UNIT-II-International business

UNIT-IIINTERNATIONAL TRADE AND INVESTMENT

GATT-INTRODUCTION:The General Agreement on Tariffs and Trade (GATT) was originally created by the Bretton Woods Conference as part of a larger plan for economic recovery after World War II.

The GATT’s main purpose was to reduce barriers to international trade.

This was achieved through the reduction of tariff barriers, quantitative restrictions and subsidies on trade through a series of different agreements. The GATT was an agreement, not an organization.

Originally, the GATT was supposed to become a full international organization like the World Bank or IMF called the International Trade Organization.

However, the agreement was not ratified, so the GATT remained simply an agreement.

The functions of the GATT have been replaced by the World Trade Organization.

Purpose of GATT: raising standards of living ensuring full employment a large and steadily growing volume of real income

and effective demand developing the full use of the resources of the world expanding the production and exchange of goods.

The role of GATT in integrating developing countries into an open

multilateral trading system is also of major consequence.

The increasing participation of developing countries in the GATT

trading system and the pragmatic support provided to them through

the flexible application of certain rules helped developing countries to

both expand and diversify their trade.

It could now be said that a great number of these countries have

already become full partners in the system as can be witnessed by

their active participation in the Uruguay Round.

The task of helping to integrate further the least-developed countries

is one of the challenges that lies ahead in the WTO.

Similarly, the full integration of countries with economies in transition

into the trading system must be achieved in order to strengthen

economic interdependence as a basis for greater prosperity and world

peace.

WTO- World Trade Organization:The World Trade Organization (WTO) is an international organization that establishes rules for international trade through consensus among its member states.

It also resolves disputes between the members, which are all signatories to its set of trade agreements.

The WTO states that its aims are to increase international trade by promoting lower trade barriers and providing a platform for the negotiation of trade and to their business.

Role of WTO in Globalization:1.WTO plays an important role in the principle of trade without discrimination in the free market trade.

• Most-favoured-nation (MFN): treating other people equally. Under the WTO agreements, countries cannot normally discriminate between their trading partners.Grant someone a special favor (such as a lower customs duty rate for one of their products) and you have to do the same for all other WTO members.

2.National treatment: Treating foreigners and locals equally. Imported and locally-produced goods should be treated equally - at least after the foreign goods have entered the market.

3. Freer trade - gradually, through negotiation : Lowering trade barriers is one of the most obvious means of encouraging trade. The barriers concerned include customs duties (or tariffs) and measures such as import bans or quotas that restrict quantities selectively.

4.Predictability - through binding and transparency: With stability and predictability, investment is encouraged, jobs are created and consumers can fully enjoy the benefits of competition -choice and lower prices. The multilateral trading system is an attempt by governments to make the business environment stable and predictable.

5.Promoting fair competition: The WTO is sometimes described as a “free trade” institution, but that is not entirely accurate. The system does allow tariffs and, in limited circumstances, other forms of protection. More accurately, it is a system of rules dedicated to open, fair and undistorted competition.

6.Encouraging development and economic reform: The WTO system contributes to development. On the other hand, developing countries need flexibility in the time they take to implement the system’s agreements

Multilateral trade negotiations and Agreements:

The term multilateral trade negotiations initially applied to negotiations between GATT member nations conducted under the auspices of the GATT and aimed at reducing tariff and nontariff trade barriers. In 1995 the World Trade Organization replaced the GATT as the administrative body. A current round of multilateral trade negotiations was conducted in the Doha development agenda round.Prior to the ongoing the Doha development agenda round, eight GATT sessions took place:•1st Round: Geneva Tariff Conference, 1947•2nd Round: Annecy Tariff Conference, 1949•3rd Round: Torquay Tariff Conference, 1950-51•4th Round: Geneva Tariff Conference, 1955-56•5th Round: Dillon Round, 1960-61•6th Round: Kennedy Round, 1963-67•7th Round: Tokyo Round, 1973-79•8th Round: Urugay Round, 1986-94

VIII ROUND-URUGAY ROUND DISCUSSIONS:The Uruguay Round was the 8th round of Multilateral trade negotiations (MTN) conducted within the framework of the General Agreement on Tariffs and Trade (GATT), spanning from 1986-1994 and embracing 123 countries as “contracting parties”.

The Round transformed the GATT into the World Trade Organization. The Round came into effect in 1995 and has been implemented over the period to 2000 (2004 in the case of developing country contracting parties) under the administrative direction of the newly created World Trade Organization (WTO).

The main objectives of the Uruguay Round were:

to reduce agricultural subsidies

to put restrictions on foreign investment, and

to begin the process of opening trade in services like banking and insurance.

They also wanted to draft a code to deal with copyright violation and other forms of intellectual property rights.

Achievements:The GATT still exists as the WTO's umbrella treaty for trade in goods, updated as a result of the Uruguay Round negotiations (a distinction is made between GATT 1994, the updated parts of GATT, and GATT 1947, the original agreement which is still the heart of GATT 1994).

The GATT 1994 is not, however, the only legally binding agreement included in the Final Act; a long list of about 60 agreements, annexes, decisions and understandings was adopted. In fact, the agreements fall into a simple structure with six main parts:

an umbrella agreement (the Agreement Establishing the WTO);

agreements for each of the three broad areas of trade that the WTO covers: goods and investment (the Multilateral Agreements on Trade in Goods including the GATT 1994 and the Trade Related Investment Measures (TRIMS)), General Agreement on Trade in Services (GATS), and Agreement on Trade-Related Aspects of Intellectual Property Rights (TRIPS);

dispute settlement (DSU);

Agreement on Customs Valuation and

reviews of governments' trade policies (TPRM)

IX ROUND- DOHA DEVELOPMENT ROUND:The Doha Development Round or Doha Development Agenda (DDA) is the current trade-negotiation round of the World Trade Organization (WTO) which commenced in November 2001. Its objective is to lower trade barriers around the world, which will help facilitate the increase of global trade.Implementation issues:Developing countries claim that they have had problems with the implementation of the agreements reached in the earlier Uruguay Round because of limited capacity or lack of technical assistance. They also claim that they have not realized certain benefits that they expected from the Round, such as increased access for their textiles and apparel in developed-country markets. They seek a clarification of language relating to their interests in existing agreements.

Before the Doha ministerial, WTO members resolved a small number of these implementation issues. At the Doha meeting, the Ministerial Declaration directed a two-path approach for the large number of remaining issues:

(a) where a specific negotiating mandate is provided, the relevant implementation issues will be addressed under that mandate; and

(b) the other outstanding implementation issues will be addressed as a matter of priority by the relevant WTO bodies.

Outstanding implementation issues are found in the area of market access, investment measures, safeguards, rules of origin, and subsidies and countervailing measures, among others bodies.

Benefits: All countries participating in the negotiations believe that

there is some economic benefit in adopting the agreement; however, there is considerable disagreement of how much benefit the agreement would actually produce.

An ambitious outcome to the Doha round is essential for maximizing the contribution of trade to poverty reduction and lifting as many people as possible out of poverty

It has been estimated that halving protection in agriculture, industrial goods and services could boost developing country incomes by around $150 billion a year - three times the value of all aid budgets put together

Analysis shows that the majority of the benefits from liberalization flow to the country doing the liberalizing, notably through lower prices for consumers and increased competition which generates more innovative companies.

Maintaining the Common Agricultural Policy (CAP) in its current form costs a family of four around €1000 a year, through higher food costs and taxes.

Despite the difficulties the Round has faced over the last 11 years we remain committed to achieving a fairer and freer trade system that increases global growth and poverty reduction and benefiting developed and developing countries alike. This is founded on two key principles: a commitment to multilateralism; and making trade a lever for achieving our development goals.

The major challenges of competing in a global marketplace are:Language barriers

Cultural diversity

Complex business models

Monetary policy + exchange rates

Geo-political environments

Lack of brand identity

Cross border shipment of goods and services

Rules and conventions governing foreign trade

Naivety, poor preparation and planning

TRADE THEORIES:Trade is nothing but Voluntary exchange of goods and services between one person/organization & another with intension of gain from such trade.

NEED FOR TRADE THEORIES: To decide what should be imported and what should be exported i.e. EXIM policies of an Economy.Government use these theories in designing different policies.Managers use them to identify promising markets.Various theories:1.MERCANTAILISM 2. ABSOLUTE ADVANTAGE THEORY3. COMPARATIVE ADVANTAGE THEORY4. FACTOR PROPORTION THEORY5. PRODUCT LIFE CYCLE THEORY6. PORTER’S THEORY OF NATIONAL COMPETITIVE ADVANTAGE

MERCANTALISIM:It is the first formal theory of trade.According to Mercantilist Version, “A country’s wealth is measured by its holding of gold and silver, and the Country’s Goal should be to enlarge these holdings.” The Mercantilist advocates Government intervention to achieve surplus balance trade i.e. exports should be increased and imports should be reduced.Imports can be reduced by imposing tariffs and quotas.Exports can be increased by providing subsidies.

FLAWS OF MERCANTAILISM:According to Davis Hume, in the Long run, no country could sustain a surplus on the balance of trade.Government imports restrictions are paid by consumers in the form of higher taxes.Government Subsidies of exports of certain industries are paid by taxes payers in form of higher taxes.ABSOLUTE ADVANTAGE THEORYThis theory is proposed by Adam Smith. Adam Smith says that trade is a Zero Sum game.He advocates free trade to encourage a country’s wealth.the basic argument by Adam smith was Countries differ in their ability to produce goods efficiently.

This Theory answered a Question that, “ What goods and services should be exported and imported?”

According to this Theory,” A country has an absolute advantage in the production of a product when it is more efficient than any other country in producing it.”

Therefore Smith says that, ”A country should never produce that product at home which it can buy from some other country at comparatively low cost.”

Smith says that, “Global efficiency increases through free trade.”

COMPARATIVE ADVANTAGE THEORY:

This theory is given David Ricardo. The concept of opportunity cost is introduced in this theory.

This theory explains that what happens when one country has an absolute advantage in the production of all goods?

David Ricardo showed that such a country may still derive benefits from International Trade.

A country which have absolute advantage in production of all goods can specialize in the production of those goods that the country produces most efficiently & buy those goods that it produces less efficiently from other countries.

FACTOR PROPORTION THEORYThis theory is given by Eli Heckscher and Bertil Ohlin. So this theory is also known as HO Theory (Heckscher – Ohlin.This theory is also known as Factor Endowment Theory.This theory tells that, “What determine the product for which the country will have comparative advantage?”According to Heckscher and Ohlin, “Factor Endowment (types of resources) varies from country to country.Goods differ according to the types of factors that are used to produce them.Difference in factor endowment leads to difference in factor costs. According to HO Theory, “A country will have a comparative advantage in producing products that intensively use resources (factors of production) it has in abundance.

Example: Saudi Arabia-abundance of crude oil reservesIndia - abundance of unskilled labourUS – abundance of capitalChina – abundance of labourAustralia & Canada – abundance of land

PRODUCT LIFE CYCLE THEORY:This theory was developed in 1960s by Raymond Vernon of the Harvard Business School.According to him, Location of the production shifts as products move through their life cycle. There are 4 stages in Product Life cycle:-

Introductory Stage Maturing Stage Standardized product Stage Declining Stage

Introductory Stage:o Also known as Innovation stage.o In this stage, A firm develops & introduces an innovative

product.o Early production generally occurs in the domestic

market.o Better to keep production facilities close to the markets

& to the center of decision making.o Companies may sell a small part of their production in

foreign markets – Exports

MATURING STAGE:-o In this stage, Demand of product expands domestically

& abroad.

o Domestic production reaches its peak

o Foreign competitors expands productive capacity.

o Set up production unit in host country to minimize distribution cost – Internationalization of Production.

STANDARDIZED PRODUCT STAGE:- o In this stage, Product become more standardized & prices becomes the

main competitive weapon.

o Production techniques are no longer exclusive & innovative.

o Stiff competition from home as well as other developed countries.

o Domestic production slumps.

PORTER’S DIAMOND THEORY:Porter claims that four kinds of variables will impact a local firm’s ability to use a country’s resources to gain a competitive advantage.

o Demand conditionso Factor conditionso Related and supporting industrieso Firm strategy, structure, rivalry

Demand Conditions:

Nature of domestic demand.

If customers are demanding, firms will produce high-quality and innovative products gaining competitive advantage

Factor Condition:

o Level and consumption of factors of production

o Lack of natural endowments has caused nations to invest in the creation of advanced factors

Related and supporting industries

Suppliers and industry support services tend to form a cluster in a given location

Firm Strategy, Structure, Rivalry

Extent of domestic competition,

The existence of barriers to entry

The firm’s management style and organization.

Factor endowments: nation’s position in factors of production such as skilled labor or infrastructure necessary to compete in a given industry.

Demand conditions: the nature of home demand for the industry’s product or service.

Related and supporting industries: the presence or absence in a nation of supplier industries or related industries that are nationally competitive.

Firm strategy, structure and rivalry: the conditions in the nation governing how companies are created, organized, and managed and the nature of domestic rivalry.

Introduction to Investment Theories:A number of attempts have been made to formulate a theory to explain the international investment. A brief outline of the important attempts in this direction is given below:

Theory of Capital Movements:

The earliest theoreticians, who assumed, in the classical tradition, the existence of a perfectly competitive market, considered foreign investments as a form of factor movement to take advantage of the differential profit.

The validity of this theory is clear from the observation of the noted economist Charles Kindle Berger that under perfect competition, foreign direct investment would not occur and that would be unlikely to occur in a world wherein the conditions were even approximately competitive.

Market Imperfections Theory:

One of the important market imperfections approach to the explanation of the foreign investment in the Monopolistic Advantage Theory propounded by Stephen in 1960.

According to this theory, foreign direct investment occurred largely in oligopolistic industries rather than in industries operating under near perfect competition.

Hymer suggested that the decision of a firm to invest in foreignmarkets was based on certain advantages the firm possessed over the local firms (in the foreign country) such as economies of scale, superior technology or skills in the fields of management, production, marketingand finance.

Internalization Theory:

According to the internationalization theory, which is an extension of the market imperfections theory, foreign investment results from the decision of a firm to internalize a superior knowledge(i.e., keeping the knowledge within the firm to maintain the competitive edge)?

For example, if a firm decides to externalize its know-how by licensing a foreign firm, the firm (the licensor) does not make any foreign investment in this respect but on the other hand, if the firm decides to internalize, it may invest abroad in production facilities.

Methods of internalization include formal ways like patents and copy rights and informal ways like secrecy and family networks.

Appropriability Theory:•A firm should be able to appropriate (to keep for its exclusive use) the benefits resulting from a technology it has generated.•If this condition is not satisfies, the firm would not be able to bear the cost of technology generation and, therefore, would have no incentive for research and development. •MNCs tend to specialize in developing new technologies which are transmitted efficiently through their internal channels.Location Specific Advantage Theory:• The location specific advantage theory suggests that foreign investment is pulled by certain location specific advantages.•According to Hood and Young, there are four factors which are pertinent to the Location Specific Theory.• They are: 1.Labour costs 2.Marketing factors (like market size, market growth, stages of development and local competition) 3.Trade barriers 4.Government policy

Eclectic Theory:John Dunning has attempted to formulate a general theory of international production by combining the postulates of some of the other theories. According to Dunning, foreign investment by MNCs results from three competitive advantages which they enjoy, viz.,1.Firm specific advantages2.Internalization advantages3.Location specific advantages

Firm specific advantages result from the tangible and intangible resources held exclusively, at least temporarily, by the firm and which provide the firm a comparative advantage over other firms.

NEED FOR GLOBAL COMPETITIVENESS:

The need for global competitiveness is much important for any industry to sustain in this competitive world and this helps the company to retain its old customers as well to obtain new customers, maintaining the profit level and also to be a leader in the market.

Aspiring to be a market leader or to be globally competitive helps a company to grow.It also helps the company in introducing new products to the world.

Eg: Apple came up with the iPad and they were first to target the people with the new product and thus were able to get advantage.

Similarly Google acquired Motorola mobility holdings to become strong in the cell phone segement too.

When firm competes with each other it does not benefit them alone but a wide range of customers too.

Regional Trade Blocs:

Regional trade blocs are intergovernmental associations that manage and promote trade activities for specific regions of the world.

Major Trade Blocs:

•EU (European Union )

•NAFTA (North American Free Trade Agreement)

•MERCOSUR (Mercado Comun del Cono Sur, also known as Southern Common Markets (SCCM)

•ASEAN (Association of Southeast Asian Nations)

•SAARC (south Asian association for regional cooperation)

EUROPEAN UNION:

Objectives:-

• Setting up a common market

• Continuous & balanced expansion

• Closer relations between the member states

ACTIVITIES OF EU:

• Elimination of custom duties, quantitative restrictions with regard to export & imports.

• Establishment of a common custom tariff & commercial policy.

• Abolition of all obstacles for movement of persons, services & capital.

• Application of programs in order to coordinate the economic policies.

ASEAN:Established in 1992 Total six members- Singapore, Brunei, Malaysia, Philippines, Thailand & Indonesia.To establish a common effective preferential tariffs (CEPT) plan.The CEPT allows for tariffs cut ranging from 0.50% to 20.00% beginning with 15 products.In 1994, ASEAN countries formed AFTA in order to develop inter ASEAN trade.

Objectives of AFTA:To encourage inflow of foreign investment into this region.To establish free trade area in the member countries.To reduce tariff of the products produced in ASEAN countries (40% value addition in the ASEAN countries to the product value is treated as manufactured in ASEAN countries).

Advantages of Trading Blocs:

The main advantages for members of trading blocs are as follows:

1) Free trade within the bloc: Knowing that they have

free access to each other’s markets, members are encouraged

to specialize. This means that at the regional level there is a

wider application of the principle of comparative advantage.

2) Market access and trade creation: Easier access

to each other's markets means that trade between members

is likely to increase. Trade creation exists when free trade

enables high cost domestic producers to be replaced by low

cost, more efficient imports. Because low cost imports lead to

lower priced imports, there is a 'consumption effect', with

increased demand resulting from lower prices.

3) Economies of scale:   Producers can benefit from the

application of scale economies, which will lead to lower costs

and lower prices for consumers.

4)   Jobs:   Jobs may be created as a consequence of

increased trade between member economies.

5)   Protection:   Firms inside the bloc are protected from

cheaper imports from outside, such as the protection of the

EU shoe industry from cheap imports from China and Vietnam.

Disadvantages of Trading Blocs:

The main disadvantages for members of trading blocs are as follows:

1)Loss of benefits: The benefits of free trade between countries in different blocs are lost.

2)Distortion of trade: Trading blocs are likely to distort world trade and reduce the beneficial effects of specialization and the exploitation of comparative advantage.

3) Inefficiencies and trade diversion: Inefficient producers within the bloc can be protected from more efficient ones outside the bloc.