prikshit IB

8/8/2019 prikshit IB

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INTRODUCTION TO INTERNATIONAL BUSINESS

The beverages you drink might be produced in India, but with the collaboration of a USA company. The

tea you drink is prepared from the tea powder produced in Sri Lanka.

The spares and hard disk of the computer you operate might have been produced in the United States

of America.

The perfume you apply might have been produced in France. The television you watch might have been

produced with the Japanese technology. The shoe you wear might have been produced in Taiwan, but

remarketed by an Italian company. Air France and so on so forth might have provided your air travel

services to you.

You get all these even without visiting or knowing the country of the company where they are produced.

All these activities have become a reality due to the operations and activities of international business.

Thus,

International business is the process of focusing on the resources of the globe and objectives of the

organizations on global business opportunities and threats.

Evolution of International Business

The term international business was not in existence

before two decades.

The term international business has emerged from the term international marketing, which in turn,

emerged from the term export marketing

International Trade to International Marketing:

Originally, the producers used to export their products to the nearby countries and gradually extended

the exports to far-off countries.

Gradually, the companies extended the operations beyond trade. For example, India used to export raw

cotton, raw jute and iron ore during the early 1900s.

The massive industrialization in the country enabled us to export jute products, cotton garments and

steel during 1960s.

International Marketing to International Business:


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The multinational companies which were producing the products in their home countries and marketing

them in various foreign countries before 1980s, started locating their plants and other manufacturing

facilities in foreign/host countries.

Later, they started producing in one foreign country and marketing in other foreign countries. For

example, Uni Lever established its subsidiary company in India, i.e., Hindustan Lever Limited (HLL). HLL

produces its products in India and markets them in Bangladesh, Sri Lanka, Nepal etc.

Thus, the scope of the

International trade is expanded into

International marketing and

International marketing is expanded into

International business.

Stages of Internationalization

The internationalization process generally includes fives stages.

Domestic company,

International company,

Multinational company,

Global company ,and

Transnational company

Stage 1: Domestic Company

Domestic company limits its operations, mission and vision to the national political boundaries. These

companies focus its view on the domestic market opportunities, domestic suppliers,

domestic financial companies, domestic customers etc.

These companies analyze the national environment of the

country, formulate the strategies to exploit the opportunities

offered by the environment. The domestic companies unconscious

motto is that, if its not happening in the home country,

Stage 2: International Company

Some of the domestic companies, which grow beyond their

production and/or domestic marketing capacities, think of

internationalizing their operations.


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Those companies who decide to exploit the opportunities outside the domestic country are the stage

two companies.

These companies remain ethnocentric or domestic country oriented. These companies believe that the

practices adopted in domestic business, the people and products of domestic business are superior to

those of other countries.

Stage: 3 Multinational Company

Sooner or later, the international companies learn that the

extension strategy (i.e., extending the domestic product, price and promotion to foreign markets) will

not work.

The best example is that Toyota exported Toyo pet cars produced for Japan in Japan to USA in 1957.

Toyo pet was not successful in USA. Toyota could not sell these cars in USA as they were over priced,

underpowered and built like tanks.

Thus these cars were not suitable for the US markets. The unsold cars were shipped back to Japan.

This statue of multinational company is also referred to as

multidomestic.

Multidomestic company formulates different strategies for different markets; thus, the orientation

shifts from

ethnocentric to polycentric. Under polycentric orientation the offices /branches/subsidiaries of a

multinational company work like domestic company in each country where they operate with distinct

policies and strategies suitable to that country concerned.

Thus they operate like a domestic company of the

country concerned in each of their markets.

Stage 4: Global Company

A global company is the one, which has either global marketing strategy or a 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.

Stage 5:Fransnational Company

Transnational company produces, markets, invests and operates across the world.


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It is an integrated global enterprise which links global resources with global markets at profit.

There is no pure transnational corporation. However, most of the transnational companies satisfy many

of the characteristics of a global corporation.

INTERNATIONAL BUSINESS APPROACHES

International business approaches are similar to the stages of internationalization or globalization.

Douglas Wind and Pelmutter advocated four approaches of international business.

They are:

1) Ethnocentric

2) Polycentric

3) Regiocentric

4) Geocentric

Ethnocentric Approach

The domestic companies normally formulate their strategies. Their product design and their operations

towards the national markets, customers and competitors. But, the excessive production more than the

demand for the product, either due to competition or due to changes in customer preferences push the

company to export the excessive production to foreign countries.

The domestic company continues the exports to the

foreign countries and views the foreign markets as an extension to the domestic markets just like a new

region

Polycentric Approach

The domestic companies, which are exporting to foreign

countries using the ethnocentric approach, find at the latter stage that the foreign markets need an

altogether different approach. .

Then, the company establishes a foreign subsidiary company and decentralists all the operations and

delegates decision making and policy-making authority to its executives.

Regiocentric Approach

The company after operating successfully in a foreign country, thinks of exporting to the neighboring

countries of the host country.


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At this stage, the foreign subsidiary considers the regions environment (for example, Asian environment

like laws, culture, policies etc.) for formulating policies and strategies.

However, it markets more or less the same product

Geocentric approach

Under this approach, the entire world is just like a single country for the company. They select the

employees from the entire globe and operate with a number of subsidiaries.

The headquarter coordinates the activities of the subsidiaries. Each subsidiary functions like an

independent and autonomous company in formulating policies, strategies, product design, human

resource policies, operations etc.

International Business Environment

I.B.E. refers to a set of external factors that affects the operation of business firm.

Since they are external to business firm and management does not have any control over them.

A firm involved in international business is exposed to the business environment in the national as well

as foreign countries/markets.

National Environment means Home country Environment

Foreign Environment means Host country Environment

Major component of the environment faced by a firm engaged in International Business are:

1) Cultural Environment

2) Political, Legal Environment

3) Economic Environment

Cultural Environment

A System of learned behavior pattern based on shared meaning, norms, tradintions,values, beliefs, that

have evolved among the member of the society.

Cultural may be :

Enduring- Passed down through generations

Dynamic- Changing with new experience & advancement

Learned Since birth people observe others

International business is differ from Domestic business business due to different culture system and to

execute business at international level knowledge of culture is essential.

Elements of Culture:-

1) Language Vehicle of communication.


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a) Verbal Trough words either written or spoken.

b) Non verbal It is used to learn the hidden language

c) Physical Distance

d) Kinesics Body Language Eye Contact, handshakes

Religion

A System of faith in the supernatural and determine a person values, lifestyle etc.

It affect the way people interact each other and with people in other societies.

1) Attitude towards business

2) Holidays and gifting

3) Role of women

4) Product and Services

5) Marketing Practices

Values and Attitude

Values are enduring belief of a group about:

What is Good?

What is Right?

What is Desirable?

Attitude refers to a thinking of person about what he likes or dislikes.

Culture differ due to different value system Like western culture/values/Indian culture/values

Customs and Manner

Custom refers to a accepted way of behavior.

Doing things in a Society

Manners The way of doing something in the Society

Aesthetics

It refers to a artistic taste of the culture.

It reflects in the arts ,color ,form ,music ,literature of the people of a particular culture.

As a thing of beauty may be consider vulgar in other country.

Education


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Education play a important role in the society. it influence may aspect of culture. formal education

supplements the role of family in the societys values and norms.

Social Structure

Social Structure consists 2 aspects: 1) Individual Vs

2) Social Stratification

I Vs G:- Some country focus on Individual or some focus on

Group.

S.s.:- Strata refers different types into which a society is

divided based on income,education,occupation,caste

Economic Environment

Economic System:- Economic system classified on the basis of ownership and control of the factor ofproduction of the economy. the factor of production are land,labour ,capital.

They may be owned and control by the government fall under Public Sector.Individual and other non

government organization owning resources fall under private sector.

Types of Economic System

Capitalistic:- In which the resources are owned and controlled by the private sector.

Socialistic:- In which the resources are owned and controlled by the government.

Mixed :- In which the resources are owned and controlled by both the government and private people.

Elements of Economic Environment

1) Economic Growth Rate.

2) Human Resource.

3) Market Size. (Population)

4) Expectancy and Age Groups.

5) Urban Rural Orientation

6) Public Debt

7) Fiscal Policy

8) Monetary Policy

9) Per Capita Income


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10)National Income

11)Inflation Rates

12)Export Policy.

13) Import Policy.

14) Balance of Payment.15) Financial System.

16) Consumption Level.

17) Income.

18) Foreign Direct Investment Policy.

19) Industrial Policy.

20) Infrastructure Facilities.

Political and Legal Environment

Political environment of a country is provided by the system of government, the policies pursued by

state and the stability of the government.

Legal Environment is the judiciary system with its set of laws of the country that has direct and indirect

Influence on the operation of the business firm in the country.

Legal Environment is the offshoot of the Political environment since the authority to frame the law

vested with the government.

Political Environment

Political environment influence the business firm, domestically as well as internationally.

Since the political environment different in each country, the I.B. Manager should aware of the political

system of the home country as well as host country.

From the point of view of business manager, the following aspects of the political environment are

important :

1) Political System

2) International political relations

3) Relation between government and business

4) Political Stability.

Political System


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Political system means the type of government in the country and there are 2 types:

1) Democracy

2) Totalitarianism

DemocracyA System of government in which people, directly or indirectly through elected representatives, take

part in decision making.

Totalitarianism

A System of government by an individual or a party with no participation in the decision making by the

citizens. It may be of different types:

Communism

In this government owns all property and makes all decisions regarding production and distribution of

goods and services.

Theocratic IN this system are the authority vests to religious group, party or leader.

Tribal In this system a political party that represent the interest of a particular tribes rules the country

Secular In this system the total control vets to the military or we can say military controls the

government

International Political relations

The political relation between the two countries also determine the trade between the courtiers.

There may be friendly or animosity relation between the countries due to historical reasons or political

reasons. Affinity between the countries encourage the trade and if the relation strained the trade

between countries may not be encouraged.

Relation between government and business

The firm has to comply with the rules and regulation of both the home as well as host country

government.

For the host country government , permitting foreign firm to have business with the country or

establishing operation in the country may be means of achieving objectives like increase

investment,production,employment etc.

The government may be manufacturer or producer in the same business therefore the relation between

the government and the foreign firm is that of may be cooperation as well as competition.

Political Stability

The major risk in political environment is political stability.

The policies framed by a government may be aside by a subsequent government.


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Political Risk

The loss that a firm engaged in international business is likely to suffer due to changes in the political

environment. It may be associated with the home country or host country.

Home environment

Sanctions

Embargoes

Export Control

Antibotcott

Antitrust Laws

Anticorruption

Antibribery

Host environment

Ownership Risk

Operation Risk

Transfer Risk

LEGAL ENVIRONMENT

The legal environment in international business comprises three interlinked sets of national

laws,regioanl laws and international laws.

So it is necessary for the firm who operates internationally to know about all these laws.

Legal System :- 1) Common Law

2) Civil Law

3) Theocratic Law

Legal Jurisdiction

Legal Jurisdiction specifies the area with in which a legal authority can exercise its powers.

International business is governed by the different national laws and international laws.

PoliticalRisk

Home

Environment

Host

Environment


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So the firm is subject to the laws of home country as well as host country and sometimes to the laws of

third country.

Laws relevant to I.B.

Contract Law

Intellectual Property rights

Patent

Copyrights

Trade mark

Product Liability Laws

International Treaties

International Conventions

International Agreements

Modes of entry

A Firm convinced about the need to go international has to choose the methods by which it can

accomplish it.

In the beginning it may like to taste water by taking least efforts and risk by being a indirect exporter.

after gaining experience ,it may progress further from indirect export to direct export and ultimately to

owning a subsidiary abroad.

Different Modes

From the point of presence in foreign market or country, the different modes of entry into international

business are as follows:

1) Exporting

a) Indirect Exporting

b) Direct Exporting

1) Overseas operation without equity investment

2) Overseas operation with equity investment

Export


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Exporting refers to selling in other country products produced domestically.

Export may be either :

Direct Export: where the sale is made to a distributor or customer in the importing country.

Indirect Export:

The sale is made through an intermediary located in the home country.

Direct Export

Direct export falls under two categories:

Manufacturer Exporter:-They export goods Manufactured in their own factory.

Merchant Exporter:- They receive orders on their names, get the goods manufactured by others and

execute the orders.

Indirect Exports

In this, Firm participate in international business through an intermediaries and does not deal with theforeign customers or distributors. Although the firms product are sold in the foreign market.

Indirect Export may be a chance occurrence or a planned activity carried out through intermediaries.

1) Chance Export

2) Export Intermediaries abroad.

3) Piggyback Exporting

Chance Export

The firms Product may land in foreign countries with out the knowledge of the firm.

For instance, A MNC executing a project in the domestic country may procure the firms product as a

apart of the project.

Export Intermediaries Abroad

Intermediary agencies specializing in export render

useful services to manufacturer by taking over all

or some of the responsibilities of market research,

financing,transport,documentation etc.thereby

enabling the manufacturer to concentrate on their

core activities.

1) Export management companies.

2) Trading companies.


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Export Intermediaries in India

In India Exporting facilities are provided by

Merchant Exporter:- They procure the orders from abroad their names, outsource the product from

the suppliers and export them.

Export Houses:- These are the giant organizations and render varied expertise services to supporting

manufacturers.

State Corporations:- The Govt. also taken initiative in forming corporations to promote the export from

India.

Piggyback Exporting

In this ,manufacturer uses the distribution channel of another firm to sell the product in the foreign

market.

The firm whose product are thus sold is the rider

The firm which distribute the product is the carrier

Overseas operations without Equity investment

The Firms product may be produced abroad without the firm setting up a permanent organization

there.

The Production may be done by other firms In the host country under contractual agreement with the

firm or the firm may itself indulge in the establishing facilities for a specific period.

It mat take place in following form:

1)Contractual Production:- Licensing & Franchising.

2) Own Production:- Management Contract & Turnkey Project

Licensing

Under the ,Licensing arrangement ,the owner of an intangible property (licensor), such as

patent,copyright,design,trade mark,authorises another entity (licensee) to use the Property for a

specific Period.

As consideration, the licensee pays royalty to the licensor.

At the expiry of the period, the arrangement may be renewed or terminated as per mutual consent of

the parties.

A firm with technology, know how or brand image can use the licensing arrangement to enters into the

foreign market/international business and improve the profits with out capital investment.

Franchising

Franchising is a special form of licensing with greater role franchisor than that of the licensor.


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Franchise is an arrangement whereby the franchisor grants rights to other entity to use its property

or to do business in a prescribed manner.

In return, the franchisor receives the royalty at an agreed percentage of franchisees revenue.

Always remember ,

licensing adopted mainly for ,manufacturing firms

where as, Franchising adopted for Service Firms

Management Contract

Under management contract, a firm undertakes to manage the operations of a foreign entity for a

specific eriod for a fees, without involving in its ownership.

The firm deputes its personnel for the period of contract.

The fees may be based on the volumes rather than Profits.

An Experienced firm in the field may be approached by new firm in another country for management

contract.

Overseas operation with Equity Investment

The final stage in international business in the firm establishing

permanent organization abroad.

It may be own the new organization fully or joint in the partnership with other firm in the host country.

It may be in the following form-

1) Joint Venture

2) Wholly owned subsidiary

Joint Venture

A joint venture is a firm jointly owned by two or more otherwise independent firm.Each participating

firm contributes to the equity and shares the risk. The contribution to the equity may be in the form of

cash, machinery or technology.

The extent of control depends on the extent of participation in equity.

The number of partners need not be 2 it can be 3 or more.

Wholly Owned Subsidiary

In a w.o.s. , the firm acquires 100 percent of the equity.

It can be done by two ways:

Green Field Strategy:- by setting up new venture or operation in the host country.


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Acquisition:- The firm may acquire an existing firm in the host country.

Choice of mode of entry

Its all depends upon:-

1)

Size of the firm

2) Resources of the firm

3) Reputation of the firm

4) Risk taking capacity of the firm

5) Cost factor

6) Time factor

7) Political environment

8) Government factors.continues

INTERNATIONAL TRADE THEORIES

Mercantilism

The first theory of international trade emerged in England in

the mid-16th century. Referred to as mercantilism, its principle assertion was gold and silver were the

mainstays of national wealth and essential to vigorous commerce. At that time, gold and silver were the

currency of trade between countries;

A country could earn gold and silver by exporting goods. By the same token, importing goods from

other countries. The main tenet of mercantilism was that it was in a countrys to maintain a trade


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surplus, to export more than it imported. By doing so, a country would accumulate gold and silver and,

consequently, increase its national wealth and prestige.

As the English mercantilist writer Thomas Mun put it in 163

The flaw with mercantilism was that it viewed trade as a zero game.

(A zero-sum game is one in which a gain by one country

results in a loss by another.)

It was left to Adam Smith and David Ricardo to show the shortsightedness of this approach and to

demon-strate that trade is a positive sum game,

or a

situation in which all countries can benefit.

Absolute Cost Advantage

In his 1776 landmark book The Wealth of Nations, Adam Smith attacked the mercantilist assumption

that trade is a zero sum game. Smith argued that countries differ in their ability to produce goods

efficiently. In his time, the English, by virtue of their superior manufacturing processes, were the worlds

most efficient textile manufacturers. Due to the combination of favorable climate, good soils, and

accumulated expertise, the French had the worlds most efficient wine industry. The English had an

absolute advantage in the production of textiles, while the French had an absolute advantage in the

production of wine.

Thus, a country has an absolute advantage in the production of a product when it is more efficient than

any other country in producing it.

According to Smith, countries should specialize in the production of goods for which they have anabsolute advantage and then trade these for goods produced by other countries.

In Smiths time, this suggested that the English should specialize in the production of textiles while the

French should specialize in the production of wine. England could get all the wine it needed by selling its

textiles to France and buy-ing wine in exchange. Similarly, France could get all the textiles it needed by

selling wine to England and buying textiles in exchange.

that you should never produce goods at home that you can buy at a lower cost from other countries.

Smith demonstrates that by specializing in the production of goods in which each has an absolute

advantage both countries benefit by engaging in trade

Absolute Advantage and the Gains from Trade

Resources Required to Produce 1 Kg of rice and Tea

rice Tea

Ghana 10 20


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South Korea 40 10

Production and Consumption without Tread

Tea Rice

Ghana 10.0 5

South Korea 2.5 10.0

Total production 12.5 15.0

Production with specialization

Tea Rice

Ghana 20 0

South Korea 0 20

Total production 20 20

Comparative Cost Advantage

David Ricardo took Adam Smiths theory one step further by exploring what might happen when one

country has an absolute advantage in the production of all goods. Smiths theory of absolute advantage

suggests that such a country might derive no benefits from international trade. In his 1817 book

Principles of Political Economy, Ricardo showed that this was not the case.

According to Ricardos theory of comparative advantage, it makes sense for a country to specialize in the

production of those goods that it produces most efficiently and to buy the goods that it produces less

efficiently from other countries, even if this means buying goods from other countries that it could

produce more efficiently itself.

Production Possibilities in Comparative Advantage

that labour,land and capital are constant, Each country has 100 unit of resource:

Name of country Tea Rice

India 10 10

Japan 5 4

Japan has an absolute cost advantage in production of both tea and rice.

With out Trade

The Country uses half of resources per product when there is no foreign trade.

Name of Country Tea Rice

India 50/10=5 50/10=5


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Japan 50/5=10 50/4=12.5

Total Production 15 17.5

With Trade: Tea Rice

India 100/10=10 0

Japan 0 100/4=25

In this theory,

Ricardo focus on the fact that in a case,

If a country has absolute cost advantage to produce both the product ,then also if the advantageous

country concentrates on utilizing its more resources for production of one product and exporting it to

the disadvantage country. so that the disadvantage country can utilize all its resources on production of

one product in the international level.

Limitations

1) Both assume that there are only 2 countries and 2 goods.

2) No Transport Costs.

3) Difference in prices of resources in different countries.

4) Resource are move from one country to other countries.

5) Each countries has a fixed cost of resources.

6) Effects of trade on income distribution with in a country.

7) Nothing about exchange rates.

Theory of country size

This theory says that countries with large size or areas are apt to have varied climates and an

assortment of natural resources, making them more self sufficient that smaller countries.

Countries with large economies and high per capita income are more likely to produce goods that use

technology requiring long production runs, to be competitive in foreign markets.


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BALANCE OF PAYMENT

Balance of Payment of a country is one of the important indicators for International trade, which

significantly affect the economic policies of a government.

As every country strives to a have a favorable balance of payments, the trends in, and the position of,

the balance of payments will significantly influence the nature and types of regulation of export and

import business

Balance of Payments is a systematic and summary record of a countrys economic and financial

transactions with the rest of the world over a period of time.

Balance of payment is the systematic record of economic transactions of the residents of country with

the rest of world during a specific period of time, normally a financial year.

Features

Economic transactions

The statement is a summary of economic records/transactions of the country with the

outsiders.

An economic transaction arises when values are exchanged or moved between nations. These are:

1) Movement of goods ( export and Import)

2) Rendering a services.

3) Gifts and Grants.

4) Investment made Abroad.

5) Income on Investment.


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Residents with non residents

Generally transactions takes place between the residents of other country with residents of other

countries are recorded in B.O.P.

Residents mean Individuals, Institutions, Government, etc.

A Flow Statement

A B.O.P is a compilation of the flow of economic transactions of the country during the period.

Its a Fund flow of a country not a balance sheet

Periodicity

Normally a balance of payment statement is prepared covering a period of 1 year. How ever depending

on the government it may be for a period of 6 months, quarter or even a month.

Balance of Trade and Balance of Payments

The Balance of Trade takes into account only the transactions arising out of the exports and imports of

the visible terms; it does not consider the exchange of invisible terms such as the services rendered by

shipping, insurance and banking; payment of interest, and dividend; expenditure by tourists, etc.

The balance of payments takes into account the exchange of both the visible and invisible terms. Hence,

the balance of

payments presents a better picture of a countrys economic and financial transactions with the rest of

the world than the balance of trade.

Nature of Balance of Payments Accounting

The transactions that fall under Balance of Payments are recorded in the standard double-entry book-

keeping form, under which each international transaction undertaken by the country results in a credit

entry and a debit entry of equal size,

As the international transactions are record in the double-entry book-keeping form, the balance of

payments must always balance, i.e., the total amount of debits must equal the total amount of credits.

Sometimes, the balancing item, error and omissions, must be added to balance the balance of

payments.

Accounting used for recording business transactions recognizes that every transaction has two aspects.

A sale for instance, result in the inflow of cash and outflow of goods for the business concern.

In accounting concern, Inflow of value is recorded as debit and outflow as credit.

This is known as Double Entry System.

Credit is indicated by the arithmetic sign ( +) and represent outflow of real assets ( export) from the

country or incur liability abroad or decrease foreign assets.


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Debitis indicated by the arithmetic sign ( -) and represent the inflow of real assets (import) into the

country or decrease in foreign liability or increase in foreign assets.

Components of Balance of Payments

Balance of Payments is generally grouped under the following heads

i) Current Account

ii) Capital Account

iii) Unilateral Payments Account

iv) Official Settlement Account

Current Account

The Current Account includes all transactions which give rise to or use up national income.

The Current Account consists of two major items, namely:

i) Merchandise exports and imports, and

ii) Invisible exports and imports.

Merchandise exports, i.e., the sale of goods abroad, are credit entries because all transactions giving rise

to monetary claims on foreigners represent credits.

On the other hand,

Merchandise imports, i.e., purchase of goods from abroad, are debit entries because all transactions

giving rise to foreign money claims on the home country represent debits.

Merchandise imports and exports form the most important international transaction of most of the

countries.

Invisible exports, i.e., sales of services, are credit entries.

invisible imports, i.e. purchases of services, are debit entries.

Important invisible exports include the sale abroad of such services as transport, insurance, etc., foreign

tourist expenditure abroad and income paid on loans and investments (by foreigners) in the home

country form the important invisible entries on the debit side.

Capital Account

The Capital Account consists of short- terms and long-term capital transactions


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A capital outflow represents a debit and a capital inflow represents a credit.

For instance, if an American firm invests Rs.100 million in India, this transaction will be represented as a

debit in the US balance of payments and a credit in the balance of payments of India.

The payment of interest on loans and dividend payments are recorded in the Current Account, since

they are really payments for the services of capital.

As has already been mentioned above, the interest paid on loans given by foreigners of dividend on

foreign investments in the home country are debits.

For the home country, while, on the other hand, the interest received on loans given abroad and

dividends on investments abroad are credit.

Unilateral Transfers Account

Unilateral transfers is another terms for gifts. These unilateral transfers include private remittances,

government grants, disaster relief, etc.

Unilateral payments received from abroad are credits and those made abroad are debits.

Official Settlements Accounts

Official reserves represent the holdings by the government or official agencies of the means of payment

that are generally accepted for the settlement of international claims.

Balance of Payments Disequilibrium

The balance of payments of a country is said to be in equilibrium when the demand for foreign exchange

is exactly equivalent to the supply of it.

The balance of payments is in disequilibrium when there is either a surplus or a deficit in the balance ofpayments.

When there is a deficit in the balance of payments, the demand for foreign exchange exceeds the

demand for it.

Disequilibrium may be of 3 types:

It may be of 3 types:

Surplus B.O.P.:- Export > Import

Equal B.O.P.:- Export = Import

Deficit B.O.P.:- Export < Import


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A number of factors may cause disequilibrium in the balance of payments. These various causes may be

broadly categorized into:

y Economic factors ;

y Political factors; andy Sociological factors

Economic Factors : A number of economic factors may

cause disequilibrium in the balance of

payments. These are

:

Development Disequilibrium

Large-scale development expenditures usually increase the

purchasing power, aggregate demand and prices, resulting in substantially large imports. The

development disequilibrium is common in developing countries, because the above factors, and large-

scale capital goods imports needed for carrying out the various development

Capital Disequilibrium

Cyclical fluctuations in general business activity are one of the prominent reasons for the balance of

payments disequilibrium.

As Lawrence W. Towle points out, depression always brings about a drastic shrinkage in world trade,

while prosperity stimulates it. A country enjoying a boom all by itself ordinarily experiences more rapidgrowth in its imports than its exports, while the opposite is true of other countries. But production in

the other countries will be activated as a result of the increased exports to the boom country

Secular Disequilibrium

Sometimes, the balance of payments disequilibrium persists for a long time because of certain secular

trends in the economy.

For instance, in a developed country, the disposable income is generally very high and, therefore, the

aggregate demand, too, is very high. At the same time, production costs are very high because of the

higher wages. This naturally results in higher prices.

These two factors high aggregate demand and higher domestic prices may result in the imports being

much higher than the exports. This could be one of the reasons for the persistent balance of payments

deficits of the USA.

Structural Disequilibrium


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Structural changes in the economy may also cause balance of payments disequilibrium. Such structural

changes include the development of alternative sources of supply, the development of better

substitutes, the exhaustion of productive resources, the changes in transport routes and costs, etc.

Political Factors

Certain political factors may also produce a balance of payments disequilibrium.

For instance, a country plagued with political instability may experience large capital outflows,

inadequacy of domestic investment and production, etc. These factors may,sometimes, cause

disequilibrium in the balance of payments.

Further, factors like war, changes in world trade routes, etc., may also produce balance of payments

difficulties

Social Factors

Certain social factors influence the balance of payments.

For instance, changes in tastes, preferences, fashions, etc. may affect imports and exports and thereby

affect the balance of payments.

Determinants of Investment

What factors determine the selection of the location of Foreign Direct Investment and trade?

World Investment Report1998set forth three sets of factors in the host country as determinants of trade

and investment They are reproduce Below:


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1- Policy Framework for F.D.I.

y Economic Stability

y Political Stability

y Social Stability

y Rules and regulation regarding Entry and Operation

y Standards of treatment of foreign Affiliates

y Policies on functioning and market structure

y International agreement on F.D.I.

y Globalization Policy

y Trade Policy (Tariffs and Non Tariffs barriers)

y Tax Policy

2- Economic Determinants

A- Market Seeking

y Market size

y Per capita income

y Market growth

y Access to regional and global market

y Country specific consumer preferences

y Structure of market

B- Resource / assets Seeking

y Raw material

y Low cost unskilled labor Skilled Labor

y Technological Assets

y Physical Infrastructure

C-Efficiency Seeking:-

y Cost of resources

y Cost of Assets

y Productivity of Labor Resources

y Other Inputs Costs (Transports, Communication)

y Regional Corporate networks

3-Business Facilitation

Investment Promotion Investment Image Building

Investment Incentives

Hassle Cost

After Investment Services

TRADE BARRIERS


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The main objectives of imposing trade barriers are

y To protect domestic industries from foreign competition,

y To guard against dumping,

y To promote indigenous research and development,

y To conserve the foreign exchange resources of the

ycountry,

y To make the balance of payments position more

y favorable, and

y To discriminate against certain countries

y Trade barriers may be broadly classified into

y Tariff Barriers

y Non tariff barriers.

Tariffs

Tariffs in international trade refer to the duties or taxes imposed on internationally traded

commodities when they cross the national borders.

Classification of Tariffs

There are different ways of classifying the tariffs.

(i) On the basis of the origin and destination of the goods crossing the national boundary,

Tariffs may be classified into the following three categories:

Export Duties

An export duty is a tax imposed on a commodity originating from the duty-levying country destined for

some other country.

Import duties

An import duty is a tax imposed on a commodity originating abroad and destined for the duty-levying

country.

Transit Duties

A transit duty is a tax imposed on a commodity crossing the national frontier originating from, and

destined for, other countries.

Ad-Valorem Duties

Ad-valorem duties are levied as a fixed percentage of the value of commodity imported/exported. Thus,

while the specific duty is based on the quantum of commodity imported/ exported, the ad-valorem duty

is based on the value of the commodity imported/exported.

Compound Duties

When a commodity is subject to both specific and ad-valorem duties, the tariff is generally referred to as

compound duty


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iii) With respect to its application between different countries, the tariff system may be classified into

following three types.

Single Column Tariff

The single-column, also known as the uni-linear, tariff system provides a uniform rate of duty for all like

commodities without making any discrimination between countries.

Double Column Tariff

Under the double-column tariff system, there are two rates of duty on some or on all commodities.

Thus, the double column tariff discriminates between countries

Triple-Column Tariff

The triple-column tariff system consists of three autonomously determined tariff schedules the

general, the intermediate and the preferential.

The general and intermediate rates are similar to the maximum and minimum rates mentioned above

under the double-column tariff systems.

The preferential rate is generally applied in trade between the mother country and the colonies

iv) With reference to the purpose they serve, tariffs may

be classified into the following categories.

Revenue Tariff

Sometimes the main intention of the government in imposing a tariff may be to obtain revenue. When

raising revenue is the primary motive, the rates of duty are generally low, lest imports should be highly

discouraged, defeating the objective of mobilizing revenue for the government.

Revenue tariffs tend to fall on articles of mass consumption.

Protective Tariff

Protective tariff is intended primarily, to accord protection to domestic industries from foreign

competition.

Naturally, the rates of duty tend to be very high in this case because generally, only high rates of duty

curtail imports to a significant extent.

Countervailing and Anti-Dumping Duties

Countervailing duties may be imposed on certain imports when they have been subsidized by foreign

governments.

Antidumping duties are applied to imports which are dumped on the domestic market at prices either

below their cost of production or substantially lower than their domestic prices.

Impact of Tariff


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Tariffs affect on economy in different ways. An import duty generally has the following effect:

(i) Protective Effect

An import duty is likely to increase the price of imported goods. This increase in the price of imports is

likely to reduce imports and increase the demand for domestic goods. Import duties may also enable

domestic industries to absorb higher production costs. Thus, as a result of the production accorded bytariffs, domestic industries are able to expand their output.

(ii) Consumption Effect

The increase in prices resulting from the levy of import duty usually reduces the consumption capacity

of the people.

(iii) Redistribution Effect

If the import duty causes and increase in the price of domestically produced goods, it amounts to

redistribution of income between the consumers and producers in favor of the producers. Further, a

part of the consumer income is transferred to the exchequer by means of the tariffs.

iv) Revenue Effect

As mentioned above, a tariff means increased revenue for the government (unless, of course, the rate of

tariff is so prohibitive that it completely stops the import of the commodity subject to the tariff).

(v) Income and Employment Effect

The tariff may cause a switchover from spending on foreign goods to spending on domestic goods. Thishigher spending within the country may cause an expansion in domestic income and employment.

vi) Competitive Effect

The competitive effect on the tariff is, in fact, an anti-competitive effect in the sense that the protection

of domestic industries against foreign competition may enable the domestic industries to obtain

monopoly power with all its associated evils.

(vii) Term of Trade Effect

In a bid to maintain the previous level of imports to the tariff imposing country, if the exporter reduces

his prices, the tariff-imposing country is able to get imports at a lower price. This wills, ceteris paribus,

improve the terms of trade of the country imposing the tariff

vii) Balance of Payments Effect

Tariffs, by reducing the volume of imports, may help the country to improve its balance of payments

position.

Non-Tariff Barriers


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Non-tariff barriers (NTBs), many of which are described as new protectionism measures (as against

tariffs which are regarded as traditional barriers), have grown considerably.

According to a World Bank study, NTBs in major industrial countries affect more than one-third of

imports from developing countries, compared to more than one-fourth from all countries.

NTBs are of two categories,

Firstly, there are those which are generally used by developing countries to prevent foreign exchange

outflows or result from their chosen strategy of economic development.

These include import licensing, foreign exchange regulations, canalization of imports etc.

The second category of NTBs is those which are used by developed economies to protect domestic

industries which have lost international competitiveness and/or which are politically sensitive for

government of these countries.

The NTBs are less transparent, difficult to Identify and their impacts on exporting countries are almost

impossible to quantify.

The following are some of the important non-tariff barriers.

Voluntary Export Restraints

Voluntary Export Restraints (VERs) are bilateral arrangements instituted to restrain the rapid growth of

exports of specific manufactured goods.

The United States and the European Community have thus regulated the imports of several products

Administered Protection

Administered protection encompasses a wide range of bureaucratic government actions, which have

grown in absolute as well as relative importance over the last decade or more.

Most recent VERs are in fact regarded as the outgrowth of administered protection actions.

1) Health and Product Standards

2) Customs Procedures

3) Counselor Formalities

4) Licensing

5) Government Procedures

6) Government Procurement

7) State Trading


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8) Monetary Controls

9) Environment Protection Laws

10) Foreign Exchange Laws

Quantitative Restrictions Quotas

Quantitative restrictions or quotas are an important means of restricting imports and exports. A quota

represents a ceiling on the physical volume of the import/export of a commodity.

Types of Import Quota

There are four important types of import quotas, including import licensing. These are

i) TariffQuota

A tariff quota combines the features of the tariff as well as of the quota. Under a tariff Quota the

imports of a commodity up to a specified volume are allowed duty free or at a special low rate; but any

imports in excess of this limit are subject to duty-a higher rate of duty.

(ii) Unilateral Quota

In a unilateral quota, a country unilaterally fixes a ceiling on the quantity of the import of particular

commodity.

iii) Bilateral Quota

A bilateral quota results from negotiations between the importing country and a particular supplier

country, or between the importing country and export groups with in the supplier country.

(iv) Mixing Quota

Under the mixing quota, the producers are obliged to utilize domestic raw materials up to a certain

proportion in the production of a finished product.

Import Licensing

Quota regulations are generally administered by means of

import licensing. In India, for instance, the import of almost

all the items is prohibited except under, and in accordance with, a license or a customs clearance permit

issued under the Imports (Control) Order, 1955, or an Open General License issued by the Government

or under any other provision under the above order.


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Under the import licensing system, the prospective importers are obliged to obtain a license from the

licensing authorities: the possession of an import license is necessary to obtain the foreign exchange to

pay for the imports

Impact ofQuotas

Like fiscal controls, the quantitative restrictions on imports have a number of effects on the economy.The following are, in general , the important economic effects of quotas:

(i) Balance of Payments Effect

As quotas enable a country to restrict the aggregate imports within specified limits, quotas are helpful in

improving its balance of payments position

ii) Price Effect

As quotas limit the total supply, they may cause an increase in domestic prices.

(iii) Consumption Effect

If quotas lead to an increase in prices, people may be constrained to reduce their consumption of the

commodity subject to quotas or some other commodities

ii) Price Effect

As quotas limit the total supply, they may cause an increase in domestic prices.

(iii) Consumption Effect

If quotas lead to an increase in prices, people may be constrained to reduce their consumption of the

commodity subject to quotas or some other commodities

(iv) Protective Effect

By guarding domestic industries against foreign competition to some extent, quotas encourage the

expansion of domestic industries.

(v) Redistributive Effect

Quotas also have a redistributive effect if the fall in supply due to important restrictions enables the

domestic producers to raise prices. The rise in prices will result in the redistribution of income between

the producers and consumers in favor of the producers

(vi) Revenue Effect

Quotas may have revenue effect. The government may obtain some revenue by charging a license fee.

Trading Blocks


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Trading Blocks are the associations of countries situated in a particular region whereby they come on to

a common understanding regarding rules and regulations to be followed while exporting and importing

goods among them.

Such blocks have liberal rules for member countries while a separate set of rules is laid for non-

members.

For example, European Union (EU),

Association of South East Asian Nations (ASEAN).

Definition Trading Blocs

According to this definition, a trading bloc is defined by four characteristics, it:

1) Participates in a special trade relationship established by a formal agreement that promotes and

facilitates trade within that group of countries in preference to trade with outside nations by

discriminating against nonmembers;

2) Has attained or has as a stated goal the deepening of trade liberalization or integration with the

objective of establishing a free trade area, customs union, or common market;

3) Strives to reach common positions in negotiations with third countries, with other trade blocs,

or in multilateral forums; and

4) Attempts to coordinate national economic policies to minimize disruption to intra bloc economic

transactions

Why T.B. Created

Trading blocs are created because according to the theory of comparative advantage, countries

should specialize in producing those goods in which they have a comparative advantage;

That is, those goods that they have a lower opportunity cost of production than other nations.

By specializing in the production of these goods, a group of nations as a whole can produce, and

therefore consume, a greater quantity of each product.

However, as countries become more specialized in the

production of goods, it becomes necessary to trade with

countries that need these goods or that have resources that are not available in that nation.

Due to this factor, as nations become more specialized, they also become increasingly

dependent on their trading partners.

Furthermore, since smaller countries with fewer resources and land are generally less powerful

than larger nations, the need arises to develop economic alliances to gain buying and selling

power. Hence, trading blocs arise

Types of Trading Blocks

Trading Blocs can be classified on the basis of the degree of integration among differenteconomies ;-

Free Trade Areas

Customs Unions

Common Market

Political Unions

Economic Union


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(a) Free Trade Area :-

This is the simple form of economic integration which provides for internal free trade between member

countries.

Each member is allowed to determine its own commercial policy with respect to non-members.

For example, Latin American Free Trade Association

(Lafta), North American Free Trade Area (Nafta) between the USA, Canada and Mexico; Asia Pacific

Economic Cooperation (APEC

Customs Union :-

A customs union is a more advanced form of economic integration which not only provides for internal

free trade between the member countries but also adopts a uniform commercial policy against the

nonmembers.

The countries will be represented at trade negotiations with organizations such as the World Trade

Organization by supra-national organizations e.g. the European Union. For example, European Economic

Community (EEC).

Common Market :-

A common market allows free movement of labor and capital within the common market in addition to

having free movement of goods between the member countries and having common commercial policy

is respect to non-members.

Economic Union :-

This is a common market where the level of integration is more developed. The member states may

adopt common economic policies e.g. the Common Agricultural Policy (CAP) of the European Union.

They may have a fixed exchange rate, they may have integrated further and have a single common

currency.

This will involve common monetary policy. For example, the European Union (EU) has introduced a

common currency Euro 2000.

) Political Union :-

Political union is the ultimate type of economic integration whereby member countries achieve not only

monetary and fiscal integration but also political

integration.

For example, the Europe Union (EU) is moving towards a political union similar to one created by 52

states of America.


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Dynamic Advantages of Joining a Trading Bloc

oAccess to larger markets leads to internal economies of scale.

o External economies of scale due to improved infrastructure (e.g. transport and

telecoms links)

o Greater international bargaining power.

o Increased competition between members.

o More rapid spread of technology

Dynamic Disadvantages of Joining a Trading Bloc

o Country may lose resources to more efficient members, or to geographical centre, and

become depressed region.

o Firms may co-operate, collude and merge, leading to greater monopoly power.

o Diseconomies of scale if firms become very large.

o High administrative costs of trading bloc.

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