air conditioning down a degree 8. Replace lighting with low energy bulbs – and turn off at night 9. Print and photocopy only when necessary and double-sided – only print the first

page of emails 10. Encourage support for local not-for-profit and community based organizations.

11. Set up flexible working

 Benefits for your business

The business benefits will vary depending on the business, the specific actions proposed and the effectiveness with which they are implemented. Often, the kinds of business benefits which other smaller companies have reported, include:

Attracting, retaining and developing motivated and committed employees. Winning and retaining consumers and business customers. Improving business reputation and positive publicity. Maintaining and improving their license to operate from the local community. Cost and efficiency savings. Networking and speaking opportunities. Anticipating future legislation and protecting yourself

 Why get started? The need to increase profit The need to reduce costs The personal values of the owner manager/CEO Questions being asked by large business customers Developing a new or revised business strategy Writing a business plan Newspaper/trade magazine article Talk at a local chamber of commerce or business club Employee’s suggestion High utility bills/costs

 An ACTION plan for Social Responsibility

A simple approach to introducing CSR in a structured way.

A C T I O N

Assess Commit Tell Integrate Organize Nurture

Whatever you do should berelevant

To a statement of whatbeing a

Set out your ethical andbusiness cases,

Responsible businessbehavior across

The project management, the details,  relevant business resources

Involve your clients and supply chain. Once

Page 60: IBE notes 1

for your business aswell as society.

Think about the issues that affect you, your staff and your business and what you can do to help support these.

Assess where you currently are so you have a  benchmark to measure future progress against.This may be formal or informal.

responsible businessmeans to your business andto clear ethical values fromthe top down.Appoint a champion/s toensure the commitment is followed through. You need a champion who walks the talk.The champion, like any boss,has to model the behavior they want to see in their co-workers if they are going to be credible.

They also need to be given the authority tomake any necessary changes.

communicatethem and  promote them at every opportunity.

Makeresponsible business anagenda item on all team meetings.Communicate to staff, clients,customers, suppliers andothers what you are doing.It is not boasting to tell peoplewhat you are doing. Establisheffective, two-way dialoguewith your key stakeholders(those who can affect or areaffected by your business).There are real businessbenefits to informing peoplethrough local/trade press,

differentfunctions and activities withinthe business.

Identify issues that are affecting your bottom line and how responsiblebusiness  practices can help address these.

Prioritize things which you can do as: (a) early wins; (b) things that will need to take some time to prepare; and(c) long-term goals.

List the risks that yourcompany faces or might faceand the actions you need totake to address

and set targets.

Look at one off,  individual and team building activities.Look at building a long term relationship with community organization/s.

Communicate the aims and boundaries to all staff and stakeholders.Collate the results and thank any staff for their involvement.

Make sure all staff knowabout and are ableto get involved in yourresponsible businesspractices/opportunities.

your programmes are established you can have  greater impactand raise your profile by widening your resources.

Clients and suppliers will besurprisingly grateful you asked and usually very willing to get involved.

Measure and report what you are doing and feedbackthe learning into your business  planning.Measuring the benefits youhave made to the businessand the wider community helps motivate staff, customers

Page 61: IBE notes 1

notice boards, newsletters,websites and achieving awards.

these. and investors.

Reporting can be done informally through word of mouth, staff team briefings,presentations to business networks or more formallythrough managementsystems and achieving relevant  standards.

 

If you integrate responsible business practices into the way you run your business and proactively communicate what you are doing, you not only increase your business success but the benefit to society as well.

By communicating what you do to a wider audience and by giving your business a voice, you will find that you inspire many others to do the same and your example could lead to much bigger impacts. By keeping quiet about what you do, you might be missing out, so shout about it and you might be surprised at the results.

 Effective Promotion

Promoting that you are approaching your business in a CSR way can enhance your business opportunities, doing this is one thing... telling others about it is quite another.

Internally Externally

Make sure your staff knows about what you do and can talk about it. They are your best sales force.

Use the intranet, website, newsletters, meetings, staff award schemes and community corridors

Generate positive publicity through local, regional or even national media.

Get your story into relevant trade magazines.

Tell your customers, suppliers, investors and other stakeholders

Page 62: IBE notes 1

to showcase your activities and events

what you are doing. Enter relevant award schemes. Commit to achieving relevant

standards that you can then tell people about.

Benefit from speaking opportunities that arise from your story and attend networking events.

Areas to focus on:

Policy:

Business Principles, Defining your Purpose, Innovation, Know the law, Managing risks, Measuring success, Sharing good practice

What are the theories and business principles which drive successful businesses?

Here you can dip into information on the law and its implications for your business.

There is also information about how to measure the intangibles e.g. how can you measure increased customer loyalty? Plus you'll find useful signposts and pointers as to where you can find more information on each topic.

Practice:

Better payment, Developing skills, Diversity, Equality, Health and safety, Managing resources, Marketing with a cause, Minimizing waste, Volunteering

If you want to save money through managing waste more effectively how do you go about it? What about health & safety? In a recent survey* 60% of small and medium sized business owners said that they had been asked about their practices in this area by a large corporate customer. Make sure you're one step ahead of the game and start by reading the guide to health and safety contained within this section.

Stakeholders:

Employees, Customers, Suppliers, Communities

Stakeholder is an umbrella term, which covers every group of individuals you deal with as a business.

Here we focus on four stakeholders- your employees, the community, your customers and your suppliers. By listening and talking to these groups on a regular basis you can really improve your business's reputation and it doesn't cost a fortune.

Page 63: IBE notes 1

Corporate Social Responsibility (CSR) or Corporate Responsibility is about managing your business to achieve both commercial and social benefit. In essence it's about managing your social, community and environmental impacts to help you improve results, reduce risks and enhance your reputation. It is also about growing your business in a way that has value for everyone connected to it.

Teleological and Deontological ethical theories

Ethical theories are often divided into two groups: teleological and deontological theories. One standard way of drawing the teleological/deontological distinction is in terms of how moral theories specify the relation between the two central concepts of ethics: the good and the right. The concept of the right is, roughly, the concept of duty, the concept of which actions we ought to perform, which it would be wrong not to perform. The concept of the good (the target of the theory of value, or axiolology (Greek: axios = worthy; logos = study of)) is concerned with the morally good properties of human beings, as well as states such as pleasure, and the experience of beauty, both of which are thought to be intrinsically good things.

Although different moral theories (or normative theories) embody different approaches to the concepts of the "good" and the "right," each must have something to say about these concepts and the way in which they are related. In other words, every ethical theory will propose a theory of right action and a theory of value, and explain how these theories connect up to one another. The theory of right action is an investigation and an attempt to answer the question: what ought I to do? The "ought" in this question is to be interpreted as a moral ought, and may be understood as equivalent to the question, "what is the right thing to do?" The theory of value provides an account of what things are good, what states of affairs ought to be promoted, or what we would like to have realised. These states include things such as pleasure, freedom, and knowledge.

On a standard taxonomy, moral theories divide up according to how they specify the relation between the "right" and the "good." In other words, moral theories may be classified according to how their theory of value and their theory of right relate to one another. There are, it is said, two possible ways in which the theory of value may connect up with the theory of right action. This is either a teleological connection or a not a teleological connection. The Greek word telos means goal, end, or purpose, and teleology is the study of goals, ends and purposes. A teleological connection between the theory of right and the theory of value, therefore, emphasises that morality is oriented toward bringing about a certain goal. A non-teleological connection denies this. Let us try to make this more precise:

[Def: TM] A teleological moral theory defines right action in terms of the good.

All this may seem rather technical but should become clearer by considering an example of a teleological and a non-teleological theory. Firstly, consider Classical Utilitarianism as an example of a teleological moral theory. Classical utilitarianism can be broken down into two main components: a theory of value (or the "good"), and a theory of right action. Classical Utilitarianism endorses hedonism as theory of value. Hedonism then, is meant to spell out what is good. A Classical Utilitarian would formulate this in terms of utility;

Page 64: IBE notes 1

quite literally, utility is that which is useful to human beings. Secondly, Classical Utilitarianism endorses consequentialism as a theory of right action. A theory of right action specifies what actions moral agents ought to perform; and consequentialism says that the rightness of an action is determined by its consequences. This is incipient, if not fully articulate, in Mill’s formulation of the Principle of Utility, which he regards as the fundamental moral principle: “The creed which accepts as the foundation of morals, Utility, or the Greatest Happiness Principle, holds that actions are right in proportion as they tend to promote happiness; wrong as they tend to produce the reverse of happiness.”Classical Utilitarianism is called a teleological moral theory because it defines right action in terms of the promotion of pleasure. (Pleasure, for the Classical Utilitarian, is the good.) The right action is the one which beings about (as its goal; hence the connection to telos) the most overall pleasure for everyone concerned.

Now, contrast this example of a teleological moral theory with an example of a deontological theory. A deontological theory (e.g. Kant’s) maintains that the wrongness of (some) actions is intrinsic, or resides in the kind of action that it is, rather than the consequences it brings about. So, for example, an act of killing an innocent man is wrong because it is the killing of an innocent man, rather than because it deprives someone of future happiness and causes grief to a family. So deontological theories do not define the notion of right action in terms of the promotion of good consequences. The rightness of an action is not determined by the goal it achieves, and this makes it non teleological as a moral theory.

Problems with the Teleological / Deontological Classification

This classification outlined above, while common enough, is a bit misleading for the relation between the theory of the right and the theory of value is not quite as straightforward as might initially be thought. Firstly, ancient Greek ethical theories are usually considered as teleological moralities, but do not fit easily into the above schema [Def: TM]. The above schema [Def: TM] says that a moral theory is teleological to the extent that it defines right action in terms of the promotion of good states of affairs. In shorthand, this is to say that teleological theories define the "right" in terms of the "good." To see the problem, we shall need to consider some details of ancient Greek ethics, of which, perhaps, the most well known example is Aristotle’s virtue theory.

According to Aristotle, the goal of ethics is to explain how one achieves the good life for human beings. Aristotle considers the good for man to be eudaimonia, which is most often translated as happiness. He argues that the good for man, (i.e., eudaimonia), is achieved by means of virtuous activity. Very roughly, he thinks that living virtuously is the best way of securing a happy (or eudaimon) life. His idea is that by possessing certain characteristics such as courage and wisdom, one will be equipped with the skills necessary to live well and succeed in living the best possible life one’s circumstances will permit. It is noteworthy, then, that Aristotle’s theory is based around the notion of virtue rather than right action. It is concerned foremost with the states of a good person (virtues and vices), rather than which actions are right and which are wrong. This is not to say that he neglects right action, but only that he is most centrally concerned with virtuous character.

Page 65: IBE notes 1

Now, given this brief characterisation, it is easy to see why Aristotle’s theory is usually regarded as a teleological morality. This is because Aristotle says that virtuous activity is activity which enables a person to live the good and happy life. In this respect, the concept of a virtue is that of which enables its possessor to achieve a certain goal, namely happiness. This makes it reasonable to regard Aristotle’s theory as a teleological moral theory; and much the same applies to the other Greek moral philosophers (see the article on eudaimonia).

The problem however is that the schema [Def: TM] outlined above does not include Aristotle’s theory as a teleological theory because Aristotle does not define the right in terms of the good. For him, the right action is part of virtuous action; it is the action which a virtuous person, or more particularly, a practically wise person would do. So the problem is that our criterion for a teleological morality seems to exclude Aristotle’s theory, which is generally regarded as a paradigmatic example of a teleological theory.One way of solving this problem is to relax our definition of a teleological theory somewhat. Earlier we said that a teleological theory defines the right in terms of the good. We may widen this definition by saying that a teleological theory defines normative properties in terms of the good. Normative properties include concepts such as rightness, wrongness, virtue, and praiseworthiness. This is consistent with the spirit of normative ethics since it is not exclusively concerned with the rightness of actions, but is also interested in understanding and explaining properties such as "virtuous," "praiseworthy," and "blameworthy." By broadening the schema beyond rightness, we may propose that a moral theory is teleological to the extent that it explains normative properties in general in terms of the promotion of some good. More precisely, we shall emend our earlier definition:

[Def 2: TM] A teleological moral theory defines normative properties in terms of the good.

Consider what this entails with reference to Classical Utilitarianism. Since rightness is but one normative property amongst many, this does not exclude theories which focus on right action from being teleological moral theories. So by widening the definition of teleological moral theories Classical Utilitarianims remains where it seems to belong. Secondly, a Utilitarian, while focussing primarily on right action need not ignore other normative properties such as virtue. Our definition allows the Classical Utilitarian to treat virtues teleologically by saying (e.g.) that a trait of character is to be considered a virtue to the extent that it tends to produce happiness. A trait such as courage, for example, is a virtue because of a person with courage makes everyone happier. And this coheres quite nicely with what Utilitarians (Mill for example)have said about virtue as opposed to right action.

Another advantage of [Def 2: TM] is that it also enables us to understand Aristotle’s theory as teleological in a similar way. Aristotle says that trait of character is a virtue to the extent that it contributes to the happiness (eudaimonia) of its possessor; and since virtue is normative property, we have brought Aristotle’s theory within the range of a teleological morality, where it would seem to belong.

Page 66: IBE notes 1

Finally, we should note another implication of the adoption of [Def 2: TM] as the criterion of distinction for teleological theories. The point encapsulated in [Def 2: TM] is that the category of teleological ethics need not be too concerned with actions rather than (e.g.) states of character, and normative properties in general. But this possibility of treating normative properties other than rightness teleologically entails that the proper contrast to teleological ethics is not deontological ethics; rather, deontological ethics refers to accounts of right action and therefore is best thought of as a subset of non-teleological accounts. Deontology is a non-teleological account of right action, and does not cover non-teleological accounts of (e.g.) virtuous character.

Deontological ethics recognizes a number of distinct duties, such as those proscribing the killing of innocent people (murder) and prohibitions on lying and promise breaking. Deontology maintains that the wrongness of (some) actions is intrinsic, or resides in the kind of action that it is, rather than the consequences it brings about. So, for example, an act of killing an innocent man is wrong because it is the killing of an innocent man, rather than because it deprives someone of future happiness and causes grief to a family. In this, deontological ethics is opposed to consequentialism, which defines the moral rightness of an action in terms of the consequences it brings about.

It seems fair to say the ordinary ethical thinking, at least that of the Judao-Christian religious tradition, is deontological in character. The Ten Commandments, for example, constitute a set of deontological constraints on action. The main problem for deontology is to explain just why people are prohibited from certain types of actions even when disobeying the rule is known to bring about much better consequences The Foreign Corrupt Practices Act (FCPA) is a United States federal statute known for its anti-bribery and accounting transparency provisions.  The anti-bribery provisions, which make it unlawful to bribe foreign officials, have serious implications for both Indian and U.S. companies operating in an increasingly global world.  

Although the FCPA was enacted in 1977, it was rarely enforced during the 1980s and 1990s.  Only recently has enforcement under its provisions increased, and gained widespread attention.  As the volume of cross-border transactions with the U.S. increases, Indian companies and individuals must exercise greater caution.  While it is a common misperception that the FCPA applies only to U.S. companies and individuals, its reach could potentially extend to any company or individual, whether U.S. or foreign. 

More specifically, the FCPA applies to (i) issuers, (ii) domestic concerns, (iii) officers, directors, employees or agents of issuers or domestic concerns, and (iv) foreign companies and individuals, if such companies or individuals, directly or indirectly, cause a violation to take place within the United States.  Under the FCPA, an "issuer" is defined as a corporation that has issued securities registered in the United States or that is required to file periodic reports with the U.S. Securities and Exchange Commission.  Any Indian company with shares traded on a U.S. exchange is thus subject to the FCPA's provisions. Companies like ICICI Bank, Infosys, Wipro, MTNL, Dr. Reddy's Labs, Tata Motors and, notably, Satyam, which are listed on US exchanges, fall directly under the FCPA scanner.

Page 67: IBE notes 1

A "domestic concern" under the FCPA is any individual, national, or resident of the United States, or any company which has its principal place of business in the United States, or which is organized under the laws of the United States.  Any U.S. subsidiary of an Indian company is therefore subject to the FCPA.  Further, since the FCPA applies to any officer, director, employee or agent of an issuer or a domestic concern, a U.S. subsidiary of an Indian company could be found liable for an FCPA violation for acts committed by an agent in India.  Finally, foreign companies and individuals are subject to the FCPA if they, directly or indirectly, cause a violation to take place within the territory of the United States.  Payments to foreign officials made or authorized by Indian individuals while such individuals are physically present in the United States could qualify as such a violation.  Note that this provision is extremely broad because there is no requirement that a U.S. company or individual be involved in the violation.   

Companies and individuals subject to the FCPA are prohibited from paying or offering to pay, directly or indirectly, money or "anything of value" to a foreign official, foreign political party, party official, or any candidate for foreign political office to corruptly influence the recipient in order to obtain or retain business, or direct business to any other person.  There is no materiality threshold for bribes under the FCPA and even bribes for small amounts could land a company in trouble.  The term "anything of value" has been interpreted broadly and can include, among other things, entertainment, meals, transportation, lodging, gifts, and discounts.  Similarly, the term "foreign official" applies not only to traditional government officials of any rank or position, but even to employees of state-owned entities.

While the FCPA does contain an exception for payments to facilitate or expedite the performance of a routine governmental action, this so-called "facilitating payment" exception is narrowly construed. "Routine governmental actions" include only non-discretionary actions such as obtaining permits or licenses, processing governmental papers, providing water and power supply, loading and unloading cargo etc. and do not include decisions by a foreign official to award new business or continue business with a company.  One charged with the violation of the FCPA's anti-bribery provisions could also assert that a payment is lawful under the written laws of the applicable foreign jurisdiction or that the money was spent as part of demonstrating a product or performing a contractual obligation.  The former defense is unlikely to be available for payment made in India due to Indian anti-corruption laws. The "demonstration exception" is also similarly limited in scope.

Violations of the FCPA's anti-bribery provisions can lead to substantial fines and penalties.  For instance, a company may be fined up to $2 million (Rs. 9.54 crores) per violation.  Individuals are subject to a fine of $100,000 (Rs. 47 lakhs) and imprisonment for up to five years.  Note that any fines imposed on an individual may not be paid by such individual's employer.  In addition, the market could penalize a company for an FCPA violation.  For instance, listed issuers may experience a drop in their stock price.  In an increasingly global marketplace, it is therefore critical for Indian companies to be cognizant of the FCPA's provisions, take steps to implement an effective compliance program, and seek to prevent actions that constitute violations.

Page 68: IBE notes 1

Module 6

What is Culture?

Definition: Culture has been defined a number of different ways. Culture is a system of values and norms that are shared among a group of people and that when taken together constitute a design for living.

While culture is a characteristic of society as a whole, it shapes individual behavior by identifying appropriate and inappropriate forms of human interaction.

The fundamental building blocks of culture are values and norms.

Values are abstract ideas about what a society believes to be good, right, and desirable. As was discussed earlier, values affect political and economic systems as well as culture. Values include attitudes towards concepts like freedom, honesty, loyalty, justice, responsibility, and personal relations including marriage. Values from the bedrock of ac culture. People argue, flight, even die over values such as “Freedom.”

Norms are social rules and guidelines that prescribe the appropriate behavior in particular situations. Norms shape the actions of people towards one another. Norms can be divided into folkways and mores.

Folkways are the routine conventions of everyday life, but generally have little moral significance. Examples would be dress, eating habits, and social graces. Foreigners may be easily excused for making a few faux pas. (blunder) Timeliness is a good example, when timeliness is critical (test days) as well as when one may be expected to be "fashionably late." Americans tend to arrive a few minutes early fro business appointments. When invited fro dinner at someone’s home it is considers polite to arrive on time or just a few minutes late. Typically, “American” individuals will have different concepts about lateness. In Britain when someone says” come fro dinner at 7 pm” he or she means come for dinner at 7.30 at 8 pm. The concept of time as a commodity is peculiar to Western society. Time can be spent, saved, wasted. That is quite different from many other societies, especially some areas of Latin America, where time is seen as an item to be enjoyed and savored.

Mores are more serious standards of behavior, the breaking of which may be very inappropriate or even illegal. Examples would be theft, adultery, murder, or use of mind-altering substances (including alcohol, caffeine, and marijuana). Mores can vary greatly between countries: what in one country may be viewed, as an innocent flirt in another may constitute a serious affront to someone’s dignity or even harassment. While it is acceptable, and even expected, to consume alcohol with business associates in Japan,

Page 69: IBE notes 1

where evening business contacts often border on drunkenness, such actions would be disallowed and is punishable by imprisonment in the United Arab Emirates.

Norms and values are an evolutionary product of a number of factors that are at work in a society, including political and economic philosophy, social structure, religion, language, and education. Culture affects both of these factors and is affected by them.

Culture within Nation–States

The nation-state is only a rough approximation of a culture. Within a nation-state, multiple cultures can easily exist (as we can only too painfully see in the former Yugoslavia), and cultures can also cut across national borders. That can often be easily illustrated by describing the differences that exist between people in a country. It is quite easy to get individuals in the Western US to agree that the people in New York are really different and generally rude, while people in the Eastern will comment on Californians or Southerners, etc. Likewise, individuals in Stockholm will have clear opinions about how different Swedes are from the far North or far South. In virtually any country or state people will easily be able to describe the differences between city-folks and country-folks, and some will “defend” their culture while making disparaging remarks about the other.

The determinant of culture: are political and economic philosophy, the social structure of a society, and the dominant religion, language and education.

Social Structure

The social structure of a country can be described along two major dimensions: individualism vs. group and degree of stratification into classes or castes.

Individuals and group:

A group is an association of two or more individuals who have a shred sense of identity and who interact with each other unstructured ways on the basis of common set of expectations about each other’s behavior.

While groups are found in different societies, societies differ according to the degree to which the group is viewed as the primary means of social organization. In some of societies individual attributes and achievements are viewed as being more important than group memberships while in some the opposite is true.

Individual: A focus on the individual and individual achievement is common in many Western societies. Earlier we discussed the implications of this for political and economic systems. An emphasis on individual achievement has positive and negative implications. On the positive side, the dynamism of the US economy owes much to people like Sam Walton, Steve Jobs, and Bill Gates - people, who took chances, tried new things, succeeded, and encouraged others to do likewise. They have an admiration of “rugged individualism and entrepreneurship”. On the other hand, individualism can lead to a lack of company loyalty and failure to gain company-specific knowledge, competition

Page 70: IBE notes 1

between individuals in a company rather than team building, and limitation of people’s ability to develop a strong network of contacts within a firm.

While moving from company to company may be good for individual mangers it may not be good for companies. The lack of loyalty and commitment to an individual company and the tendency to move on when a better offer comes can result in mangers, who have good general skills but lack in depth knowledge. The emphasis on individualism may make it difficult to build within an organization to perform collective tasks. If individuals are always competing with each other on the basis of individual performance, it may prove difficult for them to cooperate in group.

The group: In sharp contrast to the Western emphasis on the individual, in many Asian societies the group is the primary unit of social organization. While in earlier times the group was usually the family or the village, today the group may be a work team or business organization. In a social setting, Asian employees may often say they work for Sony, while a Western employee may say he/she is an electrical engineer. In Asia, the worth of an individual is more linked to the success of the group rather than individual achievement. This emphasis on the group may discourage job switching between firms, encourage lifetime employment systems, and lead to cooperation in solving business problems.

Some argue that competitive advantage of Japanese enterprises in the global economy is based on their ability to achieve close cooperation between individuals within a company and between companies. (Suppliers). Lifetime employment is the norm is most Japanese companies, where managers and workers build up knowledge, experience and a network of interpersonal business contacts. All these things can help managers perform their jobs more effectively and achieve cooperation with others.

On the other hand, it tends to suppress individual creativity and initiative. US may continue to be more successful than Japan at pioneering radically new products and new ways of doing business.

Social stratification:

Social categories in a society defined in the basis of characteristics such as the family background, occupation and income.

All societies have some sort of stratification, where individuals in higher strata or castes are likely to have a better education, standard of living, and work opportunities. What matters is less what these strata are, but rather the mobility between strata and the significance of strata levels for business.

The term social mobility refers to the extent to which individuals varies significantly from society to society. A caste system is closed system of stratification in which social position is usually is not possible during an individual’s lifetime. (i.e., social mobility is very limited.)

The mobility permitted by culture affects whether individuals can move up (or down) in strata, and can limit the types of jobs and education available. In the USA, individuals are

Page 71: IBE notes 1

very mobile ("anyone can become president"), in Britain, there is less mobility, and the caste system in India severely limits mobility. Despite the laws against it, the effects of the caste system in India still exist today, and are especially prevalent in the practice of people in non-urban areas.

The significance of the social strata can have important implications for the management and organization of businesses. In cultures where there is a great deal of consciousness over the class of others, the way individuals from different classes work together (i.e. management and labor) may be very prescribed and strained in some cultures (i.e. Britain), or have almost no significance in others (i.e. Japan). The class of a person may be very important in some hiring and promotion decisions, particularly in sales organizations where the person will be dealing with customers that may also come from a particular class.

Religious and Ethical Systems

Religion can be defined as a system of shared beliefs and rituals that are concerned with the realm of the sacred.

Ethical systems refer to a set of moral principles, or values, that are used to guide and shape behavior. The ethical practices of individuals within a culture are often closely intertwined with their religion. While there are literally thousands of religions worldwide, four that have the largest following are discussed: Christianity, Islam, Hinduism, and Buddhism. Confucianism, while not a religion, influences behavior and shapes culture in many parts of Asia. Refer the Map to see dominant religions across the world.

Christianity is the largest religion and is common throughout Europe, the Americas, and other countries settled by Europeans. Within Christianity, there are three major branches: Protestant, Roman Catholic, and Eastern Orthodox. At the turn of the century Max Weber suggested that is was the "Protestant work ethic”, that was the driving force of capitalism. This focus on hard work, wealth creation, and frugality encouraged capitalism while the Catholic promise of salvation in the next world did not foster the same kind of work ethic. The Protestant emphasis on individual religious freedom, in contrast to the hierarchical Catholic Church, was also consistent with the individualist economic and political philosophy discussed earlier.

Islam: with 750 million followers this is the second largest of the world’s major religions. Islam dates back to AD 610 when Prophet Mohammed began spreading the word. Muslims constitute a majority of aver 35 countries and inhabit a nearly continuous stretch of land from the north west coast of Africa , through the middle east, to china and Malaysia and far east.

Islam extends this to more of an all-embracing way of life that governs one’s being. It also prescribes many more "laws" on how people should act and live. These are laws that are entirely counter to the US "separation of church and state." In Islam, people do not own property, but only act as stewards for God and thus must take care of that with which they have been entrusted. They must use property in a righteous, socially beneficial, and prudent manner; not exploit others for their own benefit; and they have obligations to

Page 72: IBE notes 1

help the disadvantaged. Thus while Islam is supportive of business, the way business is practiced is strictly prescribed. For instance, no interest may be paid on business loans.

Hinduism: approximately 500 million followers, practiced primarily on the Indian sub-continent, over 4,000 years ago, making it the world’s oldest major religion. Hinduism focuses on the importance of achieving spiritual growth and development, which may require material and physical self-denial. Since Hindus are valued by their spiritual rather than material achievements, there is not the same work ethic or focus on entrepreneurship found in some other religions. Likewise, promotion and adding new responsibilities may not be the goal of an employee, or may be infeasible due to the employee’s caste.

Buddhism: Buddhists also stress spiritual growth and the afterlife, rather than achievement while in this world. Buddhism, practiced mainly in Southeast Asia, does not support the caste system, however, so individuals do have some mobility not found in Hinduism and can work with individuals from different classes. There are around 250 million Buddhists, most of who are found in Central and Southeast Asia, China, Korea and Japan.

Confucianism: practiced mainly in China, Korea, and Japan. This teaches the importance of attaining personal salvation through right action. Unlike religions, Confucianism is not concerned with the supernatural and has little to say about the concept of a supreme being or an afterlife. The needs for high moral and ethical conduct and loyalty to others are central in Confucianism. Three key teachings of Confucianism - loyalty, reciprocal obligations, and honesty - may all lead to a lowering of the cost of doing business in Confucian societies. The close ties between Japanese auto companies and their suppliers, called keiretsus, have been an important ingredient in the Japanese success in the auto industry. They have facilitated loyalty, reciprocal obligations, and honesty. In countries where these relationships are more adversarial and not bound by these same values, the costs of doing business are probably higher.

Language:

The language of a society allows it to communicate but also directs the attention of people towards certain features of the world and human interactions. A good example is how the Inuit (Eskimos) have 24 words for snow, but no word for the overall concept. (Powder snow, falling snow, wet snow, drifting snow etc.) Language helps describe how different people see the world.

Since language shapes the way people perceive the world, it also helps define the culture. In countries with more than one language, one also finds often more than one culture. In Canada, there is English speaking culture and a French speaking culture. Tensions between the two run often high demanding independence from a Canada“Dominated by English speakers.”

While English is clearly the language of international business, knowing at least some of the local language can greatly help when working in another country. In some situations, knowing the local language can be critical for business success. Knowledge of the local language is often taken as an indication that the businessperson is willing to meet the local firm “on its own court.”

Page 73: IBE notes 1

Unspoken language can be just as important for communication. Using a few facial expressions and hand gestures to the class can illustrate the point. The fact that these can have different interpretations in different cultures, and that many of these actions may be automatic or reflexive, obviously complicates international communication. Not only may the person you are dealing with be unintentionally sending non-verbal signals that you do not understand or find misleading, you may be unconsciously sending your own signals. For example, consider different perceptions of “personal space” in communications. Have a conversation with an individual (about sports or the weather) standing “a long distance apart” and a similar conversation with someone else with your faces only a few inches apart. Most individuals find both of these extreme, although a few reserved Midwesterners will find the long distance quite acceptable. People from different countries will also comment on their perceptions, and how distance varies with familiarity with the person.

Education

Schools, as a part of the social structure of a society, and one that individuals are exposed to in their formative years, convey many cultural values and norms. Education plays an important role as determinant of national business competitive advantage. The availability of a pool of skilled and educated human resources seems to be major determinant for the economical success of a country.

The knowledge base, training, and educational opportunities available to a country’s citizens can also give it a competitive advantage in the market and make it a more or less attractive place for expanding business. In nations that have a ready trained workforce for particular types of jobs, it is easier to start operations than in nations where an investor will also have to undertake time-consuming and costly training.

Michael Porter notes that Japan’s excellent education system was an important factor explaining the country’s post war economic success.

The general education level of a country is also a good index of the kind of products that might sell in a country and of the type of promotional material that should be used.

Although there is not a perfect correspondence between educational spending and literacy rates, a relation does exist, and spending on education does give an indication of a country’s commitment to education.

Culture and the Workplace

For an international business with operations in different countries, it is important to understand how a society’s culture impacts on the values found in the workplace. The opening and closing cases both provide examples of culture affecting the workplace.

Hofstede’s model:

The most famous study of how culture relates to values in the workplace was undertaken by Geert Hofstede. As part of his job as a psychologist working for IBM, from 1967 to

Page 74: IBE notes 1

1973, Hofstede collected data on employee attitudes and values for over 1, 00,000 individuals. This data enabled him to compare dimensions of culture across 40 countries.

Geert Hofstede made a study of IBM employees worldwide, and identified four dimensions that summarize different cultures: power distance, individualism vs. collectivism, uncertainty avoidance, and masculinity vs. femininity.

Power distance dimension focused on how a society deals with the fact that the people are unequal in physical and intellectual capabilities. According got Hofstede, high power distance cultures were found in countries that let inequalities grow over time into inequalities of power and wealth. Low power distance cultures were found in societies that tried to play down such inequalities as much as possible.

The individualism versus collectivism dimension focused on the relationship between individuals and his or her fellows. In individualistic societies, the ties between individuals were loose and individual’s achievement and freedom were highly valued. In societies where collectivism was emphasized the ties between individuals were tight. In such societies people were born into collectivists, such as extended families and everyone was supposed to look after the interests of his or her near ones.

Uncertainty avoidance dimension measured the extent to which different cultures socialized their members into accepting ambiguous situations and tolerating uncertainty. Members of high uncertainty avoidance cultures placed a premium on jib security, career patterns, and retirement benefits and so on. They also had a strong need for rules and regulations, the manager was expected to issue clearer instructions, and subordinates initiatives were highly controlled. Lower uncertainty avoidance cultures were characterized by greater readiness to take risks and less emotional resistance to change.

Masculinity Vs femininity dimension looked at the relationship between the gender roles and work roles. In masculine cultures, sex roles were sharply differentiated and traditional masculine values such as achievement and the effective exercise of power, determined cultural ideals. In feminine cultures sex roles were less sharply distinguished and little differentiation was made between men and women in the same job.

Hofstede created an index score for each of four dimensions that range from 0 to 100 and scored high for high individualism, high power distance, high uncertainty avoidance and high masculinity. He averaged the score of all employees from a given country and plotted the result scores of each country on series of graphs.

Page 75: IBE notes 1

Criticisms against the study:

First Hofstede assumes that there is a one to one correspondence between culture and the states of a country, many countries have more that one culture.

Second, the research tem was composed of Europeans and Americans. The questions and answers may have been shaped by their own cultural biases.

Third, his research worked only within a single industry, the computer industry, but also within a single company, IBM. It is possible that the values of IBM employees are different in important respects from the cultures of the countries they originally come from.

Fourth, the study, which is conducted between 1960s and 1970, may not be reasonable today, and may be outdated.

While critics have concerns about Hofstede’s methodology, and it is important not to take it all too seriously, the study does suggest what individuals should consider when doing business from individuals from another country.

Cultural Change

Culture is not a constant, but does evolve over time. What was acceptable behavior in the US in the 1960s is now considered “insensitive” or even harassment. Language and sensuality that was not allowed on Indian TV in the 1960s is now commonplace. Changes are taking place all the time. As countries become economically stronger and increase in the globalization of products bought and sold, cultural change is particularly common.

Implications for Business

Countries are so different because of cultural changes. Two important implications of international business flow from these differences. The first is to appreciate not only that cultural differences exist, but also what such differences mean for the practice of international business. The second is due to the cultural differences, the cost of doing the business in a country, and national competitive advantage may vary.

Cross cultural literacy:

Page 76: IBE notes 1

Individuals and firms must develop cross-cultural literacy. International businesses that are ill informed about the practices of another culture are unlikely to succeed in that culture. One way to develop cross-cultural literacy is to regularly rotate and transfer people internationally.

One must also beware of ethnocentric behavior, or a belief in the superiority of one’s own culture. Along with this superiority, they may develop contempt for all the other cultures. Some people have been unable to find some of the obvious weaknesses in our own culture and strengths of other cultures. Some people are unaware of the uniqueness of the culture. One good example on the uniqueness of American culture is the second free cup of coffee. It is so common in American restaurants, yet is unheard of in many European or Asian countries. People who have traveled internationally can often identify many other examples.

Culture and competitive advantage:

Cultural values can influence the costs of doing business in different countries, and ultimately the competitive advantage of the country. The text suggests some positive and negative aspects of US and Japanese culture than may have contributed to the economic success of these countries. Understanding what countries may have a competitive advantage has implications both for looking for potential competitors in world markets and for deciding where to undertake international expansion.

1. Discuss the implications of international business arising out of cultural differences between countries? (June-July 2003-10 marks)2. Discuss and evaluate Geert Hofstede’s model of culture at work place? (June-July 2003- 7 marks)3. What is social mobility and how does it affect international business? ( 3 marks)

Additional notes:

Country Risk Categories

Although by no means unanimous, many analysts agree upon six main points when working out a country risk assessment:.

IMPACT

ON

Globalists Antiglobalists

Consumers Free trade promotes lower costs and quality products.

Benefits the wealth at the expense of the poor

Employees Faster economic growth promotesHigher wages, etc.

Places profits above people

Environment Creates resources needed to address the issue

Exploits and destroys ecosystems

DevelopingNations

Promotes national economic development, higher standard of living, etc.

World financial institutions conspire to keep poor nations in debt

Human Rights

Creates cultures that support law and free expression

Corporations pursing profits ignore human rights violations

Page 77: IBE notes 1

• Economic Risk• Currency Risk• Transfer Risk• Sovereign Risk• Macro Risk• Geo-Political Risk

Economic Risk: Any noteworthy change in the economic structure, growth rate or direction that produces a material change in the expected return of your foreign investment.

Currency Risk: How your foreign investment will be affected by changes in the exchange rates. An example would be if the countries currency has to be converted into a different currency to complete an investment. Changes in the value of the currency relative to the European currency or the American dollar could affect the total loss or gain on the investment. (Also referred to as Exchange Rate Risk)

Transfer Risk: The risk associated with the possibility of a currency not being able to be sent out of the foreign country – usually due to central bank or political restrictions.

Sovereign Risk: The risk that a foreign central bank will amend it s foreign exchange regulations – either significantly reducing or completely abolishing the value of foreign exchange contracts.

Macro Risk: A type of political risk in which political actions in a foreign country can negatively affect foreign operations. Macro risk can come about from events that may – or may not be in the central government’s control.

Geo-political Risk: The risk an investment’s return could suffer as the direct result of political instability, or a change in political direction.

Risks in International Trade are the major barriers for the growth to the same. International trade has been a much debated topic. Economists have differed on the real benefits of international trade. The increase in the export market is highly beneficial to an economy, but on the other hand the increase in imports can be a threat to the economy of that country. It has been the worry of the policy makers to strike the right balance between free trade and restrictions.

International trade can develop an economy, but at the same time certain domestic players can be outperformed by financially stronger multi nationals and forced to close down or get merged. Sometimes these multinational companies become so powerful, especially in smaller countries, that they can dictate political terms to the government for their benefit.

International trade is characteristically costlier in terms of domestic trade. There are a number of reasons such as, tariffs, cost of delay, cost related to differences in legal system, etc. The factors of production like labor and capital are more mobile within the

Page 78: IBE notes 1

territories of the country than across other countries. International trade is restricted to the exchange of goods and services. It does not encourage the exchange of production factors, which may be more beneficial in certain cases. The assessment of risks in the international trade plays an important role in deciding the modes of payment to be used for the settlement between buyer and seller.

Risks in international trade can be divided under several types, such as,

Economic risks

Risk of concession in economic control Risk of insolvency of the buyer Risk of non-acceptance Risk of protracted default i.e. the failure of the buyer to pay off the due amount after six months of the due date Risk of Exchange rate

Political risks

Risk of non- renewal of import and exports licenses Risks due to war Risk of the imposition of an import ban after the delivery of the goods Surrendering of political sovereignty

Buyer Country risks

Changes in the policies of the government Exchange control regulations Lack of foreign currency Trade embargoes

Commercial risk

A bank's lack of ability to honor its responsibilities A buyer's failure pertaining to payment due to financial limitations A seller's inability to provide the required quantity or quality of goods

Others Risks

Cultural differences e.g., some cultures consider the payment of an incentive to help trading is absolutely lawful Lack of knowledge of overseas markets Language barriers Inclination to corrupt business associates Legal protection for breach of contract or non-payment is low Effects of unpredictable business environment and fluctuating exchange rates Sovereign risk - the ability of the government of a country to pay off its debts Natural risk – due to the various kinds natural catastrophes, which cannot be controlled

Page 79: IBE notes 1

Political risk is a type of risk faced by investors, corporations, and governments. It is a risk that can be understood and managed with reasoned foresight and investment.

Broadly, political risk refers to the complications businesses and governments may face as a result of what are commonly referred to as political decisions—or “any political change that alters the expected outcome and value of a given economic action by changing the probability of achieving business objectives.” . Political risk faced by firms can be defined as “the risk of a strategic, financial, or personnel loss for a firm because of such nonmarket factors as macroeconomic and social policies (fiscal, monetary, trade, investment, industrial, income, labour, and developmental), or events related to political instability (terrorism, riots, coups, civil war, and insurrection).” Portfolio investors may face similar financial losses. Moreover, governments may face complications in their ability to execute diplomatic, military or other initiatives as a result of political risk.

A low level of political risk in a given country does not necessarily correspond to a high degree of political freedom. Indeed, some of the more stable states are also the most authoritarian. Long-term assessments of political risk must account for the danger that a politically oppressive environment is only stable as long as top-down control is maintained and citizens prevented from a free exchange of ideas and goods with the outside world.

Understanding risk as part probability and part impact provides insight into political risk. For a business, the implication for political risk is that there is a measure of likelihood that political events may complicate its pursuit of earnings through direct impacts (such as taxes or fees) or indirect impacts (such as opportunity cost forgone). As a result, political risk is similar to an expected value such that the likelihood of a political event occurring may reduce the desirability of that investment by reducing its anticipated returns.

There are both macro- and micro-level political risks. Macro-level political risks have similar impacts across all foreign actors in a given location. While these are included in country risk analysis, it would be incorrect to equate macro-level political risk analysis with country risk as country risk only looks at national-level risks and also includes financial and economic risks. Micro-level risks focus on sector, firm, or project specific risk.

Macro-level political risk

Macro-level political risk looks at non-project specific risks. Macro political risks affect all participants in a given country. A common misconception is that macro-level political risk only looks at country-level political risk; however, the coupling of local, national, and regional political events often means that events at the local level may have follow-on effects for stakeholders on a macro-level. Other types of risk include government currency actions, regulatory changes, sovereign credit defaults, endemic corruption, war declarations and government composition changes. These events pose both portfolio investment and foreign direct investment risks that can change the overall suitability of a

Page 80: IBE notes 1

destination for investment. Moreover, these events pose risks that can alter the way a foreign government must conduct its affairs as well.

Research has shown that macro-level indicators can be quantified and modeled like other types of risk. For example, Eurasia Group produces a political risk index which incorporates four distinct categories of sub-risk into a calculation of macro-level political stability. This Global Political Risk Index can be found in publications like The Economist. Other companies which offer publications on macro-level political risk include Business Monitor International, Exclusive Analysis, Economist Intelligence Unit, and Political Risk Services.

Micro-level political risk

Micro-level political risks are project-specific risks. In addition to the macro political risks, companies have to pay attention to the industry and relative contribution of their firms to the local economy. An examination of these types of political risks might look at how the local political climate in a given region may impact a business endeavor. This type of risk includes project-specific government review (such as the Committee on Foreign Investment in the US (CFIUS) process in the United States), the selection of dangerous local partners with political power, and expropriation/nationalization of projects and assets.

To extend the CFIUS example above, imagine a Chinese company wished to purchase a US weapons component producer. A micro-level political risk report might include a full analysis of the CFIUS regulatory climate as it directly relates to project components and structuring, as well as analysis of congressional climate and public opinion in the US toward such a deal. This type of analysis can prove crucial in the decision-making process of a company assessing whether to pursue such a deal. For instance, Dubai Ports World suffered significant public relations damage from its attempt to purchase the US port operations of P&O, which might have been avoided with more clear understanding of the US climate at the time.

Political risk is also relevant for government project decision-making, whereby government initiatives (be they diplomatic or military or other) may be complicated as a result of political risk. Whereas political risk for business may involve understanding the host government and how its actions and attitudes can impact a business initiative, government political risk analysis requires a keen understanding of politics and policy that includes both the client government as well as the host government of the activity.

Mitigation

Companies may have a Chief Risk Officer who is charged with managing political risk or, in many cases, this job falls to the Chief Financial Officer.

At the macro-level, political risk mitigation largely involves understanding political uncertainties of the operating environment and the risks faced by all business operations in individual countries. Such information can come in the form of customized analysis or in-depth subject matter reporting; information that can enable an investor or firm to calibrate their risk appetite. Mitigation tactics involve both macro- and micro-level

Page 81: IBE notes 1

strategies. A recent article on the subject suggested that political risk mitigation should not simply revolve around the decision to enter or avoid a given country’s marketplace, but should rather center on the pragmatic usage of contingency planning, intellectual property safeguards, risk diversification, and sound exit planning to guard against uncertainty.

At the micro-level, political risk insurance and hedges play a larger role. MIGA and OPIC, both public sector insurers, provide project-specific political risk insurance while private market insurers can provide cover for projects as well as a portfolio of investments. This type of insurance usually outlines specific triggers, such as expropriation or breach of contract by a local party, which entitle the insured entity to a pay-out after relinquishing control of the insured project to the insurer. Political risk insurance, however, often involves premiums which must factor in considerable uncertainty and the threat that arbitrary decisions will affect the value of insured property. Policies therefore can be expensive and are manuscripted after extensive negotiations. An experienced and specialist broker can assess the availability of appropriate cover from private and public insurers and then, based on their experience and expertise, negotiate appropriate policies. Businesses can also purchase hedges, which could be derivative instruments, which allow them to reduce risk by selecting a level of return based on a given set of outcomes.

Political risk mitigation takes place before, during, and after an investment. Prior to investment, businesses can perform due diligence related to local partners and carefully word and structure their contracts. While a project is on-going, the investor may benefit from building local political leverage through community activities. After a risk has been realized, its effects may be mitigated through post-hoc litigation and retaliation, as well as the implementation of a previously developed contingency plan, or exit from the market.

CultureWhat is culture?

Basically, organizational culture is the personality of the organization. Culture is comprised of the assumptions, values, norms and tangible signs (artifacts) of organization members and their behaviors. Members of an organization soon come to sense the particular culture of an organization. Culture is one of those terms that's difficult to express distinctly, but everyone knows it when they sense it. For example, the culture of a large, for-profit corporation is quite different than that of a hospital which is quite different that that of a university. You can tell the culture of an organization by looking at the arrangement of furniture, what they brag about, what members wear, etc. -- similar to what you can use to get a feeling about someone's personality.

Corporate culture can be looked at as a system. Inputs include feedback from, e.g., society, professions, laws, stories, heroes, values on competition or service, etc. The process is based on our assumptions, values and norms, e.g., our values on money, time, facilities, space and people. Outputs or effects of our culture are, e.g., organizational behaviors, technologies, strategies, image, products, services, appearance, etc.

Page 82: IBE notes 1

The concept of culture is particularly important when attempting to manage organization-wide change. Practitioners are coming to realize that, despite the best-laid plans, organizational change must include not only changing structures and processes, but also changing the corporate culture as well.

There's been a great deal of literature generated over the past decade about the concept of organizational culture -- particularly in regard to learning how to change organizational culture. Organizational change efforts are rumored to fail the vast majority of the time. Usually, this failure is credited to lack of understanding about the strong role of culture and the role it plays in organizations. That's one of the reasons that many strategic planners now place as much emphasis on identifying strategic values as they do mission and vision.

Some Types of Culture

There are different types of culture just like there are different types of personality. Researcher Jeffrey Sonnenfeld identified the following four types of cultures.

Academy Culture

Employees are highly skilled and tend to stay in the organization, while working their way up the ranks. The organization provides a stable environment in which employees can development and exercise their skills. Examples are universities, hospitals, large corporations, etc.

Baseball Team Culture

Employees are "free agents" who have highly prized skills. They are in high demand and can rather easily get jobs elsewhere. This type of culture exists in fast-paced, high-risk organizations, such as investment banking, advertising, etc.

Club Culture

The most important requirement for employees in this culture is to fit into the group. Usually employees start at the bottom and stay with the organization. The organization promotes from within and highly values seniority. Examples are the military, some law firms, etc.

Fortress Culture

Employees don't know if they'll be laid off or not. These organizations often undergo massive reorganization. There are many opportunities for those with timely, specialized skills. Examples are savings and loans, large car companies, etc.Culture and its impact on international business

When the two aspects of human society, culture and business, interact with each other, it leads to the development of interesting conditions or scenarios. When different cultures converge at a common point with business as the platform, the clashes are bound to take place. But most importantly, such a scenario helps us adapt to challenging situations.

Page 83: IBE notes 1

Different communities or countries in the world follow different mannerisms and etiquette. The way or view to see a problem might change from country to country, across the globe.

The international business culture, as a whole, is a congregation of various business practices, cultural influences and the thought processes followed in different nations. The various things that impact an international business are mannerisms, communication, time, etc.

Body Language

Every nation has a separate culture; a part of which is reflected in the behavior and the body language of the people. In an international business, understanding the undercurrents beneath the mannerisms or gestures become necessary. There are chances that behavior might get misinterpreted by people from different cultures. Thus, it requires a skilled coordinator to handle challenging situations during meetings.

CommunicationThe way of communicating could be different in different cultures. The terms used by some might sound harsh to others. The way in which words are pronounced to impact the intercultural communication in the corporate houses. In fact, it is one of the major hindrance in the process of business communication.

TimePeople from Britain and Germany are keen on following the time-bound schedules. The different 'time-cultures' might be the reason behind clashes, between people from diverse cultures.

The way in which the boardroom meetings are handled, is also a reason behind differences in opinions. Corporate houses from western countries stick to the schedules during meetings. They get down to business in an outright manner. Other cultures may differ in this aspect of business.

The marketing executives sent for international assignments, are bound to face problems in dealing with the corporate cultures of that particular country. Understanding a foreign market and formulating the company policies to cater to the need of international clients is a challenging job. Skilled professionals possessing the quality called 'empathy' are able to deliver the goods in such cases.

With today's businesses entering a 'globalized' world, the interaction between different cultures is bound to happen. Merely learning different languages, won't be enough. It is necessary for corporate houses to understand the social conditions of different countries, to successfully tap the respective markets. Being sensitive to the values and beliefs of different cultures of the world, is necessary.

International businesses are not only a way of making profits by the exploitation of international talent, but also a bridge between different nations of the world. Tomorrow's

Page 84: IBE notes 1

world will rely more on a symbiotic relationship between international businesses and cultures as a whole.


Recommended