1. What are the various method to entry in the foreign market?

Ans:

The decision of how to enter a foreign market can have a significant impact on the results. Expansion into foreign markets can be achieved via the following four mechanisms:

Exporting Licensing

Joint Venture

Direct Investment

Exporting

Exporting is the marketing and direct sale of domestically-produced goods in another country. Exporting is a traditional and well-established method of reaching foreign markets. Since exporting does not require that the goods be produced in the target country, no investment in foreign production facilities is required. Most of the costs associated with exporting take the form of marketing expenses.

Exporting commonly requires coordination among four players:

Exporter Importer

Transport provider

Government

Licensing

Licensing essentially permits a company in the target country to use the property of the licensor. Such property usually is intangible, such as trademarks, patents, and production techniques. The licensee pays a fee in exchange for the rights to use the intangible property and possibly for technical assistance.

Because little investment on the part of the licensor is required, licensing has the potential to provide a very large ROI. However, because the licensee produces and markets the product, potential returns from manufacturing and marketing activities may be lost.

Joint Venture

There are five common objectives in a joint venture: market entry, risk/reward sharing, technology sharing and joint product development, and conforming to government regulations. Other benefits include political connections and distribution channel access that may depend on relationships.

Such alliances often are favorable when:

the partners' strategic goals converge while their competitive goals diverge; the partners' size, market power, and resources are small compared to the industry

leaders; and

partners' are able to learn from one another while limiting access to their own proprietary skills.

The key issues to consider in a joint venture are ownership, control, length of agreement, pricing, technology transfer, local firm capabilities and resources, and government intentions.

Potential problems include:

conflict over asymmetric new investments mistrust over proprietary knowledge

performance ambiguity - how to split the pie

lack of parent firm support

cultural clashes

if, how, and when to terminate the relationship

Joint ventures have conflicting pressures to cooperate and compete:

Strategic imperative: the partners want to maximize the advantage gained for the joint venture, but they also want to maximize their own competitive position.

The joint venture attempts to develop shared resources, but each firm wants to develop and protect its own proprietary resources.

The joint venture is controlled through negotiations and coordination processes, while each firm would like to have hierarchical control.

Foreign Direct Investment

Foreign direct investment (FDI) is the direct ownership of facilities in the target country. It involves the transfer of resources including capital, technology, and personnel. Direct foreign investment may be made through the acquisition of an existing entity or the establishment of a new enterprise.

Direct ownership provides a high degree of control in the operations and the ability to better know the consumers and competitive environment. However, it requires a high level of resources and a high degree of commitment.

The Case of EuroDisney

Different modes of entry may be more appropriate under different circumstances, and the mode of entry is an important factor in the success of the project. Walt Disney Co. faced the challenge of building a theme park in Europe. Disney's mode of entry in Japan had been licensing. However, the firm chose direct investment in its European theme park, owning 49% with the remaining 51% held publicly.

Besides the mode of entry, another important element in Disney's decision was exactly where in Europe to locate. There are many factors in the site selection decision, and a company carefully must define and evaluate the criteria for choosing a location. The problems with the EuroDisney project illustrate that even if a company has been successful in the past, as Disney had been with its California, Florida, and Tokyo theme parks, future success is not guaranteed, especially when moving into a different country and culture. The appropriate adjustments for national differences always should be made.

Comparision of Market Entry Options

The following table provides a summary of the possible modes of foreign market entry:

Comparison of Foreign Market Entry Modes

Mode Conditions Favoring this Mode

Advantages Disadvantages

Exporting

Limited sales potential in target country; little product adaptation required

Distribution channels close to plants

High target country production costs

Liberal import policies

High political risk

Minimizes risk and investment.

Speed of entry

Maximizes scale; uses existing facilities.

Trade barriers & tariffs add to costs.

Transport costs

Limits access to local information

Company viewed as an outsider

Licensing Import and investment barriers

Legal protection possible in

Minimizes risk and investment.

Lack of control over use of assets.

target environment.

Low sales potential in target country.

Large cultural distance

Licensee lacks ability to become a competitor.

Speed of entry

Able to circumvent trade barriers

High ROI

Licensee may become competitor.

Knowledge spillovers

License period is limited

Joint Ventures

Import barriers

Large cultural distance

Assets cannot be fairly priced

High sales potential

Some political risk

Government restrictions on foreign ownership

Local company can provide skills, resources, distribution network, brand name, etc.

Overcomes ownership restrictions and cultural distance

Combines resources of 2 companies.

Potential for learning

Viewed as insider

Less investment required

Difficult to manage

Dilution of control

Greater risk than exporting a & licensing

Knowledge spillovers

Partner may become a competitor.

Direct Investment

Import barriers

Small cultural distance

Assets cannot be fairly priced

High sales potential

Low political risk

Greater knowledge of local market

Can better apply specialized skills

Minimizes knowledge spillover

Can be viewed as an insider

Higher risk than other modes

Requires more resources and commitment

May be difficult to manage the local resources.

Feedback

2. What are various environmental factors that affect International Business?

Ans:

A company that chooses to implement an international project is obligated to conduct a thorough research in order to understand if such project is viable and can be brought to life in a certain country. Numerous factors have to be taken into consideration and investigated; it has to be done objectively from the point of view of the host country in which business will be performed. Thus the home company can ensure the realization of the project in specified terms with regards to projected profits and spending funds.

While analyzing foreign environment companies have to pay close attention to various factors that will effect, or help if used efficiently, future success of business in a new economy. First of all it is necessary to carefully examine the firm’s competitive position and understand if a project is able to bring profit in the global industry. Adequate financial resources, successful global ventures in the past, risk levels that a company is able to undertake and growing international demand are those few questions that need to posed before a firm can make any projections as to doing business abroad. There are also factors that are directly connected to specific projects and situations and that influence the outcome of the venture and have to be considered.

In case when a company is ready to start international project in terms of its internal situation, it has to study issues and challenges that are caused by macro economical and other environmental factors. Legal and political factors are essential for the implementation of the project abroad and each country has its own laws and regulations that could be of negative or positive influence which greatly depends on the nature of business. Economic condition of the host county is a core issue in deciding where and when project will be carried out and if it is feasible at all. Such environmental issues as GDP, inflation fluctuations and population growth have to be considered in order to comprehend conditions in which business will operate. Infrastructure and geography are among other factors that will affect the project or not allow its execution in case a host county has severe weather conditions or undeveloped infrastructure; for instance unpaved roads and no electrical power can easily fail the project in the very beginning and thus knowing such conditions is necessary. Security of the country in which project will be developed is essential as well, people make things happen and if they are in a dangerous environment it is priory impossible to do business. Workers who are knowledgeable about cultural differences in a host country are more likely

to perform successfully as traditions and holidays can play a huge role in certain marketing campaigns and serve for the good image of the company.

Working in a foreign country requires a great deal of preparation and assessment of all possible differences that the business is about to encounter. As was already said, major role in deciding whether or not the project will be successful is comprehending macro environment of a new country. Studying its economical condition, security levels and infrastructure system is a core competence of a company who wants to be more successful that its competitors. In case when all of those factors are studied and considered advantageous for a new enterprise, it is important to bear in mind that cultural differences can make all efforts void. Thus businesses must attentively analyze what changes have to be made in the business plan and what people are best suit for its implementation. Often, companies hire professionals already experienced in such ventures with foreign education who speak two or more languages. Those intermediaries who are familiar with host country’s traditions and have social connections are great helpers in establishing a good image of the company abroad and in avoiding mistakes in a setting up period.

Selecting and training employees for the international project is very important for the future success of the company. Culture shock and coping with it are issues that have to be addressed to potential workers. Consequently firms need to inform and train employees on how to cope with cultural diversities and benefit from them to better manage in the new environment.

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3. Give ten reasons why FDI is beneficial to developing Economy?

Ans:

Foreign direct investment (FDI) was founded by Aziz Mahdi and is a measure of foreign ownership of productive assets, such as factories, mines and land. Increasing foreign investment can be used as one measure of growing economic globalization.

A foreign direct investor may be classified in any sector of the economy and could be any one of the following:

an individual;

a group of related individuals;

an incorporated or unincorporated entity;

a public company or private company;

a group of related enterprises;

a government body;

an estate (law), trust or other societal organisation; or

any combination of the above.

Foreign direct investment (FDI) policies play a major role in the economic growth of developing countries around the world. Attracting FDI inflows with conductive policies has therefore become a key battleground in the emerging markets.

Developed countries also seek to bring in more FDI and use various policies and incentives to attract overseas investors, particularly for capital-intensive industries and advanced technology.

The primary aim of these policies is to create a friendly business environment where foreign investors feel comfortable with the legal and financial framework of the country, and have the potential to reap profits from economically viable businesses. The prospect of new growth opportunities and outsized profits encourages large capital inflows across a range of industry and opportunity types.

IN INDIA

(FDI) in India has played an important role in the development of the Indian economy. FDI in India has - in a lot of ways - enabled India to achieve a certain degree of financial stability, growth and development. This money has allowed India to focus on the areas that may have needed economic attention, and address the various problems that continue to challenge the country.

India has continually sought to attract FDI from the world’s major investors. In 1998 and 1999, the Indian national government announced a number of reforms designed to encourage FDI and present a favorable scenario for investors.

FDI investments are permitted through financial collaborations, through private equity or preferential allotments, by way of capital markets through Euro issues, and in joint ventures. FDI is not permitted in the arms, nuclear, railway, coal & lignite or mining industries.

A number of projects have been announced in areas such as electricity generation, distribution and transmission, as well as the development of roads and highways, with opportunities for foreign investors.

The Indian national government also provided permission to FDIs to provide up to 100% of the financing required for the construction of bridges and tunnels, but with a limit on foreign equity of INR 1,500 crores, approximately $352.5m.

Currently, FDI is allowed in financial services, including the growing credit card business. These services include the non-banking financial services sector. Foreign investors can buy up to 40% of the equity in private banks, although there is condition that stipulates that these banks must be multilateral financial organizations. Up to 45% of the shares of companies in the global mobile personal communication by satellite services (GMPCSS) sector can also be purchased.

By 2004, India received $5.3 billion in FDI, big growth compared to previous years, but less than 10% of the $60.6 billion that flowed into China. Why does India, with a stable democracy and a smoother approval process, lag so far behind China in FDI amounts?

Although the Chinese approval process is complex, it includes both national and regional approval in the same process.

Federal democracy is perversely an impediment for India. Local authorities are not part of the approvals process and have their own rights, and this often leads to projects getting bogged down in red tape and bureaucracy. India actually receives less than half the FDI that the federal government approves.

INVESTMENT BY NON RESIDENT INDIANS & OVERSEAS CORPORATE BODIES

For all sectors, excluding those falling under Government approval, NRIs (which alsoincludes PIOs) and OCBs (an overseas corporate body means a company or other entity owned directly or indirectly to the extent of at least 60% by NRIs) are eligible to bring investment through the automatic route of RBI. All other proposals, which do not fulfil any

or, all of the criteria for automatic approval are considered by the Government through the FIPB (Foreign Investment Promotion Board).

The NRIs and OCBs are allowed to invest in housing and real estate development sector, in which foreign direct investment is not permitted. They are allowed to hold up to 100 percent equity in civil aviation sector in which otherwise foreign equity only up to 40 per cent is permitted.

BENEFITS OF FDI:

Economic growth- This is one of the major sectors, which is enormously benefited from foreign direct investment. A remarkable inflow of FDI in various industrial units in India has boosted the economic life of country.

Trade- Foreign Direct Investments have opened a wide spectrum of opportunities in the trading of goods and services in India both in terms of import and export production. Products of superior quality are manufactured by various industries in India due to greater amount of FDI inflows in the country.

Employment and skill levels- FDI has also ensured a number of employment opportunities by aiding the setting up of industrial units in various corners of India.

Technology diffusion and knowledge transfer- FDI apparently helps in the outsourcing of knowledge from India especially in the Information Technology sector. It helps in developing the know-how process in India in terms of enhancing the technological advancement in India.

Linkages and spillover to domestic firms- Various foreign firms are now occupying a position in the Indian market through Joint Ventures and collaboration concerns. The maximum amount of the profits gained by the foreign firms through these joint ventures is spent on the Indian market.

DISADVANTAGES OF FDI:

At times it has been observed that certain foreign policies are adopted that are not appreciated by the workers of the recipient country. Foreign direct investment, at times, is also disadvantageous for the ones who are making the investmentthemselves.

Foreign direct investment may entail high travel and communications expenses. The differences of language and culture that exist between the country of the investor and the host country could also pose problems in case of foreign direct investment.

Yet another major disadvantage of foreign direct investment is that there is a chance that a company may lose out on its ownership to an overseas company. This has often caused many companies to approach foreign direct investment with a certain amount of caution.

At times it has been observed that there is considerable instability in a particular geographical region. This causes a lot of inconvenience to the investor.

CURRENT EVENTS RELATED TO FDI:

IAF Vice Chief Air Marshal P K Barbora said that private industry's participation be increased in the defence sector and India should be "bold enough" to allow more FDI in the area.

The Foreign Investment Promotion Board has rejected a proposal by the Jaipur IPL Cricket Pvt to induct 100% foreign equity by issuing shares for a non-cash consideration. While approving 17 foreign direct investment proposals worth Rs 1,159 crore at its October 30 meet.

The FIPB, will refer foreign investments in sensitive sectors to a committee of secretaries. The panel will have representatives from various government departments. The crucial difference will be that the committee will be time bound and will have specific parameters to weigh the risks.

The Textiles Minister, Mr Dayanidhi Maran, has said there is an urgent need to attract and sustain foreign direct investment in the textiles sector if India is to achieve the goals of employment generation and technology upgradation, besides attaining four per cent share in the global trade in textiles and clothing.

Feedback:

4. Discuss the FDI climate

between India, China and

Vietnam.

Ans:

FDI Climate between India, China and Vietnam

FDI or Foreign Direct

Investment is any form of

investment that earns

interest in enterprises

which function outside of the

domestic territory of the

investor

Types:

1) Outward FDI: An outward-bound FDI is backed by the government against all

PARAMETER India

FDI IN 2008-0923885 $

How to enter Through financial alliance

Through joint schemes and technical alliance

Through capital markets, via Euro issues

Through private placements or preferential allotments

Sectors in which

100% equity is allowed

Hotel & tourism Trading companies Power generation/

transmission/distribution

Drugs & Pharma Shipping Deep Sea Fishing Oil Exploration Housing and Real Estate

Development Highways, Bridges and

Ports Sick Industrial Units Industries Requiring

Compulsory Licensing Industries Reserved for

Small Scale Sector100% is not allowed

Private banking (49%) Insurance (26%) Telecommunication

(49% / 74 %) Retail (51% in single

brand)FDI not at all allowed

Arms and ammunition

Atomic Energy

Coal and lignite

Rail Transport

Mining of metals like iron, manganese, chrome, gypsum, sulfur, gold, diamonds, copper, zinc

Highest FDI is in which sector?

Financial & Non-Financial services (22%)

types of associated risks. This form of FDI is subject to tax incentives as well as disincentives of various forms

2) Inward FDI: Here, investment of foreign capital occurs in local resources.3) Vertical FDI: It takes place when a multinational corporation owns some shares of a foreign

enterprise, which supplies input for it or uses the output produced by the MNC. 4) Horizontal FDI: It happens when a multinational company carries out a similar business

operation in different nations.

I] CLIMATE IN INDIA : Several factors being attributed to the revival in foreign direct investments (FDI) in the country include liberal investment policies and reforms, innovative and technologically advanced products being manufactured in India and low cost and effective solutions. FDI equity inflows amounting to US$ 10.532 billion were received during April-July 2009. The largest FDI of US$ 153.31 million will be brought in by Essel Group-promoted DTH service provider. India is targeting annual foreign direct investments worth $50 billion by 2012. It would double the inflows by 2017. The government has approved 17 (FDI) proposals amounting to US$ 250.56 million. Among those projects approved were FDI applications for steel maker ArcelorMittal and iron pipe maker Electrosteel Castings. With the government planning more liberalisation measures across a broad range of sectors and continued investor interest, the inflow of FDI into India is likely to further accelerate.

II]CLIMATE IN CHINA: The top sources of FDI in China in 2008 were: Hong Kong, the British Virgin Islands, Singapore, Japan, the Cayman Islands, South Korea, the United States, Western Samoa, and Taiwan.

The growth rate of foreign direct investment (FDI) into China accelerated to 23% in 2008 to $92.3 billion, according to Ministry of Commerce statistics. According to the United Nations Conference on Trade and Development (UNCTAD), in 2007, mainland China was the world’s sixth largest FDI recipient, after the United States, the United Kingdom, France, Canada, and the Netherlands. China also received the most votes in a 2007 UNCTAD poll of attractive investment destinations, followed by India, the United States, Russia, Brazil, and Vietnam.

While FDI in China shot higher, investors continued to face a range of potential problems that could expose them to risks in the future. Problems foreign investors face in China include lack of transparency, inconsistently enforced laws and regulations, weak IPR protection, corruption, industrial policies that protect and promote local firms, and an unreliable legal system. In 2008, China continued to lay out a legal and regulatory framework granting it the authority to restrict foreign investment that it deems not to be in China’s national interest. In many ways, the new rules, codify standards and practices that China was already employing in its existing, mandatory foreign investment approval process. Key terms and standards in the new regulations are undefined. At the moment, China appears to be using the rules to restrict foreign investments that are:

intended to profit from currency speculation; in sectors where the government is trying to tamp down aggregate capital inflows

and inflation; in sectors where China is seeking to cultivate “national champions;” in sectors that have benefited historically from state-authorized monopolies or from

a legacy of state investment; in sectors deemed key to social stability, like foodstuffs and heavily polluting

industries; and nominally “foreign” investment that is actually Chinese capital that has been

exported and re-imported to take advantage of preferential treatment accorded to foreigners.

Although it remains to be seen how many of these rules will be applied, they present several concerns to foreign investors. First, they appear to give regulators significant discretion to shield inefficient or monopolistic enterprises from foreign competition. They are also often applied in a manner that is not transparent. Finally, overall predictability for foreign investors has suffered because investors are less certain that China will approve proposed investment projects. Some areas where investment is restricted are news agencies radio and TV transmission networks, film production, publication and importation of press and audio-visual products, compulsory basic education, mining and processing of certain minerals, processing of green and “special” tea using Chinese traditional crafts and preparation of Chinese traditional medicine

At the end of 2008, in response to the weakening economy, China announced a stimulus package that includes fiscal stimulus, business tax cuts, and support for priority sectors that may present foreign investors with new opportunities. China offers preferences for investments in sectors it seeks to develop, including transportation, communications, energy, metallurgy, construction materials, machinery, chemicals, pharmaceuticals, medical equipment, environmental protection, energy conservation, and electronics. Finally, China boasts numerous national science parks, many focused on commercializing research developed in Chinese universities. The parks provide infrastructure, management and funding support for start-ups across a variety of industries, and welcome foreign firms.

Investment Guidelines

While insisting it remains open to inward investment, China’s leadership has also stated that China is actively seeking to target investment in higher value-added sectors, including high technology research and development, advanced manufacturing, energy efficiency, and modern agriculture and services, rather than basic manufacturing. China would also seek to spread the benefits of foreign investment beyond China’s more wealthy coastal areas by encouraging multinationals to establish regional headquarters and operations in Central, Western, and Northeastern China.

Distribution of Foreign Investment

The vast majority of foreign investment is concentrated in China's more prosperous coastal areas, including Guangdong, Jiangsu, Fujian, and Shandong provinces, and Shanghai. Foreign investment in most service sectors lags manufacturing, mainly due to government-imposed restrictions. China is committed to gradually phasing out barriers in many service industries, but progress has been slow

Dispute Settlement

Foreign firms report inconsistent results with all of China’s dispute settlement mechanisms, none of which are independent of the government. The government often intervenes in disputes. Corruption may also influence local court decisions and local officials may disregard the judgments of domestic courts. Well-connected local business people are often in a better position to win court cases than are foreign investors and it is possible that they may use their connections to avoid prosecution for taking illegal actions against their former foreign partners. China’s legal system rarely enforces foreign court judgments

As the economy has slowed, there have been anecdotal reports of local governments singling out foreign investors, clients, and partners of Chinese businesses to repay debts incurred by local businesses

III] CLIMATE IN VIETNAM

Vietnam has seen a vertical surge in its FDI inflows in the recent years, thus becoming the third most popular investment destination after China and India. The Vietnamese government is also trying its best to mould the existing policies and laws, so as to keep the capital flow coming. Statistically speaking, the FDI pledges in Vietnam have galloped from a meager $ 11.3 billion in 2005 to $ 50 million in 2008. This year though the FDI flows have taken a drubbing because of the volatile economic prevalence and thus the reluctance of the foreign majors to part with the cash, but the experts feel that Vietnam’s identity as an investor’s heaven is here to stay. The major factors in the country which have led, multinationals park huge investments in the country can be tabulated as follows-

Availability of a young, literate and cheap workforce. A stable socio-political situation Vietnam’s professionalized investment promotion activities, policy formulation and

implementation Cost of land, cost of consumables, very low as compared to other locales

On account o the above stated reasons, the FDI in Vietnam surged to a level of $64 billion in 2008. The investments were primarily in sectors like

Construction High-tech areas Production of electronics Telecommunications

thus turning Vietnam into a manufacturing hub in Asia.

In 2009, the expected inflows in the country in the form of FDI pledges are reported to plunge drastically on account of the skepticism, on the part of the global investors, due to the ongoing slowdown. Experts have forecasted a figure of $ 20-25 billion for this financial year in terms of the FDI pledges, which is a fall of above 60%. Apart from the slowdown, the various reasons that can be attributed to the same are doubts of Vietnam’s capability to digest such huge investment sums. The various factors that play a role here are

inadequate infrastructure Management problems Shortage of adequately trained human resource

This lack of absorption capability has become a huge spoilsport as it is believed that in 2006, out of the total investment funds inflow, 60 % remained unutilized. These trends could further intensify the dollar shortage faced by the country, on account of hoarding by companies expecting the dong to depreciate. Thus the need of the hour for the government is to plan and implement policies and infrastructure development, which will restore investor confidence in Vietnam’s capability to absorb the incoming funds.

Feedback

5. Discuss various international trade theories.

Ans:

1. Theory of Mercantilism1) 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.

2) The main tenet of mercantilism was that it was in a country’s hand to maintain a trade 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.

3) As the English mercantilist writer Thomas Mun put it in 1630, The ordinary means therefore to increase our wealth and treasure is by foreign tread, where we must ever observe this rule: to sell more to strangers yearly than we consume of theirs in value.

4) Consistent with this belief, the mercantilist doctrine advocated government intervention to achieve a surplus in the balance of trade. The mercantilists saw no virtue in a large volume of trade per se. Rather, they recommended policies to maximize exports and minimize imports. To achieve this, imports were limited by tariffs and quotas, while exports were subsidized.

5) The classical economist David Hume pointed out an inherent inconsistency in the mercantilist doctrine in 1752. According to Hume, if England had a balance-of-trade surplus with France (it exported more than it imported) the resulting inflow of gold and silver would swell the domestic money supply and generated inflation in England. In France, however the outflow of gold and silver would have the opposite effect. France’s money supply would contract, and its prices would fall. This change in relative prices between France and England would encourage the France to buy fewer English goods (because they were becoming more expensive) and the English to buy more Franch goods. The result would be deterioration in the English balance of trade and an improvement in France’s trade balance, until the English surplus was eliminated.

6) Hence, according to Hume, in the long run no country could sustain a surplus OD the balance of trade and so accumulate gold and silver as the mercantilists had envisaged.

7) 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.)

2. Absolute Advantage Theory1) In his 1776 landmark book The Wealth of Nations, Adam Smith attacked the

mercantilist assumption that trade is a zerosum game. 2) Smith argued that countries differ in their ability to produce goods efficiently. 3) In his time, the English, by virtue of their superior manufacturing processes, were the

world’s most efficient textile manufacturers. 4) Due to the combination of favorable climate, good soils, and accumulated expertise,

the French had the world’s most efficient wine industry. 5) 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.

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

7) In Smith’s 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 buying wine in exchange.

8) Similarly, France could get all the textiles it needed by selling wine to England and buying textiles in exchange. Smith’s basic argument, therefore, is that you should never produce goods at home that you can buy at a lower cost from other countries.

9) Smith demonstrates that by specializing in the production of goods in which each has an absolute advantage, both countries benefit by engaging in trade.

10) Consider the effects of trade between Ghana and South Korea. The production of any good (output) requires resources (inputs) such as land, labor, and capital. Assume that Ghana and South Korea both have the same amount of resources and that these resources can be used to produce either rice or cocoa.

11) Assume further that 200 units of resources are available in each country. Imagine that in Ghana it takes 10 resources to produce one ton of cocoa and 20 resources to produce one ton of rice. Thus, Ghana could produce 20 tons of cocoa and no rice, 10 tons of rice and no cocoa, or some combination of rice and cocoa between these two extremes.

12) The different combinations that Ghana could produce are represented by the line GG’ in Figure 2.1. This is referred to as Ghana’s production possibility frontier (PPF). Similarly, imagine that in South Korea it takes 40 resources to produce one ton of cocoa and 10 resources to produce one ton of rice.

13) Thus, South Korea could produce 5 tons of cocoa and no rice, 20 tons of rice and no cocoa, or some combination between these two extremes. The different combinations available to South Korea are represented by the line KK’ in Figure 2.1, which is South Korea’s PPF.

14) Clearly, Ghana has an absolute advantage in the production of cocoa. (More resources are needed to produce a ton of cocoa in South Korea than in Ghana.) By the same token, South Korea has an absolute advantage in the production of rice.

3. Ricardian Model (Comparative Advantage Theory)1) David Ricardo took Adam Smith’s theory one step further by exploring what might

happen when one country has an absolute advantage in the production of all goods. 2) Smith’s theory of absolute advantage suggests that such a country might derive no

benefits from international trade. 3) In his 1817 book Principles of Political Economy, Ricardo showed that this was not

the case. 4) According to Ricardo’s theory of comparative advantage, it makes sense for a

country to specialize in the production of those goods that it produces most efficiently and to buy the goods that it produces less efficiently from other countries, even if this means buying goods from other countries that it could produce more efficiently itself.

5) While this may seem counterintuitive, the logic can be explained with a simple example. Assume that Ghana is more efficient in the production of both cocoa and rice; that is Ghana has an absolute advantage in the production of both products. In Ghana it takes 10 resources to produce one ton one ton of cocoa and, 13 1/3 resources to produce one ton of rice. Thus, given its 200 units of resources, Ghana can produce 20 tons of cocoa and no rice, 15 tons of rice and no cocoa, or any combination in between on its PPF (the ling GG’ in figure 2.2). In South Korea it takes 40 resources to produce one ton of cocoa and 20 resources to produce one ton of rice. Thus South Korea can produce 5 tons of cocoa and no rice, 10 tons of rice and no cocoa, or any combination on its PPF (the link KK’ in figure 2.2).

6) Again assume that without trade, each country uses half of its resources to produce rice and

7) half to produce cocoa. Thus, without “trade, Ghana will produce 10 tons of cocoa, and 7.5 tons of rice (point A in

8) Figure 2.2), while South Korea will produce 2.5 tons of cocoa and 5 tons of rice (point B in Figure2.2).

9) In light of Ghana’s absolute advantage in the production of both goods, why should it trade with South Korea? Although Ghana has an absolute advantage in the production of both cocoa and rice, it has a comparative advantage only in the production of cocoa: Ghana can produce 4 times as much cocoa as South Korea, but only 1.5 times as much rice. Ghana is comparatively more efficient at producing cocoa than it is at producing rice. Without trade the combined production of cocoa will be 12.5 tons (10 tons in Ghana and 2.5 in South Korea), and the combined production of rice will also be 12.5 tons (7.5tons in Ghana and 5 tons in South Korea). Without trade each country must consume what it produces. By engaging in trade, the two countries can increase their combined production of rice and cocoa, and consumers in both nations can consume more of both goods.

10) The Gains from Trade

a) Imagine that Ghana exploits its comparative advantage in the production of cocoa to increase its output from 10 tons to 15 tons. This uses up 150 units of resources, leaving the remaining50 units of resources to use in producing 3.75 tons of rice (point C in fig-ure 1.2).

b) Meanwhile, South Korea specializes in the production of rice, producing l0 tons. The combined output of both cocoa and rice has now increased. c) Before specialization, the combined output was 12.5 tons of cocoa and 12.5 tons of rice. Now it is 15 tons of cocoa and 13.75 tons of rice (3.75 tons in Ghana and 10 tons in South Korea). The source of the increase in production is summarized in Table 2.2. d) Not only is output higher, but also both countries can now benefit from trade. If Ghana and South Korea swap cocoa and rice on a one-to-one basis, with both countries choosing to exchange 4 tons of their export for 4 tons of the import, both countries are able to consume more cocoa and rice than they could before specialization and trade (see Table 2.2). e) Thus, if Ghana exchanges 4 tons of cocoa with South Korea for 4 tons of rice, it is still left with 11 tons of rice, which is 1 ton more than it had before trade. The 4 tons of rice it gets from South Korea in exchange for its 4 tons of cocoa, when added to the 3.75 tons it now produces domestically, leaves it with a total of 7.75 tons of rice, which is 25 of a ton more than it had before specialization. Similarly, after swapping 4 tons of rice with Ghana, South Korea still ends up with 6 tons office, which is more than it had before specialization. f) In addition, the 4 tons of cocoa it receives in exchange is 1.5 tons more than it produced before trade. Thus, consumption of cocoa and rice can increase in both countries as a result of specialization and trade.

11) The basic message of the theory of comparative advantage is that potential’ world production is greater with unrestricted free trade than it is with restricted trade.

12) Ricardo’s theory suggests that consumers in all nations can consume more if there are no restrictions on trade. This occurs even in countries that lack an absolute advantage in the production of any good.

13) In other words, to an even greater degree than the theory of absolute advantage, the theory of comparative advantage suggests that trade is a positive-sum game in which all countries that participate realize economic gains.

14) As such, this theory provides a strong rationale for encouraging free trade. So powerful is Ricardo’s theory that it remains a major intellectual weapon for those who argue for free trade.

4. Heckscher-Ohlin Theory

Swedish economists Eli Heckscher (in 1919) and Bertil Ohlin (in 1933) argued that comparative advantage arises from differences in national factor endowments. By factor endowments they meant the extent to which a country is endowed with such resources as land, labor, and capital Nations have varying factor endowments, and different factor endowments explain differences in factor costs. The more abundant a factor, the lower its cost. The Heckscher-Ohlin theory predicts that countries will export those goods that make

intensive use of factors that are locally abundant, while importing goods that make intensive use of factors that are locally scarce. Thus, the Heckscher-Ohlin theory attempts to explain the pattern of international trade that we observe in the world economy. Like Ricardo’s theory the Heckscher-Ohlin theory argues that free trade is beneficial. Unlike Ricardo’s theory, however, the Heckscher-Ohlin theory argues that the pattern of international trade is determined by differences in factor endowments, rather than differences in productivity. The Heckscher-Ohlin theory also has commonsense appeal. For example, ‘United States has long been a substantial exporter of agricultural goods, reflecting in part its unusual abundance of arable land. In contrast, China excels in the export of goods produced in labor-intensive manufacturing industries, such as textiles and footwear. This reflects China’s relative abundance of low-cost labor. The United States, which lacks abundant low-cost labor, has been a primary importer of these goods. Note that it is relative, not absolute, endowments that are important; a country may have larger absolute amounts of land and labor than another country, but be relatively abundant in one of them.

The Leontief Paradox

Using the Heckscher Ohlin theory, Wassily Leontief postulated that since the United States was relatively abundant in capital compared to other nations, the United States would be an exporter of capital-intensive goods and an importer of labor-intensive goods. To his surprise, however, ‘he found that U.S. exports were less capital intensive than U.S. imports. Since this result was at variance with the predictions of the theory, it has become known as the Leontief paradox. No one is quite sure why we observe the Leontief paradox. One possible explanation is that the United States has a special advantage in producing new products or goods made with innovative technologies. Such products may be less capital intensive than products whose technology has had time to mature and become suitable for mass production. Thus, the United States may be exporting goods that heavily use skilled labor and innovative entrepreneurship, such as computer software, while importing heavy manufacturing products that use large amounts of capital.

What is Leontief Paradox?

Wassily Leontief (winner of the Nobel Prize in economics in 1973), many of these tests have raised questions about the validity of the Heckscher- Ohlin theory.

As per Heckscher- Ohlin theory Leontief postulated that since the united States was relatively abundant in capital compared to other nations, the united States would be an exporter of capital-intensive goods and an importer of labor-intensive goods. To his surprise, however, ‘he found that U.S. exports were less capital intensive than U.S. imports. Since this result was at variance with the predictions of the theory, it has become known as the Leontief paradox.

No one is quite sure why we observe the Leontief paradox. One possible explanation is that the United States has a special advantage in producing new products or goods made with innovative technologies. Such products may be less capital intensive than products whose technology has had time to mature and become suitable for mass production. Thus, United States may be exporting goods that heavily use skilled labor and innovative entrepreneurship, such as computer software, while importing heavy manufacturing products that use large amounts of capital.

Example : As per the theory, United States exports commercial aircraft and imports automobiles not because its factor endowments are especially suited to aircraft manufacture and not suited to automobile manufacture, but because the United States is more efficient at producing aircraft than automobiles. A key assumption in the Heckscher-Ohlin theory is that technologies are .the same across countries. This may not to be the case, and differences in technology may lead to differences in productivity, which in turn, drives international trade patterns.

5. The Product Life Cycle Theory

Raymond Vernon initially proposed the product life-cycle theory in the mid-1960s. Vernon’s theory was based on the observation that for most of the 20th century a very large proportion of the world’s new products had been developed by U.S. firms and sold first in the U.S. market (e.g.mass-produced automobiles, televisions, instant cameras, photocopiers, personal computers, and semiconductor chips). To explain this, Vernon argued that the wealth and size of the U.S market gave U.S. firms a strong incentive to develop new consumer products. Inaddition, the high cost of U.S. labor gave U.S. firms an incentiveto develop cost-saving process innovations. -Just because a new product is developed by a U.S. firm and first sold in the U.S. market, it does not follow that the product must be produced in the United States. It could be produced abroad at some low-cost location and then exported back into the United States. However, Vernon argued that most new products were initially products were initially produced- in America. Apparently, the pioneering firms believed it was better to keep production facilities close the market and to the firm’s center of decision making, given the uncertainty and risks inherent in introducing new products. Also, the demand for most new products tends to be based on nonprice factors.

Consequently, firms can charge relatively high prices for new products, which obviate the need to look for low cost production sites in other countries. Vernon went on to argue that early in the life cycle of a typical new product, demand is starting to grow rapidly in the United States, demand in other advance countries is limited to highincome groups. The limited initial demand in other advanced countries does not make it worthwhile for firms in those countries to start producing the new product, but it does necessitate some exports from the United States to those countries.

Over time, demand for the new product starts to grow in other advanced countries (e.g., Great Britain, France, Germany, and Japan). As it does, it becomes worthwhile for foreign producers to begin producing for their home markets. In addition, U.S.firms might set up production facilities in those advanced countries where demand is growing. Consequently, production within other advanced countries begins to limit the potential for exports from the United States. As the market in the United States and other advanced nations matures, the product becomes more standardized, and price becomes the main competitive weapon. As this occurs, cost considerations start to play a greater role in the competitive process. Producers based in advanced countries where labor costs are lower than in the United States (e.g., Italy, Spain) might now be able to export to the United States. If cost pressures become intense, the process might, not stop there. The cycle by which the United States lost its advantage to other advanced countries might be repeated once more, as developing countries (e.g., Thailand) begin to acquire a production advantage over advanced countries. Thus, the locus of global production initially switches from the United States to other advanced nations and then from those nations to developing countries.

The consequence of these trends for the pattern of world trade is that is over time the United States switches, from being an exporter of the Product to an importer of product as production becomes concentrated in lower-cost foreign locations.

Figure 2.5 shows the growth of production and consumption over time in the United States, other advanced countries, and developing countries.

6. New Trade Theory

New Trade Theory (NTT) is the economic critique of international free trade from the perspective of increasing returns to scale and the network effect

1. New Trade theorists challenge the assumption of diminishing returns to specialization used in international trade theory. It argues that increasing returns to specialization might exist in some industries.

2. New trade theory also argues that if the output required to realize significant scale economies represents a substantial proportion of total world demand for that product the world market may be able to support only a limited number of firms based in a limited number of countries producing that product

Example: The commercial aerospace industry, which is currently dominated by just two firms, Boeing and Airbus, is a good example of this theory. Economies of scale in this industry come from the ability to spread fixed costs over a large output.

Implication:

"NTD" was the rigor of the mathematical economics used to model the increasing returns to scale, and especially the use of the network effect to argue that the formation of important industries was path dependent in a way which industrial

planning and judicious tariffs might control. The model they developed was highly technical, and predicted the possibilities of

national specialization-by-industry observed in the industrial world. The story of path-dependent industrial concentrations sometimes leads to monopolistic competition.

Econometric evidence:

The econometric evidence for NTT was mixed, and again, highly technical. Due to the time-scales required and the particular nature of production in each 'monopolizable' sector, statistical judgements have been hard to make. In many ways, there is too limited a dataset to produce a reliable test of the hypothesis which doesn't require arbitrary judgements from the researchers.

Japan is cited as evidence of the benefits of "intelligent" protectionism, but critics of NTT have argued that the empirical support post-war Japan offers for beneficial protectionism is unusual, and that the NTT argument is based on a selective sample of historical cases. Although many examples (like Japanese cars) can be cited where a 'protected' industry subsequently grew to world status, regressions on the outcomes of such "industrial policies" (including the failures) have been less conclusive

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6.Discuss the impact of WTO on India’s trade policy.

Ans:

Agreement Provisions Impact Policy issue

GeneralAgreement onTrade'" Tariff.

Prohibits:-Actions of Government I

Binding of tariff lines. (India is committed to a bind tariff lines at 40

-Competition from foreign goods.-This affects efficacy of

(GATT) Organisations that distort normal-Discrimination betweenMember nations-Discrimination between domesticand lawfully imported foreigngoods

per cent on finished goods and 2S per cent on intermediate goods. machinery and equipment; phased reduction by 2005).-Quantitative restrictions of imports to be phased out by 1.4.2000 (original deadline set was 2003. but India has lost in theDisputes Settlement Case). -Create freer trade regime.

Reservation Policy.Need for Reservation Policy to move in tandem with OGL list, with greater emphasis on competitiveness.-Need to strengthen competitiveness among domestic SSI through modernisation and technology development.

Agreement onvaluation ofGoods

Countries to follow uniform procedures in respect of customs formalities.

-Greater transparency-Beneficial to both importers and exporters

India bas amended the Customs Act in conformity with the Agreement.

Agreement onPre-shipmentinspection (PSI)

To check arbitrary ways of PSI companies in valuation of goods.

Indian companies exporting to countries usingPSI companies to benefit

India does not use services of PSI companies.

Agreement onTechnical;Barriers to Trade(TBT)

-Conformity with internationalstandards-Checks on misuse of mandatoryproducts standards-Establishment of enquiry points

-Indian exporters to benefit. As import by other countries are subject to mandatory product standards.-Enquiry points help facilitation.-Process and production methods can be used to discriminate against Indian exports.

-Bureau of Indian Standards (SIS) conforms to Agreement.-SIS in conformity with International standards.-BIS to serve as enquiry point.

Agreement onSanitary andPhytosanitary Measure. (SPM)

Same as above except that countriescan deny import from certainregion/country on the ground ofpest I disease

International standards to be adopted

Most of Indian standards in conformity with International standards.

Agreement on Transparency and Beneficial to small Delays, discretion and

import licensing time bound businesses, as they are usually at the receiving end of restricted practices.

misuse of licensing procedures to be cut.

Rules Applicableon Exports

-Allows export (to be relieved of indirect taxes (e.g. Excise Duty).-Prohibits direct tax benefits (e.g.Income Tax waiver on export earnings).-Allows levy of duties on exports

-Neutralisation of indirect taxes good.-Present schemes providing waiver ofIncome Tax on export earnings to be scrapped. Would affect pricecompetitiveness

-EXIM policy provides scheme for neutralisation of incidence of indirect taxes (e.g. Duty drawback, advance licenses etc.)-Review of direct tax benefits.

Agreement onSubsidies andCountervailingMeasures (SCM)

-Prohibits export subsidies-Phasing out by 2003.-Permits permissible subsidies.

-Subsidies given to small businesses are usually permissible and non-actionable.-Importing countries can countervail subsidies that are actionable. Will makeIndian exports more expensive.-Small businesses have to become more competitive.

EXIM Policy to be made WTO compatible.

Agreement onSafeguardMeasures

Allows countries to take action against undue import surge injurious to domestic industry during transition period. Measures can include Quantitative Restrictions (QRs), duty enhancement beyond bound rates etc. period extendable

Helpful provision Ministry of Commerce & Industry is putting required system in place.

Agreement onAnti-DumpingMeasures (ADP)

Allows countering unfair trade practices.

Helpful provision Directorate of Anti-Dumping established in Ministry of Commerce & Industry.

Trade RelatedInvestment Measures

Prohibits countries from imposing

-Affects FOREX position.

Measures underway to terminate notified

(TRIMS) conditions such as localisation, export obligation on investors.

-Affects Government foreign InvestmentPolicy-Enhances competition to domestic industry

TRIMs such as Dividend Balancing

Market AccessNegotiations

Binding of tariff lines -Increased competition from foreign goods.-Does not help Indian exporters, as tariffs in developed countries already low.-India to really benefit from removal of QRs in these countries.

India followed the WTO time-table in terms of reduction and binding of tariff lines.

Agreement onGovernmentProcurement

MFN and National Treatment onGovernment procurement

-India not partly to the agreement.-Under severe pressure to fall in line.-Indian exporters of goods and services canexport to countries who have signed this agreement barring USA.-Can affect exports of footwear, textiles,computer hardware and software, stationary etc.

We need to carefully review the policy.

General Agreementon Trade in Services(GATS)

-All services covered.-MFN principle-Liberalisation commitments.

Helpful to Indian exporters of services.

India has made commitments in 33 service activities as compared to an average of 23 developing countries. Inflow of capital and technology with adequate employment prospects is the main consideration.

Trade RelatedIntellectualProperty Rights(TRIPs)

-Provides protection to IPRs as patents, copy rights, trade marks,

-Reverse engineering becomes more difficult.-Transfer of

Patent Act amended in 1991. Allows product patent in pharmaceuticals, agro-

industrial designs, layout designs,geographical indications andundisclosed information-National and MFN treatment.-Developing countries to implement within 5 years.

technology may increase due to lesser fear of counterfeit.-India's own R&D institutions could benefit.

chemicals and food. Patent life increased to 20 years. Micro organisms made patentable. New laws being drafted for trademarks, copyrights etc. India has acceded to Paris Convention.

Most Favoured Nation Treatment (MFN): No discrimination between member nations.

National Treatment: No discrimination between domestic products and lawfully imported products.

Subsidies: Permissible - Actionable and non-actionable; non-permissible.

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7. Discuss the various organisational structure in International Business.

Ans:

There are five types of organizational structures: International Division Structure, International Area Structure, Global Product Structure, Global Matrix Structure, and Global Functional Design Structure.

INTERNATIONAL AREA STRUCTURE

The one that would be optimal for a company that is just expanding is the International Area Structure. The reason this would be optimal is because a company is new to selling internationally. "In this organizational structure, the company is organized into countries or

geographic regions." This would be a benefit to have the organizational in this manner because it would allow a company to focus on the region of the world we are selling to and tailor the needs of mobility products to that area. As a company grows internationally we can expect to see a companies organization grow as well.

Using the International Area Structure will allow a company to hire managers who specialize in understanding the cultural, commercial, social and economic conditions we wish to expand to.

By using the International Area Structure, this is going to allow the company to adapt additional marketing strategies, without disrupting the ones company managers have worked so hard for. In addition, "an international firm must address its coordination needs" Meaning, a company must link and integrate functions and activities of different divisions of the company.

Worldwide area structure Favored by firms with low degree of diversification & domestic structure based of

function World is divided into autonomous geographic areas

Operational authority decentralized Facilitates local responsiveness Fragmentation of organization can occur Consistent with multi-domestic strategy

INTERNATIONAL DIVISION STRUCTURE

When a company has a branch that is located abroad and that abroad company is said to be attached with the original company, then this is an international division structure.The abroad unit is required to control all the activities which are to be performed internationally. It is usually based on the characteristics like a function, product or on geography. This structure is designed do that the multinational will have a free access to explore the resources that are present internationally.

Adopted in early stages of international business operations Coordinate all IB activities Develop international expertise & skills Develop a global/international mindset

Champion of foreign business Favored by firms with low degree of diversification. Area is usually a country. Largely autonomous. Facilitates local responsiveness

GLOBAL PRODUCT STRUCTURE

The product division structure is popular with large conglomerates with multiple, unrelated business. Under this structure different subsidiaries pertaining to different products within the same foreign country report to the head of different product groups at the head quarters.

The product division structure enhances coordination between different areas for any one product line but it reduces coordination of all product lines within each zone.

Adopted by firms that are reasonably diversified Original domestic firm structure based on product division Value creation activities of each product division coordinated by that division

worldwide Help realize location and experience curve economies

Facilitate transfer of core competencies Problem: area managers have limited control, subservient to product division managers, leading to lack of local responsiveness

GLOBAL MATRIX STRUCTURE

Over time, we can expect to see a company grow into a Global Matrix Structure. "In this organizational structure, the chain of command is split between product managers and area managers." As we develop the sales in areas of the world, we can expect to see the chain of command split between product managers and area managers.

Helps to cope with conflicting demands of earlier strategies Two dimensions: product division and geographic area Product division and geographic areas given equal responsibility for operating

decisions Problems: Bureaucratic structure slows decision making Conflict between areas and product divisions Difficult to make one party accountable due to dual responsibility

GLOBAL FUNCTIONAL DESIGN STRUCTURE

Under the functional structure, the head of functional areas, such as production, marketing, finance and personnel, are responsible for the worldwide operations of their own functional areas.

In certain industries like energy and mining, a variation of the functional structure known as the process structure, which uses processes as the basis for the structure, is common.

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