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Introduction to Global Business (MGMT 1005) - Coggle Diagram

- - - - greenfield investments - the establishment of a wholly new operation in a foreign country
      - acquisitions or mergers with existing firms in the foreign country
      - acquisitions vs greenfield investments
        
        Most cross-border investment is in the form of mergers and acquisitions rather than greenfield investments
        
        between 40-80% of all FDI inflows per annum from 1998 to 2009 were in the form of mergers and acquisitions, however, in developing countries two-thirds of FDI is greenfield investment - this is due to the existence of fewer target companies
        
        Firms prefer to acquire existing assets
        
        mergers and acquisitions are quicker to execute than greenfield investments
        
        it is easier and perhaps less risky for a firm to acquire desired assets than build them from the ground up
        
        firms believe that they can increase the efficiency of an acquired unit by transferring capital, technology, or management skills
    - - The flow of FDI
        
        refers to the amount of FDI undertaken over a
        given time period
        
        Outflows of FDI are the flows of FDI out of a country while Inflows are the flows of FDI into the country
      - The stock of FDI
        
        the total accumulated value of foreigno wned assets at a given time
    - - The growth of FDI is a result of
        
        a fear of protectionism
        
        want to circumvent trade barriers
        
        political and economic changes ➢ deregulation, privatization, fewer restrictions on FDI
        
        deregulation, privatization, fewer restrictions on FDI
        
        new bilateral investment treaties ➢ designed to facilitate investment
        
        designed to facilitate investment
        
        the globalization of the world economy ➢ many companies now view the world as their market ➢ need to be closer to their customers
        
        many companies now view the world as their market
        
        need to be closer to their customers
      - Gross fixed capital formation
        
        the total amount of capital invested in factories, stores, office buildings, and the like: the greater the capital investment in an economy, the more favorable its future prospects are likely to be
        
        Hence, FDI is an important source of capital investment and a
        determinant of the future growth rate of an economy
  - - - exporting
        
        exporting is producing goods at home and then shipping
        them to the receiving country for sale
        
        exports can be limited by transportation costs and trade barriers
        
        FDI may be a response to actual or threatened trade barriers such as import tariffs or quotas
      - licensing
        
        licensing is granting a foreign entity the right to produce and sell the firm’s product in return for a royalty fee on every unit that the foreign entity sells
        
        compared to FDI licensing is less attractive
        
        Internalization theory (aka market imperfections theory)
        
        firm could give away valuable technological know-how to a potential foreign competitor
        
        does not give a firm the control over manufacturing, marketing, and strategy in the foreign country
        
        the firm’s competitive advantage may be based on its management, marketing, and manufacturing capabilities
    - - FDI flows are a reflection of strategic
        rivalry between firms in the global marketplace (Knickerbocker, 1973)
        
        multipoint competition -when two or more enterprises encounter each other in different regional markets, national markets, or industries
      - Vernon - firms undertake FDI at particular stages in the life cycle
        of a product
    - - Dunning’s (1981,1988) eclectic paradigm/ OLI's theory
        
        location-specific advantages
        
        arise from using resource endowments or assets that are tied to a particular location and that a firm finds valuable to combine with its own unique assets
        
        externalities
        
        knowledge spillovers that occur when companies in the same industry locate in the same area
        
        FDI can reap all three categories of advantages: ownership advantages, location specific advantages and internalisation advantages, while exporting doesn't touch upond location specific advantages and licensing only has ownership advantage
  - - - international production should be distributed among countries according to the theory of comparative advantage
      - embraced by advanced and developing nations including the United States and Britain, but no country has adopted it in its purest form
    - - FDI has both benefits (inflows of capital, technology, skills and jobs) and costs (repatriation of profits to the home country and a negative balance of payments effect)
      - FDI should be allowed only if the benefits outweigh the costs
    - - the MNE is an instrument of imperialist domination and a tool for exploiting host countries to the exclusive benefit of their capitalist-imperialist home countries
      - In retreat everywhere
    - - Recently, there has been a strong shift toward the free market
        stance creating
      - a surge in FDI worldwide
      - an increase in the volume of FDI in countries with newly liberalized regimes
  - - - Balance of payments effects
        
        FDI can help a country to achieve a current account surplus
      - Resource transfer effects
        
        FDI brings capital,
        technology, and management resources
      - Effects on competition and economic growth
        
        greenfield investments increase the level of competition in a market, driving down prices and improving the welfare of consumers
        
        can lead to increased productivity growth, product and process innovation, and greater economic growth
      - Employment effects
        
        FDI can bring jobs
    - - Adverse effects on the balance of payments
        
        when a foreign subsidiary imports a substantial number of its inputs from abroad, there is a debit on the current account of the host country’s balance of payments
      - Perceived loss of national sovereignty and autonomy
        
        decisions that affect the host country will be made by a foreign parent that has no real commitment to the host country, and over which the host country’s government has no real control
      - Adverse effects of FDI on competition within the host nation
        
        subsidiaries of foreign MNEs may have greater economic power than indigenous competitors because they may be part of a larger international organization
    - - The effect on the capital account of the home country’s balance of payments from the inward flow of foreign earnings
      - The employment effects that arise from outward FDI
      - The gains from learning valuable skills from foreign markets that can subsequently be transferred back to the home country
    - - The home country’s balance of payments can suffer
        
        from the initial capital outflow required to finance the FDI
        
        if the purpose of the FDI is to serve the home market from a low cost labor location
        
        if the FDI is a substitute for direct exports
      - Employment may also be negatively affected if the FDI is a substitute for domestic production
        
        But, international trade theories suggest that home country concerns about the negative economic effects of offshore production (FDI undertaken to serve the home market) may not be valid
        
        may stimulate economic growth and employment in the home country by freeing resources to specialize in activities where the home country has a comparative advantage
  - - - FDI Promotion
        
        Financial
        
        Tax incentives
        
        Low-interest loans
        
        Infrastructure improvements
        
        Better seaports, roads, and telecom networks
      - FDI Restriction
        
        Ownership restrictions
        
        Prohibit investment
        
        Performance demands
        
        Local content requirements
        
        Export targets
        
        Technology transfers
    - - FDI Promotion
        
        Political pressure
        
        persuade other nations to accept FDI
        
        tax breaks
        
        Special tax treaties
        
        Tax breaks on profits earned abroad
        
        Insurance
        
        on assets abroad
        
        Loans
        
        and loan guarantees
      - FDI Restriction
        
        Differntial tax rates
        
        Higher taxes on foreign income
        
        sanctions
        
        Sanctions that prohibit investing in certain nations
  - - - however, it does not explain why FDI is preferable to exporting or licensing, must consider internalization theory
    - - firms have the most bargaining power when the host government values what the firm has to offer, when the firm has multiple comparable alternatives, and when the firm has a long time to complete negotiations
- - - - Dispute Settlement in the WTO
        
        recent trade dispute between China and US
        
        Bypassing the agreement makes WTO seem less effective
        
        This power gives it prevalence over GATT
      - Dumping and the WTO
        
        WTO settles disputes when dumping has occurred
        
        Dumping is hard to prove because it could be a strategy to lower production value
      - Subsidies and the WTO
        
        High levels of agricultural protection has been a focus on reducing subsidies
        
        both tariffs and subsidies are higher for agricultural products than non agricultural products
      - Relationship between tariffs, world GDP and volume of world trade
        
        Tariffs have gone down while world gdp and trade has gone up
    - - Until the Great Depression of the 1930s, most countries
        had some degree of protectionism
        
        Smoot-Hawley tariff (1930)
      - After WWII, the U.S. and other nations realized the value of freer trade
        
        established the General Agreement on Tariffs and Trade (GATT) - a multilateral agreement to liberalize trade
      - In the 1980s and early 1990s protectionist trends emerged
        
        Japan’s perceived protectionist (neo-mercantilist) policies created intense political pressures in other countries
        
        Persistent trade deficits by the U.S
        
        Use of non-tariff barriers increased
      - The Uruguay Round of GATT negotiations began in 1986 focusing on
        
        Services and intellectual property
        
        The World Trade Organization
        
        The WTO encompassed GATT along with two sisters organizations
        
        the General Agreement on Trade in Services (GATS)
        
        working to extend free trade agreements to services
        
        the Agreement on Trade Related Aspects of Intellectual Property Rights (TRIPS)
        
        working to develop common international rules for
        intellectual property rights
        
        The WTO has emerged as an effective advocate and facilitator of future trade deals, particularly in such areas as services. Main goals of WTO are
        
        Help the free flow of trade
        
        Help negotiate further opening of markets
        
        Settle trade disputes among its members
    - - The WTO launched a new round of talks at Doha, Qatar in 2001 with many issues yet to be fully resolved.
        
        New contexts, new agenda for Doha
        
        Expectation that rich countries would reform policies.
        
        Policies centred around developed countries.
        
        Didn’t take into context what was happening in the 2000s:
        
        Economic growth 2002–7
        
        Global recession post-2007
        
        Economic, food and energy security.
        
        Post-2007 governments retreated into protectionism.
        
        Trade barriers were increased.
        
        A move towards a more restrictive investment environment.
        
        Doha doesn’t have the capacity to deal with these issues.
        
        Lack of progress with Doha
        
        Failed in its attempt to be a ‘development’ round.
        
        Agenda includes
        
        cutting tariffs on industrial goods and services
        
        phasing out subsidies to agricultural producers
        
        reducing barriers to cross-border investment
        
        limiting the use of anti-dumping laws
      - Trade and FDI liberalisation
      - Substantial work still remains to be done on the international trade and investment liberalisation front four issues on the current agenda of the WTO:
        
        Antidumping policies
        
        Agricultural protection
        
        Enforcement of rules for intellectual property
        
        Tariff protection of non-agricultural products imposed by developing countries
  - - - Tariffs
        
        Types of tarriffs
        
        Specific tariffs
        
        levied as a fixed charge for each unit of a
        good imported
        
        Compound tariff
        
        levied as a percentage of a product’s stated price
        and partly as a specific fee for each unit
        
        Ad valorem tariffs
        
        levied as a proportion of the value of the
        imported good
        
        taxes levied on imports that effectively raise the
        cost of imported products relative to domestic products
        
        increase government revenues
        
        force consumers to pay more for certain imports
        
        are pro-producer and anti-consumer
        
        reduce the overall efficiency of the world economy
      - Import Quotas
        
        restrict the quantity of some good that may be
        imported into a country
        
        Types of quotas
        
        Tariff rate quotas
        
        a hybrid of a quota and a tariff where a lower tariff is applied to imports within the quota than to those over the quota
        
        A quota rent
        
        the extra profit that producers make when
        supply is artificially limited by an import quota
      - Voluntary Export Restraints
        
        quotas on trade imposed by the exporting country, typically at the request of the importing country’s government
        
        Import quotas and voluntary export restraints
        
        benefit domestic producers
        
        raise the prices of imported goods
      - Local content requirments
        
        demand that some specific fraction of a good be produced domestically
        
        benefit domestic producers
        
        consumers face higher prices
      - Administrative delays
        
        bureaucratic rules designed to
        polices hurt consumers by limiting choice
        
        make it difficult for imports to enter a country
      - Embargoes
        
        complete ban on trade (imports and exports) in one or more products with a particular country
        
        benefit domestic producers
        
        consumers face higher prices
      - Antidumping policy
        
        aka countervailing duties
        
        What is dumping?
        
        selling goods in a foreign market below their costs of production, or selling goods in a foreign market below their “fair” market value
        
        punish foreign firms that engage in dumping and protect domestic producers from “unfair” foreign competition
        
        enables firms to unload excess production in foreign markets
        
        may be predatory behavior - producers use profits from their home markets to subsidize prices in a foreign market to drive competitors out of that market, and then later raise prices
      - Currency controls
        
        restrict convertibility of a currency
        
        licenses
        
        governments can require licenses to convert currency and
        hence restrict who they trade with
      - Types and effects of govt intervention
        
        Week 9 slide 17-18
    - - Two main arguments
        
        Political arguments
        
        concerned with protecting the interests of certain groups within a nation (normally producers), often at the expense of other groups (normally consumers)
        
        Protecting jobs
        
        the most common political reason for trade restrictions
        
        results from political pressures by unions or industries that are "threatened" by more efficient foreign producers, and have more political clout than consumers
        
        Protecting industries deemed important for national security
        
        industries are often protected because they are deemed important for national security
        
        semiconductors or aerospace
        
        Retaliation for unfair foreign competition
        
        when governments take, or threaten to take, specific actions, other countries may remove trade barriers
        
        if threatened governments do not back down, tensions can
        escalate and new trade barriers may be enacted
        
        Risky strategy
        
        Protecting consumers from “dangerous” products
        
        limit
        “unsafe” products
        
        Protecting the environment
        
        international trade is associated
        with a decline in environmental quality
        
        concern over global warming
        
        enforcement of environmental regulations
        
        Furthering the goals of foreign policy
        
        preferential trade terms can be granted to countries that a government wants to build strong relations with
        
        trade policy can also be used to punish rogue states
        
        the Helms-Burton Act and the D’Amato Act
        
        Protecting the human rights of individuals in exporting countries
        
        through trade policy actions
        
        the decision to grant China MFN status in 1999 was based on this philosophy
        
        Economic arguments
        
        concerned with boosting the overall wealth of a nation – benefits both producers and consumers
        
        Strategic trade policy
        
        first mover advantages can be important to success
        
        governments can help firms from their countries attain these advantages
        
        governments can help firms overcome barriers to entry into
        industries where foreign firms have an initial advantage
        
        The infant industry argument
        
        an industry should be protected until it can develop and be viable and competitive internationally
    - - Economic arguments for intervention
        
        Strategic trade policy
        
        The revised case for free trade—Krugman argues that there are two situations where restrictions on trade may be inappropriate: retaliation and politics.
        
        Retaliation and trade war
        
        Domestic politics
  - - - government payments to domestic producers
      - Subsidies help domestic producers
        
        compete against low-cost foreign imports
        
        gain export markets
      - Consumers typically absorb the costs of subsidies
    - - government assists exporting companies
        by financing their exporting activities
      - Export financing helps domestic producers
    - - assist domestic business to succeed in trade and investment
    - - designated geographic region through which merchandise is allowed to pass with lower customs duties and/or fewer customs procedures
  - - - Trade barriers raise the cost of exporting products to a country
      - Voluntary export restraints (VERs) may limit a firm’s ability to serve a country from locations outside that country
      - To conform to local content requirements, a firm may have to locate more production activities in a given market than it would otherwise
      - Managers have an incentive to lobby for free trade, and keep protectionist pressures from causing them to have to change strategies
- - - - Why free trade is beneficial
        
        International trade allows a country to specialize in the manufacture and export of products and services that it can produce efficiently
        
        In turn, countries import products and services that can be produced more efficiently in other countries, placing limits on imports may be beneficial to producers, but not beneficial for consumers
        
        reasons for trade
        
        trade is widely regarded as a spur for economic growth
        
        by encouraging countries to produce things they specialise in, it allows the world to produce more goods and more kinds of goods
        
        opening a country to trade could increase
        
        a country's stock of resources as increased supplies become available from abroad
        
        the efficiency of resource utilisation and so free up resources for other uses
        
        economic growth
      - a situation where a government does not attempt to influence through quotas or duties what its citizens can buy from another country or what they can produce and sell to another country
    - - Trade theories
        
        How has international trade theory evolved?
        
        Mercantilism (16th and 17th centuries) promoted the idea of encouraging exports and discouraging imports
        
        What is merchantilism?
        
        Mercantilism (mid-16th century) suggests that it is in a country’s best interest to maintain a trade surplus -to export more than it imports - advocates government intervention to achieve a surplus in the balance of trade
        
        Mercantilism views trade as a zero-sum game
        
        Neo-merchantilism
        
        Neomercantilism is a policy regime that encourages exports, discourages imports, controls capital movement, and centralizes currency decisions in the hands of a central government, it emphasises trade restrictions and commercial policies as means of increasing domestic income and employment
        
        in 1776, Adam Smith promoted the idea of unrestricted free trade
        
        Smith’s Theory Of Absolute Advantage
        
        Adam Smith (1776) argued that a country has an absolute advantage in the production of a product when it is more efficient than any other country in producing it
        
        countries should specialize in the production of goods for which they have an absolute advantage and then trade these goods for goods produced by other countries
        
        How does the theory of absolute advantage work?
        
        2 more items...
        
        in the 19th century, David Ricardo built on Smith ideas, and in the 20th century, Eli Heckscher and Bertil Ohlin refined Ricardo’s work
        
        Ricardo’s Theory Of Comparative Advantage
        
        David Ricardo asked what happens when one country has an absolute advantage in the production of all goods
        
        The theory of comparative advantage (1817) - countries should specialize in the production of those goods they produce most efficiently and buy goods that they produce less efficiently from other countries, even if this means buying goods from other countries that they could produce more efficiently at home
        
        How Does The Theory Of Comparative Advantage Work?
        
        if each country specializes in the production of the good in which it has a comparative advantage and trades for the other, both countries gain
        
        Comparative advantage theory provides a strong rationale for encouraging free trade
        
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        Qualifications and Assumptions
        
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        theories of trade as an evolutionary process
        
        Factor proportions theory/ Heckscher-Ohlin Theory
        
        Eli Heckscher (1919) and Bertil Ohlin (1933) - comparative advantage arises from differences in national factor endowments
        
        factor endowments are defined as the extent to which a country is endowed with resources like land, labor, and capital
        
        The more abundant a factor, the lower its cost
        
        The pattern of trade is determined by factor endowments
        
        Heckscher and Ohlin predict that countries will export goods that make intensive use of locally abundant factors and import goods that make intensive use of factors that are locally scarce
        
        validity of the theory
        
        the Leontief Paradox revealed that countries can successfully export products that use less abundant resources (e.g., the U.S. often exports labor-intensive goods). This implies that international trade is complex and cannot be fully explained by a single theory.
        
        Product life cycle theory
        
        as products mature both the location of sales and the optimal production location will change affecting the flow and direction of trade
        
        Each product and its associated manufacturing technologies go through three stages of evolution: introduction, maturity, and standardisation.
        
        maturity
        
        In the maturity stage, the product’s manufacturing becomes relatively standardised, and other countries start producing and exporting the product.
        
        standarisation
        
        In the standardisation stage, manufacturing ceases in the original innovator country, and this country becomes a net importer of the product. Today, due to globalisation, the cycle occurs quickly for many products.
        
        introduction
        
        In the introduction stage, the inventor country enjoys a monopoly both in manufacturing and exports.
        
        validity of the theory
        
        globalization and integration of the world economy has made this theory less valid today
        
        the theory is ethnocentric
        
        production today is dispersed globally
        
        products today are introduced in multiple markets simultaneously
        
        The New trade theory
        
        What is the new trade theory?
        
        New trade theory suggests that the ability of firms to gain economies of scale (unit cost reductions associated with a large scale of output) can have important implications for international trade
        
        Countries may specialize in the production and export of particular products because in certain industries, the world market can only support a limited number of firms
        
        2 main points in the theory
        
        Through its impact on economies of scale, trade can increase the variety of goods available to consumers and decrease the average cost of those goods
        
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        In those industries when output required to attain economies of scale represents a significant proportion of total world demand, the global market may only be able to support a small number of enterprises
        
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        What Are The Implications Of New Trade Theory For Nations?
        
        Nations may benefit from trade even when they do not differ in resource endowments or technology
        
        a country may dominate in the export of a good simply because it was lucky enough to have one or more firms among the first to produce that good
        
        Governments should consider strategic trade policies that nurture and protect firms and industries where first mover advantages and economies of scale are important
        
        Porter’s Diamond Of Competitive Advantage
        
        Michael Porter (1990) tried to explain why a nation achieves international success in a particular industry, he identified four attributes that promote or impede the creation of competitive advantage
        
        factor endowments
        
        a nation’s position in factors of production necessary to compete in a given industry
        
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        demand conditionas
        
        the nature of home demand for the industry’s product or service
        
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        relating and supporting industries
        
        the presence or absence of supplier industries and related industries that are internationally competitive
        
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        firm strategy, structure and rivalry
        
        the conditions governing how companies are created, organized, and managed, and the nature of domestic rivalry
        
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        validity of the thoery
        
        Government policy can affect demand through product standards, influence rivalry through regulation and antitrust laws, impact the availability of highly educated workers and advanced transportation infrastructure.
        
        The four attributes, government policy, and chance work as a reinforcing system, complementing each other and in combination creating the conditions appropriate for competitive advantage
        
        So far, Porter’s theory has not been sufficiently tested to know how well it holds up
        
        Porter on the global competitiveness report
        
        there's a need to focus on many aspects of the economy, government and political system to measure competitiveness, GCR focuses more on broader macro contexts (and BCI (business competitive index) on the micro context)
        
        the report is a way of researching and revealing what really matters in terms of competitiveness and its fundamental drivers, it's also a tool for governments and stakeholders to motivate and inform the process of economic policy making - tangible impact on process of economic growth
        
        BCI reveals the multi faceted quality of the competitive environment, infrastructure and stable electricity supply, crucial role of competition, paradocx of the role of regulation, openness
        
        competitive agenda depends on where the country is and its journey
        
        Patterns of trade
        
        Why Do Certain Patterns Of Trade Exist?
        
        Geographical advantage
        
        government intervention
        
        role of government in trade
        
        The mercantilist philosophy makes a crude case for government involvement in promoting exports and limiting imports
        
        Smith, Ricardo, and Heckscher-Ohlin promote unrestricted free trade
        
        New trade theory and Porter’s theory of national competitive advantage justify limited and selective government intervention to support the development of certain export-oriented industries
        
        factor endowments
        
        Heckscher and Ohlin predict that countries will export goods that make intensive use of locally abundant factors and import goods that make intensive use of factors that are locally scarce
    - - Unrestricted free trade is beneficial, but the gains may not be as great as the simple model of comparative advantage would suggest
        
        immobile resources
        
        diminishing returns
        
        dynamic effects and economic growth
        
        the Samuelson critique
        
        Paul Samuelson - the dynamic gains from trade may not always be beneficial
        
        free trade may ultimately result in lower wages in the rich country
      - A rich country may potentially become worse off in unrestricted free trade
        
        The ability to offshore services jobs that were traditionally not internationally mobile may have the effect of a mass inward migration into the United States, where wages would then fall
        
        however, protectionist measures could create a more harmful
        situation than free trade
  - - - location implications
        
        Different countries have advantages in different productive activities: these differences influence a firm’s decision about where to locate productive activities
        
        it makes sense for a firm to disperse its various productive activities to those countries where they can be performed most efficiently
      - first-mover implications
        
        Firms that establish a first-mover advantage in the production of a new product may later dominate global trade in that product
        
        it can be worthwhile for a firm to invest resources in trying to build first-mover advantages, even if it means losses for a few years before a venture becomes profitable
      - policy implications
        
        Government policies with respect to free trade or protecting domestic industries can significantly impact global competitiveness\
        
        businesses should work to encourage governmental policies that support free trade
        
        want policies that have a favorable impact on each component of the diamond
- - - - The foreign exchange market
        
        provides some insurance against foreign exchange risk - the adverse consequences of unpredictable changes in exchange rates
        
        is used to convert the currency of one country into the currency of another
      - The exchange rate
        
        the rate at which one currency is
        converted into another
        
        events in the foreign exchange market affect firm sales, profits,
        and strategy
    - - International companies use the foreign exchange market when doing business with foreign firms in foreign currencies
      - they must pay a foreign company for its products or services in its country’s currency
      - they have spare cash that they wish to invest for short terms in money markets
      - they are involved in currency speculation - the short-term movement of funds from one currency to another in the hopes of profiting from shifts in exchange rates
    - - The foreign exchange market provides insurance to protect against foreign exchange risk
        
        the possibility that unpredicted changes in future exchange
        rates will have adverse consequences for the firm
      - A firm that insures itself against foreign exchange risk is hedging
    - - The foreign exchange market is a global network of banks, brokers, and foreign exchange dealers connected by electronic communications systems
        
        the average total value of global foreign exchange trading in March, 1986 was just $200 billion, in April, 2010 it hit $4 trillion per day
        
        the most important trading centers are London, New York, Zurich, Tokyo, and Singapore
        
        the market is always open somewhere in the world—it never sleeps
  - - - Spot exchange rate
        
        The spot exchange rate is the rate at which a foreign exchange dealer converts one currency into another currency on a particular day
        
        spot rates change continually depending on the supply and demand for that currency and other currencies
        
        Spot exchange rates can be quoted as the amount of foreign currency one U.S. dollar can buy, or as the value of a dollar for one unit of foreign currency
      - Forward excvhange rate
        
        To insure or hedge against a possible adverse foreign exchange rate movement, firms engage in forward exchanges
        
        two parties agree to exchange currency and execute the deal
        at some specific date in the future
        
        forward exchange rate is the rate used for these transactions
        
        ➢rates for currency exchange are typically quoted for 30, 90, or 180 days into the future
    - - High-speed computer linkages between trading centers mean there is no significant difference between exchange rates in the differing trading centers
      - If exchange rates quoted in different markets were not essentially the same, there would be an opportunity for arbitrage: the process of buying a currency low and selling it high
      - Most transactions involve dollars on one side—it is a vehicle currency
        
        85% of all foreign exchange transactions involve the U.S. dollar
        
        other vehicle currencies are the euro, the Japanese yen, and the British pound
        
        China’s renminbi is still only used for about 0.3% of foreign exchange transactions
        
        other types of currency
        
        Bitcoin is unlike other major currencies because it is not associated with governments. Governments cannot influence or manipulate Bitcoin like other currencies
  - - - Exchange rates are determined by the demand and supply for different currencies
      - Three factors impact future exchange rate movements
        
        A country’s price inflation
        
        How Do Prices Influence Exchange Rates?
        
        The law of one price states that in competitive markets free of transportation costs and barriers to trade, identical products sold in different countries must sell for the same price when their price is expressed in terms of the same currency
        
        otherwise there is an opportunity for arbitrage until prices
        equalize between the two markets
        
        Purchasing power parity theory (PPP) argues that given relatively efficient markets (a market with no impediments to the free flow of goods and services) the price of a “basket of goods” should be roughly equivalent in each country
        
        predicts that changes in relative prices will result in a change in
        exchange rates
        
        A positive relationship exists between the inflation rate and the
        level of money supply , when the growth in the money supply is greater than the growth in output, inflation will occur
        
        PPP theory suggests that changes in relative prices between
        countries will lead to exchange rate changes, at least in the short run
        
        a country with high inflation should see its currency depreciate relative to others
        
        PPP can be explained by virtually universal goods
        
        How well does PPP work?
        
        Empirical testing of PPP theory suggests that it is most accurate in the long run for countries with high inflation and underdeveloped capital markets
        
        it is less useful for predicting short term exchange rate movements between the currencies of advanced industrialized nations that have relatively small differentials in inflation rates
        
        A country’s interest rate
        
        How Do Interest Rates Influence Exchange Rates?
        
        The International Fisher Effect states that for any two countries the spot exchange rate should change in an equal amount but in the opposite direction to the difference in nominal interest rates between two countries
        
        [(S1 - S2 ) / S2 ] x 100 = i $ - i ¥
        where i$ and i¥ are the respective nominal interest rates in two countries (in this case the U.S. and Japan), S1 is the spot exchange rate at the beginning of the period and S2 is the spot exchange rate at the end of the period
        
        Market psychology
        
        How Does Investor Psychology Influence Exchange Rates?
        
        The bandwagon effect occurs when expectations on the part of
        traders turn into self-fulfilling prophecies
        
        investor psychology and bandwagon effects greatly influence
        short term exchange rate movements
        
        government intervention can prevent the bandwagon from
        starting, but is not always effective
  - - - 2 Schools of thought
        
        The efficient market school
        
        forward exchange rates do the best possible job of forecasting future spot exchange rates, and, therefore, investing in forecasting services would be a waste of money
        
        An efficient market is one in which prices reflect all
        available information
        
        if the foreign exchange market is efficient, then forward exchange rates should be unbiased predictors of future spot rates
        
        Most empirical tests confirm the efficient market hypothesis suggesting that companies should not waste their money on forecasting services
        
        The inefficient market school
        
        companies can improve the foreign exchange market’s estimate of future exchange rates by investing in forecasting services
        
        An inefficient market is one in which prices do not reflect
        all available information
        
        in an inefficient market, forward exchange rates will not be the best possible predictors of future spot exchange rates and it may be worthwhile for international businesses to invest in forecasting services
        
        However, the track record of forecasting services is not
        good
    - - 2 Schools of thought on forecasting
        
        Fundamental analysis
        
        draws upon economic factors like interest rates, monetary policy, inflation rates, or balance of payments information to predict exchange rates
        
        Technical analysis
        
        charts trends with the assumption that past trends and waves are reasonable predictors of future trends and waves
  - - - A currency is freely convertible when a government of a country allows both residents and non-residents to purchase unlimited amounts of foreign currency with the domestic currency
      - A currency is externally convertible when non-residents can convert their holdings of domestic currency into a foreign currency, but when the ability of residents to convert currency is limited in some way
      - A currency is nonconvertible when both residents and non-residents are prohibited from converting their holdings of domestic currency into a foreign currency
      - Most countries today practice free convertibility but many countries impose restrictions on the amount of money that can be converted
        
        Countries limit convertibility to preserve foreign exchange reserves and prevent capital flight
      - When a currency is nonconvertible, firms may turn to countertrade
        
        barter-like agreements where goods and services are traded for other goods and services
        
        was more common in the past when more currencies were nonconvertible, but today involves less than 10% of world trade
    - - Managers need to consider three types of foreign
        exchange risk
        
        Translation exposure
        
        the impact of currency exchange rate changes on the reported financial statements of a company
        
        concerned with the present measurement of past events
        
        gains or losses are “paper losses”
        
        they are unrealized
        
        Economic exposure
        
        the extent to which a firm’s future international earning power is affected by changes in exchange rates
        
        concerned with the long-term effect of changes in exchange
        rates on future prices, sales, and costs
        
        Transaction exposure
        
        the extent to which the income from individual transactions is affected by fluctuations in foreign exchange values
        
        includes obligations for the purchase or sale of goods and services at previously agreed prices and the borrowing or lending of funds in foreign currencies
      - How Can Managers Minimize Exchange Rate Risk and translation exposure?
        
        transaction and translation exposure
        
        Lead and lag payables and receivables
        
        lead and lag strategies can be difficult to implement
        
        Lead strategies
        
        attempt to collect foreign currency receivables early when a foreign currency is expected to depreciate and pay foreign currency payables before they are due when a currency is expected to appreciate
        
        Lag strategies
        
        delay collection of foreign currency receivables if that currency is expected to appreciate and delay payables if the currency is expected to depreciate
        
        Buy forward
        
        economic exposure
        
        Distribute productive assets to various locations so the firm’s long-term financial well-being is not severely affected by changes in exchange rates
        
        Ensure assets are not too concentrated in countries where likely rises in currency values will lead to increases in the foreign prices of the goods and services the firm produces
        
        In general:
        
        Managers should have central control of exposure to protect resources efficiently and ensure that each subunit adopts the correct mix of tactics and strategies
        
        Distinguish between transaction and translation exposure on the one hand, and economic exposure on the other hand
        
        Attempt to forecast future exchange rates
        
        Establish good reporting systems so the central finance function can regularly monitor the firm’s exposure position
        
        Produce monthly foreign exchange exposure reports
- - - - agreements between countries in a geographic region to reduce tariff and non-tariff barriers to the free flow of goods, services, and factors of production between each other
  - - - eliminates all barriers to the trade of goods and services among member countries
      - North American Free Trade Agreement (NAFTA) - U.S., Canada, and Mexico
      - European Free Trade Association (EFTA) - Norway, Iceland, Liechtenstein, and Switzerland
    - - eliminates trade barriers between member countries and adopts a common external trade policy
      - Andean Community (Bolivia, Columbia, Ecuador, and Peru)
    - - has no barriers to trade between member countries, a common external trade policy, and the free movement of the factors of production
      - MERCOSUR (Brazil, Argentina, Paraguay, and Uruguay)
    - - has the free flow of products and factors of production between members, a common external trade policy, a common currency, a harmonized tax rate, and a common monetary and fiscal policy
      - European Union (EU)
    - - involves a central political apparatus that coordinates the economic, social, and foreign policy of member state
      - the EU is headed toward at least partial political union, and the U.S. is an example of even closer political union
  - - - The European Union (EU) with 27 members
        
        What Is The European Union?
        
        The devastation of two world wars on Western Europe
        prompted the formation of the EU, Members wanted lasting peace and to hold their own on the world’s political and economic stage
        
        Forerunner was the European Coal and Steel Community
        (1951)
        
        The European Economic Community (1957) was formed at the Treaty of Rome with the goal of becoming a common market
        
        The Single European Act (1987)
        
        committed the EC countries to work toward establishment of a single market by December 31, 1992
        
        was born out of frustration among EC members that the community was not living up to its promise
        
        provided the impetus for the restructuring of substantial sections of European industry allowing for faster economic growth than would otherwise have been the case
        
        The main institutions in the EU
        
        The European Council
        
        the ultimate controlling authority within the EU
        
        The European Commission
        
        responsible for proposing EU legislation, implementing it, and monitoring compliance with EU laws by member states
        
        The European Parliament
        
        debates legislation proposed by the commission and forwarded to it by the council
        
        The Court of Justice
        
        the supreme appeals court for EU law
        
        Should The EU Continue To Expand?
        
        Many countries have applied for EU membership
        
        Ten countries joined in 2004 expanding the EU to 25 states
        
        In 2007, Bulgaria and Romania joined bringing membership to 27 countries; Croatia is the newest member state of the EU (2013)
        
        Turkey has been denied full membership because of concerns over human rights
        
        Britain no longer part of EU (BREXIT)
        
        31st Jan 2020 Britain left the EU
        
        Transition period until 31st Dec 2020
        
        Short term v/s long term impact – political, economic
        
        Jobs, international trade, economic growth, public finances
        
        Mobility of people (EU citizens)
        
        Forced migration (terror, political instability, climate)
        
        Businesses left in a limbo “slowbalisation” – exit negotiations are complex and lengthy
      - The European Free Trade Area (EFTA) with 4 members
      - What Is The Euro?
        
        The Maastricht Treaty committed the EU to adopt a single currency
        
        created the second largest currency zone in the world after that of the U.S. dollar
        
        used by 17 of the 27 member states
        
        Britain, Denmark and Sweden opted out
        
        since its establishment January 1, 1999, the euro
        has had a volatile trading history with the USD
        
        Benefits of the euro
        
        savings from having to handle one currency, rather than many
        
        it is easier to compare prices across Europe, so firms are forced to be more competitive
        
        Increasing competition has led to long term increases in efficiency of European countries
        
        increases the range of investment options open both to individuals and institutions
        
        Costs of the euro
        
        loss of control over national monetary policy
        
        EU is not an optimal currency area
    - - There is a move toward greater regional economic integration in the Americas
      - The biggest effort is the North American Free Trade Area (NAFTA)
        
        What Is The North American Free Trade Agreement?
        
        The North American Free Trade Area includes the United States,
        Canada, and Mexico
        
        abolished tariffs on 99% of the goods traded between members
        
        removed barriers on the cross-border flow of services
        
        protects intellectual property rights
        
        removes most restrictions on FDI between members
        
        allows each country to apply its own environmental standards
        
        establishes two commissions to impose fines and remove trade privileges when environmental standards or legislation involving health and safety, minimum wages, or child labor are ignored
        
        Is The North American Free Trade Area Beneficial?
        
        Supporters of NAFTA claimed that Mexico would benefit
        
        from increased jobs as low cost production moves south and will see more rapid economic growth as a result
        
        U.S. and Canada would benefit from
        
        access to a large and increasingly prosperous market
        
        the lower prices for consumers from goods produced in Mexico
        
        low cost labor and the ability to be more competitive on world markets
        
        increased imports by Mexico
        
        Critics of NAFTA claimed that
        
        jobs would be lost and wage levels would decline in the U.S. and Canada
        
        pollution would increase due to Mexico's more lax standards
        
        Mexico would lose its sovereignty
        
        The debate
        
        Research indicates that NAFTA’s early impact was subtle, and both advocates and detractors may have been guilty of exaggeration
        
        NAFTA is credited with helping create increased political stability in Mexico
        
        Other Latin American countries would like to join NAFTA
        
        Being renegotiated or terminated?
      - Other efforts include the Andean Community and MERCOSUR
        
        What Is The Andean Community?
        
        The Andean Pact
        
        formed in 1969 using the EU model
        
        had more or less failed by the mid-1980s
        
        was re-launched in 1990, and now operates as a customs union
        
        renamed the Andean Community in 1997
        
        signed an agreement in 2003 with MERCOSUR to restart negotiations towards the creation of a free trade area
        
        What Is MERCOSUR?
        
        originated in 1988 as a free trade pact between Brazil and Argentina
        
        was expanded in 1990 to include Paraguay and Uruguay and in 2005 with the addition of Venezuela
        
        Is now comprised of Argentina, Brazil, Paraguay, Uruguay, and Venezuela.
        
        Yeats (1996) MERCOSUR may be diverting trade rather than creating trade, and local firms are investing in industries that are not competitive on a worldwide basis
        
        initially made progress on reducing trade barriers between member states, but more recently efforts have stalled
      - A hemisphere-wide Free Trade of the Americas is under discussion
        
        What Is Free Trade Of The Americas?
        
        Talks began in April 1998 to establish a Free Trade of The
        Americas (FTAA) by 2005
        
        The FTAA was not established and now support from the U.S.
        and Brazil is mixed
        
        the U.S. wants stricter enforcement of intellectual property
        rights
        
        Brazil and Argentina want the U.S. to eliminate agricultural
        subsidies and tariffs
      - What Is The Central American
        Trade Agreement And CARICOM?
        
        two other trade pacts in the Americas
        
        the Central American Trade Agreement
        
        (CAFTA, 2005) - to lower trade barriers between the U.S. and members
        
        CARICOM (1973)
        
        to establish a customs union
        
        In 2006, six CARICOM members formed the Caribbean Single Market and Economy (CSME) - to lower trade barriers and harmonize macro-economic and monetary policy between members
    - - Various efforts at integration have been attempted in Asia, but most exist in name only
        
        Association of Southeast Asian Nations (ASEAN)
        
        Regional Comprehensive Economic Partnership (RCEP) agreed on in 2019
        
        What Is the Regional Comprehensive Economic Partnership (RCEP)
        
        15 Asia-Pacific nations agree to trade deal (to be signed in 2020)
        
        Covers 29% of the global economy
        
        The pact formalises trade rules across 15 countries and gives
        Australia better access to those markets
        
        1 more item...
        
        What Is The Association Of Southeast Asian Nations?
        
        The Association of Southeast Asian Nations (ASEAN, 1967) currently includes Brunei, Indonesia, Malaysia, the Philippines, Singapore, Thailand, Vietnam, Myanmar, Laos, and Cambodia
        
        wants to foster freer trade between member countries and to
        achieve some cooperation in their industrial policies
        
        An ASEAN Free Trade Area (AFTA) between the six original members of ASEAN came into effect in 2003
        
        ASEAN and AFTA are moving towards establishing a free trade zone
        
        Asia-Pacific Economic Cooperation (APEC)
        
        What Is The Asia-Pacific Economic Cooperation?
        
        has 21 members including the United States, Japan, Australia and China
        
        wants to increase multilateral cooperation
        
        member states account for 55% of world’s GNP, and 49% of world trade
    - - Africa Continental Free Trade Area (AfCFTA)
        
        Will be the largest free trade area when operational in July 2020
        
        Agreed on in July, 2019 – 54 countries
        
        Seen as a first step to improving free trade between African countries
        
        Avoid protectionism, harmonizing regulations
        
        2019 intra-African exports only 16.6% (for comparison, 68% in Europe and 59% in Asia)
        
        Needs to focus on fostering entrepreneurship, providing access to credit and capital as well as infrastructure between countries
    - - CPTPP Pros and Cons
        
        Pros
        
        Reduces barriers for trade particularly intellectual property and foreign investment
        
        Not being part of it might be worse
        
        Several countries regulatory rules and standards might increase
        
        Cons
        
        Empowers foreign corporations
        
        Lack of transparency and accountability in negotiation
        
        Would be better if US was part of the agreement
        
        Will take time for effects – potentially a decade for some industries
  - - - All countries gain from free trade and investment
        
        regional economic integration is an attempt to exploit the gains from free trade and investment
      - Linking countries together, making them more dependent on each other
        
        creates incentives for political cooperation and reduces the likelihood of violent conflict
        
        gives countries greater political clout when dealing with other nations
  - - - Economic integration can be difficult
        
        while a nation as a whole may benefit from a regional free trade
        agreement, certain groups may lose
        
        it implies a loss of national sovereignty
      - Regional economic integration is only beneficial if the amount of trade it creates exceeds the amount it diverts
        
        trade creation occurs when low cost producers within the free trade area
        replace high cost domestic producers
        
        trade diversion occurs when higher cost suppliers within the free trade area replace lower cost external suppliers
    - - China’s bid for global geopolitical dominance
      - Reviving the Silk Route
      - Financial & regulatory institutions under BRI
        
        Series of projects to be undertaken through bilateral agreements between China and the partner countries.
        
        No institutional framework or decision-making mechanism through which participating countries are connected with one another.
        
        Chinese state-owned banks as well as China-led international financial institutions such as the Asian Infrastructure Investment Bank and the New Development Bank are key lenders
        
        The Bank of China intends to make the Renminbi the main trading and investment currency in the countries involved.
        
        The expansion of Chinese banks into new BRI markets to serve the globalisation of the Chinese economy is also being promoted.
        
        The project lacks transparency and accountability
      - ‘Debt-trap diplomacy’
        
        Repayment arrears where debt was converted to equity
        (Pakistan – Gwadar port, Sri Lanka – Hambantota port)
      - Benefits & Costs to China
        
        Economic Benefits & Costs
        
        Stimulate domestic industry
        
        Use overcapacity in steel & minerals; access new markets
        
        Mitigate rising domestic labour and manufacturing costs
        
        Yuan a global currency?
        
        Financing the $1 trillion BRI
        
        Political Benefits & Costs
        
        Increased Asian influence in the West
        
        Chinese influence in smaller partner countries (debt lock-in)
        
        Chinese military presence across BRI
        
        Will China create an economic empire in Asia and Africa ??
      - Benefits & Costs to World
        
        Who benefits
        
        Central Asia, Africa, ME, Europe
        
        Facilitate global trade
        
        Infrastructure development, strong supply chain and logistics networks
        
        Australia-China BRI Initiative
        
        Who loses out
        
        Hidden costs of investment
        
        Threats to security, autonomy (India)
        
        Chinese exports win! (eg. Pakistan)
        
        Worries about China’s long-term control/ ownership of infrastructure, natural resources & associated land assets in partner nations
        
        Coal v/s renewables, emissions
      - India's decision to stay out
        
        Antagonism with Pakistan and strategic distrust with China are significant impediments to India’s involvement
        
        3000 km China-Pakistan Economic Corridor
        
        China control of Pakistan's Gwadar port - boosts Chinese presence in the Indian Ocean, encircles India’s borders
        
        Fight for Asian influence between the two fastest growing economies
        
        It can be argued that India has isolated itself both regionally and globally
        
        Strategic engagement, trade & investment with China is ongoing
        
        Trade partnerships in Europe and Asia: India-EU, IndiaAfghanistan, IndiaBangladesh/Myanmar, IndiaRussia.
        
        India, USA, AU, Japan in talks to establish BRI alternative