International Business

1) “Multinational Corporations are great contributors to many

economies in the world, at the same time few are criticized for their

remedies” Discuss (Pg 81)

2) “FDI are essential for long term prosperity of the country.” Justify

(Pg 38)

3) “IB is completely different from Domestic business both in planning

and operations – Discuss (Pg 8)

4) “Globalization is not a quick process, it is an outcome of long term

strategy moves for companies and countries” Justify (Pg 101)

5) WTO lost its objectives and control due to emerging FTA’s and RTA’s

in force - Discuss

6) “ Trade theories are losing their relevance today” – Analyze the

statement with

a. Theory of absolute advantage (Pg 164)

b. Purchasing power parity (Pg 173)

c. Competitive advantage of nation (Pg 165)

7) Categorize different modes and methods of entry in IB practices by

MNC’s (Pg 12)

8) Discuss different challenges encounterd by global HR personnal

2day (Pg190)

9) India in developing close trade ties with ASEAN through initiatives

such as, FTA.. Discuss the potential for business in ASEAN bloc. (Pg

229)

10) Enumerate various aspects of foreign exchange management

applicable to international business.(Pg 344)

11) What is your opinion on world class management – illustrate

with current example.

12) What is the risk analysis? Categories all the risk and their

impact on IB.

1. what are the various methods of entry into a foreign market? OR

What are the various collaborative strategies employed in IB?

(R. Chandra Pg 12)

2. what are the various environmental factors that impact IB? give examples.(Pg 25)

3. Give reasons why FDI happens? (Pg 38 R chandran) (Notes)

4. Compare FDI figures vis-à-vis India,China, Vietnam (NET)

5. What are the various international trade theories? (Pg 163 R chandran)

6. Impact of WTO on India esp. Seattle and Doha. (Pg 113)

7. Various organizational structures in IB

8. NAFTA (Pg 213) (Notes)

9. ASEAN (Pg 229) (Notes)

10.Swaps, Options and futures (From Derivatives)

11.ADR/GDR (From AFM)

12.International logistics and its importance in IB (Pg 153)

13.Country evaluation and selection.(Notes)

Solve any 4 out of 74 Q’s 10 marks each – 40

1 case study – 20 marks

Q1) Define International Business? Domestic and International Business - difference? Mode  of entry into IB?

Q2) Risk analysis in IB?

Q3) Foreign direct investment , Doha round – impact in India

Q4) How do we raise funds from international markets?

Q5) What is globalization? Role of Global organization? Structure of MNC ?

Q6) Explain WTO, Hongkong round?

Q7) International trade theories?

Q8) Culture in global organization? International Logistics and Distribution?

Q9) Short notes on- European union- G20- LAFTA- NAFTA- G8 Trade Barriers- IMF, IPR, TRIPS, MERGERS and Acquisition

Q10) Case Study on international trade

1. what is international business? how does it differ from domestic  business?  2. Discuss the prime motive behind companies and nation going in for  international business?  3. What is Multinational Corporation? Classify MNC's depending upon their  structure and country of origin?  4. Discuss FDI and strategies to attract FDI from the investors point of  view?  5. Discuss modern foreign trade theories and implications in trade?  6. What is globalization? how do global organisation focus on strategies  to prospect?  7. what is risk analysis? how do companies overcome risks?  8. Discuss the environmental factors in international business?  9. What is WTO? how does it functions to maintain its agenda? discuss its  limitations and achievements?  10. discuss the importance of international organisations and their rate  to promote international business?  11. How will you do business with NAFTA?  12. discuss the business strategy to do business in EU?  13. how will u do business with ASEAN?  14. Compare and contrast the business potential in India and China?  15. Discuss the challenges involved in Global Human Resource Management?  16. Discuss all the barriers related to international business?  17. discuss the role played by the government of India to promote  international trade?  18. discuss the major criteria to set up business in another country?  19. how will u evaluate the competitive force in international business?  20. discuss the Intellectual Property Rights and their  commercializations?

Instructions:

1. Answer any six questions2. All questions carry equal marks3. Case study is compulsory4. Candidates are required to give clear concepts, illustrations, examples and

analysis.

Q1. “ WTO aims at removing non-tariff barriers and reducing tariff Barriers”. If so, critically evaluate achievements and problem areas which WTO has encounter in order to succeed in the above objective.

Q2. Define “International Business”. Explain fundamental difference between domestic business operations and International Business operations using business characteristics.

Q3. Discuss the contemporary theories of International Trade with suitable examples. How can the Porter’s Model of competitive advantage be used to assess competitive advantages for India’s Textile Industries?

Q4. How Multinational Enterprise can be classified. State features of MNE’S. Explain briefly International Subsidiary Strategy.

Q5. Developing countries welcome FDI as part of reform process. Discuss the advantages to both the Investor and the country of destinations. Enumerate the risk factors which an investor takes into account before deciding to invest.

Q6. Depreciation of Rupee has created trouble for Indian Exporters and Importers. State and Explain how Pharma Companies, Textile, BPO / KPO sector companies can deal with this scenario?

Q7. Discuss the role of Culture in International Business and enumerate all the challenges encountered by global human resource division operating in a cross border business environment.

Q8. Writ short notes on any two of the following:-

a) G-20 – The London Summitb) Balance of Paymentsc) WORLD BANK and IMFd) Purchasing Power Theory

Q9. Case Study.

C A S E S T U D I E S

THE COLLAPSE OF THE THAI BAHT IN 1997

During the 1980s and 1990s, Thailand emerged as one of Asia’s most dynamic tiger economies. From 1985 to 1995, Thailand achieved an annual average economic growth rate of 8.4 percent, while keeping its annual inflation rate at only 5 percent. Much of Thailand’s economic growth was powered by Exports. From 1990 to 1996, for Example, the value of exports from Thailand grew by 16 percent per year compounded. The wealth created by Export-led growth fueled an investment boom in commercial and residential property, industrial assets and infrastructure. As demand for property increased the value of commercial and residential real estate in Bangkok soared. This fed a building boom seen in Thailand. Offices and Apartment buildings were going up all over the city. Heavy borrowing from Banks financed much of this construction, but as long as property values continued to rise, the banks were happy to lend to property companies.

By early 1997, however, it was clear that the boom had produced excess capacity in residential and commercial property. An estimated 3,65,000 apartment units were unoccupied in Bangkok in late 1996. With another 100,000 units scheduled to be completed in 1997, years of excess of demand in the Thai

property market had been replaced by excess supply. By one estimate, Bangkok’s building boom by 1997 had produced enough excess space to meet its residential and commercial needs for at least five years. At the same time, Thailand’s investment in infrastructure, industrial capacity and commercial real estate were sucking in foreign goods at unprecedented rates.

(2)

To build infrastructure, factories and office building, Thailand was purchasing capital equipment and materials from America, Europe and Japan.

As a consequence, the current account of the Balance of Payment shifted strongly into the red during the mid-1990s. Despite strong export growth, Imports grew faster. By 1995. Thailand was running a current account deficit equivalent of 8.1% percent of its GDP.

Things started to fall apart February 5th 1997. When Somprasong Land, Thai property developer, announced it had failed to make a schedule $3.1 million interest payment on an $80 billion Eurobond loan, effectively entering into default, Somprasong Land was the first victim of speculative overbuilding in the Bangkok property market. The Thai stock market had already declined by 45% since its high in early 1996. Primarily on concerns that several property companies might be forced into bankruptcy. Now one had been. The stock market fell another 2.7% in the news, but it was only the beginning.

In the aftermath of Somprasong’s default, it became clear that, along with several other property developers, many of the country’s financial institutions, including Finance One, the country’s largest financial institutions, had pioneered a practice that had become widespread among Thai Institutions-issuing bonds denominated in U.S. Dollars and using the proceeds to finance lending to the country’s booming property developers. In theory, this practice made sense because Finance one was able to exploit the interest rate differential between Dollar-denominated debt and Thai Debt.( Finance One borrowed in U.S. Dollars at a low interest rate and Lent in Thai baht at high interest rates). The only problem with this financing strategy was that when the Thai Property market began to unravel in 1996 and 1997, the Property developers could no longer pay back the Cash they had borrowed from Finance One. This made it difficult for Finance One to pay back its creditors. As the effects of overbuilding became evident in 1996. Finance One’s non performing loans doubled, then doubled again in the first quarter of 1997.

(3)

In Feb.1997, trading in the shares of Finance One was suspended while the government tried to small Thai Bank in a deal sponsored by the Thai Central Bank. It didn’t work, and when trading resumed in Finance One Shares in May, they fell 70% in a single day. By this time bad loans in the Thai property market were swelling daily and had risen to more than $30 billion. Finance One was bankrupt, and it was feared that others would follow.

It was at this point that currency traders began a concerned attack on the Thai currency. For the previous 13years, Thai baht had been pegged to the US Dollars at an exchange rate of about $1=Bt25. This peg, however, had become increasingly difficult to defend. Currency traders, looking at Thailand’s growing current account deficit and dollar denominated debt burden, reasoned that demand for dollars in Thailand would rise while demand for Baht would fall. There were several attempts to force a devaluation of the Baht in late 1996 and early 1997. These speculative attacks typically involved traders selling baht short to profit from a future decline in the value of the baht against the dollar. In this context, short selling involves a currency trader borrowing baht from a financial institutions and immediately reselling those baht in the Foreign Exchange market for Dollars. The theory is that if the value of the baht subsequently fall against the dollar, than when the trader has to buy the baht back to repay the financial institutions, it will cost her fewer dollars than she received from the initial sale of Baht. For examples, a trader might borrow Baht 100 from a Bank for $4 ( at an exchange rate of $1=Baht 25). If the exchange rate subsequently declines to $1=Baht50, it will cost the trader only $2 to repurchase the Bt100 in six months and pay back the bank, leaving the trader with a 100 percent profit.

( 4 )

In May 1997, short sellers were swarming over the Thai Government used its foreign Exchange reserves( which were denominated in US Dollars) to purchase

Baht. It cost the Thai government $5 billion to defend the baht, which reduced its “officially reported” foreign exchange reserves to a two-year low of $ 33 Billion. In addition, the Thai government raised key interest rates from 10% to 12.5% to make holding baht more attractive, but because this also raised corporate borrowing costs it exacerbated the debt crisis. What the world financial community did not know at this point, was that with the blessings of his superiors, a foreign exchange trader at the Thai central bank had locked up most of Thailand’s foreign exchange reserves in forward contracts. The reality was that Thailand had only $1.14 billion in available foreign exchange reserves left to defend the dollar peg. Defending the Peg was now impossible.

On July 2, 1997, the Thai Government bowed to the inevitable and announced it would allow the Baht to float freely against the dollar. The Baht immediately lost 18 percent of its value and started a slide that would bring the exchange rate down to $1=Bt55 by January 1998. As the Baht declined, the Thai debt bomb exploded. A 50 percent decline in the value of the Baht against the dollar doubled the amount of baht required to serve the dollar-denominated debt commitments taken on by Thai Financial institutions and business. This made more bankruptcies and further pushed down the battered Thai stock market. The Thailand set stock market index ultimately declined from 787 in January 1997 to a low of 337 in December of that year, and this on top of a 45 percent decline in 1996.

(5)

Questions:

1. Identify the main factors that led to the collapse of the Thai Baht in 1997.

2. Do you think the sudden collapse of the Thai baht can be explained by the purchasing power parity theorem?

3. What role did speculators play in the fall of the Thai Baht? Did they cause its fall?

4. What steps might the Thai Government have taken to preempt the financial crisis that swept the nation in 1997?

5. How will the collapse of the Thai baht affect business in Thailand, particularly those that purchase inputs from abroad or export finished products?

THE END.

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 Euro Disney

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 target environment.

Low sales potential in target country.

Large cultural distance

Minimizes risk and investment.

Speed of entry

Able to circumvent trade barriers

High ROI

Lack of control over use of assets.

Licensee may become competitor.

Knowledge spillovers

License period is limited

Licensee lacks ability to become a competitor.

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.

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.

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.

4. Discuss the FDI climate

between India, China and

Vietnam.

Ans:

FDI or Foreign Direct Investment is any form of investment that earns interest in enterprises which function outside of the domestic territory of the investorTypes:

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

PARAMETER India

FDI IN 2008-09 23885 $

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%)

Topmost investing country

Mauritius (44%)

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.

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

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.

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 company’s 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 Favoured 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.

8. Discuss Regional Trade Blocs : NAFTA and ASEAN

Trade bloc is a type of intergovernmental agreement, often part of a regional intergovernmental organization, where regional barriers to trade (tariffs and non-tariff barriers) are reduced or eliminated among the participating states.[1]

What is NAFTA?

The North American Free Trade Agreement or NAFTA, which came into force on January 1, 1994, is not just another treaty that aims to facilitate trade between its member nations. It is one of the world’s most powerful and successful treaties comprising the United States, Canada and Mexico.

The North American Agreement for Labor Cooperation (NAALC) and North American Agreement for Economic Cooperation (NAAEC) are major additions to this treaty. Following the unfortunate September 11/2001 attack in the US, the Security and Prosperity Partnership of North America (SPPNA) was also added to NAFTA.

Interestingly, the goods that are traded between the NAFTA members feature labels. These labels are printed in three languages, namely, English, Spanish and French. No doubt, NAFTA has been highly beneficial for consumers, farmers and ranchers.

When Was NAFTA Started?:

NAFTA was signed by U.S. President George H.W. Bush, Mexican President Salinas, and Canadian Prime Minister Brian Mulroney in 1992. It was ratified by the legislatures of the three countries in 1993. The U.S. House approved it by 234 to 200 on November 17 and the Senate by 60 to 38 on November 20. It was signed into law by President Bill Clinton on December 8, 1993 and entered force January 1,1994. Although it was started by President

Bush, it was a priority of President Clinton's, and its passage is considered one of his first successes.

How Was NAFTA Started?:

The impetus for NAFTA actually began with President Ronald Regan, who campaigned on a North American common market. In 1984, Congress passed the Trade and Tariff Act. This is important because it gave the President "fast-track" authority to negotiate free trade agreements, while while only allowing Congress the ability to approve or disapprove, not change negotiating points. Canadian Prime Minister Mulroney agrees with Reagan to begin negotiations for the Canada-U.S. Free Trade Agreement, which was signed in 1988, went into effect in 1989 and is now suspended due to NAFTA.

Meanwhile, Mexican President Salinas and President Bush began negotiations for a liberalized trade between the two countries. Prior to NAFTA, Mexican tariffs on U.S. imports were 250% higher than U.S. tariffs on Mexican imports. In 1991, Canada requests a trilateral agreement, which then led to NAFTA. In 1993, concerns about liberalization of labor and environmental regulations led to the adoption of two addendums to NAFTA.

Why Was NAFTA Formed?:

Article 102 of the NAFTA agreement outlines its purpose:

Grant the signatories Most Favored Nation status. Eliminate barriers to trade and facilitate the cross-border movement of goods and

services. Promote conditions of fair competition. Increase investment opportunities. Provide protection and enforcement of intellectual property rights. Create procedures for the resolution of trade disputes. Establish a framework for further trilateral, regional and multilateral cooperation to expand

NAFTA's benefits.

What Are the Advantages of NAFTA?:

NAFTA created the world’s largest free trade area, linking 439 million people and producing $15.3 trillion in goods and services annually. Estimates are that NAFTA increases U.S. GDP by as much as .5% a year.

That's because its elimination of tariffs and agreements on international rights for business investors increases trade and capital, spurring business growth. Elimination of tariffs also reduces inflation, by decreasing costs of imports.

Increase in Trade:

Trade between the NAFTA signatories tripled, from $297 billion in 1993 to $903 billion in 2007. Specifically,

U.S. goods exports to Canada and Mexico grew 157%, from $142 billion to $364.6 billion. Exports from Canada and Mexico to the U.S. grew 231%, from $151 billion in to $501

billion.

NAFTA provides the ability for firms in member countries to bid on government contracts. It also protect intellectual properties.

Increase in U.S. Agricultural Exports:

NAFTA is especially helpful for agricultural exports because it reduces high Mexican tariffs. Mexico is the top export destination for beef, rice, soybean meal, corn sweeteners, apples and beans. It is the second largest for corn, soybeans and oils. As a result of NAFTA, the percent of U.S. agricultural exports to Canada and Mexico has grown from 22% in 1993 to 30% in 2007.

Increase in Trade of Services:

More than 40% of U.S. GDP is services, including financial services and health care. These aren't as easily transported as are goods, so being able to expand services to nearby countries is important. Thanks to NAFTA, U.S. services exports to Canada and Mexico grew 125%, from $25 billion to $62 billion in 2006. Services exports from Canada and Mexico grew to $37 billion.

NAFTA eliminates trade barriers in nearly all service sectors. Service industries are often highly regulated, and the regulations aren't always apparent. NAFTA requires authorities to use open administrative procedures and publish all regulations.

Increase in Foreign Direct Investment:

Since NAFTA was enacted, U.S. foreign direct investment (FDI) in Canada and Mexico tripled to $331 billion (as of 2006, latest data available). Canadian and Mexican FDI in the U.S. was $165 billion.

NAFTA reduces risk for investors by guaranteeing they will have the same legal rights as local investors. It also guarantees they will receive fair market value for their investments in case the government decides to nationalize the industry or take the property by eminent domain. NAFTA provides a legal mechanism for investors to make claims against a government, if needed

Disadvantages of NAFTA:

NAFTA has many disadvantages. NAFTA allowed U.S. manufacturers to move jobs to lower-cost Mexico. Those manufacturers that remained had to decrease wages to compete.

Many of Mexico's farmers were put out of business by U.S.-subsidized farm products. NAFTA provisions for Mexican labor and environmental protection were not strong enough, allowing for exploitation.

Loss of U.S. Jobs:

Since the cost of labor is cheaper in Mexico, many manufacturing industries moved part of their production from high-cost U.S. states. Between 1994 and 2002, the U.S. lost 1.7 million jobs, gaining only 794,00, for a net loss of 879,000 jobs. Most of these jobs(78%) were in manufacturing. States hit hard included California, New York, Michigan and Texas. These states had high concentrations of the industries that moved plants to Mexico. These industries included motor vehicles, textiles, computers, and electrical appliances.

Lower U.S. Wages:

Employers in industries that could move to Mexico used that as a threat during union organizing drives, thus suppressing wage growth. Between 1993 and 1995, 50% of all companies used the threat; by 1999, that rate had grown to 65%.

Mexico's Farmers Are Being Put Out of Business:

Thanks to the 2002 Farm Bill, U.S. agribusiness is heavily subsidized - as much as 40% of net farm income. As tariffs are removed, corn and other food is exported to Mexico below cost. This benefits consumers, who pay less for food, but makes it impossible for rural Mexican farmers to compete. In contrast, between 1990-2001, Mexico decreased its subsidies to farmers from 33.2% to 13.2% of total farm income. Most of those subsidies go to Mexico's large farms.

Maquiladora Workers Are Exploited:

NAFTA caused an increase of the maquiladora program, in which U.S. owned companies employ Mexican workers near the border to cheaply assemble products for "export" to the U.S. This now comprises 30% of Mexico's labor force. These workers have "no labor rights or health protections, workdays stretch out 12 hours or more, and if you are a woman, you could be forced to take a pregnancy test when applying for a job," according to Continental Social Alliance.

Degradation of Mexico's Environment Has Increased:

In response to NAFTA competitive pressure, Mexico agribusiness has increased its use of fertilizers and other chemicals, costing $36 billion per year in pollution. Rural farmers have expanded into more marginal land, resulting in deforestation at a rate of 630,000 hectares per year.

ASEAN:

The Association of Southeast Asian Nations, is a geo-political and economic organisation of 10 countries located in Southeast Asia, which was formed on 8 August 1967 by Indonesia, Malaysia, the Philippines, Singapore and Thailand.Since then, membership has expanded to include Brunei, Burma (Myanmar), Cambodia, Laos, and Vietnam. Its aims include the acceleration of economic growth, social progress, cultural development among its members, the protection of the peace and stability of the region, and to provide opportunities for member countries to discuss differences peacefully

In 2005, the bloc spanned over an area of 4.46 million km2 with a combined GDP (Nominal/PPP) of about USD$896.5 billion/$2,728 billion growing at an average rate of around 5.6% per annum. In 2008, its combined GDP had grown to more than USD $1.5 trillion with a population of approximately 580 million people (8.7% of the world population

OBJECTIVES

The ASEAN Declaration states that the aims and purposes of the Association are:

(i) To accelerate the economic growth, social progress and cultural development in the

region through joint endeavors.

(ii) To promote regional peace and stability through abiding respect for justice and the

rule of law in the relationship among countries in the region and adherence to the

principles of the United Nations Charter.

(iii) To maintain close cooperation with the existing international and regional

organizations with similar aims.

WORKING OF ASEAN

The member countries of ASEAN have Preferential Trading Arrangements (PTA), which

reduces tariffs on products traded among member countries. In 1992, ASEAN developed a

Common Effective Preferential Tariffs (CEPT) plan to reduce tariffs systematically for

manufactured and processed products.

The members have also established a series of co-operative efforts to encourage joint

participation in industrial, agricultural and technical development projects and to increase

foreign investments in their economies. These efforts include an ASEAN finance corporation,

the ASEAN Industrial Joint Ventures Programme (AJIV) etc. ASEAN nations have

introduced some programmes for greater diversification in their economies.

India and ASEAN

India is interested in maintaining close economic relations with the members of ASEAN, as

these countries are closer to India. The ASEAN countries are offering co-operation to India

in the field of trade, investment, science and technology and training of personnel. Also,

India’s trade with ASEAN countries is satisfactory in recent years.

TRADE BLOC:

A trade bloc is a type of intergovernmental agreement, often part of a regional

intergovernmental organization, where regional barriers to trade (tariffs and non-tariff

barriers) are reduced or eliminated among the participating states.

ASEAN has emphasised regional cooperation in the “three pillars” of security, sociocultural and economic integration. The regional grouping has made the most progress in economic integration, aiming to create an ASEAN Economic Community (AEC) by 2015

Free Trade Area

The foundation of the AEC is the ASEAN Free Trade Area (AFTA), a common external preferential tariff scheme to promote the free flow of goods within ASEAN The ASEAN Free Trade Area (AFTA) is an agreement by the member nations of ASEAN concerning local manufacturing in all ASEAN countries. The AFTA agreement was signed on 28 January 1992 in Singapore When the AFTA agreement was originally signed, ASEAN had six members, namely, Brunei, Indonesia, Malaysia, the Philippines, Singapore and Thailand. Vietnam joined in 1995, Laos and Myanmar in 1997, and Cambodia in 1999. The latecomers have not fully met the AFTA's obligations, but they are officially considered part of the AFTA as they were required to sign the agreement upon entry into ASEAN, and were given longer time frames in which to meet AFTA's tariff reduction obligations

Comprehensive Investment Area

The ASEAN Comprehensive Investment Area (ACIA) will encourage the free flow of investment within ASEAN. The main principles of the ACIA are as follows

All industries are to be opened up for investment, with exclusions to be phased out according to schedules

National treatment is granted immediately to ASEAN investors with few exclusions Elimination of investment impediments Streamlining of investment process and procedures Enhancing transparency Undertaking investment facilitation measures

Full realisation of the ACIA with the removal of temporary exclusion lists in manufacturing agriculture, fisheries, forestry and mining is scheduled by 2010 for most ASEAN members and by 2015 for the CLMV (Cambodia, Lao PDR, Myanmar, and Vietnam) countries.

Trade in Services

An ASEAN Framework Agreement on Trade in Services was adopted at the ASEAN Summit in Bangkok in December 1995. Under AFAS, ASEAN Member States enter into successive

rounds of negotiations to liberalise trade in services with the aim of submitting increasingly higher levels of commitments. The negotiations result in commitments that are set forth in schedules of specific commitments annexed to the Framework Agreement. These schedules are often referred to as packages of services commitments. At present, ASEAN has concluded seven packages of commitments under AFAS.

Single Aviation Market

The ASEAN Single Aviation Market (SAM), proposed by the ASEAN Air Transport Working Group, supported by the ASEAN Senior Transport Officials Meeting, and endorsed by the ASEAN Transport Ministers, will introduce an open-sky arrangement to the region by 2015. The ASEAN SAM will be expected to fully liberalise air travel between its member states, allowing ASEAN to directly benefit from the growth in air travel around the world, and also freeing up tourism, trade, investment and services flows between member states. Beginning 1 December 2008, restrictions on the third and fourth freedoms of the air between capital cities of member states for air passengers services will be removed, while from 1 January 2009, there will be full liberalisation of air freight services in the region, while By 1 January 2011, there will be liberalisation of fifth freedom traffic rights between all capital cities.

Free Trade Agreements With Other Countries

ASEAN has concluded free trade agreements with China, Korea, Japan, Australia, New Zealand and most recently India. In addition, it is currently negotiating free trade agreement with the European Union. Taiwan has also expressed interest in an agreement with ASEAN but needs to overcome diplomatic objections from

QUESTION BANK = INTERNATIONAL BUSINESS

1) Explain the nature of International Business? Globalization–

Its Components (Pg 2)

2) Explain the stages of Internationalization? Pros & Cons

3) Explain the Comparative Cost Theory of International

Business. What are its assumptions and outcomes? (Pg 165)

4) Explain the Opportunity Cost Theory of International

Business?

5) What are the assumptions, merits and derivatives of

Hecklscher-Ohlin Theory? (Pg 168)

6) What is Business Environment? Explain the different factors

of International Business Environment? (Pg 25)

7) What is Social & Cultural Environment? Analyze the impact of

Social & Cultural factors on global business? (Pg 30)

8) Explain Cross-Cultural Communication process and

negotiation with a suitable example?(Pg 183)

9) What is Economic Environment? Explain different kinds of

economic systems & their influences on International

Business? (Pg 27)

10) How do you classify the countries as low income, middle

income & rich income countries? Do you think that the

economic status of the country influence the global

business?

11) What are the advantages & disadvantages of different

modes of entry? (Pg 12)

12) What is Exporting? How do the firms enter international

markets through exporting strategy? (Pg 13,14)

13) What is International Licensing? What are the advantages

& disadvantages of International Licensing? (Pg 13,15)

14) What is International Franchising? Explain the basic issues

involved in Franchising & Franchising Agreements? (Pg

15,16)

15) What is Foreign Direct Investment? What are the

advantages & disadvantages of FDI? Also explain different

strategies of FDI? (Pg 39)

16) What is Joint Venture? Why do the firms Joint Venture to

go globally? (Pg 18)

17) What are the conflicting situations in the Alliances? How

do you manage them?

18) What is Dumping? What are the impacts of Dumping by

China & East Asian countries on Indian industry?

19) “Some argue that WTO is the third pillar of Global

Business. But many argue that WTO is the Wrong Trade

Organization.” Critically comment?

20) What is Multinational Corporation? How is it different from

a global company, an international company & a

transnational company? (Pg 81)

21) Why do developing countries allow MNC’s to operate in

their countries? Why do some countries impose control over

MNC’s? (Pg 98,99)

22) What are the peculiarities of Global Strategic

Management? What is International SWOT analysis? How do

you use it in formulating global strategies?

23) What is Foreign Exchange? How do you determine the

Exchange Rates?

24) Discuss the origin, objective & functions of International

Monetary Fund (IMF)? (Dhondse)

25) What is SDR? Explain its role in maintaining International

Liquidity? (Dhondse)

26) Explain the origin, objectives & functions of International

Bank for Reconstruction & Development (IBRD)? (Dhondse)

27) GATT, GATS, TRIPS, etc?

28) Economic Integration levels – EU, NAFTA, SAFTA, BRIC,

etc?

29) International Business Strategy & Organization Structure/

HR? (Pg 190)

30) PEST Analysis’s/ Business Environment (Pol, Eco, Soc, Cul,

Tech, Legal)? (Pg 25)

Q1. What are the various entry methods for International Business?

Export

Exporting is the most traditional way of entering into International Business. Export can

be done in two ways:

1. Direct Export – Products are sold directly to buyers in target markets either through

local sales representatives or distributors. Sales representatives promote their

company’s products and do not take title to the merchandise. Distributors take

ownership of the goods (and the accompanying risk) and usually on-sell through

wholesalers and retailers to end-users.

Advantages of Direct Exports:

o Give a higher return on your investment than selling through an agent or

distributor

o Allows the exporting company to set lower prices and be more competitive

o Gives the company a close contact with its customers

Disadvantages of Direct Exports:

o The company may not have the services of a foreign intermediary, so it may need

more time to become familiar with the market

o The customers or clients may take longer to get to know the company and its

products, and such familiarity is often important when doing business

internationally

2. Indirect Export - Products are sold through intermediaries such as agents and trading

companies. Agents may represent one or more indirect exporters in return for

commission on sales.

Foreign direct Investment

FDI are investments made to acquire a lasting interest by a resident entity in one

economy in an enterprise resident in another economy. FDI has come to play a major

role in the internationalization of business. This has happened due to changes in

technologies, improved trade and investment policies of governments, regulatory

environment in terms of liberalization and easing of restrictions on foreign investments

and acquisitions, and deregulation and privatization of many industries.

Advantages:

o It can provide a firm with new markets and marketing channels, cheaper production

facilities, access to new technologies, capital process, products, organizational

technologies and management skills.

o FDI can provide a strong impetus to economic development of the host country. This

is all the more true when large MNCs enter developing nations through FDI.

o FDI allows companies to avoid foreign government pressure for local production.

o It allows making the move from domestic export sales to a locally based national

sales office.

o Capability to increase total production capacity.

Depending on the industry sector and type of business, a foreign direct investment may

be an attractive and viable option. With rapid globalization of many industries and

vertical integration rapidly taking place on a global level, at a minimum a firm needs to

keep abreast of global trends in their industry. From a competitive standpoint, it is

important to be aware of whether a company’s competitors are expanding into a foreign

market and how they are doing that. Often, it becomes imperative to follow the

expansion of key clients overseas if an active business relationship is to be maintained.

New market access is also another major reason to invest in a foreign country. At some

stage, export of product or service reaches a critical mass of amount and cost where

foreign production or location begins to be more cost effective. Any decision on investing

is thus a combination of a number of key factors including:

o Assessment of internal resources

o Competitiveness

o Market Analysis

o Market expectations

Licensing

Licensing is a legal agreement between the owner of intellectual property such as a

copyright, patent or trademark and someone who wants to use that IP. The licensee pays

“rent” to the licensor for the use of an idea/product/process that is otherwise protected

by IP law. Like a lease on a building, the license is for a specific period of time. The

licensee uses that idea/product/process to sell products or services and earns money.

Advantages:

o Licensing appeals to prospective global players because it does not require large

capital investment not detailed involvement with foreign customers. By generating

royalty income, licensing provides an opportunity to exploit research and

development already conducted. After initial costs, the licensor can reap benefits

until the end of license contract period.

o It reduces the risk of expropriation because the licensee is a local company that can

provide leverage against government action.

o Helps avoid host country regulations that are more prevalent in equity ventures.

o Provides a way of testing foreign markets without significant resources.

o Can be used as a preemption major in new market before the entry of competition.

Limitations:

o Limited form of market entry which does not guarantee a basis for expansion.

o Licensor may create more competition in exchange of royalty.

Franchising

Franchising involves granting of rights by a parent company to another (franchisee) to do

business in a prescribed manner. This right can take the form of selling the franchiser’s

products, using its name, production and marketing techniques or using its general

business approach.

It allows provides a network of interdependent business relationships that allows a

number of people to share:

o Brand identification

o Successful method of doing business

o Proven marketing and distribution system

Franchise agreement typically requires the payment of a fee upfront and then a

percentage on sales. In return, the franchiser provides assistance and at times may

require the purchase of goods or supplies to ensure the same quality of goods or services

worldwide.

Franchising is adaptable to international arena and requires minor modification for the

local market. It can be beneficial to both groups. Franchiser has a new stream of income

and the franchisee gets time proven concept/product which can be quickly bought to the

market.

Major Forms of Franchising:

- manufacturer-retailer system (e.g. car dealership)

- manufacturer-wholesaler system (e.g. soft-drink companies)

- service firm – retailer system (fast-food, hotel) e,g, McDonald’s, Burger King

Joint Ventures

A joint venture is an agreement involving two or more organizations that arrange to

produce a product or service through a collectively owned enterprise. It has been one of

the most popular way of entering a new market.

Typically, it is a 50-50 joint venture in which each of the party holds 50% ownership

stake and contributes a team of managers to share operating control. At times, this stake

can be a majority one so as to ensure tighter control.

Advantages:

o Domestic company brings in the knowledge of the domestic market.

o The risk is divided between joint-venture partners.

o Normally, foreign partner has an option to sell its stake in the venture to another

entity.

Limitations:

o Limited control over business approach for foreign entity.

o Profits have to be shared.

e.g. Danone-Brittania, Hero Honda, Maruti Suzuki

Wholly Owned Subsidiaries

In a wholly owned subsidiary, the company owns 100% of the equity. Establishing a

wholly owned subsidiary in a foreign market can be done in 2 ways:

1. Set up of new operation

2. Acquisition of established firm.

WOS allows a foreign firm complete control and freedom to execute its business strategy

in the foreign country. This freedom is accompanied by a greater risk due to lack of

knowledge of the market. Acquisition of an established company can reduce this risk to

an extent.

Q2. Influence of PEST Factors on International Business

Any business is affected by its external environment. The major macroeconomic factors

in the external environment that affect the business are political, environmental, social

and technological.

A. Political Environment

The political environment of a country greatly influences the business operating in those

countries or business trading with those countries. The success and growth of

international business depends on the stable, collaborative, conducive and secure

political system in the country.

The following factors affect the political environment in a country.

1. Tax Policy : The tax policy of a country affects the profitability of the business

there. The Corporate Taxation laws affect the profitability directly. The direct

taxation laws also affect the business because it influences consumer spending.

The structure of indirect taxation in a country like its excise duty structure,

customs and sales tax greatly affects the input costs of a business.

For e.g. Countries like UAE have very low direct taxation levels inducing great spending

and hence trading and marketing based business are successful. But due to very high

indirect taxation levels the manufacturing business is not very successful.

2. Government support : One of the most important political factor is the

Government support to international businesses. Business can be successful only

if the local government provides support in terms of infrastructure, license

clearing if required, transparent policy and quick dispute resolution mechanism.

Also the nature of the political system i.e. democracy, communism etc. in the

country influences the Government support.

For e.g. the RBI has provided single window clearance for FDI and hence has greatly

increased the FDI levels in our country.

3. Labor Laws : the labor laws in a country affect the viability of a business in that

country. The pension laws also play a critical role especially in cross border

acquisitions. Many businesses had to be withdrawn or closed because of the labor

unrest in the country.

For e.g.: Withdrawal of Premier Automobiles due to union strikes in our country.

The problems faced by doctors and nurses in UK due to the restrictive laws in that

country.

4. Environmental policy : The countries environmental policy (under the Kyoto

Protocol or otherwise) affects many business like chemicals, refineries and heavy

engineering.

5. Tariffs and duty structure : The level of duties and tariffs that are imposed by the

country influence its imports and exports greatly. Some countries follow a

protectionist policy to the domestic industry by raising import barriers For e.g.

India in the pre liberalization era, Russia.

6. Political stability and political milieu : Political stability greatly affects the longevity

of the businesses in a country. Political risk assessment should be done to

determine the country risk on the basis of following parameters :

a. Confiscation: the nationalization of businesses without compensation. For e.g.

India during the nationalist wave during Indira Gandhi’s tenure.

b. Nationalization : Resource nationalization is a major risk for businesses

involving local resources like oil, minerals etc. For e.g. the resource

nationalization in Columbia.

c. Instability risk : The possibility of military takeovers or huge government

changes. For e.g. the coups in Thailand or in Fiji has affected the profits of

businesses there by as much as 60% due to work stoppage and property

destruction.

d. Domestication : The global company relinquishing control in favor of domestic

investors. For e.g. Barclays bank in South Africa

B. Economic factors

The economic factors in a country greatly influence the business in that country. The

following factors are important in the macroeconomic environment.

1. Economic system : the economic system in a country i.e. capitalism/ communism/

mixed economy (India) is important for deciding the nature of the businesses. The

nature of the system decides the allocation of resources. Due to globalization

there is a gradual shift toward market forces to allocate resources even in the

communist countries like China.

2. Interest rates : The interest rates in the country affect the cost of capital (if raised

locally) and the operational costs. Interest rates also determine the confidence of

the Government in the economy and consumer spending.

3. Exchange rates : The exchange rates affect international trade and capital inflows

in the country.

4. Income levels and spending pattern : Though it is more of a demographic

parameter has is very important bearing on the sell side of all international

businesses. For e.g. In a country like India, with rising aspirer population there is a

market opportunity for products like IPod (considered luxury items till now)

C. Social factors

Businesses are driven by people both as human capital and as consumers. It is necessary

for an international businessman to understand the social and cultural aspects of the

country they operate in. The following are the important social factors.

1. Age distribution : the age distribution of the population is important to consider

the consumption patterns in the markets. Age distribution also determines the

mindset of the market and helps segmentation of the market accordingly. It also

has a bearing on the employee quality. A young population also determines a

workforce.

2. Family system : the family system has a bearing on the decision makers in

consumption. For e.g. in Islamic countries women have a less say in making

consumption decisions. In emerging economies like India children are gaining

important role in consumption. This helps in positioning of products.

3. Cultural aspects : The cultural aspects influence the way the business is conducted

in countries. In Japan there is a different way in which contracts are signed and

executed. In Russia being a communist oriented mindset the business is

conducted in a closed manner. Italians have a seemingly lazy way of doing

business and hence it is very difficult to conduct business in the pacy US way.

4. Career attitudes : the career attitude of the workforce is important social aspect.

D. Technological Factors

Technology has a very important role to play in determining the success of international

businesses because technology has made international business possible. The following

are the technological factors that influence the business.

1. R&D : the support that the Government gives to R&D encourages setting up R&D

business levels. Also the ease of a qualified local workforce influence business. For

e.g. the semiconductor industry in Taiwan

2. Technology transfer : The ease of technology transfer influences the business

climate. The environment where the technology transfer is not viable gradually

loses out on business from emerging countries that seek technology transfers. For

e.g. in the early 40s countries like Czechoslovakia (the Czech Republic) was a very

technologically advanced country but had very low business interest due to the

less chances of technology transfers. For e.g. GE withdrew operations from a JV as

there as they could not access local expertise)

Q3. Trade Theories

1. Classical Country-Based Theories

1.1.Mercantilism (pre-16th century)

This theory takes an “us-versus-them” view of trade; other country’s gain is our

country’s loss.

Neo-mercantilism views persist today.

A nation’s wealth depends on accumulated treasure.

Theory says you should have a trade surplus.

Maximize exports through subsidies.

Minimize imports through tariffs and quotas.

Flaw: “Zero-sum game”.

Mercantilism- Zero-Sum Game

In 1752, David Hume pointed out that:

Increased exports lead to inflation and higher prices

Increased imports lead to lower prices

Result: Country A sells less because of high prices and Country B

sells more because of lower prices

In the long run, no one can keep a trade surplus

1.2. Free Trade supporting theories

This theory shows that specialization of production and free flow of goods grow all

trading partners’ economies

Trade Theories

Classical Trade Theories

Mercantilism Free Trade Theories

Theory of Absolute

Advantage

Theory of Relative

Advantage

Free Trade Theories Refined

Factor Endowment

Theory

Product Life Cycle Theory

Modern Trade Theories Other Theories

Productivity Theory

The vent for surplus theory

Theory of Reciprocal Demand

1.2.1. Absolute Advantage (Adam Smith, The Wealth of Nations, 1776)

Mercantilism weakens a country in the long run and enriches only a few

segments; it robs individuals of the ability to trade freely.

Adam Smith claimed market forces, not government controls, should

determine the direction, volume and composition of international trade.

Under free (unregulated) trade each nation should specialize in producing those

goods it could produce most efficiently.

This theory states that a country is capable of producing more of a good with the

same input than another country. Hence, a country should specialize in and

export products for which it has absolute advantage; import others.

A country has absolute advantage - either natural or acquired when it is

more productive than another country in producing a particular product.

Trade between countries is, therefore, beneficial.

Assume that there are just two countries in the world, the India and Japan.  Pretend also

that they produce only two goods, shoes and shirts.  The resources of both countries can

be used to produce either shoes or shirts.  Both countries make both products, spending

half of their working hours on each.  But India makes more shoes than shirts, and Japan

makes more shirts than shoes. 

TABLE A

Shoes Shirts

India 100 75

Japan 80 100

Total 180 175

What will happen when each country specializes and spends all its working hours making

one product?  It will make twice as much of that product and none of the other, as shown

in Table B.

TABLE   B

Shoes Shirts

India 200 0

Japan 0 200

Total 200 200

The world now has both more shoes and more shirts.  India can trade 100 units of shoes

for 100 units of shirts, and both countries will benefit.

In this example, India could make more shoes than Japan with the same resources.  It

has an absolute advantage at shoemaking.  Japan, on the other hand, had an absolute

advantage at shirt making.

Assumptions:

Perfect competition and no transportation costs in a world of two countries and

two products

One unit of input (combination of land, labor, and capital)

Each nation has two input units it can use to produce either rice or automobiles

Each country uses one unit of input to produce each product

1.2.2. Comparative Advantage (David Ricardo, Principals of Political

Economy, 1817) – Also known as Opportunity Cost Theory

David Ricardo, in his theory of comparative costs, suggested that countries will

specialize and trade in goods and services in which they have a comparative

advantage.

A country has a comparative advantage in the production of a good or service

that it produces at a lower opportunity cost than its trading partners.

The theory of comparative costs argues that, put simply, it is better for a country

that is inefficient at producing a good to specialize in the production of that good

it is least inefficient at, compared with producing other goods.

Now suppose one country has an absolute advantage in both products.  Table C shows

what production might be like if India had an absolute advantage at making both shoes

and shirts.

TABLE C

Shoes Shirts

India 100 80

China 80 75

Total 180 155

In this case, the India can produce more of each good with the same set of resources

than China can. The India could produce either 200 units of shoes or 160 units of

shirts. China could produce either 160 units of shoes or 150 units of shirts. If the India

produces only shoes, it gives up 80 units of shirts to gain 100 units of shoes. If China

produces only shoes, it gives up 75 units of shirts to gain 80 units of shoes. For India, the

opportunity cost of producing shirts is higher and the opportunity cost of producing shoes

is lower; vice-versa for China. Hence, India has a comparative advantage in shoemaking

and China has a comparative advantage in shirt making. 

Table D shows what happens when each country specializes in the product in which it

has a comparative advantage.

TABLE D

Shoes Shirts

India 200 0

China 0 150

Total 200 150

By specializing in this way, the India and China have increased the production of shoes

by twenty units over what they produced before, from 180 to 200. But the world has lost

five units of shirts, going from 155 to 150. 

Production in the India could be adjusted to make up the difference. For example, if the

India gave up 10 units of shoes, it could produce 8 units of shirts.  Table E shows the

results of such a tradeoff.

TABLE E

Shoes Shirts

India 190 8

China 0 150

Total 190 158

In this way, the total production of both goods could be increased.

For India, the opportunity cost of choosing to produce 80 units of shirts was the 100 units

of shoes that could have been produced with the same resources.  In the like manner,

China's opportunity cost of producing 80 units of shoes was 75 units of shirts. 

In the terms of trade each reduce each country's opportunity cost of acquiring the good

traded for, trade will take place.  In this example, China will not accept fewer than 80

units of shoes for 75 units of shirts and the India will not pay more than 100 units of

shoes for 80 units of shirts.  Both countries must benefit for trade to occur.

The real world is much more complex than this two-country, two-product mode. Trade

involves many different countries and products. And it is not always clear where a

country's comparative advantage lies.

Summary

Country should specialize in the production of those goods in which it is relatively

more productive, even if it has absolute advantage in all goods it produces.

This extends free trade argument.

Efficiency of resource utilization leads to more productivity.

1.3.Free Trade refined

1.3.1. Factor-proportions (Heckscher-Ohlin, 1919)

Eli Heckscher and Bertil Ohlin developed the theory of relative factor

endowments, now often referred to as the Heckscher-Ohlin theory. The theory

states that the pattern of international trade depends on differences in factor

endowments not on differences in productivity.

Relative endowments of the factors of production (land, labour, and capital)

determine a country's comparative advantage.

Countries have comparative advantage in those goods for which the required

factors of production are relatively abundant. This is because the prices of goods

are ultimately determined by the prices of their inputs.

Goods that require inputs that are locally abundant will be cheaper to produce

than those goods that require inputs that are locally scarce.

For example, a country where capital and land are abundant but labour is scarce will

have comparative advantage in goods that require lots of capital and land, but little

labour - grains, for example.

Since capital and land are abundant, their prices will be low. Those low prices will ensure

that the price of the grain that they are used to produce will also be low - and thus

attractive for both local consumption and export.

Labor intensive goods on the other hand will be very expensive to produce since labor is

scarce and its price is high. Therefore, the country is better off importing those goods.

Summary

Factor endowments vary among countries

Products differ according to the types of factors that they need as inputs

A country has a comparative advantage in producing products that intensively

use factors of production (resources) it has in abundance

Assumptions

A given technology was universally available.

Relative factor endowments are different in each country

Tastes and preferences are identical in both countries

A given product was either labor- or capital-intensive

The theory ignored transportation costs.

1.3.2. Product Life Cycle (Ray Vernon, 1966)

As products mature, both location of sales and optimal production changes

Affects the direction and flow of imports and exports

Globalization and integration of the economy makes this theory less valid

Classic Theory Limitations:

All the classical theories are based on the following assumptions that no longer hold true

–

Simple world (two countries, two products)

No transportation costs

No price differences in resources

Resources immobile across countries

Constant returns to scale

Each country has a fixed stock of resources & no efficiency gains in resource use

from trade

Full employment

2. Modern Trade Theory

In industries with high fixed costs:

Specialization increases output, and the ability to enhance economies of scale

increases

Learning effects are high.

These are cost savings that come from “learning by doing”

New Trade Theory-Applications

Typically, requires industries with high, fixed costs

o World demand will support few competitors

o Competitors may emerge because of “ First-mover advantage”

Economies of scale may preclude new entrants

o Role of the government becomes significant

Some argue that it generates government intervention and strategic trade policy

Theory of National Competitive Advantage

The theory attempts to analyze the reasons for a nation’s success in a particular

industry

Porter studied 100 industries in 10 nations

- Postulated determinants of competitive advantage of a nation were based

on four major attributes

Factor endowments

Demand conditions

Related and supporting industries

Firm strategy, structure and rivalry

Factor endowments: A nation’s position in factors of production such as skilled labor

or infrastructure necessary to compete in a given industry

Basic factor endowments

Advanced factor endowments

Basic Factor Endowments

Basic factors: Factors present in a country

- Natural resources

- Climate

- Geographic location

- Demographics

While basic factors can provide an initial advantage they must be supported

by advanced factors to maintain success

Advanced Factor Endowments

Advanced factors: The result of investment by people, companies, and

government are more likely to lead to competitive advantage

If a country has no basic factors, it must invest in advanced factors

- Communications

- Skilled labor

- Research

- Technology

- Education

Porter’s Theory-Predictions

Porter’s theory should predict the pattern of international trade that we observe in

the real world.

Countries should be exporting products from those industries where all four

components of the diamond are favorable, while importing in those areas where

the components are not favorable

3. Other Theories:

3.1.The productivity theory by H. Myind

It is criticized that the comparative cost theories are not applicable to developing

countries. Hence, H. Myint proposed productivity theory and the vent for surplus

theory.

The productivity theory points toward indirect and direct benefits. This theory

emphasizes that the process of specialization involves adapting and reshaping the

production structure of a trading country to meet the export demands.

Countries increase productivity in order to utilize the gains of exports. This theory

encourages the developing countries to go for cash crops, increase productivity

by enhancing the efficiency of human resources, adapting latest technology etc.

Limitations:

Labor productivity did not increase after certain level

Increase in working hours

Increase in proportion of gainfully employed labour in proportion to disguised

unemployed labour

3.2.The vent for surplus theory

International trade absorbs the output of unemployed factors.

If the countries produce more than the domestic requirements, they have to

export the surplus to other countries. Otherwise, a part of the productive labour of

the country must cease and the value of its annual Produce diminishes.

In the absence of foreign trade, they would be surplus productive capacity in the

country. This surplus productive capacity is taken by another country and in turn

gives the benefit under international trade.

Appropriateness of this Theory for Developing Countries:

According to this theory, the factors of production of developing countries are

fully utilized.

The unemployed labour of the developing countries is profitably employed when

the vent for surplus is exported.

3.3.Mills’ theory of reciprocal demand

Comparative cost advantage theories do not explain the ratios at which

commodities are exchanged for one another. J.S. Mill introduced the concept of

‘reciprocal demand’ to explain the determinations of the equilibrium terms of

trade.

Reciprocal demand indicates a country’s demand for one commodity in terms of

the other commodity; it is prepared to give up in exchange. It determines the

terms of trade and relative share of each country.

Equilibrium:

Quality of a product exported by country A = Quality of another product exported by

country B

Assumptions:

Existence of two countries

Trade in only two goods – both the goods are produced under the law of constant

returns

Absence of transportation Costs.

Existence of perfect competition

Existence of full employment

Q4. Ten reasons why FDI happens

1. Foreign Direct Investments (FDI) as defined in the BOP Manual, are investments made

to acquire a lasting interest by a resident entity in one economy in an enterprise

resident in another economy. The purpose of the investor is to have a significant

influence, an effective voice in the management of the enterprise. The definition of

the Organization for Economic Cooperation and Development (OECD) which considers

as direct investment enterprise an incorporated or unincorporated enterprise in which

a direct investor who is resident in another economy owns ten percent or more of the

ordinary shares or voting power (for incorporated enterprise) or the equivalent (for an

unincorporated enterprise).

2. It provides a firm with new markets and marketing channels, cheaper production

facilities, access to new technology, products, skills and financing. For a host country

or the foreign firm which receives the investment, it can provide a source of new

technologies, capital, processes, products, organizational technologies and

management skills, and as such can provide a strong impetus to economic

development.

3. FDI inflows are considered as channels of entrepreneurship, technology, management

skills, and of resources that are scarce in developing countries. Hence, they could

help their host countries in their industrialization.

4. For small and medium sized companies, FDI represents an opportunity to become

more actively involved in international business activities. In the past 15 years, the

classic definition of FDI as noted above has changed considerably, over 2/3 of direct

foreign investment is still made in the form of fixtures, machinery, equipment and

buildings.

5. FDI is viewed as a basis for going “global”. FDI allows companies to accomplish

following tasks:

Avoiding foreign government pressure for local production

Circumventing trade barriers, hidden and otherwise

Making the move from domestic export sales to a locally-based national sales

office

Capability to increase total production capacity.

Opportunities for co-production, joint ventures with local partners, joint marketing

arrangements, licensing, etc

6. Foreign direct investment is viewed as a way of increasing the efficiency with which

the world's scarce resources are used. A recent and specific example is the perceived

role of FDI in efforts to stimulate economic growth in many of the world's poorest

countries. Partly this is because of the expected continued decline in the role of

development assistance (on which these countries have traditionally relied heavily),

and the resulting search for alternative sources of foreign capital.

7. FDI enables the firm owns assets to be profitably exploited on a comparatively large

scale, including intellectual property (such as technology and brand names),

organizational and managerial skills, and marketing networks. And it is more

profitable for the production utilizing these assets to take place in different countries

than to produce in and export from the home country exclusively.

8. FDI may result in a greater diffusion of know-how than other ways of serving the

market. While imports of high-technology products, as well as the purchase or

licensing of foreign technology, are important channels for the international diffusion

of technology, FDI provides more scope for spillovers. For example, the technology

and productivity of local firms may improve as foreign firms enter the market and

demonstrate new technologies, and new modes of organization and distribution,

provide technical assistance to their local suppliers and customers, and train workers

and managers who may later be employed by local firms.

9. FDI increases employment in host country. Inflows of FDI also increase the amount of

capital in the host country. Even with skill levels and technology constant, this will

either raise labor productivity and wages, allow more people to be employed at the

same level of wages, or result in some combination of the two.

10. Proponents of foreign investment point out that the exchange of investment flows

benefits both the home country (the country from which the investment originates)

and the host country (the destination of the investment). Opponents of FDI note that

multinational conglomerates are able to wield great power over smaller and weaker

economies and can drive out much local competition. The truth might lie somewhere

in between but they surely become reasons for companies to invest in foreign

markets.

Q5. WTO Rounds wrt India

The WTO came into being on January 1, 1995, and is the successor to the General

Agreement on Tariffs and Trade (GATT), which was created in 1948. India was one of the

76 countries that signed the accession to the WTO and is one of the founder members of

the WTO.

Trade implications of signing the WTO for India:

The implications of signing the WTO agreement for Indian trade have been mixed. India

has benefited in the areas of garment exports, agricultural products exports and in

market access to foreign markets in automobiles and electronics. India has a

disadvantage mainly in areas of TRIPs, drug prices, patents in agriculture, TIS ( trade in

services ) and TRIMS especially in biomedical areas, AoA export subsidies etc.

Benefits:

1. Garment exports : The Multi Fiber Arrangement (MFA) that required Indian garment

exporters to have quotas for exporting to developed countries was phased out in

2005. The readymade garment exports from India has reached Rs 800 crores in 2007

and expected to reach Rs 1000 crores in 2008. This is thrice the exports in 2004-05.

2. Market access : as a signatory to the WTO India automatically gets the MFN ( most

favored nation ) status. This gives India access to markets in Europe and US in

sectors like automobiles and engineering. India also benefits from the clauses related

to trade without discrimination and benefit from capital good exports.

3. Anti Dumping measures : India suffered from persistent dumping by Romanian and

Russian steel majors in the areas of steel casings, pipes affecting Indian domestic

industry greatly. Also India suffered from dumping by Chinese steel industry. The anti

dumping provisions and countervailing duties lend security to India’s domestic

industries.

4. The Agreement on Agriculture : the AoA stipulates that the developed countries will

reduce tariffs on agriculture imports (up to 35%) thus helping India’s agriculture

exports. It also promises reduction of domestic subsidies in the developed countries

helping exports from India.

5. Competitive advantage : India has competitive advantage in the areas of merchandise

trade. India can utilize its competitive advantage in processing, beverages, gems and

jeweler compared to the traditional centers in Europe like Amsterdam or Manchester

etc increasing its trade with both the Euro region and the US.

Disadvantages:

1. TRIPS : the Indian Patent Act is not compatible with the TRIPS agreement under the

WTO. The Indian Patent Act allows only process patents in areas of foods, chemicals

and medicines. Under the TRIPS the IPA will have to modify to allow product patents

also. Also products developed outside India can claim international patents applicable

to India. This will hurt our agriculture foods. E.g. the Alphanso mango and the

Basmati strand controversy.

2. Drug prices : the granting of the product patents in India will hurt the Indian generic

drugs industry and benefit the foreign pharma companies that own the formulation

patents. This will lead to increase in drug prices in India. (This resulted in regulatory

intervention in the recent budget in life saving drugs) e.g. the Pfizer controversy

3. Genetics : Indian seed and genetic research organizations are Government funded

and will not be able to compete with the MNCs like Montessanto etc that have

economies of scale. This will increase seed prices for Indian farmers and also lend our

genetic resources to the MNCs

4. Services : the opening up of the banking sector in 2009 will affect Indian banks due to

the foreign banks with huge balance sheets.

5. TRIMS : the Trade Related Investment Measures resulted in problems in trade in

investment issues like transit charges, formalities etc. together called as Singapore

issues. Indian companies would have to lose in the differential charges that are

applied. These issues were dropped in the Chachun ministerial conferences.

6. Anti dumping: the anti dumping rules were imposed on Indian linen in EU. Similarly

Indian textiles faced anti dumping regulations in US. There is no mechanism to

resolve anti dumping duties issues.

India’s stand in the Doha round and the following ministerial conferences:

1. Doha round: The Doha Development Round commenced at Doha, Qatar in

November 2001 and is still continuing. Its objective is to lower trade barriers around

the world, permitting free trade between countries of varying prosperity. As of 2008,

talks have stalled over a divide between the developed nations led by the European

Union, the United States and Japan and the major developing countries (represented

by the G20 developing nations), led and represented mainly by India, Brazil, China

and South Africa.

Issues: Singapore issues: the issues related to the trade facilitation and differential

charges in investment vehicles affected Indian investment and venture companies. This

affected the Indian services.

Agricultural subsidies: the EU, US and Japan support domestic agriculture by subsides.

This was opposed by countries like India and Brazil.

2. Cancun conference 2003 :

The objective of this conference was to forge the agreement discussed in Doha.

Issues: market access to foreign markets. This agreement on market access for the

developing countries in capital and industrial goods increased strength of G20 countries.

India benefited greatly in the capital goods export.

The Singapore issues were resolved that resulted in removing the undue advantage for

countries like US and Japan in investment arena. This also benefited the Indian financial

sector internationally.

3. Geneva 2004: In Geneva conference the developed nations reduced subsidiaries on

manufactured goods. This resulted in Indian small manufacturers like steel forging,

casting to export largely and benefit from the construction boom in US.

4. Paris 2005: France reduced subsidies on farm products. However US and Japan did

not relent.

Hong Kong 2006 and Potsdam 2007 talks failed in resolving the farm subsidies. So the

recent rounds are in a stalemate situation from India’s point of view.

Q6. Discuss NAFTA/ EU/ ASEAN/ SAARC/ MERCUSOR

Mercosur

Mercosur is a regional trade agreement among Argentina, Brazil ,Paraguay & Uruguay

founded in 1991 by the Treaty of Asunción, which was later amended and updated by the

1994 Treaty of Ouro Preto. Its purpose is to promote free trade and the fluid movement

of goods, people, and currency. Bolivia, Chile, Colombia, Ecuador and Peru currently have

associate member status. Venezuela signed a membership agreement on 17 June 2006,

but before becoming a full member its entry has to be ratified by the Paraguayan and the

Brazilian parliaments.

The bloc comprises a population of more than 263 million people, and the combined

Gross Domestic Product of the full-member nations is in excess of US$2.78 trillion a year

(Purchasing power parity, PPP) according to International Monetary Fund (IMF) numbers,

making Mercosur the fifth largest economy in the World.

Objectives of MERCOSUR

Free transit of production goods, services and factors between the member states

with inter alia, the elimination of customs rights and lifting of nontariff restrictions on

the transit of goods or any other measures with similar effects;

Fixing of a common external tariff (TEC) and adopting of a common trade policy with

regard to nonmember states or groups of states, and the coordination of positions in

regional and international commercial and economic meetings;

Coordination of macroeconomic and sectorial policies of member states relating to

foreign trade, agriculture, industry, taxes, monetary system, exchange and capital,

services, customs, transport and communications, and any others they may agree on,

in order to ensure free competition between member states; and

The commitment by the member states to make the necessary adjustments to their

laws in pertinent areas to allow for the strengthening of the integration process. The

Asuncion Treaty is based on the doctrine of the reciprocal rights and obligations of

the member states.

MERCOSUR initially targeted free-trade zones, then customs unification and, finally, a

common market, where in addition to customs unification the free movement of

manpower and capital across the member nations' international frontiers is possible, and

depends on equal rights and duties being granted to all signatory countries. During the

transition period, as a result of the chronological differences in actual implementation of

trade liberalization by the member states, the rights and obligations of each party will

initially be equivalent but not necessarily equal. In addition to the reciprocity doctrine,

the Asuncion Treaty also contains provisions regarding the most-favored nation concept,

according to which the member nations undertake to automatically extend--after actual

formation of the common market--to the other Treaty signatories any advantage, favor,

entitlement, immunity or privilege granted to a product originating from or intended for

countries that are not party to ALADI.

SAARC

The South Asian Association for Regional Cooperation (SAARC) is an economic and

political organization of eight countries in Southern Asia. It was established on December

8, 1985 by India, Pakistan, Bangladesh, Sri Lanka, Nepal, Maldives and Bhutan. In April

2007, at the Association's 14th summit, Afghanistan became its eighth

member.Sheelkant Sharma is the current secretary & Mahinda Rajapaksa is the current

chairman of SAARC which is headquartered at Kathmandu.

Objectives of SAARC:

to promote the welfare of the peoples of South Asia and to improve their quality

of life;

to accelerate economic growth, social progress and cultural development in the

region and to provide all individuals the opportunity to live in dignity and to

realize their full potential;

to promote and strengthen collective self-reliance among the countries of South

Asia;

to contribute to mutual trust, understanding and appreciation of one another's

problems;

to promote active collaboration and mutual assistance in the economic, social,

cultural, technical and scientific fields;

to strengthen cooperation with other developing countries;

to strengthen cooperation among themselves in international forums on matters

of common interest; and

to cooperate with international and regional organizations with similar aims and

purposes.

Free Trade Agreement

Over the years, the SAARC members have expressed their unwillingness on signing a

free trade agreement. Though India has several trade pacts with Maldives, Nepal, Bhutan

and Sri Lanka, similar trade agreements with Pakistan and Bangladesh have been stalled

due to political and economic concerns on both sides. India has been constructing a

barrier across its borders with Bangladesh and Pakistan. In 1993, SAARC countries signed

an agreement to gradually lower tariffs within the region, in Dhaka. Eleven years later, at

the 12th SAARC Summit at Islamabad, SAARC countries devised the South Asia Free

Trade Agreement which created a framework for the establishment of a free trade area

covering 1.4 billion people. This agreement went into force on January 1, 2006. Under

this agreement, SAARC members will bring their duties down to 20 per cent by 2007.

The last summit (15th) was held in Colombo where four major agreements - the SAARC

development fund, the establishment of a SAARC standard organization, the SAARC

convention on mutual legal assistance in criminal matters, and the protocol on

Afghanistan's admission to the South Asia Free Trade Agreement (SAFTA) were adopted

with emphasis on region-wide food security.

NAFTA

The North American Free Trade Agreement (NAFTA) is a trilateral trade bloc in North

America created by the governments of the United States, Canada, and Mexico. In terms

of combined purchasing power parity GDP of its members, as of 2007 the trade bloc is

the largest in the world and second largest by nominal GDP comparison. It also is one of

the most powerful, wide-reaching treaties in the world.

The North American Free Trade Agreement (NAFTA) has two supplements, the North

American Agreement on Environmental Cooperation (NAAEC) and the North American

Agreement on Labor Cooperation (NAALC).

Implementation of the North American Free Trade Agreement (NAFTA) began on January

1, 1994. This agreement will remove most barriers to trade and investment among the

United States, Canada, and Mexico.

Under the NAFTA, all non-tariff barriers to agricultural trade between the United States

and Mexico were eliminated. In addition, many tariffs were eliminated immediately, with

others being phased out over periods of 5 to 15 years.  This allowed for an orderly

adjustment to free trade with Mexico, with full implementation beginning January 1,

2008. 

The agricultural provisions of the U.S.-Canada Free Trade Agreement, in effect since

1989, were incorporated into the NAFTA. Under these provisions, all tariffs affecting

agricultural trade between the United States and Canada, with a few exceptions for items

covered by tariff-rate quotas, were removed by January 1, 1998.

Mexico and Canada reached a separate bilateral NAFTA agreement on market access for

agricultural products. The Mexican-Canadian agreement eliminated most tariffs either

immediately or over 5, 10, or 15 years.

U.S. trade with Mexico and Canada has grown more rapidly than total U.S. trade since

1994. The automotive, textile, and apparel industries have experienced the most

significant changes in trade flows, which may also have affected employment levels in

these industries. The five major U.S. industries that have high volumes of trade with

Mexico and Canada are automotive industry, chemicals and allied products, computer

equipment, textiles and apparel, and microelectronics.

The effects of NAFTA, both positive and negative, have been quantified by several

economists. Some argue that NAFTA has been positive for Mexico, which has seen its

poverty rates fall and real income rise (in the form of lower prices, especially food), even

after accounting for the 1994–1995 economic crisis. Others argue that NAFTA has been

beneficial to business owners and elites in all three countries, but has had negative

impacts on farmers in Mexico who saw food prices fall based on cheap imports from U.S.

agribusiness, and negative impacts on U.S. workers in manufacturing and assembly

industries who lost jobs. Critics also argue that NAFTA has contributed to the rising levels

of inequality in both the U.S. and Mexico.

EU

The European Union (EU) is a political and economic union of 27 member states, located

primarily in Europe. The EU generates an estimated 30% share of the world's nominal

gross domestic product (US$16.8 trillion in 2007). Thus EU presents an enormous export

and investor market that is both mature and sophisticated.

The EU has developed a single market through a standardised system of laws which

apply in all member states, guaranteeing the freedom of movement of people, goods,

services and capital. It maintains a common trade policy. Fifteen member states have

adopted a common currency, the euro.

Objectives of the EU: Its principal goal is to promote and expand cooperation among

members’ states in economics, trade, social issues, foreign policies, security, defense,

and judicial matters. Another major goal of the EU is to implement the Economic and

Monetary Union, which introduced a single currency, the Euro for the EU members.

The single market refers to the creation of a fully integrated market within the EU, which

allows for free movement of goods, services and factors of production. The EU, in

conjunction with Member States, has a number of policies designed to assist the

functioning of the market. Some of the policies are given below:

Competition Policy: The main competition lied in energy and transport sector. The union

designed this strategy to prevent price fixing, collusion (secret agreement), and abuse of

monopoly.

Free movement of goods: A custom union covering all trade in goods was established

and a common customs tariff was adopted with respect to countries outside the union.

Services: Any member nation has a right to provide services in other Member States.

Free movement of persons: Any citizen of EU member state can live work in any other EU

member state

Capital: There are no restrictions on the movement of capital and on payments with the

EU and between member states and third countries.

Trade between the European Union and India

India was one of the first Asian nations to accord recognition to the European Community

in 1962. The EU is India’s largest trading partner and biggest source of FDI. It is a major

contributor of developmental aid and an important source of technology. Over the years,

EU – India trade has grown from 4.4 bn to 28.4 bn US$.

Top items of trade between India and EU

India’s exports to EU % India’s Imports from EU %

Textile and clothing 35 Gemstones and jewellery 31

Leather and leather products 25 Power generating equipment 28

Gemstones and jewelery 12 Chemical products 15

Agriculture products 10 Office machinery 10

Chemical products 9 Transport equipment 6

India is EU’s 17th largest supplier and 20th largest destination for exports.

Tariff and non-tariffs have been reduced, but compared to International standards

they are still high.

Under the Bilateral trade between India and EU, it accounts for 26% of India’s exports

and 25% of its imports.

The European Union (EU) and India agreed on September 29,2008 at the EU-India

summit in Marseille, France's largest commercial port, to expand their cooperation in

the fields of nuclear energy and environmental protection and deepen their strategic

partnership.

Trade between India and the 27-nation EU has more than doubled from 25.6 billion

euros ($36.7 billion) in 2000 to 55.6 billion euros last year, with further expansion to

be seen.

ASEAN

The Association of Southeast Asian Nations or ASEAN was established on 8 August 1967

in Bangkok by the five original Member Countries, namely, Indonesia, Malaysia,

Philippines, Singapore, and Thailand. Brunei Darussalam joined on 8 January 1984,

Vietnam on 28 July 1995, Laos and Myanmar on 23 July 1997, and Cambodia on 30 April

1999.

OBJECTIVES

The ASEAN Declaration states that the aims and purposes of the Association are:

(iv) To accelerate the economic growth, social progress and cultural development in

the region through joint endeavors.

(v) To promote regional peace and stability through abiding respect for justice and

the rule of law in the relationship among countries in the region and adherence to

the principles of the United Nations Charter.

(vi) To maintain close cooperation with the existing international and regional

organizations with similar aims.

WORKING OF ASEAN

The member countries of ASEAN have Preferential Trading Arrangements (PTA), which

reduces tariffs on products traded among member countries. In 1992, ASEAN developed

a Common Effective Preferential Tariffs (CEPT) plan to reduce tariffs systematically for

manufactured and processed products.

The members have also established a series of co-operative efforts to encourage joint

participation in industrial, agricultural and technical development projects and to

increase foreign investments in their economies. These efforts include an ASEAN finance

corporation, the ASEAN Industrial Joint Ventures Programme (AJIV) etc. ASEAN nations

have introduced some programmes for greater diversification in their economies.

India and ASEAN

India is interested in maintaining close economic relations with the members of ASEAN,

as these countries are closer to India. The ASEAN countries are offering co-operation to

India in the field of trade, investment, science and technology and training of personnel.

Also, India’s trade with ASEAN countries is satisfactory in recent years.

Q7. Effect of Current Economic Meltdown on International Business

1. Slower global growth: Global growth stood at 5 percent in 2007, but the IMF expects

world growth to slow to 3 percent in 2009 - 0.9 percentage points lower than

forecasted in July 2008.

2. Economic contraction in some countries: In G7 countries except for the United States

and Canada, GDP growth was slower in Q2 of 2008 compared to Q1. Three major

European economies (Italy, France and Germany) experienced negative GDP growth

in Q2, and forecasts are for a continued decline in Q3. The IMF forecasts around 0

percent growth for advanced economies in 2009.

3. Depth of slowdown: It is observed that economic slowdowns, preceded by financial

stress tend to be more severe. Although employment has contracted in several

countries in recent months, it has not been as severe as that during 1990-91.

4. Financing challenges for governments: State and local governments may be faced

with financial crisis. Even administrative costs may be difficult to come by. The

governments would be hard pressed for funds for guarantees and development work.

For e.g. In the case of Iceland the banking sector has assets of around 300% of GDP,

something no government could ever guarantee, at least not on a short-term basis.

5. Rising unemployment: According to IMF, unemployment in the advanced economies

will rise from 5.7 percent in 2008 to 6.5 percent in 2009.

6. Large employment losses in sectors: Some sectors like construction, real estate

services will experience disproportionate employment declines. In addition there will

be significant job losses in the financial sector.

7. Reduced world trade volume: According to the IMF, the world trade will grow only at

the rate of 1.9% as against the earlier estimate of 4.1% for 2009. A drop in exports,

as well as capital inflow, may trigger a falloff in investments.

8. Rising income insecurity and disproportionate impact on low-income groups: As stock

markets around the world have eroded trillions of dollars in wealth and rolled back

some of the investment gains of the past 5 years, the investment and retirement

savings of many individuals have lost significant value. There is a risk that low-

income countries and lower-income groups within countries will bear the brunt of

challenges, as “the most poor are the most defenseless,” says World Bank President

Robert Zoellick.

9. Return to Tariff and Non-Tariff Barriers: Developed economies in order to ward off

unemployment and financial crisis may erect barriers to free trade. This might start a

local business environment. For e.g. President-elect Barrack Obama has already

announced his intention to reduce outsourcing from US by 30%.

10. Surplus Production Capacities: In line with demand destruction, many branded

products may face surplus capacities. For e.g. Car, Steel & Aircrafts manufacturers

are already staring at excess capacity.

11. Increase in Government Controls: In order to bail out sinking Corporates the

governments, would buy out or control the operations of large companies. For e.g.

AIG and Citibank

12. Impact on India:

a. BPO Operations: India is likely to face a severe crunch on the IT and ITes services,

rendered by Indian BPO Companies.

b. Increase in Trade Deficit: Already in the last quarter, India’s trade deficit has

grown where exports are not meeting the set targets while imports continue to

grow.

c. Falling Currency: as the demand for dollars increases the Indian rupee is likely to

weaken. The rupee has already depreciated to Rs. 50 a dollar.

d. Pressure on Services Sector: As the demand for services is destroyed, these

sunshine industries such as BPOs, Airlines, and Telecommunication etc. will face

salary and employment cutbacks.

Q8. Organizational Structures in International Business

Douglas Wind and Pelmutter advocated four approaches of international business. They

are:

1. Echnocentric Approach

The domestic companies normally formulate their strategies, their product design

and their operations towards the national markets, customers and competitors. But,

the excessive production more than the demand for the product, either due to

competition or due to changes in customer preferences push the company to export

the excessive production to foreign countries. The domestic company continues the

exports to the foreign countries and views the foreign markets as an extension to the

domestic markets just like a new region. The executives at the head office of the

company make the decisions relating to exports and, the marketing personnel of the

domestic company monitor the export operations with the help of an export

department. The company exports the same product designed for domestic markets

to foreign countries under this approach. Thus, maintenance of domestic approach

towards international business is called ethnocentric approach.

Fig: Organization Structure of an Echnocentric Company

2. Polycentric Approach

The domestic companies, which are exporting to foreign countries using the

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

altogether different approach. Then, the company establishes a foreign subsidiary

company and decentralists all the operations and delegate decision making and

policy-making authority to its executives. In fact, the company appoints executives

Managing Director

Manager - R&DManager -

Human Resources

Manager - Production

Manager - Finances

Manager - Marketing

Asst. Manager - North India

Asst. Manager - South India

Asst. Manager - Exports

and personnel including a chief executive who reports directly to the Managing

Director of the company. Company appoints the key personnel from the home

country and the people of the host country fill all other vacancies.

Fig: Organization Structure of a Polycentric Company

3. Regiocentric Approach

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

neighboring countries of the host country. At this stage, the foreign subsidiary considers

the regions environment (for example, Asian environment like laws, culture, policies etc.)

for formulating policies and strategies. However, it markets more or less the same

product designed under polycentric approach in other countries of the region, but with

different market strategies.

Fig: Organization Structure of a Regiocentric Company

4. Geocentric approach

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

They select the employees from the entire globe and operate with a number of

subsidiaries. The headquarters coordinate the activities of the subsidiaries. Each

subsidiary functions like an independent and autonomous company in formulating

policies, strategies, product design, human resource policies, operations etc.

Fig: Organization Structure of a Geocentric Company

Q9. Discuss Swaps, Options, Futures

Swaps

a) A swap is a derivative in which two counterparties agree to exchange one stream of

cash flows against another stream. These streams are called the legs of the swap.

b) The cash flows are calculated over a notional principal amount, which is usually not

exchanged between counterparties. Consequently, swaps can be used to create

unfunded exposures to an underlying asset, since counterparties can earn the profit

or loss from movements in price without having to post the notional amount in cash

or collateral.

c) Swaps can be used to hedge certain risks such as interest rate risk, or to speculate on

changes in the underlying prices.

d) Most swaps are traded over-the-counter (OTC), "tailor-made" for the counterparties.

Some types of swaps are also exchanged on futures markets such as the Chicago

Mercantile Exchange Holdings Inc., the largest U.S. futures market, the Chicago Board

Options Exchange and Frankfurt-based Eurex AG.

e) The five generic types of swaps, in order of their quantitative importance, are:

interest rate swaps, currency swaps, credit swaps, commodity swaps and equity

swaps.

Futures

a) A futures contract is a standardized contract, traded on a futures exchange, to buy or

sell a standardized quantity of a specified commodity of standardized quality at a

certain date in the future, at a price determined by the instantaneous equilibrium

between the forces of supply and demand among competing buy and sell orders on

the exchange at the time of the purchase or sale of the contract.

b) The future date is called the delivery date or final settlement date. The official

price of the futures contract at the end of a day's trading session on the exchange is

called the settlement price for that day of business on the exchange.

c) A futures contract gives the holder the obligation to make or take delivery under the

terms of the contract,

d) Both parties of a "futures contract" must fulfill the contract on the settlement date.

The seller delivers the underlying asset to the buyer, or, if it is a cash-settled futures

contract, then cash is transferred from the futures trader who sustained a loss to the

one who made a profit. To exit the commitment prior to the settlement date, the

holder of a futures position has to offset his/her position by either selling a long

position or buying back (covering) a short position, effectively closing out the futures

position and its contract obligations.

e) Futures contracts, or simply futures, are exchange traded derivatives. The

exchange's clearinghouse acts as counterparty on all contracts, sets margin

requirements, and crucially also provides a mechanism for settlement.

Options

a) An option is a contract written by a seller that conveys to the buyer the right — but

not the obligation — to buy (in the case of a call option) or to sell (in the case of a put

option) a particular asset, such as a piece of property, or shares of stock or some

other underlying security, such as, among others, a futures contract. In return for

granting the option, the seller collects a payment (the premium) from the buyer.

b) For example, buying a call option provides the right to buy a specified quantity of a

security at a set strike price at some time on or before expiration, while buying a put

option provides the right to sell. Upon the option holder's choice to exercise the

option, the party who sold, or wrote, the option must fulfill the terms of the contract.

c) The theoretical value of an option can be evaluated according to several models.

These models, which are developed by quantitative analysts, attempt to predict how

the value of the option will change in response to changing conditions. Hence, the

risks associated with granting, owning, or trading options may be quantified and

managed with a greater degree of precision, perhaps, than with some other

investments.

d) Exchange-traded options form an important class of options which have standardized

contract features and trade on public exchanges, facilitating trading among

independent parties. Over-the-counter options are traded between private parties,

often well-capitalized institutions that have negotiated separate trading and clearing

arrangements with each other.

e) Another important class of options, particularly in the U.S., are employee stock

options, which are awarded by a company to their employees as a form of incentive

compensation

f) Other types of options exist in many financial contracts, for example real estate

options are often used to assemble large parcels of land, and prepayment options are

usually included in mortgage loans.

Question Bank

1) What is International Business? Domestic Business V/S IB ?2) Globalisation? Features and Types3) Globalisation – Bane or Boon4) What are the modes of entry? / Collaborative arrangement alternatives modes of entry.5) PEST Analysis6) Risk? How to manage political, economic and foreign exchange risk.7) Trade Theories – Factor endowment, PLC, New Trade Theory, Porter, PPP theory.8) World Bank , IMF ,ADB ( SN/ Full Question)

Trade Barriers (SN)9) WTO – Functions/Objectives/Activities carried out by WTO.

Program in DOHA Round.IPRIs WTO any use to India?

10) FDI – Theories and Benefits11) BOP(SN)12) ERPG Frame Work(SN)13) Trade Blocks – NAFTA, EU, APEC, SAFTA , SAARC and its benefits to India.14) MNE’s – Benefits

Bane or Boon15) Globalisation strategies16) Difference between international/Global/Multinational and Transnational17) Logistics and Supply Chain18) Country Selection and Evaluation(case study)19) Offshore Banking (CHANDRAN)20) Organisation Structure of MNE.21) Current Opportunities of Indian MNC.

Q1. What are the various entry methods for International Business?

Export

Exporting is the most traditional way of entering into International Business. Export can

be done in two ways:

3. Direct Export – Products are sold directly to buyers in target markets either through

local sales representatives or distributors. Sales representatives promote their

company’s products and do not take title to the merchandise. Distributors take

ownership of the goods (and the accompanying risk) and usually on-sell through

wholesalers and retailers to end-users.

Advantages of Direct Exports:

o Give a higher return on your investment than selling through an agent or

distributor

o Allows the exporting company to set lower prices and be more competitive

o Gives the company a close contact with its customers

Disadvantages of Direct Exports:

o The company may not have the services of a foreign intermediary, so it may need

more time to become familiar with the market

o The customers or clients may take longer to get to know the company and its

products, and such familiarity is often important when doing business

internationally

4. Indirect Export - Products are sold through intermediaries such as agents and trading

companies. Agents may represent one or more indirect exporters in return for

commission on sales.

Foreign direct Investment

FDI are investments made to acquire a lasting interest by a resident entity in one

economy in an enterprise resident in another economy. FDI has come to play a major

role in the internationalization of business. This has happened due to changes in

technologies, improved trade and investment policies of governments, regulatory

environment in terms of liberalization and easing of restrictions on foreign investments

and acquisitions, and deregulation and privatization of many industries.

Advantages:

o It can provide a firm with new markets and marketing channels, cheaper production

facilities, access to new technologies, capital process, products, organizational

technologies and management skills.

o FDI can provide a strong impetus to economic development of the host country. This

is all the more true when large MNCs enter developing nations through FDI.

o FDI allows companies to avoid foreign government pressure for local production.

o It allows making the move from domestic export sales to a locally based national

sales office.

o Capability to increase total production capacity.

Depending on the industry sector and type of business, a foreign direct investment may

be an attractive and viable option. With rapid globalization of many industries and

vertical integration rapidly taking place on a global level, at a minimum a firm needs to

keep abreast of global trends in their industry. From a competitive standpoint, it is

important to be aware of whether a company’s competitors are expanding into a foreign

market and how they are doing that. Often, it becomes imperative to follow the

expansion of key clients overseas if an active business relationship is to be maintained.

New market access is also another major reason to invest in a foreign country. At some

stage, export of product or service reaches a critical mass of amount and cost where

foreign production or location begins to be more cost effective. Any decision on investing

is thus a combination of a number of key factors including:

o Assessment of internal resources

o Competitiveness

o Market Analysis

o Market expectations

Licensing

Licensing is a legal agreement between the owner of intellectual property such as a

copyright, patent or trademark and someone who wants to use that IP. The licensee pays

“rent” to the licensor for the use of an idea/product/process that is otherwise protected

by IP law. Like a lease on a building, the license is for a specific period of time. The

licensee uses that idea/product/process to sell products or services and earns money.

Advantages:

o Licensing appeals to prospective global players because it does not require large

capital investment not detailed involvement with foreign customers. By generating

royalty income, licensing provides an opportunity to exploit research and

development already conducted. After initial costs, the licensor can reap benefits

until the end of license contract period.

o It reduces the risk of expropriation because the licensee is a local company that can

provide leverage against government action.

o Helps avoid host country regulations that are more prevalent in equity ventures.

o Provides a way of testing foreign markets without significant resources.

o Can be used as a preemption major in new market before the entry of competition.

Limitations:

o Limited form of market entry which does not guarantee a basis for expansion.

o Licensor may create more competition in exchange of royalty.

Franchising

Franchising involves granting of rights by a parent company to another (franchisee) to do

business in a prescribed manner. This right can take the form of selling the franchiser’s

products, using its name, production and marketing techniques or using its general

business approach.

It allows provides a network of interdependent business relationships that allows a

number of people to share:

o Brand identification

o Successful method of doing business

o Proven marketing and distribution system

Franchise agreement typically requires the payment of a fee upfront and then a

percentage on sales. In return, the franchiser provides assistance and at times may

require the purchase of goods or supplies to ensure the same quality of goods or services

worldwide.

Franchising is adaptable to international arena and requires minor modification for the

local market. It can be beneficial to both groups. Franchiser has a new stream of income

and the franchisee gets time proven concept/product which can be quickly bought to the

market.

Major Forms of Franchising:

- manufacturer-retailer system (e.g. car dealership)

- manufacturer-wholesaler system (e.g. soft-drink companies)

- service firm – retailer system (fast-food, hotel) e,g, McDonald’s, Burger King

Joint Ventures

A joint venture is an agreement involving two or more organizations that arrange to

produce a product or service through a collectively owned enterprise. It has been one of

the most popular way of entering a new market.

Typically, it is a 50-50 joint venture in which each of the party holds 50% ownership

stake and contributes a team of managers to share operating control. At times, this stake

can be a majority one so as to ensure tighter control.

Advantages:

o Domestic company brings in the knowledge of the domestic market.

o The risk is divided between joint-venture partners.

o Normally, foreign partner has an option to sell its stake in the venture to another

entity.

Limitations:

o Limited control over business approach for foreign entity.

o Profits have to be shared.

e.g. Danone-Brittania, Hero Honda, Maruti Suzuki

Wholly Owned Subsidiaries

In a wholly owned subsidiary, the company owns 100% of the equity. Establishing a

wholly owned subsidiary in a foreign market can be done in 2 ways:

3. Set up of new operation

4. Acquisition of established firm.

WOS allows a foreign firm complete control and freedom to execute its business strategy

in the foreign country. This freedom is accompanied by a greater risk due to lack of

knowledge of the market. Acquisition of an established company can reduce this risk to

an extent.

Q2. Influence of PEST Factors on International Business

Any business is affected by its external environment. The major macroeconomic factors

in the external environment that affect the business are political, environmental, social

and technological.

E. Political Environment

The political environment of a country greatly influences the business operating in those

countries or business trading with those countries. The success and growth of

international business depends on the stable, collaborative, conducive and secure

political system in the country.

The following factors affect the political environment in a country.

7. Tax Policy : The tax policy of a country affects the profitability of the business

there. The Corporate Taxation laws affect the profitability directly. The direct

taxation laws also affect the business because it influences consumer spending.

The structure of indirect taxation in a country like its excise duty structure,

customs and sales tax greatly affects the input costs of a business.

For e.g. Countries like UAE have very low direct taxation levels inducing great spending

and hence trading and marketing based business are successful. But due to very high

indirect taxation levels the manufacturing business is not very successful.

8. Government support : One of the most important political factor is the

Government support to international businesses. Business can be successful only

if the local government provides support in terms of infrastructure, license

clearing if required, transparent policy and quick dispute resolution mechanism.

Also the nature of the political system i.e. democracy, communism etc. in the

country influences the Government support.

For e.g. the RBI has provided single window clearance for FDI and hence has greatly

increased the FDI levels in our country.

9. Labor Laws : the labor laws in a country affect the viability of a business in that

country. The pension laws also play a critical role especially in cross border

acquisitions. Many businesses had to be withdrawn or closed because of the labor

unrest in the country.

For e.g.: Withdrawal of Premier Automobiles due to union strikes in our country.

The problems faced by doctors and nurses in UK due to the restrictive laws in that

country.

10. Environmental policy : The countries environmental policy (under the Kyoto

Protocol or otherwise) affects many business like chemicals, refineries and heavy

engineering.

11. Tariffs and duty structure : The level of duties and tariffs that are imposed by the

country influence its imports and exports greatly. Some countries follow a

protectionist policy to the domestic industry by raising import barriers For e.g.

India in the pre liberalization era, Russia.

12. Political stability and political milieu : Political stability greatly affects the longevity

of the businesses in a country. Political risk assessment should be done to

determine the country risk on the basis of following parameters :

a. Confiscation: the nationalization of businesses without compensation. For e.g.

India during the nationalist wave during Indira Gandhi’s tenure.

b. Nationalization : Resource nationalization is a major risk for businesses

involving local resources like oil, minerals etc. For e.g. the resource

nationalization in Columbia.

c. Instability risk : The possibility of military takeovers or huge government

changes. For e.g. the coups in Thailand or in Fiji has affected the profits of

businesses there by as much as 60% due to work stoppage and property

destruction.

d. Domestication : The global company relinquishing control in favor of domestic

investors. For e.g. Barclays bank in South Africa

F. Economic factors

The economic factors in a country greatly influence the business in that country. The

following factors are important in the macroeconomic environment.

5. Economic system : the economic system in a country i.e. capitalism/ communism/

mixed economy (India) is important for deciding the nature of the businesses. The

nature of the system decides the allocation of resources. Due to globalization

there is a gradual shift toward market forces to allocate resources even in the

communist countries like China.

6. Interest rates : The interest rates in the country affect the cost of capital (if raised

locally) and the operational costs. Interest rates also determine the confidence of

the Government in the economy and consumer spending.

7. Exchange rates : The exchange rates affect international trade and capital inflows

in the country.

8. Income levels and spending pattern : Though it is more of a demographic

parameter has is very important bearing on the sell side of all international

businesses. For e.g. In a country like India, with rising aspirer population there is a

market opportunity for products like IPod (considered luxury items till now)

G. Social factors

Businesses are driven by people both as human capital and as consumers. It is necessary

for an international businessman to understand the social and cultural aspects of the

country they operate in. The following are the important social factors.

5. Age distribution : the age distribution of the population is important to consider

the consumption patterns in the markets. Age distribution also determines the

mindset of the market and helps segmentation of the market accordingly. It also

has a bearing on the employee quality. A young population also determines a

workforce.

6. Family system : the family system has a bearing on the decision makers in

consumption. For e.g. in Islamic countries women have a less say in making

consumption decisions. In emerging economies like India children are gaining

important role in consumption. This helps in positioning of products.

7. Cultural aspects : The cultural aspects influence the way the business is conducted

in countries. In Japan there is a different way in which contracts are signed and

executed. In Russia being a communist oriented mindset the business is

conducted in a closed manner. Italians have a seemingly lazy way of doing

business and hence it is very difficult to conduct business in the pacy US way.

8. Career attitudes : the career attitude of the workforce is important social aspect.

H. Technological Factors

Technology has a very important role to play in determining the success of international

businesses because technology has made international business possible. The following

are the technological factors that influence the business.

3. R&D : the support that the Government gives to R&D encourages setting up R&D

business levels. Also the ease of a qualified local workforce influence business. For

e.g. the semiconductor industry in Taiwan

4. Technology transfer : The ease of technology transfer influences the business

climate. The environment where the technology transfer is not viable gradually

loses out on business from emerging countries that seek technology transfers. For

e.g. in the early 40s countries like Czechoslovakia (the Czech Republic) was a very

technologically advanced country but had very low business interest due to the

less chances of technology transfers. For e.g. GE withdrew operations from a JV as

there as they could not access local expertise)

Q3. Trade Theories

Trade Theories

Classical Trade Theories

Mercantilism Free Trade Theories

Theory of Absolute

Advantage

Theory of Relative

Advantage

Free Trade Theories Refined

Factor Endowment

Theory

Product Life Cycle Theory

Modern Trade Theories Other Theories

Productivity Theory

The vent for surplus theory

Theory of Reciprocal Demand

4. Classical Country-Based Theories

4.1.Mercantilism (pre-16th century)

This theory takes an “us-versus-them” view of trade; other country’s gain is our

country’s loss.

Neo-mercantilism views persist today.

A nation’s wealth depends on accumulated treasure.

Theory says you should have a trade surplus.

Maximize exports through subsidies.

Minimize imports through tariffs and quotas.

Flaw: “Zero-sum game”.

Mercantilism- Zero-Sum Game

In 1752, David Hume pointed out that:

Increased exports lead to inflation and higher prices

Increased imports lead to lower prices

Result: Country A sells less because of high prices and Country B

sells more because of lower prices

In the long run, no one can keep a trade surplus

4.2. Free Trade supporting theories

This theory shows that specialization of production and free flow of goods grow all

trading partners’ economies

4.2.1. Absolute Advantage (Adam Smith, The Wealth of Nations, 1776)

Mercantilism weakens a country in the long run and enriches only a few

segments; it robs individuals of the ability to trade freely.

Adam Smith claimed market forces, not government controls, should

determine the direction, volume and composition of international trade.

Under free (unregulated) trade each nation should specialize in producing those

goods it could produce most efficiently.

This theory states that a country is capable of producing more of a good with the

same input than another country. Hence, a country should specialize in and

export products for which it has absolute advantage; import others.

A country has absolute advantage - either natural or acquired when it is

more productive than another country in producing a particular product.

Trade between countries is, therefore, beneficial.

Assume that there are just two countries in the world, the India and Japan.  Pretend also

that they produce only two goods, shoes and shirts.  The resources of both countries can

be used to produce either shoes or shirts.  Both countries make both products, spending

half of their working hours on each.  But India makes more shoes than shirts, and Japan

makes more shirts than shoes. 

TABLE A

Shoes Shirts

India 100 75

Japan 80 100

Total 180 175

What will happen when each country specializes and spends all its working hours making

one product?  It will make twice as much of that product and none of the other, as shown

in Table B.

TABLE   B

Shoes Shirts

India 200 0

Japan 0 200

Total 200 200

The world now has both more shoes and more shirts.  India can trade 100 units of shoes

for 100 units of shirts, and both countries will benefit.

In this example, India could make more shoes than Japan with the same resources.  It

has an absolute advantage at shoemaking.  Japan, on the other hand, had an absolute

advantage at shirt making.

Assumptions:

Perfect competition and no transportation costs in a world of two countries and

two products

One unit of input (combination of land, labor, and capital)

Each nation has two input units it can use to produce either rice or automobiles

Each country uses one unit of input to produce each product

4.2.2. Comparative Advantage (David Ricardo, Principals of Political

Economy, 1817) – Also known as Opportunity Cost Theory

David Ricardo, in his theory of comparative costs, suggested that countries will

specialize and trade in goods and services in which they have a comparative

advantage.

A country has a comparative advantage in the production of a good or service

that it produces at a lower opportunity cost than its trading partners.

The theory of comparative costs argues that, put simply, it is better for a country

that is inefficient at producing a good to specialize in the production of that good

it is least inefficient at, compared with producing other goods.

Now suppose one country has an absolute advantage in both products.  Table C shows

what production might be like if India had an absolute advantage at making both shoes

and shirts.

TABLE C

Shoes Shirts

India 100 80

China 80 75

Total 180 155

In this case, the India can produce more of each good with the same set of resources

than China can. The India could produce either 200 units of shoes or 160 units of

shirts. China could produce either 160 units of shoes or 150 units of shirts. If the India

produces only shoes, it gives up 80 units of shirts to gain 100 units of shoes. If China

produces only shoes, it gives up 75 units of shirts to gain 80 units of shoes. For India, the

opportunity cost of producing shirts is higher and the opportunity cost of producing shoes

is lower; vice-versa for China. Hence, India has a comparative advantage in shoemaking

and China has a comparative advantage in shirt making. 

Table D shows what happens when each country specializes in the product in which it

has a comparative advantage.

TABLE D

Shoes Shirts

India 200 0

China 0 150

Total 200 150

By specializing in this way, the India and China have increased the production of shoes

by twenty units over what they produced before, from 180 to 200. But the world has lost

five units of shirts, going from 155 to 150. 

Production in the India could be adjusted to make up the difference. For example, if the

India gave up 10 units of shoes, it could produce 8 units of shirts.  Table E shows the

results of such a tradeoff.

TABLE E

Shoes Shirts

India 190 8

China 0 150

Total 190 158

In this way, the total production of both goods could be increased.

For India, the opportunity cost of choosing to produce 80 units of shirts was the 100 units

of shoes that could have been produced with the same resources.  In the like manner,

China's opportunity cost of producing 80 units of shoes was 75 units of shirts. 

In the terms of trade each reduce each country's opportunity cost of acquiring the good

traded for, trade will take place.  In this example, China will not accept fewer than 80

units of shoes for 75 units of shirts and the India will not pay more than 100 units of

shoes for 80 units of shirts.  Both countries must benefit for trade to occur.

The real world is much more complex than this two-country, two-product mode. Trade

involves many different countries and products. And it is not always clear where a

country's comparative advantage lies.

Summary

Country should specialize in the production of those goods in which it is relatively

more productive, even if it has absolute advantage in all goods it produces.

This extends free trade argument.

Efficiency of resource utilization leads to more productivity.

4.3.Free Trade refined

4.3.1. Factor-proportions (Heckscher-Ohlin, 1919)

Eli Heckscher and Bertil Ohlin developed the theory of relative factor

endowments, now often referred to as the Heckscher-Ohlin theory. The theory

states that the pattern of international trade depends on differences in factor

endowments not on differences in productivity.

Relative endowments of the factors of production (land, labour, and capital)

determine a country's comparative advantage.

Countries have comparative advantage in those goods for which the required

factors of production are relatively abundant. This is because the prices of goods

are ultimately determined by the prices of their inputs.

Goods that require inputs that are locally abundant will be cheaper to produce

than those goods that require inputs that are locally scarce.

For example, a country where capital and land are abundant but labour is scarce will

have comparative advantage in goods that require lots of capital and land, but little

labour - grains, for example.

Since capital and land are abundant, their prices will be low. Those low prices will ensure

that the price of the grain that they are used to produce will also be low - and thus

attractive for both local consumption and export.

Labor intensive goods on the other hand will be very expensive to produce since labor is

scarce and its price is high. Therefore, the country is better off importing those goods.

Summary

Factor endowments vary among countries

Products differ according to the types of factors that they need as inputs

A country has a comparative advantage in producing products that intensively

use factors of production (resources) it has in abundance

Assumptions

A given technology was universally available.

Relative factor endowments are different in each country

Tastes and preferences are identical in both countries

A given product was either labor- or capital-intensive

The theory ignored transportation costs.

4.3.2. Product Life Cycle (Ray Vernon, 1966)

As products mature, both location of sales and optimal production changes

Affects the direction and flow of imports and exports

Globalization and integration of the economy makes this theory less valid

Classic Theory Limitations:

All the classical theories are based on the following assumptions that no longer hold true

–

Simple world (two countries, two products)

No transportation costs

No price differences in resources

Resources immobile across countries

Constant returns to scale

Each country has a fixed stock of resources & no efficiency gains in resource use

from trade

Full employment

5. Modern Trade Theory

In industries with high fixed costs:

Specialization increases output, and the ability to enhance economies of scale

increases

Learning effects are high.

These are cost savings that come from “learning by doing”

New Trade Theory-Applications

Typically, requires industries with high, fixed costs

o World demand will support few competitors

o Competitors may emerge because of “ First-mover advantage”

Economies of scale may preclude new entrants

o Role of the government becomes significant

Some argue that it generates government intervention and strategic trade policy

Theory of National Competitive Advantage

The theory attempts to analyze the reasons for a nation’s success in a particular

industry

Porter studied 100 industries in 10 nations

- Postulated determinants of competitive advantage of a nation were based

on four major attributes

Factor endowments

Demand conditions

Related and supporting industries

Firm strategy, structure and rivalry

Factor endowments: A nation’s position in factors of production such as skilled labor

or infrastructure necessary to compete in a given industry

Basic factor endowments

Advanced factor endowments

Basic Factor Endowments

Basic factors: Factors present in a country

- Natural resources

- Climate

- Geographic location

- Demographics

While basic factors can provide an initial advantage they must be supported

by advanced factors to maintain success

Advanced Factor Endowments

Advanced factors: The result of investment by people, companies, and

government are more likely to lead to competitive advantage

If a country has no basic factors, it must invest in advanced factors

- Communications

- Skilled labor

- Research

- Technology

- Education

Porter’s Theory-Predictions

Porter’s theory should predict the pattern of international trade that we observe in

the real world.

Countries should be exporting products from those industries where all four

components of the diamond are favorable, while importing in those areas where

the components are not favorable

6. Other Theories:

6.1.The productivity theory by H. Myind

It is criticized that the comparative cost theories are not applicable to developing

countries. Hence, H. Myint proposed productivity theory and the vent for surplus

theory.

The productivity theory points toward indirect and direct benefits. This theory

emphasizes that the process of specialization involves adapting and reshaping the

production structure of a trading country to meet the export demands.

Countries increase productivity in order to utilize the gains of exports. This theory

encourages the developing countries to go for cash crops, increase productivity

by enhancing the efficiency of human resources, adapting latest technology etc.

Limitations:

Labor productivity did not increase after certain level

Increase in working hours

Increase in proportion of gainfully employed labour in proportion to disguised

unemployed labour

6.2.The vent for surplus theory

International trade absorbs the output of unemployed factors.

If the countries produce more than the domestic requirements, they have to

export the surplus to other countries. Otherwise, a part of the productive labour of

the country must cease and the value of its annual Produce diminishes.

In the absence of foreign trade, they would be surplus productive capacity in the

country. This surplus productive capacity is taken by another country and in turn

gives the benefit under international trade.

Appropriateness of this Theory for Developing Countries:

According to this theory, the factors of production of developing countries are

fully utilized.

The unemployed labour of the developing countries is profitably employed when

the vent for surplus is exported.

6.3.Mills’ theory of reciprocal demand

Comparative cost advantage theories do not explain the ratios at which

commodities are exchanged for one another. J.S. Mill introduced the concept of

‘reciprocal demand’ to explain the determinations of the equilibrium terms of

trade.

Reciprocal demand indicates a country’s demand for one commodity in terms of

the other commodity; it is prepared to give up in exchange. It determines the

terms of trade and relative share of each country.

Equilibrium:

Quality of a product exported by country A = Quality of another product exported by

country B

Assumptions:

Existence of two countries

Trade in only two goods – both the goods are produced under the law of constant

returns

Absence of transportation Costs.

Existence of perfect competition

Existence of full employment

Q4. Ten reasons why FDI happens

11. Foreign Direct Investments (FDI) as defined in the BOP Manual, are investments made

to acquire a lasting interest by a resident entity in one economy in an enterprise

resident in another economy. The purpose of the investor is to have a significant

influence, an effective voice in the management of the enterprise. The definition of

the Organization for Economic Cooperation and Development (OECD) which considers

as direct investment enterprise an incorporated or unincorporated enterprise in which

a direct investor who is resident in another economy owns ten percent or more of the

ordinary shares or voting power (for incorporated enterprise) or the equivalent (for an

unincorporated enterprise).

12. It provides a firm with new markets and marketing channels, cheaper production

facilities, access to new technology, products, skills and financing. For a host country

or the foreign firm which receives the investment, it can provide a source of new

technologies, capital, processes, products, organizational technologies and

management skills, and as such can provide a strong impetus to economic

development.

13. FDI inflows are considered as channels of entrepreneurship, technology, management

skills, and of resources that are scarce in developing countries. Hence, they could

help their host countries in their industrialization.

14. For small and medium sized companies, FDI represents an opportunity to become

more actively involved in international business activities. In the past 15 years, the

classic definition of FDI as noted above has changed considerably, over 2/3 of direct

foreign investment is still made in the form of fixtures, machinery, equipment and

buildings.

15. FDI is viewed as a basis for going “global”. FDI allows companies to accomplish

following tasks:

Avoiding foreign government pressure for local production

Circumventing trade barriers, hidden and otherwise

Making the move from domestic export sales to a locally-based national sales

office

Capability to increase total production capacity.

Opportunities for co-production, joint ventures with local partners, joint marketing

arrangements, licensing, etc

16. Foreign direct investment is viewed as a way of increasing the efficiency with which

the world's scarce resources are used. A recent and specific example is the perceived

role of FDI in efforts to stimulate economic growth in many of the world's poorest

countries. Partly this is because of the expected continued decline in the role of

development assistance (on which these countries have traditionally relied heavily),

and the resulting search for alternative sources of foreign capital.

17. FDI enables the firm owns assets to be profitably exploited on a comparatively large

scale, including intellectual property (such as technology and brand names),

organizational and managerial skills, and marketing networks. And it is more

profitable for the production utilizing these assets to take place in different countries

than to produce in and export from the home country exclusively.

18. FDI may result in a greater diffusion of know-how than other ways of serving the

market. While imports of high-technology products, as well as the purchase or

licensing of foreign technology, are important channels for the international diffusion

of technology, FDI provides more scope for spillovers. For example, the technology

and productivity of local firms may improve as foreign firms enter the market and

demonstrate new technologies, and new modes of organization and distribution,

provide technical assistance to their local suppliers and customers, and train workers

and managers who may later be employed by local firms.

19. FDI increases employment in host country. Inflows of FDI also increase the amount of

capital in the host country. Even with skill levels and technology constant, this will

either raise labor productivity and wages, allow more people to be employed at the

same level of wages, or result in some combination of the two.

20. Proponents of foreign investment point out that the exchange of investment flows

benefits both the home country (the country from which the investment originates)

and the host country (the destination of the investment). Opponents of FDI note that

multinational conglomerates are able to wield great power over smaller and weaker

economies and can drive out much local competition. The truth might lie somewhere

in between but they surely become reasons for companies to invest in foreign

markets.

Q5. WTO Rounds wrt India

The WTO came into being on January 1, 1995, and is the successor to the General

Agreement on Tariffs and Trade (GATT), which was created in 1948. India was one of the

76 countries that signed the accession to the WTO and is one of the founder members of

the WTO.

Trade implications of signing the WTO for India:

The implications of signing the WTO agreement for Indian trade have been mixed. India

has benefited in the areas of garment exports, agricultural products exports and in

market access to foreign markets in automobiles and electronics. India has a

disadvantage mainly in areas of TRIPs, drug prices, patents in agriculture, TIS ( trade in

services ) and TRIMS especially in biomedical areas, AoA export subsidies etc.

Benefits:

6. Garment exports : The Multi Fiber Arrangement (MFA) that required Indian garment

exporters to have quotas for exporting to developed countries was phased out in

2005. The readymade garment exports from India has reached Rs 800 crores in 2007

and expected to reach Rs 1000 crores in 2008. This is thrice the exports in 2004-05.

7. Market access : as a signatory to the WTO India automatically gets the MFN ( most

favored nation ) status. This gives India access to markets in Europe and US in

sectors like automobiles and engineering. India also benefits from the clauses related

to trade without discrimination and benefit from capital good exports.

8. Anti Dumping measures : India suffered from persistent dumping by Romanian and

Russian steel majors in the areas of steel casings, pipes affecting Indian domestic

industry greatly. Also India suffered from dumping by Chinese steel industry. The anti

dumping provisions and countervailing duties lend security to India’s domestic

industries.

9. The Agreement on Agriculture : the AoA stipulates that the developed countries will

reduce tariffs on agriculture imports (up to 35%) thus helping India’s agriculture

exports. It also promises reduction of domestic subsidies in the developed countries

helping exports from India.

10. Competitive advantage : India has competitive advantage in the areas of merchandise

trade. India can utilize its competitive advantage in processing, beverages, gems and

jeweler compared to the traditional centers in Europe like Amsterdam or Manchester

etc increasing its trade with both the Euro region and the US.

Disadvantages:

7. TRIPS : the Indian Patent Act is not compatible with the TRIPS agreement under the

WTO. The Indian Patent Act allows only process patents in areas of foods, chemicals

and medicines. Under the TRIPS the IPA will have to modify to allow product patents

also. Also products developed outside India can claim international patents applicable

to India. This will hurt our agriculture foods. E.g. the Alphanso mango and the

Basmati strand controversy.

8. Drug prices : the granting of the product patents in India will hurt the Indian generic

drugs industry and benefit the foreign pharma companies that own the formulation

patents. This will lead to increase in drug prices in India. (This resulted in regulatory

intervention in the recent budget in life saving drugs) e.g. the Pfizer controversy

9. Genetics : Indian seed and genetic research organizations are Government funded

and will not be able to compete with the MNCs like Montessanto etc that have

economies of scale. This will increase seed prices for Indian farmers and also lend our

genetic resources to the MNCs

10. Services : the opening up of the banking sector in 2009 will affect Indian banks due to

the foreign banks with huge balance sheets.

11. TRIMS : the Trade Related Investment Measures resulted in problems in trade in

investment issues like transit charges, formalities etc. together called as Singapore

issues. Indian companies would have to lose in the differential charges that are

applied. These issues were dropped in the Chachun ministerial conferences.

12. Anti dumping: the anti dumping rules were imposed on Indian linen in EU. Similarly

Indian textiles faced anti dumping regulations in US. There is no mechanism to

resolve anti dumping duties issues.

India’s stand in the Doha round and the following ministerial conferences:

5. Doha round: The Doha Development Round commenced at Doha, Qatar in

November 2001 and is still continuing. Its objective is to lower trade barriers around

the world, permitting free trade between countries of varying prosperity. As of 2008,

talks have stalled over a divide between the developed nations led by the European

Union, the United States and Japan and the major developing countries (represented

by the G20 developing nations), led and represented mainly by India, Brazil, China

and South Africa.

Issues: Singapore issues: the issues related to the trade facilitation and differential

charges in investment vehicles affected Indian investment and venture companies. This

affected the Indian services.

Agricultural subsidies: the EU, US and Japan support domestic agriculture by subsides.

This was opposed by countries like India and Brazil.

6. Cancun conference 2003 :

The objective of this conference was to forge the agreement discussed in Doha.

Issues: market access to foreign markets. This agreement on market access for the

developing countries in capital and industrial goods increased strength of G20 countries.

India benefited greatly in the capital goods export.

The Singapore issues were resolved that resulted in removing the undue advantage for

countries like US and Japan in investment arena. This also benefited the Indian financial

sector internationally.

7. Geneva 2004: In Geneva conference the developed nations reduced subsidiaries on

manufactured goods. This resulted in Indian small manufacturers like steel forging,

casting to export largely and benefit from the construction boom in US.

8. Paris 2005: France reduced subsidies on farm products. However US and Japan did

not relent.

Hong Kong 2006 and Potsdam 2007 talks failed in resolving the farm subsidies. So the

recent rounds are in a stalemate situation from India’s point of view.

Q6. Discuss NAFTA/ EU/ ASEAN/ SAARC/ MERCUSOR

Mercosur

Mercosur is a regional trade agreement among Argentina, Brazil ,Paraguay & Uruguay

founded in 1991 by the Treaty of Asunción, which was later amended and updated by the

1994 Treaty of Ouro Preto. Its purpose is to promote free trade and the fluid movement

of goods, people, and currency. Bolivia, Chile, Colombia, Ecuador and Peru currently have

associate member status. Venezuela signed a membership agreement on 17 June 2006,

but before becoming a full member its entry has to be ratified by the Paraguayan and the

Brazilian parliaments.

The bloc comprises a population of more than 263 million people, and the combined

Gross Domestic Product of the full-member nations is in excess of US$2.78 trillion a year

(Purchasing power parity, PPP) according to International Monetary Fund (IMF) numbers,

making Mercosur the fifth largest economy in the World.

Objectives of MERCOSUR

Free transit of production goods, services and factors between the member states

with inter alia, the elimination of customs rights and lifting of nontariff restrictions on

the transit of goods or any other measures with similar effects;

Fixing of a common external tariff (TEC) and adopting of a common trade policy with

regard to nonmember states or groups of states, and the coordination of positions in

regional and international commercial and economic meetings;

Coordination of macroeconomic and sectorial policies of member states relating to

foreign trade, agriculture, industry, taxes, monetary system, exchange and capital,

services, customs, transport and communications, and any others they may agree on,

in order to ensure free competition between member states; and

The commitment by the member states to make the necessary adjustments to their

laws in pertinent areas to allow for the strengthening of the integration process. The

Asuncion Treaty is based on the doctrine of the reciprocal rights and obligations of

the member states.

MERCOSUR initially targeted free-trade zones, then customs unification and, finally, a

common market, where in addition to customs unification the free movement of

manpower and capital across the member nations' international frontiers is possible, and

depends on equal rights and duties being granted to all signatory countries. During the

transition period, as a result of the chronological differences in actual implementation of

trade liberalization by the member states, the rights and obligations of each party will

initially be equivalent but not necessarily equal. In addition to the reciprocity doctrine,

the Asuncion Treaty also contains provisions regarding the most-favored nation concept,

according to which the member nations undertake to automatically extend--after actual

formation of the common market--to the other Treaty signatories any advantage, favor,

entitlement, immunity or privilege granted to a product originating from or intended for

countries that are not party to ALADI.

SAARC

The South Asian Association for Regional Cooperation (SAARC) is an economic and

political organization of eight countries in Southern Asia. It was established on December

8, 1985 by India, Pakistan, Bangladesh, Sri Lanka, Nepal, Maldives and Bhutan. In April

2007, at the Association's 14th summit, Afghanistan became its eighth

member.Sheelkant Sharma is the current secretary & Mahinda Rajapaksa is the current

chairman of SAARC which is headquartered at Kathmandu.

Objectives of SAARC:

to promote the welfare of the peoples of South Asia and to improve their quality

of life;

to accelerate economic growth, social progress and cultural development in the

region and to provide all individuals the opportunity to live in dignity and to

realize their full potential;

to promote and strengthen collective self-reliance among the countries of South

Asia;

to contribute to mutual trust, understanding and appreciation of one another's

problems;

to promote active collaboration and mutual assistance in the economic, social,

cultural, technical and scientific fields;

to strengthen cooperation with other developing countries;

to strengthen cooperation among themselves in international forums on matters

of common interest; and

to cooperate with international and regional organizations with similar aims and

purposes.

Free Trade Agreement

Over the years, the SAARC members have expressed their unwillingness on signing a

free trade agreement. Though India has several trade pacts with Maldives, Nepal, Bhutan

and Sri Lanka, similar trade agreements with Pakistan and Bangladesh have been stalled

due to political and economic concerns on both sides. India has been constructing a

barrier across its borders with Bangladesh and Pakistan. In 1993, SAARC countries signed

an agreement to gradually lower tariffs within the region, in Dhaka. Eleven years later, at

the 12th SAARC Summit at Islamabad, SAARC countries devised the South Asia Free

Trade Agreement which created a framework for the establishment of a free trade area

covering 1.4 billion people. This agreement went into force on January 1, 2006. Under

this agreement, SAARC members will bring their duties down to 20 per cent by 2007.

The last summit (15th) was held in Colombo where four major agreements - the SAARC

development fund, the establishment of a SAARC standard organization, the SAARC

convention on mutual legal assistance in criminal matters, and the protocol on

Afghanistan's admission to the South Asia Free Trade Agreement (SAFTA) were adopted

with emphasis on region-wide food security.

NAFTA

The North American Free Trade Agreement (NAFTA) is a trilateral trade bloc in North

America created by the governments of the United States, Canada, and Mexico. In terms

of combined purchasing power parity GDP of its members, as of 2007 the trade bloc is

the largest in the world and second largest by nominal GDP comparison. It also is one of

the most powerful, wide-reaching treaties in the world.

The North American Free Trade Agreement (NAFTA) has two supplements, the North

American Agreement on Environmental Cooperation (NAAEC) and the North American

Agreement on Labor Cooperation (NAALC).

Implementation of the North American Free Trade Agreement (NAFTA) began on January

1, 1994. This agreement will remove most barriers to trade and investment among the

United States, Canada, and Mexico.

Under the NAFTA, all non-tariff barriers to agricultural trade between the United States

and Mexico were eliminated. In addition, many tariffs were eliminated immediately, with

others being phased out over periods of 5 to 15 years.  This allowed for an orderly

adjustment to free trade with Mexico, with full implementation beginning January 1,

2008. 

The agricultural provisions of the U.S.-Canada Free Trade Agreement, in effect since

1989, were incorporated into the NAFTA. Under these provisions, all tariffs affecting

agricultural trade between the United States and Canada, with a few exceptions for items

covered by tariff-rate quotas, were removed by January 1, 1998.

Mexico and Canada reached a separate bilateral NAFTA agreement on market access for

agricultural products. The Mexican-Canadian agreement eliminated most tariffs either

immediately or over 5, 10, or 15 years.

U.S. trade with Mexico and Canada has grown more rapidly than total U.S. trade since

1994. The automotive, textile, and apparel industries have experienced the most

significant changes in trade flows, which may also have affected employment levels in

these industries. The five major U.S. industries that have high volumes of trade with

Mexico and Canada are automotive industry, chemicals and allied products, computer

equipment, textiles and apparel, and microelectronics.

The effects of NAFTA, both positive and negative, have been quantified by several

economists. Some argue that NAFTA has been positive for Mexico, which has seen its

poverty rates fall and real income rise (in the form of lower prices, especially food), even

after accounting for the 1994–1995 economic crisis. Others argue that NAFTA has been

beneficial to business owners and elites in all three countries, but has had negative

impacts on farmers in Mexico who saw food prices fall based on cheap imports from U.S.

agribusiness, and negative impacts on U.S. workers in manufacturing and assembly

industries who lost jobs. Critics also argue that NAFTA has contributed to the rising levels

of inequality in both the U.S. and Mexico.

EU

The European Union (EU) is a political and economic union of 27 member states, located

primarily in Europe. The EU generates an estimated 30% share of the world's nominal

gross domestic product (US$16.8 trillion in 2007). Thus EU presents an enormous export

and investor market that is both mature and sophisticated.

The EU has developed a single market through a standardised system of laws which

apply in all member states, guaranteeing the freedom of movement of people, goods,

services and capital. It maintains a common trade policy. Fifteen member states have

adopted a common currency, the euro.

Objectives of the EU: Its principal goal is to promote and expand cooperation among

members’ states in economics, trade, social issues, foreign policies, security, defense,

and judicial matters. Another major goal of the EU is to implement the Economic and

Monetary Union, which introduced a single currency, the Euro for the EU members.

The single market refers to the creation of a fully integrated market within the EU, which

allows for free movement of goods, services and factors of production. The EU, in

conjunction with Member States, has a number of policies designed to assist the

functioning of the market. Some of the policies are given below:

Competition Policy: The main competition lied in energy and transport sector. The union

designed this strategy to prevent price fixing, collusion (secret agreement), and abuse of

monopoly.

Free movement of goods: A custom union covering all trade in goods was established

and a common customs tariff was adopted with respect to countries outside the union.

Services: Any member nation has a right to provide services in other Member States.

Free movement of persons: Any citizen of EU member state can live work in any other EU

member state

Capital: There are no restrictions on the movement of capital and on payments with the

EU and between member states and third countries.

Trade between the European Union and India

India was one of the first Asian nations to accord recognition to the European Community

in 1962. The EU is India’s largest trading partner and biggest source of FDI. It is a major

contributor of developmental aid and an important source of technology. Over the years,

EU – India trade has grown from 4.4 bn to 28.4 bn US$.

Top items of trade between India and EU

India’s exports to EU % India’s Imports from EU %

Textile and clothing 35 Gemstones and jewellery 31

Leather and leather products 25 Power generating equipment 28

Gemstones and jewelery 12 Chemical products 15

Agriculture products 10 Office machinery 10

Chemical products 9 Transport equipment 6

India is EU’s 17th largest supplier and 20th largest destination for exports.

Tariff and non-tariffs have been reduced, but compared to International standards

they are still high.

Under the Bilateral trade between India and EU, it accounts for 26% of India’s exports

and 25% of its imports.

The European Union (EU) and India agreed on September 29,2008 at the EU-India

summit in Marseille, France's largest commercial port, to expand their cooperation in

the fields of nuclear energy and environmental protection and deepen their strategic

partnership.

Trade between India and the 27-nation EU has more than doubled from 25.6 billion

euros ($36.7 billion) in 2000 to 55.6 billion euros last year, with further expansion to

be seen.

ASEAN

The Association of Southeast Asian Nations or ASEAN was established on 8 August 1967

in Bangkok by the five original Member Countries, namely, Indonesia, Malaysia,

Philippines, Singapore, and Thailand. Brunei Darussalam joined on 8 January 1984,

Vietnam on 28 July 1995, Laos and Myanmar on 23 July 1997, and Cambodia on 30 April

1999.

OBJECTIVES

The ASEAN Declaration states that the aims and purposes of the Association are:

(vii) To accelerate the economic growth, social progress and cultural development in

the region through joint endeavors.

(viii) To promote regional peace and stability through abiding respect for justice and

the rule of law in the relationship among countries in the region and adherence to

the principles of the United Nations Charter.

(ix) To maintain close cooperation with the existing international and regional

organizations with similar aims.

WORKING OF ASEAN

The member countries of ASEAN have Preferential Trading Arrangements (PTA), which

reduces tariffs on products traded among member countries. In 1992, ASEAN developed

a Common Effective Preferential Tariffs (CEPT) plan to reduce tariffs systematically for

manufactured and processed products.

The members have also established a series of co-operative efforts to encourage joint

participation in industrial, agricultural and technical development projects and to

increase foreign investments in their economies. These efforts include an ASEAN finance

corporation, the ASEAN Industrial Joint Ventures Programme (AJIV) etc. ASEAN nations

have introduced some programmes for greater diversification in their economies.

India and ASEAN

India is interested in maintaining close economic relations with the members of ASEAN,

as these countries are closer to India. The ASEAN countries are offering co-operation to

India in the field of trade, investment, science and technology and training of personnel.

Also, India’s trade with ASEAN countries is satisfactory in recent years.

Q7. Effect of Current Economic Meltdown on International Business

13. Slower global growth: Global growth stood at 5 percent in 2007, but the IMF expects

world growth to slow to 3 percent in 2009 - 0.9 percentage points lower than

forecasted in July 2008.

14. Economic contraction in some countries: In G7 countries except for the United States

and Canada, GDP growth was slower in Q2 of 2008 compared to Q1. Three major

European economies (Italy, France and Germany) experienced negative GDP growth

in Q2, and forecasts are for a continued decline in Q3. The IMF forecasts around 0

percent growth for advanced economies in 2009.

15. Depth of slowdown: It is observed that economic slowdowns, preceded by financial

stress tend to be more severe. Although employment has contracted in several

countries in recent months, it has not been as severe as that during 1990-91.

16. Financing challenges for governments: State and local governments may be faced

with financial crisis. Even administrative costs may be difficult to come by. The

governments would be hard pressed for funds for guarantees and development work.

For e.g. In the case of Iceland the banking sector has assets of around 300% of GDP,

something no government could ever guarantee, at least not on a short-term basis.

17. Rising unemployment: According to IMF, unemployment in the advanced economies

will rise from 5.7 percent in 2008 to 6.5 percent in 2009.

18. Large employment losses in sectors: Some sectors like construction, real estate

services will experience disproportionate employment declines. In addition there will

be significant job losses in the financial sector.

19. Reduced world trade volume: According to the IMF, the world trade will grow only at

the rate of 1.9% as against the earlier estimate of 4.1% for 2009. A drop in exports,

as well as capital inflow, may trigger a falloff in investments.

20. Rising income insecurity and disproportionate impact on low-income groups: As stock

markets around the world have eroded trillions of dollars in wealth and rolled back

some of the investment gains of the past 5 years, the investment and retirement

savings of many individuals have lost significant value. There is a risk that low-

income countries and lower-income groups within countries will bear the brunt of

challenges, as “the most poor are the most defenseless,” says World Bank President

Robert Zoellick.

21. Return to Tariff and Non-Tariff Barriers: Developed economies in order to ward off

unemployment and financial crisis may erect barriers to free trade. This might start a

local business environment. For e.g. President-elect Barrack Obama has already

announced his intention to reduce outsourcing from US by 30%.

22. Surplus Production Capacities: In line with demand destruction, many branded

products may face surplus capacities. For e.g. Car, Steel & Aircrafts manufacturers

are already staring at excess capacity.

23. Increase in Government Controls: In order to bail out sinking Corporates the

governments, would buy out or control the operations of large companies. For e.g.

AIG and Citibank

24. Impact on India:

a. BPO Operations: India is likely to face a severe crunch on the IT and ITes services,

rendered by Indian BPO Companies.

b. Increase in Trade Deficit: Already in the last quarter, India’s trade deficit has

grown where exports are not meeting the set targets while imports continue to

grow.

c. Falling Currency: as the demand for dollars increases the Indian rupee is likely to

weaken. The rupee has already depreciated to Rs. 50 a dollar.

d. Pressure on Services Sector: As the demand for services is destroyed, these

sunshine industries such as BPOs, Airlines, and Telecommunication etc. will face

salary and employment cutbacks.

Q8. Organizational Structures in International Business

Douglas Wind and Pelmutter advocated four approaches of international business. They

are:

5. Echnocentric Approach

The domestic companies normally formulate their strategies, their product design

and their operations towards the national markets, customers and competitors. But,

the excessive production more than the demand for the product, either due to

competition or due to changes in customer preferences push the company to export

the excessive production to foreign countries. The domestic company continues the

exports to the foreign countries and views the foreign markets as an extension to the

domestic markets just like a new region. The executives at the head office of the

company make the decisions relating to exports and, the marketing personnel of the

domestic company monitor the export operations with the help of an export

department. The company exports the same product designed for domestic markets

to foreign countries under this approach. Thus, maintenance of domestic approach

towards international business is called ethnocentric approach.

Fig: Organization Structure of an Echnocentric Company

Managing Director

Manager - R&DManager -

Human Resources

Manager - Production

Manager - Finances

Manager - Marketing

Asst. Manager - North India

Asst. Manager - South India

Asst. Manager - Exports

6. Polycentric Approach

The domestic companies, which are exporting to foreign countries using the

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

altogether different approach. Then, the company establishes a foreign subsidiary

company and decentralists all the operations and delegate decision making and

policy-making authority to its executives. In fact, the company appoints executives

and personnel including a chief executive who reports directly to the Managing

Director of the company. Company appoints the key personnel from the home

country and the people of the host country fill all other vacancies.

Fig: Organization Structure of a Polycentric Company

7. Regiocentric Approach

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

neighboring countries of the host country. At this stage, the foreign subsidiary considers

the regions environment (for example, Asian environment like laws, culture, policies etc.)

for formulating policies and strategies. However, it markets more or less the same

product designed under polycentric approach in other countries of the region, but with

different market strategies.

Fig: Organization Structure of a Regiocentric Company

8. Geocentric approach

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

They select the employees from the entire globe and operate with a number of

subsidiaries. The headquarters coordinate the activities of the subsidiaries. Each

subsidiary functions like an independent and autonomous company in formulating

policies, strategies, product design, human resource policies, operations etc.

Fig: Organization Structure of a Geocentric Company

Q9. Discuss Swaps, Options, Futures

Swaps

f) A swap is a derivative in which two counterparties agree to exchange one stream of

cash flows against another stream. These streams are called the legs of the swap.

g) The cash flows are calculated over a notional principal amount, which is usually not

exchanged between counterparties. Consequently, swaps can be used to create

unfunded exposures to an underlying asset, since counterparties can earn the profit

or loss from movements in price without having to post the notional amount in cash

or collateral.

h) Swaps can be used to hedge certain risks such as interest rate risk, or to speculate on

changes in the underlying prices.

i) Most swaps are traded over-the-counter (OTC), "tailor-made" for the counterparties.

Some types of swaps are also exchanged on futures markets such as the Chicago

Mercantile Exchange Holdings Inc., the largest U.S. futures market, the Chicago Board

Options Exchange and Frankfurt-based Eurex AG.

j) The five generic types of swaps, in order of their quantitative importance, are:

interest rate swaps, currency swaps, credit swaps, commodity swaps and equity

swaps.

Futures

f) A futures contract is a standardized contract, traded on a futures exchange, to buy or

sell a standardized quantity of a specified commodity of standardized quality at a

certain date in the future, at a price determined by the instantaneous equilibrium

between the forces of supply and demand among competing buy and sell orders on

the exchange at the time of the purchase or sale of the contract.

g) The future date is called the delivery date or final settlement date. The official

price of the futures contract at the end of a day's trading session on the exchange is

called the settlement price for that day of business on the exchange.

h) A futures contract gives the holder the obligation to make or take delivery under the

terms of the contract,

i) Both parties of a "futures contract" must fulfill the contract on the settlement date.

The seller delivers the underlying asset to the buyer, or, if it is a cash-settled futures

contract, then cash is transferred from the futures trader who sustained a loss to the

one who made a profit. To exit the commitment prior to the settlement date, the

holder of a futures position has to offset his/her position by either selling a long

position or buying back (covering) a short position, effectively closing out the futures

position and its contract obligations.

j) Futures contracts, or simply futures, are exchange traded derivatives. The

exchange's clearinghouse acts as counterparty on all contracts, sets margin

requirements, and crucially also provides a mechanism for settlement.

Options

g) An option is a contract written by a seller that conveys to the buyer the right — but

not the obligation — to buy (in the case of a call option) or to sell (in the case of a put

option) a particular asset, such as a piece of property, or shares of stock or some

other underlying security, such as, among others, a futures contract. In return for

granting the option, the seller collects a payment (the premium) from the buyer.

h) For example, buying a call option provides the right to buy a specified quantity of a

security at a set strike price at some time on or before expiration, while buying a put

option provides the right to sell. Upon the option holder's choice to exercise the

option, the party who sold, or wrote, the option must fulfill the terms of the contract.

i) The theoretical value of an option can be evaluated according to several models.

These models, which are developed by quantitative analysts, attempt to predict how

the value of the option will change in response to changing conditions. Hence, the

risks associated with granting, owning, or trading options may be quantified and

managed with a greater degree of precision, perhaps, than with some other

investments.

j) Exchange-traded options form an important class of options which have standardized

contract features and trade on public exchanges, facilitating trading among

independent parties. Over-the-counter options are traded between private parties,

often well-capitalized institutions that have negotiated separate trading and clearing

arrangements with each other.

k) Another important class of options, particularly in the U.S., are employee stock

options, which are awarded by a company to their employees as a form of incentive

compensation

l) Other types of options exist in many financial contracts, for example real estate

options are often used to assemble large parcels of land, and prepayment options are

usually included in mortgage loans.