MS-97

International Business
Indira Gandhi
National Open University
School of Management Studies

Block

1
INTRODUCTION TO INTERNATIONAL BUSINESS
UNIT 1
Dynamics of International Business 5
UNIT 2
International Trade Theories and its Business Implications 21
UNIT 3
Process of Globalization 38
COURSE DESIGN AND PREPARATION TEAM
Prof. M. L. Bhatia Prof. N. V. Narasimham
(Course Editor) SOMS, IGNOU
Vasantkunj New Delhi
New Delhi
Prof. Srilatha
Dr. S. R. Mahnot Director
Centre for Industrial and Economic SOMS, IGNOU
Research, New Delhi New Delhi
Dr. Pinaki Dasgupta Prof. G. Subbayamma
Indian Institute of Foreign Trade (Course Coordinator)
New Delhi SOMS, IGNOU
New Delhi
Dr. Rajiv Ranjan Thakur
Jaipuria Institute of Management Dr. Neeti Agarwal
Noida SOMS, IGNOU
New Delhi
Prof. Prafulla Agnihotri
IIM, Tiruchirappalli Dr. Leena Singh
Tamil Nadu SOMS, IGNOU
New Delhi
Prof. Justin Paul
University of Puerto Rico
USA

Print Production
Mr. K.G. Sasi Kumar
Assistant Registrar (Publication)
SOMS, IGNOU, New Delhi

November, 2015
 Indira Gandhi National Open University, 2015
ISBN-978-93-85911-22-4
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BLOCK 1 INTRODUCTION TO
INTERNATIONAL BUSINESS
A thorough understanding of international business is essential in order to understand
the process of globalization. This block is concerned with the basic concepts of
international business and its relevance to the global economy. This block has three
units.

Unit 1: Dynamics of International Business gives an account of international business,

which is of recent origin, but it also includes international trade, which is an old concept.
International business activities have become diverse and complex due to the integration
of world economy now called global economy. The evolution is from a domestic
organization, to homogeneous home market, to becoming active exporter and finally
international corporation. This unit discusses the reasons in support of globalization or
internationalization. It tires to draw the difference between national and international
business. It highlights the advantages and importance of internationalization. It also
points the disadvantages but since the advantages are more, therefore this unit supports
the cause of internationalization.
Unit 2 is concerned with International Trade Theories and its Business Implications.
This unit focuses on economic interdependence of nations, which includes flow of
goods, services and payments between a nation and the rest of the world and develops
an understanding for current international economic problems. It deals with trade
theories, trade policies, the determination of balance of payments accounts of the nation,
functioning of foreign exchange market, floating foreign exchange rate and risk and
uncertainty attached with foreign exchange market such that gains outweigh the risk in
the larger interest of international trade. It discusses the International Monetary System
(IMS), which includes rules, customs, instruments and organizations for affecting
international payments.

Unit 3: Process of globalization presents different definitions of globalization and

global firm by various experts. It discusses the underlying assumptions regarding Global
Standardization Philosophy and the related pitfalls associated with these assumptions.
The unit examines the various drivers which determine the potential for globalization
of an industry namely market, cost/economic, government and competitive drivers along
with the factors which affect implementation of global strategy.
Introduction to
International Business

4
 Dynamics of International
UNIT 1 DYNAMICS OF INTERNATIONAL Business

BUSINESS

Objectives

After reading this unit you should be able to understand and appreciate:
§ the origin of international trade;
§ the concept and dynamism of international business;
§ the reasons behind firms going international; and
§ the benefits and importance of international business.

Structure

1.1 Introduction
1.2 Domestic vs International Business
1.3 Importance of International Business
1.4 Benefits of International Business
1.5 Challenges in International Business
1.6 Why do Firms go International?
1.7 Summary
1.8 Key Words
1.9 Self-Assessment Questions
1.10 Further Readings

1.1 INTRODUCTION
International business as a discipline is of a recent origin. It is hard to imagine a world
without international business. Virtually every nation, howsoever small it may be, has
firms involved in various types of international business activities. It is through these
activities that nations enjoy the benefits of international business by trading in a variety
of goods and services produced around the world and made available locally.
International business, conventionally called as international trade, has been known to
exist ever since man learned to live in an organized manner. India, for instance, is well
known for spices. Egyptians had a significant foreign trade. The fundamental basis of
international trade lies in the fact that countries are endowed by nature with different
resources. These differences arise from geographical, physical or climatic features.
Some countries have a monopoly of certain crops, for example, Bengal (India) and
have high jute production, and Punjab (Pakistan) produces best quality of basmati rice.
International business is thus inevitable when there are marked differences in the
countries regarding material, natural vegetation, climate, soils and other physical and
geographical conditions. It is also affected by several other factors besides natural and
geographical factors, such as stage of economic development, accumulation of capital
by a nation and its foreign investments, technological progress, trade and financial
regulations, political affiliations, education and special skills of the population (for
example, software skills of India), and so on.

5
Introduction to Though international business, as a discipline, as stated earlier, is of a recent origin,
International Business
international trade is claimed to be as old as the history of mankind itself (Monye,
1993). Even at the most tribal level, communities found it in their interest to trade,
albeit in a very primitive manner and involving the exchange of simple objects mostly
for immediate consumption (Harrison, Dalkiran, and Elsey, 2000, 3-4). Historically
trade was in the form of barter and was undertaken both for social as well as economic
reasons.

Even though modern trade is conducted in far more advanced forms and for more
complex reasons than ever before, the basic human need for trade remains the same.
However, unlike ancient times during which trade was devised and undertaken by
communities for the benefit of communities themselves, over 90 per cent of modern
trade is undertaken by private firms in pursuit of their own aims and objectives (Harrison
et al., 2000, 4).

The growth of modern trade coincided, to a large extent, with the emergence of the
modern nation state and with the consequent formation of national borders. The clear
recognition and appreciation of the mutual benefits of free trade (trade without barriers
and based on the principle of comparative advantage) provided sufficient incentives
for nation states to seek greater opportunities in each others’ domestic markets and thus
to increase the volume of trade among themselves. Such mutual benefits have been
largely responsible for the growth of alliances and regional integration around the world,
as evidenced by the establishment of a considerable number of trading areas, such as
the European Union (EU) and North American Free Trade Agreement (NAFTA). Over
the years, nations have been promoting trade and international business activities by
attempting to create suitable business and investment environments within their borders,
not only out of political and strategic necessity but also out of a desire to attract business
and foreign investment, often in competition with other nations. For example, the recent
spate of liberalization, deregulation, and privatization programmes by governments
around the world, in particular by those of the former Soviet republics and Eastern
Europe, has given special impetus to the growth of foreign direct investment (FDI).

Many countries around the world have witnessed substantial growth in the economy in
the past two decades. There has been faster growth in the international transactions
especially in the form of FDIs (prathi, 2011). Not only has the total stock of capital
grown rapidly, but more significantly, there has been growth in the number of subsidiaries
of Multi National Companies (MNCs). There has also been growth in the number of
countries in which specific firms were active.

As both, international trade and investment grew rapidly, international competition

became more intense, and many national industries became global industries. Similarity
of markets in different countries and intense global competition drove international
competitors to coordinate their marketing and competitive strategies between countries
more actively. The relevant scope of strategy thus shifted from discrete national markets
to global markets. The coordination of worldwide competitive actions among the various
subsidiaries of MNCs became more important.

The removal of trade barriers, especially in the last decade of the previous millennium
and the growing similarity of the national markets created the potential for globalization
of markets and competition. The development of global networks brought about by
MNCs and alliances between independent firms on the one hand and the technology of
cheap, effective transportation and global communication networks on the other hand
provided the practical means necessary for the integration of supply. These conditions
were necessary, though not sufficient. Intense competition in most industries was the
driving force necessary for integration and globalization.
6
Globalization is a process by which a business looks at the world market as one single Dynamics of International
Business
market without the barriers of social, cultural, economic, political or commercial factors
which separate different country markets. For example, India and USA can be different
in terms of economic factors such as the per capita income and purchasing power of the
consumers, the stage of economic development etc. Since these barriers are less effective
in a global scenario, it leads to the increased movement of goods and services across
boundaries, namely, trade and investment, often of people through migration. We shall
learn more about globalization in Unit 3 of Block.

1.2 DOMESTIC VS INTERNATIONAL BUSINESS

The basic principles of business concerning tasks, functions, and processes that apply
to international business are the same as that of domestic business. However, the
environment in which domestic and international firms operate varies considerably
and therefore requires an international firm to modify and adapt its business practices
country by country. Unlike a domestic business manager, an international manager
faces greater difficulties, greater uncertainties, and more importantly, much greater
risks. The tasks of an international business executive are clearly much more challenging.

These difficulties, uncertainties, and risks originate from differences in the political,
economic, legal and cultural environment, and from differences in foreign exchange
markets and exchange rate systems. In most cases, these problems manifest themselves
as constraints which render the process of decision-making and its implementation in
international business more difficult (and in some cases, more hazardous) than in
domestic business. More importantly, culturally insensitive decisions often result in
conflicts which are more difficult (and costly) to resolve without seriously affecting the
performance of the firm, its future operations, and the effectiveness of its management.
The dynamic nature of constant changes in business, economic, political, and legal
environments in the host country adds still more difficulties with which the international
business executive must deal on an almost daily basis.

The differentiation between domestic and international business can broadly be done
on the following parameters:

Culture
Each country in which the firm operates is culturally different. To be successful,
the firm must operate in a culturally sensitive manner and within the constraints
of the culturally determined manners, customs, values, and norms of the host
country. An international business manager must respect and empathize with cultural
differences in all aspects of business and social life, seek to conform and cooperate
rather than confront or behave as if operating in his/her own culture. Nike, the global
sports shoe manufacturer, realized this fact in a hard way when it produced and marketed
Nike Air brand of shoes for the first time. It wrote “Air” in cursive fonts and in an
artistic way but it created a great problem in Saudi Arabia because it looked like the
word ‘Allah’ in Persian. Similarly, marketing campaigns, especially the advertising
may have to be adapted according to the local culture. Many years ago, campaign for
‘Tuff’ shoes which had shown male and female models wearing only shoes and no
clothes had come under scanner. It was considered as obscene and was subsequently
banned in India. However a similar campaign in some other country like France may
not have evoked public outcry and might have been considered normal like any other
campaign.

7
Introduction to Fiscal and Government Policies
International Business
Conducting business across national borders involves the use of different currencies
and observing different government rules and regulations limiting the firm’s freedom
of action; for example, restrictions on the amount of profit to be transferred. Different
governments practice different exchange rate policies and systems, ranging from daily
decrees about the value of the local currency in terms of the world’s major currencies to
fixed and floating exchange rate systems. These practices add greater risk and uncertainty
to the already highly risky and uncertain nature of international financial transactions.
To be successful, the firm must develop an appropriate strategy to deal with these
differences and the associated problems.

Legal Environment
The legal environment differs from country to country, requiring firms to show
particular sensitivity to laws, rules, and regulations which may affect operations
and performance. Disregarding or disobeying the laws of the host country can be
very damaging to the finances and the image of the firm. Laws pertaining to joint
ownership of assets, for example, are often very complicated, bureaucratic, frustrating,
and time-consuming. Legal difficulties are often the source of serious disputes between
the host government and the firm, requiring protracted negotiations which may end in
failure to invest or to continue the existing business.

Consumer Tastes and Preferences

Differences in consumer tastes and preferences and demand patterns arising
from cultural differences require the firm to adopt appropriate production, procurement,
and marketing strategies to minimize costs and maintain the firm’s value. McDonald’s
for example, does not offer beef and pork items in India and sells only vegetarian food
dishes in predominantly vegetarian state of Gujarat. Even in the case of standard global
products, certain modifications may be necessary to render the product more acceptable
to the consumer in the host culture. For example, the name of the product in the host
country’s language may be offensive or the packaging may be inappropriate.

Availability of Factors of Production

Different countries possess different factor endowments with different qualities,
requiring the firm to formulate and implement suitable product development and
logistics strategies consistent with the availability and quality of resources in the
host country. Certain skills or supplies may be either unavailable or available in
limited quantities and qualities. If unavailable, the firm must either import them
or develop local sources of supply. Following its entry into the Soviet market in
1990, McDonald’s, one of the first Western fast food firms, experienced serious
difficulties in obtaining high-quality local food supplies consistent with its food
technology. To meet its high standards in quality, delivery, and production
methods, McDonald’s had to transfer agricultural technology, equipment, and consultants
from other countries with superior technology to work with Soviet farmers. One
astonishing outcome was an increase of 100 per cent in potato output alone. It even set
up its own dairy farms, cattle farms, food-processing plants, and distribution system.

Thus, international business should not be seen just as an extension of domestic business.
It is quite different from the domestic business. The factors which lead to these
differences are summarized in Table 1.1.

8
 Table 1.1: Differences between International Business and Domestic Business Dynamics of International
Business
International Business Domestic Business
i) Many nations, many cultures i) One nation, one culture.
ii) Patriotism hinders trade. ii) Patriotism helps trade.
iii) Markets are diverse and iii) Market is much more
fragmented. homogeneous.
iv) Multiple currencies, differing in iv) Single currency
stability and exchange value.
v) Varied economic (monetary and v) Uniform economic (monetary
fiscal) climate. and fiscal) climate.
vi) Political factors may play major vi) Political factors are of minor
role. importance.
vii) Government influences business vii) Minimum Government
decisions. interference in business
decisions.
viii) Transport cost influences
viii) Transport cost forms/influences
marketing decisions to a great
only to a small extent.
extent.
ix) Considerable risks, both financial ix) Minimum payment and credit
and non-financial, necessitate risk.
credit and general insurance.

1.3 IMPORTANCE OF INTERNATIONAL

BUSINESS
In recent years, international business has acquired additional importance for host
countries in particular and world economies in general as a result of developments in
the following areas:

Technology Diffusion
Technological developments are transmitted to every corner of the earth through the
practice of international business. This transmission is not only in the form of products
and services used every day, but also in the form of modern management, production,
marketing, and logistics systems employed by domestic as well as international firms.
And thanks to the dramatic developments in communication and information technology,
the benefits of such transmissions are shared worldwide.

Stimulation to Competition
Except in the case of entry through acquisition, the arrival of an international firm in
the host country, either in partnership with a local firm or on its own, may stimulate
domestic competition and lead to increased entrepreneurial challenges, especially in
the developing countries. International firms with superior worldwide experience,
knowledge, technology, and other relevant resources have the ability to offer goods and
services often at lower prices and higher quality.

Higher Standard of Living

Availability of a wide range of goods of international quality at competitive prices has
brought many so called “luxury” products within the reach of common man, especially
9
Introduction to in developing countries. Thanks to international business, the standard of living in
International Business
many developing countries has increased significantly.

Impetus for Standardization

Standardization refers to the adoption of norms and practices generally acceptable in
world markets. In some cases, one standard product may be sold throughout the world
using similar selling techniques. Common standards enable easier and more effective
comparisons to be made by consumers and other interested parties, e.g., health and
safety authorities. The product standardization has become an easier option due to
diminishing differences in consumer tastes, preferences, and interests. This is due to
advances in technology, telecommunication, transport, and advertising.

Adapting to International Environment

A business firm operates within its internal and external environment. The internal
environment is one over which the firm has considerable control: the firm determines
its own internal environmental factors by specifying its corporate mission, organizational
structure, recruitment policy, and its relationship with suppliers, etc. The external
environment is one over which the firm has little or no control. Whatever little control
the firm may have is usually the consequence of its market power or collective action
by a representative body, such as the Confederation of British Industries (CBI) in Britain
or the Confederation of Indian Industries (CII) in India. The firm must, therefore, conform
to its external environmental factors, whether they be national, international, or global,
or suffer the consequences of its failure to do so. For example, changes in health and
safety regulations, trade policies, and the legal environment are unavoidable. Nike, one
of the world’s biggest manufacturers of sports and leisure wear, was forced into cancelling
its licensing agreement with one of its Asian licensees suspected of employing child
labour (Harrison, et al., 2000 p.9).

With the increasing internationalization of business activities, the methods of dealing

with internal and external environmental factors tend to become more standardized.
The main reason for this development is that domestic firms aspiring to expand
internationally often emulate existing international firms in adapting to environmental
changes. In other words, international business acts as an instrument for domestic firms
to adopt more effective business policies and techniques as a preparation for going
international. For example, many US and European firms have adopted Japanese
management techniques, such as quality circles, the just-in-time system (JIT), and total
quality management (TQM) in order to remain competitive in their own domestic markets
in general and in international market in particular.

Encouragement to Global Business and Economic Reforms

Governments play an important role in the development and promotion of international
business activities. They provide a great variety of financial and non-financial incentives
to attract FDI into their countries, often in competition with their neighbours. The
increasing scale of liberalization of trade and investment, deregulation of domestic
industries, and privatization of state-owned enterprises have the attraction of foreign
business as one of its primary objectives. These measures have created immense
international business opportunities. The major impact of international business in this
context has been the encouragement to governments to open up their borders to
international trade and investment, standardize their systems and procedures, adopt
internationally acceptable values and attitudes, particularly with respect to human rights
and child labour, and encourage the development of democratic institutions.

10
Economic Cooperation and Integration Dynamics of International
Business
One of the most fundamental impacts of the process of internationalization since the
end of World War II has been the progressive ending of the isolation of national
economies. Gradually more and more barriers to international trade and investment are
being replaced with measures designed to enhance cooperation and coordination among
nation states. The need to cooperate and coordinate over wider geographical areas has
led to the formation of regional groupings in the form of free trade areas resulting in
rapid increase in the growth of international business activities.

Activity 1
Pick up one multinational firm from the US and one from Japan and study with respect
to the following:

a) Their organization structures;

b) The way they plan their activities; and
c) The way they make their marketing decisions like new product introductions,
branding and advertising, pricing, etc.

Note down the differences you find in the working of the multinationals from the two
countries.
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1.4 BENEFITS OF INTERNATIONAL BUSINESS

Foreign trade gives rise to several advantages, some of which are as follows:
Mutual Exchange: As seen earlier, the countries in foreign trade stand to gain by
exchange of goods and services.

Higher Standard of Living: Because of mutual exchange of products, the citizens of

trading countries can enjoy the goods and services which are not available or cannot be
produced in their own country. For example, in the absence of international trade, the
people staying in Arabian Gulf would have lived a miserable life for want of many
essential items like foodstuff, clothing, etc. But thanks to the international trade, they
can sell oil and in return buy whatever they need. This has helped them to improve their
standard of living.

Stabilization of Prices: Prices, it is said, are a function of demand and supply. Naturally,
during the time of natural calamities like flood, famine, etc. the supply of food grain
will be affected. Thus, when a country cannot grow sufficient amount of food-grain
required for its domestic consumption, they have to be imported to maintain adequate
supply and prices. The same principle holds good when there is a surplus of production.
The excess production may be exported to maintain prices in the domestic market.

Specialization: As seen earlier, a country tends to export such product in which it has
comparative or absolute advantage, for example, India in Rice or Gulf countries in oil.
When a country keeps on exporting the same product over a number of years, it leads to
specialization. 11
Introduction to Increased Productivity: Because of the geographical specialization and expertise
International Business
attained, the country can produce more goods and better quality of goods and services
which, in turn, leads to higher productivity. The excess capacity, if any, of industrial
products can be utilized fully. This will lead to economies of large scale production.
The shining example is of Japanese car manufacturers.

Wider Markets: Many firms are attracted towards the international market for the
growing opportunities for their products in other countries. This may be because of the
saturation in the domestic market or because the foreign market may be more profitable.

Economic Development: Due to foreign trade developing countries like India can
earn valuable foreign exchange through exports. The income of the government in the
form of customs duty can also increase. Countries like Japan, UK and USA have achieved
economic growth through imports of raw materials and export of manufactured goods.

Promotion of International Peace: When countries trade with each other and depend
upon each other for their requirements, the tension amongst them gets reduced and a
bond of friendship may develop. This helps in developing the cultural and social relations
along with the business relations.

Activity 2
Refer the latest Economic Survey and highlight the salient points in relation to promotion
of export trade and India’s international business.
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1.5 CHALLENGES IN INTERNATIONAL

BUSINESS
As seen earlier, international trade differs from domestic trade in a number of aspects.
As compared to domestic trade, foreign trade faces some peculiar/unique difficulties
which are as follows:

1) Distance and High Cost of Transport: International trade is normally carried

over a long distance between the place of manufacture (or origin) and place of
consumption, the transport cost may be huge and hence distance plays a major role
in decision-making.

2) Time Lag: Due to the above factor, it takes much more time to execute an order. It
may take several months to realize the money after the receipt of an order and
dispatch of goods. Further, longer the time lag more is the risk of the cargo being
damaged in transit, especially if it is perishable.

3) Language, Customs and Laws: Every country has different social, cultural and
legal practices. These differences can create a hindrance in the smooth flow of
international trade. Further the difference in languages can also act as a barrier, for
example, while trading with Arabian countries the knowledge of Arabic would be
great advantage. Many a times these differences in language lead to misunderstanding.

12
4) Currency and Measurement: Every country has its own currency which is subject Dynamics of International
Business
to fluctuations in exchange rates. This fluctuation must be properly understood in
terms of the currency in the domestic market. Further the system of weights and
measurements followed in foreign market may be quite different than the one in
the domestic market. For instance, the system followed in India is Metric System,
but USA does not follow the same. One must understand how to convert one into
the other.

5) Government Control, Regulation and Taxes: Every Government sets its own
rules and regulations for import of goods and services. These rules may differ from
commodity to commodity and from country to country. Depending upon the country
of origin, there may be different set of rules. For example, when EU (European
Union) countries trade with each other, they charge negligible or no import duty.
But when these countries trade with outsiders, they charge heavy duties.

6) Risk and Uncertainty: Because of all these difficulties mentioned above, export-
import trade is full of risk and uncertainty and hence needs specialized knowledge.

1.6 WHY DO FIRMS GO INTERNATIONAL?

There are various methods of entering foreign markets, from the simplest and least
costly (indirect importing and exporting) to one which is complex and risky and requires
a great deal of commitment involving foreign direct investment (FDI). The various
strategies for entry into foreign markets are explained in Unit 10 of Block 3. The basic
question, however, still remains: why do firms want to internationalize their operations?
What do they hope to achieve by going international? This section offers some answers
by considering the key elements of the internationalization process which describe the
sequence in which a firm evolves from a domestic organization, serving a relatively
homogeneous home market, to becoming an active exporter, and then an international
corporation serving a large number of diverse multinational and cultural markets.

A firm seeking to enter into foreign markets may do so through one or more of the
following mechanisms/arrangements.

Exporting
At its most risk-averse phase, a firm decides to enter foreign markets through licensing
arrangement with a local party. The firm is willing to accept the risks of servicing
foreign markets through exports. This means exposing oneself to the risks of transit,
non-payment, currency fluctuations, among others. The firm discovers that to consolidate
and expand the gains of export business, it must invest on the creation of a marketing
set up in the foreign market (s).

Licensing
When a Company is unwilling to take any risks for the sake of international business, it
sometimes opts for licensing as the mode of entry. Licensing is, simply put, nothing but
entering into a contract to allow another firm to use an intellectual property, such as,
patent or a trade mark. This definition clearly brings out the fact that as an entry mode,
this option is not available to all firms. Only those which have saleable technology,
know-how, can use the licensing route.

The attraction of licensing lies in the fact that it involves no investment and very little
up-front expenditures. And if successful, it can generate a fairly high rate of return.

13
Introduction to Under a licensing agreement, the holder of the knowledge (technology or know-how)
International Business
transfers the same to the buyer for his use against the payment of a fixed amount, which
can either be a one time lump-sum payment or a percentage of sales, or a combination
of the two.

Licensing arrangements suffer from several disadvantages from the standpoint of the
licensor. First, the licensor does not have any management control over the licensee
and is therefore unable to control either the quality or price. An unscrupulous or
inefficient licensee can therefore cause damage to the long-term development of the
market potential. Second, licensing is extremely limited in its scope. The licensor cannot
have a share of the returns from the manufacturing and marketing operations of the
licensee. Third, the life of the successful licensing arrangements is normally short, as
the licensee may develop his own manufacturing capability within a reasonable short
period. But the most dangerous aspect of the licensing arrangement is that sometimes
the licensees, after they internalize the technology and also in some cases improves
upon it, turn into competitors of the licensors.

Franchising
A similar method of entry is franchising which is globally very common in the food,
soft drinks and fast food business. Franchising is a form of marketing, under which the
parent company allowed the franchises to use its methods, symbols, trademarks and
architecture. The contract will specify the place of operation of the franchisee and the
period for which the arrangement will remain valid. Several forms of franchising are in
operation. One form is hundred per cent franchisee ownership; the second form envisages
a concept of area or master franchisee who in turn can appoint sub-franchisee(s). The
third is where the franchise is in fact owned by the parent firm itself. This happens
essentially at the market-testing stage. The principal wants initially to find out the market
potential himself before deciding whether large scale franchising will be profitable.

The basic advantage of this entry method is akin to that of licensing. The upfront
expenditure is minimal while the return can be substantial. The disadvantage lies in the
fact that unless strict monitoring is done, franchisees may default on quality and delivery,
thus affecting the reputation of the principal.

International Joint Ventures

International joint venture involves creation of a separate legal entity by an association
of two or more firms. Normally, one of the partners will be a local firm though it is not
necessarily so. The choice of this entry method is dictated by several important
considerations. First, it reduces the cost of entry because the equity will be divided
between/among the partners. The foreign firm can thus make an entry into a market
even with a minority participation and still can have substantial management control.
Second, having a local partner can reduce the political risks. In an environment which
may not be friendly to foreign investors, having a local partner can help in creating a
more acceptable public perception. Third, the local partner is expected to have a good
grasp of local operating conditions and therefore can be of great help to the foreign
firm which is unaware of these details.

While these advantages can be substantial, the biggest danger of international joint
venture lies in the inappropriate selection of a partner. If the choice is proper, the strengths
of the parties will be complementary. But if the choice is wrong, either in terms of
operative attributes or management cultures, the joint ventures are bound to break up.
Several surveys have shown a considerable ‘divorce’ rate among the joint venture
partners or taking over of the businesses by the dominant partners.

14
The choice of the joint ventures as the entry mode may, however, be dictated by the Dynamics of International
Business
host country’s regulations. Some countries stipulate that foreign firms can set up facilities
only in association with local firms.

Subsidiaries and Acquisitions

Wholly owned subsidiaries have been the preferred entry mode for large enterprises.
The advantages of complete ownership are: avoidance of conflict of interest, as may
happen in the case of joint ventures, and fullest exploitation of the market potential in
terms of both manufacturing and marketing. But these advantages are to be evaluated
against the large scale commitment of financial and managerial resources. Some firms
which are anxious to keep their competitive edge under the strictest control, normally
favour this entry mode.

The internationalization process is initiated for many different reasons. It is not simply
a matter of wishing to go international and achieving success over a short period. The
process of internationalization requires the following five basic ingredients if the firm
has to be successful:

• A well-developed and clearly articulated mission which reflects a serious

commitment to international business activities.
• The ability of the firm to identify and adjust rapidly to consumer needs and
opportunities in international markets using products which clearly reflect the firm’s
competitive advantage.
• The ability to understand consumer behaviour in different cultures and to evaluate
the nature of changes taking place.
• The ability to develop and maintain high-quality products which can withstand
competition from the nearest rivals in domestic as well as overseas markets.
• A programme of serious and effective business research to identify international
markets and their requirements.

Within the context of these ingredients for success in the internationalization process,
it would be useful to consider the dichotomy between a reactive firm and a proactive
firm. A reactive firm is a passive firm. It follows rather than leads; responds to
opportunities rather than actively seeking them; it avoids risk rather than taking risk; it
is content with the status quo rather than actively seeking ways to change it; it is inward-
rather than forward-looking; and is more concerned with the present rather than with
the future which requires planning and investing. In short, a reactive firm is defensive
in character and its actions reflect management’s response to changes in the firm’s
external environment and pressures from its competitors. In contrast, a proactive firm
is always initiating and creating new products to stay ahead of rivals, always seeking
new challenges rather than being content with what has so far been achieved. It is
aggressive and is prone to taking risks, and invests for the future to take on its rivals. It
is often the case that the more proactive the firm, the more likely it is to succeed in
international business.

The internationalization process demonstrates a proactive firm at its best. In some

instances much of the firm’s FDI activity may be a reactive response to competitors’
moves, basically a defensive strategy to discourage entry of new firms into the industry,
to increase market concentration, or to undertake mergers and acquisitions (M&As) in
order to deny rivals access to valuable assets. The process starts with the firm having a
product which clearly reflects its competitive advantage over its rivals, both in home
and international markets, often as a leader in its field. Its competitive advantage may

15
Introduction to be its superior design capability, the skills of its workforce, the unique talents of its
International Business
management or marketing team, or simply its ability to do things better or more efficiently
than its competitors. In short, to be successful in international markets, the firm must
first be successful in its own domestic market. It is this success in its domestic market
which often propels the firm to go international.

It has been seen, from the discussion so far, that the firm uses its firm-specific intangible
assets to enter foreign markets. Its products and brand name developed over many
years need to be fully exploited if the firm is not only to recover its initial research and
development costs but also earn sufficient profits to satisfy its shareholders and fund
future investment. So, the profit motive is the most compelling proactive motive. In
cases where the domestic market is either too small or too saturated, the firm may have
no real alternative but to seek markets overseas. The key difference between a reactive
and a proactive firm is that a proactive firm does not wait until its domestic market is
saturated, demand is showing signs of decline, or it is forced to take action before it
actively seeks opportunities abroad by undertaking continuous market research and
acting upon its findings.

The major reasons why firms go international are:

1) To Look for New Markets

International business firms are often characterized as opportunity seekers; that is,
seeking to take advantage of any event or development worldwide which is likely
to have a positive impact on their marketing and resource acquisition strategies.
This particular attribute is especially relevant to reactive firms. One major source
of such an impact has been the creation of the European Union or single European
market which helped to create one of the world’s largest markets by integrating the
individual member states’ markets into one. Consequently, many distinct
opportunities have been created for international business firms to undertake market-
seeking and production-seeking investments.

2) To Expand Market for their Products / Services

As a consequence of the increasing convergence of consumer tastes and preferences
and demand patterns in general, firms find it necessary to establish international
customer bases in foreign countries to serve the needs of existing as well as potential
customers. The firm is, thus, able to expand its market internationally at a lower
cost than by exporting from the home base. A firm with a declining home market
may like to enter into foreign markets and extend the life cycle of its product. As
the experience of many US, Japanese, and Korean MNCs demonstrates, EU member
states offer many location-specific advantages to these firms to enable them to gain
access to its single market with over 370 million inhabitants. Firms like Nokia,
Siemens, Bayer, Johnson and Johnson, etc. went in search for foreign markets as
their domestic markets were shrinking.

3) To Circumvent International Trade Barriers

Governments erect various forms of barriers for foreign firms to enter in their
domestic markets. These barriers include some of the most common measures such
as tariffs and quotas as well as rules and regulations to protect specific industries
and markets. These measures make imports less attractive and more costly. Therefore,
it makes it necessary for the firm to establish export bases or production facilities
in host countries in order to avoid these protectionist measures.

16
4) Factor endowment Dynamics of International
Business
Countries are endowed with different natural and acquired resources which offer
international firms yet another set of location-specific advantages, ranging from
relatively low-cost labour, raw materials, land for large-scale operations and suitable
climate to specific technical skills and knowledge which can only be accessed by
establishing operations on location. Even if the firm’s home country has similar
resources, it may still be advantageous for the firm to locate facilities in another
country for additional low-cost resources such as finance. For example, Japan is
known for the quality of its steel; however, the Japanese firms have to look at India
for the supply of iron ore – a raw material for making steel.

5) To Reap Benefits of Economies of Scale

In cases where the domestic market may be too small for efficient production, the
firm may want to expand into world markets to create economies of scale (reduction
in cost per unit produced as the scale of production is increased). Entry into overseas
markets increases total sales and therefore, justifies larger-scale operations in
production, marketing, and transport.

6) To Follow Competition
With an increasing number of firms going international, other firms feel compelled
to follow their competitors into markets which may later be denied to them. In
oligopolistic industries (those dominated by a few firms making interdependent
decisions), it is normal to expect several firms to establish operations in a given
country within a short time. The main reason is that any particular change in the
internal and external business environment affecting one firm will affect the others
at about the same time and, given their interdependence on each other for decision-
making, will induce a similar response. For example, the liberalization of trade and
investment in India produced almost an instant response by the world’s most
dominant car producers to establish a presence in one of the world’s biggest potential
markets. An associated motive might be to create synergy which would result from
combining benefits from one location with those of another, especially in cases
where the firm is able to combine its own managerial competence with the intimate
knowledge and expertise of the local personnel in order to overcome cultural
difficulties.

7) To Take Advantage of Government Incentives

Governments throughout the world offer a variety of incentives to attract international
firms, especially reactive firms. These incentives range from direct financial
assistance to defray part of the initial costs of operations to indirect financial schemes
such as favourable corporate tax rates. All these incentives help companies to
maximize their after-tax profits and thus provide additional funds to invest either in
the host country, home country, or in other countries.

8) To Protect the Domestic Market

In essence this is a defensive (reactive) approach whereby the firm initiates an
offensive into the competitors’ home market in order to protect its own domestic
market. Such an offensive may have the effect of putting pressure on the competitor
to reconsider its move or, depending on the strength of the offensive, abandon it
completely.

17
Introduction to Activity 3
International Business
Identify a company in India which has internationalized its operations over the past 5-
10 years. Meet an executive of its international division and ascertain the reasons/
motivations for the company going international.

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1.7 SUMMARY
International business may be defined as business carried out across national boundaries.
The genesis of international business may be traced back to the ancient times when
different well known communities carried on their trading activities in different parts
of the world. The MNCs are the central actors in international business.

There could be several reasons behind a firm’s move to internationalize its business. A
firm may want to engage in international business in search of new markets, to widen
its present market for goods and services, to overcome the barriers that it perceives it
would confront if it goes international, to reap the benefits of economies of scale, to
take advantage of the opportunities offered by other (foreign) governments, or to protect
its domestic market from foreign competition, etc.

International business differs from domestic business in terms of the environment it

faces. The actors in international business confront different socio-economic, cultural
and physical environment in different countries. Therefore, they have to make necessary
adjustments in their strategies and approaches of managing business to conform to the
diverse environments in overseas markets.

There are some difficulties that are unique to international business which arise because
of long distance between trading nations, different languages, customs and laws, currency
measurements, different controls, regulations and tax regimes in different countries,
and greater risk and uncertainty.

Important benefits of international business include higher standard of living of people

in different countries, stability in prices, advantages emanating from specialization,
increased productivity, wider markets, overall growth of economies, and promotion of
international peace.

International business has assumed greater importance as it enables in the diffusion of

new technologies, stimulates competition, provides impetus to standardization, motivates
firms to adapt to international environment, encourages globalization of business, and
promotes economic cooperation and integration.

International business activities have not only grown but have become much more
diverse and complex. As such they require collective or multilateral efforts at global
level by global agencies. One direct result has been the emergence of a new world
economic order in which national economies are merging into one global economy,
either on an individual basis, or as it has recently been seen, in (new) regional groupings.
Globalization is a dynamic process in which world markets and the production of goods
18
and services become integrated and interdependent. For individual governments, the Dynamics of International
Business
most compelling reason to integrate their economies with other economies is to enable
them to take collective measures to maximize the perceived gains and minimize the
perceived costs of globalization.

1.8 KEY WORDS

International Business : Business carried out across the national boundaries.
Some important forms of international business are:
export and import of goods and services which
includes appointing foreign agents abroad,
management of consulting and turn key operations,
licensing, franchising, joint ventures and
collaborations, and wholly owned subsidiaries.
Globalization : Globalization can be defined as the growth of
economic activity spanning politically defined national
and regional boundaries. It leads to the increased
movement across the boundaries of goods and services,
namely, trade and investment, often of people via
migration. It is driven by the actions of individual
economic actors – firms, banks, and people – usually
in the pursuit of profit and often spurred by the
pressures of competition.

Multinational Enterprises : MNEs are the central actors in international business

(MNEs) and have played a major role in making the world
market ‘global’. MNEs are generally defined as
organizations whose operations extend beyond the
national political boundaries and operate in many
nations by making FDI.
Marketing : Marketing is an activity which advocates looking at
business activities from the customers’ point of view.
It suggests that the firm should develop its products
as per the customers’ choice and preferences. The term
market refers to the sum total of all the customers
(which includes present and potential customers - non-
users and customers of the competitors’ products as
well).
FDI : Foreign Direct Investment (sometimes also referred
to as DFI) means direct investment in business
operations in a foreign country. Generally, take the
form of either a joint venture/ collaborations or wholly
owned subsidiary.
European Union (EU) : An economic group of 15 European nations: Austria,
Belgium, Denmark, Finland, France, Germany, Great
Britain, Greece, the Netherlands, Ireland, Italy,
Luxemburg, Portugal, Spain, and Sweden. Established
as a customs union, it is now moving toward economic
union (formerly known as the European Community).

North American Free : Free trade area between Canada, Mexico, and the
Trade Agreement (NAFTA) United States.
19
Introduction to
International Business 1.9 SELF-ASSESSMENT QUESTIONS
1) What do you understand by ‘proactive’ and ‘reactive’ firms? Differentiate between
them by highlighting their distinguishing features.

2) What prompts the firms to internationalize?

3) What special tasks or difficulties an international manager may have to face?

4) What are the characteristics of international business? How is it different from

domestic business?

5) Using examples, examine the possible reasons why a firm may trade in international
markets.

6) Why should Indian firms go global? Why should they not be content with domestic
market which is vast and growing so rapidly?

7) Discuss why the culture of a country might influence the costs of doing business in
that country. Illustrate your answer with examples.

8) In what ways has the risk of doing business changed in Russia and Eastern Europe
since the fall of communism?

9) How do you account for the vast increase in world trade since World War II?

10) What is culture? Is it important for a manager of international business to take

account of it? Are the forces of globalization making culture a thing of the past?
Discuss.

11) Identify the barriers to free movement of goods and services. Explain how barriers
influence the development of international trade.

12) “Selecting the market entry strategy is the key decision which many companies
have to take for expanding into overseas markets.” Why is it a key decision? What
kind of risks and controls are involved? Explain how risk and control is affected by
different entry methods.

1.10 FURTHER READINGS

Ali Abbas J. (2001). Globalisation of Business, Jaico Publishing House.

Bartlett, Christopher A. and Sumantra Ghoshal. (1992). Transnational Management:

Text, Cases and Readings in Cross-Border Management. Homewood, Illinois: Irwin.

Bhalla, V. K. and S. Shiva Ramu (2000). International Business: Environment and

Management, Anmol Publications.

Czinkota, Michael R. and Ikko A. Ronkainen (1998). International Marketing. Fort

Worth, TX: Dryden Press.

Harrison Andrew, Dalkiran Ertugrul, and Elsey Ena (2000). International Business,
Oxford University Press.

Hill Charles W. L. (2005) International Business, Tata McGraw-Hill Edition.

Prathi 1608 (2011). FDI introduction and History. www. Studymode.com Retrieved on
Jan 4, 2012.
20
 Dynamics of International
UNIT 2 INTERNATIONAL TRADE Business

THEORIES AND ITS BUSINESS

IMPLICATIONS

Objectives

After studying this unit, you should be able to comprehend:

• the theories and principles of international economics and their implications;
• how the nations decide on their trade policy;
• how the balance of payments accounts of a nation is determined;
• the functioning of the foreign exchange market; and
• how to minimize risks and make gains in the foreign exchange market.

Structure

2.1 Introduction
2.2 International Trade Theories and their Implications
2.3 International Trade Policy
2.4 Balance of Payments
2.5 Foreign Exchange Market
2.6 Determination of a Floating Exchange Rate
2.7 International Monetary System (IMS)
2.8 Summary
2.9 Key Words
2.10 Self-Assessment Questions
2.11 Further Readings

2.1 INTRODUCTION
International economics deals with the economic interdependence of nations. It analyses
the flow of goods, services and payments between a nation and the rest of the world,
the policies directed at regulating this flow and their effect on the nations’ welfare. Its
main components are the pure trade theories, the trade policies, the foreign exchange
markets and the balance of payments.

The pure theory of trade examines the basis for and the gains from trade, as well as the
patterns of trade. The theory of trade policy investigates the reasons for and the effects
of trade restrictions. The study of foreign exchange markets gives you an idea on how
one national currency is exchanged against the other, and the method of predicting the
movement of a nation’s currency against other currencies. Balance of payments measures
a nation’s total receipts from the total payments to the rest of the world, and discusses
mechanisms for correcting balance of payments instability.

21
Introduction to
International Business 2.2 INTERNATIONAL TRADE THEORIES AND
THEIR IMPLICATIONS
International trade theory seeks to answer two basic questions:

1) What is the basis for trade and what are the gains from trade? Since two nations
trade voluntarily they must gain from trade. The question is how are these gains
generated and how are they divided among trading nations/partners?
2) What is the pattern of trade? What commodities are traded and which nation will
export and import which commodity?

We begin with the theory of absolute advantage developed by Adam Smith.

Absolute Advantage
According to this theory, when one nation is more efficient than (or has an absolute
advantage over) another in the production of one commodity but is less efficient than
(or has an absolute disadvantage with respect to) the other nation in producing a second
commodity, then both nations can gain by each specializing in the production of the
commodity of its absolute advantage and exchanging part of its output with the other
nation for the commodity of its absolute disadvantage. Then the output of both
commodities will rise, which measures the gain from specialization in production. The
trade between two nations enables the gain to be divided between them.

We will now look at a numerical example of absolute advantage to make things clearer.
Before that, however, let us define a production possibility schedule of a country by the
combination of goods an economy can produce given its existing resources and the
present state of technology. Table 2.1 depicts a hypothetical production possibility
schedule for India and USA.

Table 2.1: Production Possibility Schedule

Labour required One computer One sack of rice

In India 25 5
In USA 10 10

Note that India is more efficient in rice production, while US is more efficient in
producing computers. Let both countries initially have 100 units of labour. If operating
separately or without trading with the other country, let us assume that both the nations
devote half of their (labor) resources to manufacturing computers and producing rice.
The USA will produce 5 sacks of rice and 5 computers, and India will produce 10 sacks
of rice and 2 computers. The world economy as a whole produces 7 computers and 15
sacks of rice.

Now assume that by following the theory of absolute advantage, the USA and India
specialize in producing computers and rice, that is, those goods where they have an
absolute advantage. Then India will produce 20 sacks of rice and US will produce 10
computers. Comparing it to the no-trade case, we see that the world economy is producing
more computers and more rice. Hence, if they can agree on a suitable exchange rate
ratio (or terms of trade), which simply tells us how many sacks of rice will exchange
for a computer in a world economy, both can gain from trade. Suppose they agree on
exchanging one computer for two sacks of rice. In that case both countries can have 5
computers and 10 sacks of rice, which means they both gain from trade. Table 2.2
makes the gains clearer.
22
 Table 2.2: Gains from Trade International Trade
Theories and its Business
Pre Trade Production Consumption Implications

Computers Sacks of rice Computers Sacks of rice

USA 5 5 5 5
India 2 10 2 10
World 7 15 7 15

Post Trade.
Computers Sacks of rice Computers Sacks of rice
USA 10 0 5 10
India 0 20 5 10
World 10 20 10 20

Thus both countries gain in the sense that USA consumes as many computers as before
while they consume more rice in free trade situation compared to no trade. India, on the
other hand, consumes more computers in the free trade situation, while their rice
consumption remains the same.

Comparative Advantage
The Absolute Advantage theory seems to postulate that if one country is more efficient
than the other in the production of all commodities; it will have no gains from trade
with the inefficient country, and as such should refrain from trading. David Ricardo, in
his theory of comparative advantage, showed that even in such cases there could be a
basis for gainful trade. According to the law of comparative advantage, even when a
nation is less efficient than (has absolute disadvantage with respect to) the other nation
in the production of both commodities, there is still a basis for gainful trade. The
inefficient nation should specialize in the production of and export the commodity in
which its absolute disadvantage is smallest (called the commodity of its comparative
advantage), and import the commodity in which its absolute disadvantage is highest
(called the commodity of its comparative disadvantage). The law can be best understood
from the following example. Consider this production possibility schedule, assuming
India and USA have 120 and 100 units of labour respectively.

Table 2. 3: Production Possibility Schedule

Labour required One computer One sack of rice

In India 30 12
In USA 10 10

Here though USA has an absolute advantage introducing both the commodities, it is
thrice as productive as India in producing computers, while only 1.2 times as productive
in producing rice. However, the relative comparative advantage of USA in producing
computers is more than the comparative advantage it has in producing rice. As such
USA and India are said to have comparative advantages in producing computers and
rice respectively. Thus if following the law of comparative advantage India and USA
specialize in producing rice and computers respectively, they have a basis for gainful
trade, as evident from the table below (we carry on with the previous assumption of
dividing labour resources equally over two items of production).

23
Introduction to Table 2.4: Gains from Trade
International Business
Pre Trade Production Consumption
Computers Sacks of rice Computers Sacks of rice
USA 5 5 5 5
India 2 5 2 5
World 7 10 7 10
Post Trade
Computers Sacks of rice Computers Sacks of rice
USA 10 0 7 5
India 0 10 3 5
World 10 10 10 10.

Thus both USA and India consume the same amount of rice in post trade compared to
pre -trade, but both use/consume more computers and are hence better off trading. The
logic of comparative advantage is basically this: Suppose a lawyer can type twice as
fast as his secretary. Now the lawyer has a comparative advantage in both typing and
law, since the secretary cannot practice law without a law degree. Suppose the lawyer
earns $100 per hour by practicing law, while the hourly wage rate of typing is $20. By
the theory of comparative advantage the lawyer should still practice only law and let
his secretary do the typing. For, he loses $80 for each hour that he types. The reason for
this is he would save $20 (since he can type twice as fast as his secretary can), but he
loses $100 that he could have earned by practicing law in that hour.

Factor Proportions (Heckscher Ohlin (H-O) Model)

If labour was the only factor of production, comparative advantage could only arise
because of difference in labour productivity. In the real world however, comparative
advantage is also explained by differences in country resources. Canada exports forest
products to the US not because its lumberjacks are more productive relative to their
USA counterparts, but because sparsely populated Canada has more forested land per
capita than the USA. Bangladesh is the largest producer of jute not because its labour is
more productive but because of certain factors like a suitable climate, soil of appropriate
quality and great abundance of cheap labour. Similarly South Africa is the largest exporter
of diamond simply because natural diamonds are found there in great abundance. To
highlight this importance of resource difference in trade, the H-O model considers
resource differences as the only source of trade.

First we define factor intensity as the relative use of a factor proportion in producing a
product. e. g., production of cars requires a lot of capital and less labour, while textiles
require relatively more labour than capital. Having defined this, we are now in a position
to state the H-O theorem.

Heckscher Ohlin Theorem: Trade is based on differences in relative factor endowments.

Countries export those products that are relatively intensive in the nation’s relatively
abundant factor and import the commodities that require more intensive use of the
nation’s relatively scarce factor. In short, the relatively labour rich nations export the
relatively labour- intensive products or commodities and import the relatively capital
intensive products.

The logic of the theorem is as follows. Consider two countries, India and USA. If we
assume that USA is heavily endowed with capital relative to labour, the relative price
24
of capital will be cheaper in the USA than in India. This means, other things remaining International Trade
Theories and its Business
equal it will be relatively cheaper to produce cars — a capital-intensive good – in USA
Implications
than in India. Similarly it will be relatively cheaper to produce textiles – a labour-
intensive commodity — in India, which is abundant in labour. As such when trade
opens up, US should be exporting cars while India will be exporting textiles.

Also, the post trade prices of the two goods should settle down at a level that is between
the two self sufficient price ratios. While the price of textiles will rise in India and that
of cars will fall. Similarly, the price of cars in USA will rise, and that of textiles will
decline. Because changes in relative prices have very strong effects in the relative
earnings of resources, and because trade changes relative prices, international trade has
strong income distribution effects. This is summarized by the following theorem.

Stopler-Samuelson Theorem: The countries that have abundant factors gain from trade,
but the countries that have scarce factors lose. This explains that though there are always
gains from trade, why there is so much opposition to opening up in all countries. Trade
might benefit the country as a whole, but some sectors within the country might lose.

The International trade theories and their implications can be summarized in Table 2.5.

Table 2.5: Summary of International Trade Theories

Trade theory Theoretical Implication Described by

Absolute Ability of a country to produce more Adam Smith (1776)
Advantage of a good or service than competitors
using same amount of resources.
Comparative Ability to produce a particular good or David Ricardo (1817)
Advantage service at a lower marginal &
opportunity cost over another.
Factor Production Countries tend to specialize in the Heckscher (1919) &
production of goods and services that Ohlin (1933)
utilize most abundant resources

Source: en.wikipedia.org.

Activity 1
Study the pattern of current India-USA trade (for both goods and services) and analyze
how the two nations stand to benefit from the bilateral trade. Analyze the physical
goods and services separately in order to appreciate the results better.
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2.3 INTERNATIONAL TRADE POLICY

Practically all nations impose some restrictions on the free flow of international trade.
Since these regulations or restrictions deal with a country’s trade and commerce they
are called Trade Policies.
25
Introduction to Despite ample evidence that free trade is generally the best way to go about, politicians
International Business
always talk of restricting trade by imposing tariffs and erecting non-tariff barriers (NTBs).
It is a standard result in economics that the small countries are better off by pursuing
free trade, while the large countries are better off imposing an optimal tariff.

Instruments of Trade Policy

Some important instruments of trade policy are discussed below.

Tariffs: A tariff is a tax on imports. Specific tariffs are levied as a fixed charge on each
unit of goods imported. Ad-valorem tariffs are taxes that are levied as a fraction of the
value of the imported goods. In either case the effect of a tariff is to raise the cost of
shipping goods to a country. For example, a specific tariff of $10 on imported bicycles
means that customs officials collect the fixed sum of $10 on each imported bicycle
regardless of its price. In contrast, a 10% ad valorem tariff on imported bicycles would
result in the payment to customs officials of the sum of $10 on each $100 imported
bicycle.

Non-tariff Barriers (NTBs): Such barriers impose a physical limit on the quantity of
goods that can be imported. Worldwide tariffs have been reduced steadily since 1945.
Starting with the first round of GATT talks in Geneva (1947) world tariffs have been
reduced from an average rate of 40% in 1947 to around 4% in 1994 on manufactured
goods. The same cannot be said of NTBs, which became popular in the late 1970’s and
show little signs of fading away. As per the statement made at United Nations Conference
on Trade and Development (UNCTAD, 2005), use of NTBs based on amount and control
of price levels has decreased significantly from 45% in 1994 to 15% 2004. The use of
other NTBs has increased from 55% in 1994 to 85% in 2004. A brief list of the types of
NTBs is given below.

There are different classifications of non-tariff barriers. When we talk about tariff barriers
related to trade then some popular NTBs are as follows:

1) Licenses
2) Quotas
3) Agreement on Voluntary Export Restraints (VERs)

Licenses: These are most common instruments of direct regulation of imports

(sometimes exports). Almost all industrialized nations apply this. The license system
requires that a state through a specially authorised office issues permit for international
trade transaction of import and export commodities which are included in the list of
licensed merchandises. The use of this system is based on international level standards
agreements.

Quotas: Quotas are quantitative restrictions on imports and exports of certain goods.
An import quota is a NTB that places a direct restriction on the quantity of some goods
that can be imported. An export quota is the restriction on amount of goods that can
leave a country. But because quotas are not permitted under current international trade
rules, many countries have gone to great lengths to establish different varieties of trade
restrictions that are functionally identical to quotas.

A quota rent arises because an import quota on a product raises the domestic price of
that product. An alert businessman can walk away with the rent if he purchases the
import at the world price and sells it to the domestic market at higher price.

Agreement on Voluntary Export Restraints (VERs): Under a VER, a foreign industry,

such as the Japanese car industry, agrees to limit the quantity of products it exports to a
26
particular country. In the early 1980s the US negotiated a VER with the Japanese car International Trade
Theories and its Business
industry that limited the number of Japanese cars that could be exported from Japan to
Implications
the US.

Though a quota and a VER are similar in effect, but because a VER is undertaken
‘voluntarily,’ the initiating country cannot be accused of unilaterally introducing trade
restrictions – although there is always the nagging question of how much arm-twisting
is necessary to get the exporting industry to volunteer to restrict its exports to a certain
country. One difference is that VERs can be used to restrict imports from a particular
country, not on all countries. Till now textiles, steel and agricultural products are the
three products that have mostly been subjected to VERs. The European Union (EU)
imposed VERs mostly on Japanese products, followed by the Korean products.

Embargo: It is a specific type of quotas prohibiting the trade. Usually this is introduced
for political reasons but has an impact on the economy of a nation.

Orderly Marketing Agreements (OMA): Under such an arrangement two or more

countries agree to limit the quantity of exports from each other country. Such agreements
are framed to ensure that the future increase in trade may not disrupt or impair competitive
industries.

Standards: The standards are usually imposed on classification, labeling and testing
of products. These are some times used to protect the health and safety of local
population.

Quotas versus Tariffs: Tariffs are generally believed to be better than quotas because
of the following reasons. First, under a tariff, the government gets the revenue, which
it can spend on projects benefiting the society in general or which it may use to reduce
overall tax rates. In contrast, if the quota revenue ends up in the hands of the importers,
the government will subsidise a lucky few at the expense of all citizens. If foreign firms
end up with the quota rent, the government will in effect have taxed its citizens and
transferred wealth to foreigners.

Second, quotas benefit the (domestic) producers at the expense of the domestic
consumers. If tariffs are $10 per unit of one good, and the international price of that
good is $100, then domestic producers cannot price the good at more than $110. But
under a quota, they can charge a higher price; since consumers do not have the choice
to shift to imports even if domestic prices are very high once the quota amount is sold
out of the market.

2.4 BALANCE OF PAYMENTS

The balance of payments (BoP) of a country is a summary statement in which all
transactions between ‘residents’ of the country concerned and those of other countries
are recorded during a particular period of time, usually a calendar year. However, in the
context of BoP, it is important to note that :

• Millions of transactions of a nation with rest of the world cannot appear individually
in the BoP – it aggregates all trade into a few major categories.

• By residents we mean all citizens of a country. A corporation is a resident of a

nation in which it is incorporated, but its foreign branches/subsidiaries are not.
International Institutions like IMF, World Bank etc. are not residents of the nations
where they are located.

27
Introduction to • It is always with reference to certain time period. BoP considers flow of goods,
International Business
services, gifts and assets between residents of a country with residents of other
nations during a particular period of time, usually a year.

Debits and Credits in International Transactions: Debit transactions involve payment

by domestic residents to foreigners. Credit transactions involve the receipt of a payment
from foreigners by domestic citizens.

Examples of Debit transaction items are imports of goods and services, dividend, interest
and debt payment on foreign owned capital, unilateral gifts or transfers made to foreigners
and foreign investment by domestic citizens. Similarly some of the credit transaction
items are exports of goods and services, unilateral transfers (gifts) received from
foreigners and domestic investment by foreigners. Thus, while export of commodities
is considered a credit transaction since it fetches receipt of payment, outflow of capital
like buying a plant or shares abroad is considered a liability since domestic residents
make a payment to foreigners for it.

Double-Entry Book keeping: BoP accounting is based on double entry book keeping,
which means that a credit item on the BoP should be offset by a corresponding debit
item. Hence the BoP always balances, or the debits always equal credits in the BoP
account. A nation’s balance of payments consists of two main accounts: the current
account and the capital account. There is also an official reserve account.

The Current Account: It essentially records exchanges in goods and services. It consists
of three sub accounts. The goods or merchandise account records the trade in visible
commodities like cars, food grains, machinery etc. The service account records the
transactions in invisibles that are bought or sold internationally, like royalties, banking,
shipping insurance, tourism services, etc.

The trade balance or the balance of trade equals the sum of the merchandise account
and the service account. Thus, it is basically the sum of exports of goods and services
minus the sum of imports of goods and services. Unilateral transfers, the final item on
the current account, are payments made by private citizens and governments of one
country to another. If India sends so many dollars to Somalia to help fight famine, it
will be listed as an official unilateral transfer on India’s BoP.

The Capital Account: The capital account records the net changes in a nation’s
international financial assets and liabilities over the BoP period. Its first sub-accounts
are as follows.

The Foreign Direct Investment (FDI) consists of building a plant overseas or acquiring
what is deemed to be a ‘controlling’ interest in an established overseas firm.

The Foreign Portfolio Investment consists of purchase of shares of a foreign firm or

bonds issued by a foreign government. The difference between these two types is
somewhat arbitrary. If one buys 10% or more stocks of a foreign company, as prescribed
under the applicable regulations, it will be called FDI, assuming then one gains a
controlling interest in the firm. If one acquires less than 10% of the outstanding stock
the capital export is regarded as portfolio investment.

Official Reserve Account: It deals with (a) gold imports and exports, (b) increases or
decreases in foreign exchange and SDRs (Special Drawing Rights) and (c) increases or
decreases in liabilities to foreign central bank. Thus, if they are current dollars, since
we receive rupees, it is regarded as a credit item.

28
BoP — Surplus and Deficit: All transactions in current and capital account are said to International Trade
Theories and its Business
be autonomous because they take place for business or profit motive, independent of
Implications
BoP considerations. They are sometimes called ‘items above the line’. Transactions in
Official Reserve Account are called accommodating transactions, or ‘items below the
line’ because they are determined by the net consequence of autonomous terms – they
result from and are needed to balance international transactions. If the sum of current
and capital account are in deficit, then foreign exchange or gold or loan must be taken
from official reserve account to balance the BoP.

Therefore, the BoP is said to be in surplus (deficit) if the autonomous account is in

surplus (deficit). A deficit in BoP can be measured by the excess of debits over credits
in the current and capital accounts, or the corresponding drop in official reserves.

Activity 2
Study the relevant provisions of the latest budget presented to the Parliament and fill in
the specific data/figures against each of the following subjects:

a) Balance of Payments surplus/deficit

b) India’s Total Foreign Exchange Reserves
c) Main classification of Current Account Transactions
d) Main classification of Capital Account Transactions
e) Balance of Trade surplus/deficit
.................................................................................................................................

.................................................................................................................................

.................................................................................................................................

.................................................................................................................................

.................................................................................................................................

2.5 FOREIGN EXCHANGE MARKET

The foreign-exchange market refers to the organisational setting within which
individuals, business, governments, and banks buy and sell foreign currencies and other
debt instruments. It is the largest financial market in the world. The major trading
centres are in London, New York and Tokyo. Roughly 30%, 16% and 10% of the average
daily volume of foreign exchange trading takes place in London, New York and Tokyo
trading centers. The next in line in terms of importance are Singapore, Switzerland and
Hong Kong, each of which accounts for approximately 6% of the daily volume. The
actual trades are carried out by large commercial banks such as Citibank, Deutsche
Bank, JP Morgan and HSBC/Midland – the top five foreign exchange dealers in 1995,
in that order.

A typical foreign-exchange market functions at three levels: (1) in transactions between

commercial banks and their customers, who are the ultimate buyer and sellers of foreign
exchange; (2) in the domestic inter-bank market conducted through brokers; and (3) in
active trading in foreign exchange with banks overseas.

Exporters, importers, investors, and tourists buy and sell foreign exchange from and to
commercial banks rather than each other. As an example, consider the import of German
autos by a U.S. dealer. The dealer is billed for each car it imports at the rate of 50,000
Euros. The U.S. dealer cannot write a cheque for this amount because it does not have
29
Introduction to the needed account denominated in Euros. Instead, the dealer goes to the foreign
International Business
exchange department of, say, Deutsche Bank to arrange payment. If the exchange rate
is 1.76• marks per $1, the auto dealer writes a cheque to Deutsche Bank for $65789.47
per car. Deutsche Bank is able to do this because it has the needed deposit in Euro at its
branch in Bonn.

The major banks that trade foreign exchange generally do not deal directly with one
another but instead use the services of foreign-exchange brokers. The purpose of a
broker is to permit the trading banks to maintain desired foreign exchange balances. If
at a particular moment a bank does not have the proper foreign-exchange balances, it
can turn to a broker to buy additional foreign currency or sell the surplus. Brokers thus
provide wholesale inter-bank market, in which trading banks can buy and sell foreign
exchange.

The third tier of the foreign-exchange market consists of the transactions between the
trading banks and their overseas branches or foreign correspondents. Although several
dozen U.S. banks trade in foreign exchange, it is the major New York banks that usually
carry out transactions with foreign banks. The other inland trading banks meet their
foreign-exchange needs by maintaining correspondent relationships with the New York
banks. Trading with foreign banks permits the matching of supply and demand of foreign
exchange in the New York market. These international transactions are carried out
primarily online.

Types of Foreign Exchange Transaction

When conducting purchases and sales of foreign currencies, banks promise to pay a
stipulated amount of currency to another bank or customer on an agreed-upon date.
Banks typically engage in three types of foreign-exchange transactions: spot, forward,
and swap.

Spot Transaction: It is an outright purchase and sale of foreign currency at the prevailing
exchange rate or the spot rate for cash settlement not more than two business days
after the date the transaction is recorded as a spot deal. The two-day period, known as
immediate delivery, allows time for the two parties to forward instructions to debit and
credit bank accounts at home and abroad.

Forward Transaction: These involve an agreement today to buy or sell a specified

amount of a foreign currency at a specified future date at a rate agreed upon today – the
forward rate. In many cases, a business or financial institution knows it will be receiving
or paying an amount of foreign currency on a specific date in the future. For example,
in August an Indian importer may arrange for a special Diwali season shipment of
Japanese radios to arrive in October. The agreement with the Japanese manufacturer
may call for payment in Yen on October 20. To guard against the possibility of the yen’s
becoming more expensive in terms of the rupee, the importer might enter in a contract
with a bank to buy yen at a stipulated price, but not actually receive them until October
20 when they are needed. When the contract matures, the U.S. importer pays for the
yen with a known amount of rupees. This is known as a forward transaction.

Forward transactions differ from spot transactions in that their maturity date is more
than two business days in the future. “A forward-exchange is usually available at 30,
60, 90 or 180 day basis. If the forward rate is below the present spot rate (i.e. it will be
cheaper to buy a foreign currency 30 day’s later than today), the foreign currency is
said to be at a forward discount with respect to the domestic currency. On the other
hand, if the forward rate is above the present spot rate, the foreign currency is said to be
at a forward premium.

30
Currency Swap Transaction: It is the conversion of one currency to another currency International Trade
Theories and its Business
at one point in time, with an agreement to reconvert it back to the original currency at
Implications
a specified time in the future. The rates of both exchanges are agreed to in advance.
Swaps provide an efficient mechanism through which banks can meet their foreign-
exchange needs over a period of time. Banks are able to use a currency for a period in
exchange for another currency that is not needed during that time.

Foreign Exchange Risks, Hedging and Speculation

Foreign Exchange risks are the risks resulting from changes in exchange rates over
time and faced by anyone who expects to make or to receive a payment in a foreign
currency at a future date.

Hedging is the avoidance of a foreign exchange risk by buying the currency today at
the forward market to insure oneself against exchange rate fluctuations – it is called
taking a covered position. If the individual does not buy the currency today in the
forward market and thus exposes himself against the risk, he is taking an open position.
Hedging is the most common way to avoid the risks involved in transactions involving
foreign exchange.

Speculation is the opposite of hedging. A speculator accepts and even seeks out a
foreign exchange risk, or an open position in the hope of making a profit e.g. if a
speculator believes that the spot rate of dollars will be higher in 3 months than its
present 3-month forward rate, he purchases a specified amount of the foreign currency
forward for delivery in 3 months. After three months, if he is correct, he receives delivery
of dollars at the lower agreed rate and immediately resells it at the higher spot rate, thus
realizing a profit. However, if he is wrong and the spot rate in 3 months is lower than
the agreed forward rate, he will make a loss. Speculation, essentially, is a kind of betting
concerned with the movement (up or down) of exchange rate. When a speculator buys
a foreign currency spot or forward in the expectation of reselling it at a higher future
spot rate he is said to take a long position. When he borrows or sells forward a foreign
currency in the expectation of buying it at a future lower price to repay his loan or
honour his forward sale contract, the speculator is said to take a short position (i.e. he
is selling what he does not have now).

2.6 DETERMINATION OF A FLOATING FOREIGN

EXCHANGE RATE
In a floating exchange rate system, the central bank allows the exchange rate to adjust
to equate the supply and demand of foreign currency. In a free market, the unregulated
forces of supply and demand determine currency values as long as central banks do not
attempt to stabilize them. The supply and demand for a currency arise from private
individuals, corporations, banks, and government agencies other than central banks. In
a free market, the equilibrium exchange rate occurs at the point at which the quantity
demanded of a foreign currency equals the quantity of that currency supplied. To say
that supply and demand determine exchange rates in a free market is at once to say
everything and to say nothing. If we are to understand why some currencies depreciate
and others appreciate, we must investigate the factors that cause the supply and demand
schedules of currencies to change. These factors include market fundamentals
(economic variables) and market expectations:

Market fundamentals include (i) Real income; (ii) Real interest rates; (iii) Inflation
rates; and (iv) Consumer preferences for domestic or foreign products.

31
Introduction to Let us first briefly discuss how economic fundamentals affect exchange rate. Consider
International Business
for example the effect of real inflation rate on the exchange rate. If the Indian rate of
inflation exceeds the American rates of inflation, the price of Indian goods will increase
relative to the price of U.S. goods. As a result, the demand for U.S. commodities will
rise relative to the demand of Indian products. In the foreign exchange market, this will
lead to an increased demand for dollars and a decreased demand for rupees, and at the
same time, an increased supply of rupees and decreased supply of dollars. As a result,
the rupee will fall in terms of dollars. Similarly, if the real interest rate is higher in U.S.
than in India, capital will flow from U.S. to India, and lead to a similar effect as above,
that is, rupee will fall against the dollar.

Market expectations
If the supply and demand for a currency were determined solely by market fundamentals,
foreign exchange dealers would have far less stressful jobs. However, the fact that
exchange rate, like share prices, is affected by day to day developments or in other
words market sentiments makes their task difficult. In the short run, ‘herd behavior’
dominates the exchange rate movements. Currency values shoot up and down not so
much because of market fundamentals but because of the prevailing sentiment that the
price of a currency is rising, and therefore one should buy it to make a profit, or vice
versa sell the currency if the feeling is that its price is going to fall. Sometimes, a panic
like situation prevails. At times, the participants in the foreign exchange market attempt
to avoid losses rather than seeking speculative profits, particularly when they observe
that the price of a certain currency is incessantly declining. This kind of a situation
creates what is known as a panic run. The currencies rise or fall not necessarily dictated
by fundamentals.

2.7 INTERNATIONAL MONETARY SYSTEM (IMS)

The International Monetary System (IMS) refers to the rules, customs, instruments and
organizations for affecting international payments. IMS can be classified according to
the way in which exchange rates are determined or according to the form that
international reserve assets take.

Types of Exchange Rates

There are various types of exchange rates which may be in operation.

Fixed exchange rate: In this system, the central bank of a country officially fixes the
price of its domestic currency in terms of other currencies, and (in principle) stands
ready to buy or sell its domestic currency at a fixed price in terms of some other currency.

Floating exchange rate: Here the central bank of a country allows the exchange rate to
adjust to equate the supply and demand of foreign currency.

Dirty/Managed Float: Under managed floating, Central Banks intervene to buy and
sell foreign currencies in attempts to influence the speed of adjustment and fluctuation
of the exchange rate. Most countries in the world, including India, now have a managed
float.

Peg system: It is a form of fixed exchange rate, where the domestic currency is pegged
to some major currency, e.g. rupee may be fixed in terms of dollars. Note that here if
the dollar value rises or falls in terms of some other currency, so does the rupee’s value
in terms of that currency. There can be some different forms of pegged exchange rate
system as discussed below:

32
 • Adjustable Peg: Here the exchange rate is pegged to some major currency, International Trade
Theories and its Business
with the stipulation that the exchange rate will be adjusted periodically.
Implications

• Crawling Peg: Mexico in early 1990’s used this system. Here the Mexican
peso was pegged to the U.S. dollar, but the exchange rate – pesos per dollar –
is adjusted by small pre-announced amounts at regular clearly specified
intervals (say 6% devaluation per year). This takes care of inflation rate
differences.

Depreciation refers to an increase in the domestic price of foreign currency.

Appreciation refers to a decline in the domestic price of foreign currency. These terms
are used in case of floating exchange rate system.

Devaluation takes place when the price of foreign currencies is increased by official
action under a fixed exchange rate system. The opposite of devaluation is revaluation.

International Reserves
They are a sum of funds that a country sets aside to finance trade imbalances or intervene
in the foreign exchange market to strengthen its currency when it comes to face pressure.
In most cases a country’s international reserves consist of its holdings of major foreign
currencies plus its line of credit at the IMF plus its holdings of SDRs.

Types of International Reserves

Gold Standard (1880-1914): Gold is the only international reserve asset. Each country
sets a certain number of units of its currency per ounce of gold, and the composition of
the number of units per ounce from country to country is the exchange rate between
any two countries on the gold standard. Thus it was a fixed exchange rate system. Each
country was ready to buy or sell gold at a particular number of currency units.

Gold Exchange Standard (1944-1971): The US maintained the price of gold fixed at
35$ per ounce, and stayed ready to exchange, on demand, dollars for gold at that price.
Thus the US $ became the central reserve asset. Other economies were assigned par
values in relationship to the US $. It was still a fixed exchange rate system.

Present International Monetary System: In the present international monetary system,

operational from 1971, dollar, or for that matter no currency is convertible into gold in
any country’s central bank. Many of the nations have moved away from the fixed
exchange rate system and adopted the ‘managed float’. Under such a system, a nation’s
monetary authorities are entrusted with the responsibility to intervene in foreign exchange
markets to smooth out short-term fluctuations in exchange rates without affecting the
long–term trends. Therefore the nations still need international reserves to intervene in
the foreign exchange markets to smooth out short-run fluctuations. While such
interventions are still made with foreign exchange, most of planned increase in
international reserves can take place in the form of SDRs.

Special Drawing Rights (SDRs)

SDRs, sometimes called paper gold, are accounting entries in the books of the IMF,
which were conceived at the IMF annual meeting at Rio in 1967. The objective then
was to make SDR the principal reserve asset in the IMS. Upon approval from 85% of
its members the IMF issues SDRs to its member countries who can use them as
international reserves to settle international debt. The IMF voting is weighted in such a
manner that big nations who have larger deposits in the IMF have more clout. Once the
decision to create SDR has been made, the IMF credits each member nation’s account
with its allocation, which is based on a nations importance to world economy.
33
Introduction to There is a limit on the amount of SDRs a creditor nation must accept in settling debts.
International Business
This limit is up to three times their allocation. That is, if one country is allocated 200
SDRs, till it has not accepted up to 600 SDRs as international debt repayment, it cannot
refuse to take SDRs as debt repayment from its debtor countries. SDRs are not backed
by gold or any other currency but represent genuine international reserves created by
the IMF.

Value of SDR: The value of SDR was initially set equal to one US $, but rose above $1
as a result of the devaluation of the dollar in 1971 and 1973. Starting in 1974, the value
of the SDRs was tied to a basket of currencies. At present, it consists of dollar (41.9%),
yen (9.4%), Euro (37.4%) and the pound (11.3%) (Wikipedia)

Uses of SDR: Like any form of international liquidity, they primarily benefit nations
with balance-of-payments deficits. Some economists argue that it is beneficial to the
nations and that SDR creation is one way by which rich nations could help the poor
nations.

Secondly, its value remains more stable than that of any single currency. So it is more
attractive as a unit of denominating international transactions e.g. future payment on a
contract can be agreed to be made in a National currency at its rate in terms of the SDR.
Some Swiss and British banks now accept accounts denominated in SDR’s.

Despite these obvious advantages of SDRs as central reserve assets, there has been, in
general, lack of enthusiasm about them. In 1993, SDR holdings by member countries
are only 4% of their non-gold reserves. The reason is that dollar and other hard currencies
are more flexible and have more uses, usually yield higher interest returns, and can
officially be credited or debited to any one in contrast to the limited numbers with
official access to SDRs.

Activity 3
In the Indian context study the depreciation of Rupee from time to time and attempt the
following questions:

Identify the sections of Indian industry which were most affected globally. Justify.
.................................................................................................................................

.................................................................................................................................

.................................................................................................................................

.................................................................................................................................

.................................................................................................................................

.................................................................................................................................

2.8 SUMMARY
International economics deals with flow of goods, services and payments between
nations, and the policies directed at regulating this flow and the effect of international
transactions on the welfare of nations. Its main components include trade theories,
trade policies, foreign exchange markets and the balance of payments.

International trade theory seeks to answer the basis of trade and the pattern of trade.
There are various theories that seek to explain the basis of international trade and how
nations stand to benefit from it.
34
According to Absolute Advantage Theory, nations mutually stand to gain if they International Trade
Theories and its Business
concentrate on the production of those goods/commodities in which they have absolute
Implications
advantage, that is, in which they are more efficient than other nations. Mutual exchange
of goods between the nations will facilitate the overall world production to the maximum
and each nation will benefit from specialization. The Comparative Advantage Theory
postulates that nations stand to mutually benefit in the exchange of goods between
themselves where each country exports those products in which it is relatively more
efficient in production than other countries. Heckscher-Ohlin Model states that it is not
merely the labour (or cheap labour) as a factor of production, but also several other
factors in which a nation has special or natural advantages/endowments, such as suitable
climate, quality soil, availability of capital or high technology, etc which would determine
its advantage in foreign trade.

International trade policy deals with Tariffs, Non-tariff, Barriers, Import Quotas,
Voluntary Export Restraints, Orderly Market Agreement, etc.

Balance of payments (BoP) of a country is a summary statement of its transactions with

other countries during a defined period. While debit transactions involve payments to
foreigners, credit transactions involve receipts from foreigners. While the Current
Account records exchanges in goods and services, the Capital Account records the net
changes in a nation’s international financial assets and liabilities over the BoP period.

Foreign exchange market consists of individuals, businesses, governments, banks, and

other institutions that buy and sell foreign exchange/currencies and other debt
instruments. Foreign exchange transactions include spot, forward, and currency swap
transactions. Hedging and speculation are some of the ways by which parties involved
in international trade can take care of the risks.

A floating foreign exchange rate is determined by market fundamentals and market

expectations.

International monetary system refers to rules, customs, instruments, and organizations

that affect international payments. The system deals with various types of exchange
rates, peg system, and international reserves.

2.9 KEY WORDS

Absolute Advantage : Advantage arising to a nation from absolute efficiency
in the production of a certain commodity/good.

Comparative Advantage : Advantage arising to a nation from (relative) greater

efficiency in the production of a certain commodity/
good compared to the other nation.

Heckscher-Ohlin Theorem : A postulation that a nation gains by exporting those

goods/commodities in the production of which it has
abundance of factors(s) of production, and by
importing those good/commodities in whose
production it has scarcity of factor(s) of production.

Tariff : A tax on imports, e.g., custom duty.

Non-tariff Barriers : Quantitative restrictions imposed on the volume of

imports, e.g., quotas, voluntary export restraints
(VERs), antidumping restrictions, subsidies, local
content requirements, procurement policies etc.
35
Introduction to Import Quota : A non-tariff barrier that places a direct restriction on
International Business
the quantity of a certain good that can be imported
from a country, e. g., textile quotas (called the
multifibre agreement).

Balance of Payments : A statement that summarizes all payments and receipts

of a nation from transactions with other nations.

Current Account : An account that records exchanges in goods and

services.

Capital Account : An account that records net changes of a nation’s

international financial assets and liabilities over the
BoP period.

Spot Transaction : Purchase and sale of foreign currency at the prevailing

(spot) exchange rate.

Forward transaction : A transaction as a result of an agreement in the present

to buy or sell a certain amount of foreign currency at
the agreed rate at a specified future date.

Hedging : An arrangement entered into to avoid/minimize foreign

exchange risk by buying/selling currency in the present
for use at a future date, i. e., to protect from exchange
rate fluctuations.

Fixed Exchange Rate : An exchange rate fixed officially by the central bank
of a country for converting domestic currency into
foreign currencies.

Floating exchange Rate : An exchange rate that is allowed by the central bank
to adjust so as to equate supply and demand for a
foreign currency.

Peg System : A form of fixed exchange rate where domestic

currency is pegged to some major foreign currency, e.
g., rupee to dollars.

Special Drawing Rights : Drawing rights issued by the IMF to its member
(SDRs) countries for using as international reserves to settle
international debt.

2.10 SELF-ASSESSMENT QUESTIONS

1) Discuss the theory of comparative advantage and compare and contrast it with the
theory of absolute advantage.
2) What are the main instruments of trade policy? Why are ‘tariffs’ thought to be
superior to ‘quotas’?
3) If the balance of payments always balances, how do surpluses and deficits in the
balance of payments arise?
4) What are the major foreign exchange markets in the world? What are the most
common types of foreign exchange transactions?
5) What are foreign exchange risks and how can they be avoided? What is speculation?
Discuss its role.
36
6) How are exchange rates determined in a floating exchange rate system? International Trade
Theories and its Business
7) What are the main types of foreign exchange regimes? Implications

8) Write a short note on SDRs.

2.11 FURTHER READINGS

i) Daniels, D. John; Radebaugh, H. Lee (2000). International Business- Environments
and Operations, New Delhi: Addison Wesley Longman Pte. Ltd. (Chapter 9, 10).

ii) Sundaram, K. Anant; Black, J. Stewart; (2000). The International Business-

Environments, New Delhi: Prentice Hall of India. (Chapter 3, 4, 5, 6).

37
Introduction to
International Business UNIT 3 PROCESS OF GLOBALIZATION

Objectives

After reading this unit you should be able to:

• explain the concept of globalization;
• describe the evolution of globalization in various phases;
• identify the factors which influence the process of globalization;
• describe the importance of industry globalization drivers; and
• explain the strategic implications of global strategy.

Structure

3.1 Introduction
3.2 Concept and Meaning of Globalization
3.3 The Evolution of Globalization
3.4 Effects of Globalization
3.5 Industry Globalization Drivers
3.6 Strategic Implications of Globalization
3.7 Summary
3.8 Key Words
3.9 Self-Assessment Questions
3.10 Further Readings

3.1 INTRODUCTION
Globalization has long been considered similar to internationalization. However,
globalization is a broader concept which extends beyond integration of market and
influences all aspects of international economy. Its evolution can be traced to the
beginning of 19th century and it has developed in different phases to the present times.
It has led to the integration of the world economy which has added an element of
interdependence. The process of globalization deals with the integration of global
economies, global strategies, global industry and global markets. There are certain
globalization identifiers which have been termed as industry globalization drivers. These
include all major industry external drivers which affect the potential for globalization.
Globalization also has strategic implications which are in the form of international
alliances, organizational challenges, Government relations and competition. In this Unit
we will discuss different aspects of globalization.

3.2 CONCEPT AND MEANING OF

GLOBALIZATION
‘Globalization may be hard to define, because the term “globalization” could be defined
from different points of view. Globalization is perhaps the most important force at
work in contemporary society, business, management and economics (Stonehouse

38
et. al., 2004). While some people think of globalization as primarily synonym to global Process of Globalization
business, it is much more than that. Economic globalization has been joined by political
globalization, leading to providing opportunities to respond to globalization challenges.
Technological globalization accelerated the rapid diffusion of free enterprise through
new means of communication. Many new opportunities are coming from advances in
computer technology. E-commerce and Internet are changing many a selling and
purchasing process. The Internet has emerged as a vital tool linking enterprises/firms
internally and externally with customers, strategic partners and critical suppliers. The
computer network expanded technological possibilities of data exchange with 200
countries (Krajewski et.al. 2005). Together, economic, political and technological
globalization has spawned a new phenomenon called psychological globalization which
is defined as deepening relationships and broadening interdependence among people
from different countries (Kluyver et al., 2003; Daniels et al., 2002; Grazina J and
Marija K., Ekonomika 2006).

As per UNESCO globalization can be defined as a set of economic, social, technological,

political and cultural structures and processes arising from the changing character of
production, consumption and trade of goods and assets that comprise the base of the
international political economy.

Globalisation can also be defined as the world-wide spread of production and technology
promoted by unrestricted mobility of capital and freedom of trade. It involves the
interconnection of countries, as well as an increase in the impact of international
situations on all aspects of economic activity. The spread of globalisation has also
resulted in the coming together of disparate cultures, political systems and patterns of
economic development (www.exampleessays.com).

In recent years, globalization has become a key concept/theme in every research or

conference relating to international business/international marketing strategy. Ever since
Levitt’s (1983) article on globalization of markets was published, academics and
practitioners have debated whether international markets are becoming homogenous,
and if the international marketing paradigm ought to change from highlighting national
differences to exploring international similarities. In the field of management, the term
globalization has often been used interchangeably with internationalization.

For managers, globalization is not only a curiosity, but also an actuality that has to be
dealt with on a daily basis. Managers, like scholars, however, are also diverse in their
thinking and attitudes toward globalization. Christopher Rodriguez, the then CEO of
Thomas Cook Group, views globalization in a very narrow way as “running a global
business from a global center.” Similarly, Richard Grasso, the then Chairman and CEO
of the New York Stock Exchange, treats globalization as an economic trend: “Global
markets when they are realized in their entirety, are the ultimate result of a trend now
under way … called globalization.”

Percy Barnevik, CEO of Asia Brown Boveri, goes further in his view of globalization:
“What I mean by globalization is not only that you export to other markets and compete
with people there - but also that you have a presence in [product] development and
indeed, in manufacturing in many markets”. Harry Stonecipher, President and CEO of
McDonnell Douglas, views globalization as “the whole movement toward a single world
economy and a single world society.” Previously, Edwin Artzt, Chairman and
CEO, P&G, provided a more comprehensive definition of globalization in the business
world:

39
Introduction to Globalization means doing a better job than your competitors at
International Business
satisfying consumers’ needs and their demand for quality, no matter
where they live. It means creating the network and infrastructure to
efficiently compete in the increasingly homogeneous worldwide
marketplace. Globalization has special meaning to Procter & Gamble.
It means that we will continue to change from a United States-based
business that sells some of its products in international markets to a
truly world company. A company that thinks of everything it does -
including the development of products – in terms of the entire world.

Keeping in view the various interpretations discussed in the preceding paragraphs,

globalization may be defined as a process which is built on the collective understanding
of the need to establish a world community that is prosperous and tolerant, and on the
respect for and equitable treatment of people across the globe. It is a process that enhances
and strengthens global understanding and improves the quality and effectiveness of
business, professional, and personal interactions through unrestricted access to world
commodities, technology, and information. Thus, globalization can be defined as a set
of beliefs that foster a sense of connectivity, interdependence, and integration in the
world community. It highlights commonalties without overlooking differences, and it
extends benefits and responsibilities on a global scale. At the firm level, globalization
should mean the ability of a corporation to conduct business across borders in an open
market, maximizing organizational benefits, without inflicting social damage or violating
the rights of people from other cultures.

In today’s business environment, global corporations stress objectivity in the treatment

of issues across the globe and have the courage to confront biases and prejudices. They
should not behave like a “colonial entity” that is interested only in making profits and
reinvesting them in the “home market.” Global corporations should treat globalization
as a view and outlook that broadens and energizes human minds and perspectives.
Practically and spiritually, globalization must be an inclusive, rather than an exclusive,
endeavor.

Globalization reflects the growth of economic activities spanning politically defined

national and regional boundaries. The firms in globalization aim at the ‘world’ market
and do not restrict themselves to the country or regional markets; they aim at developing
products for the whole world, i.e., global products which can be standardized across
the world to reap the benefits of economies of scale in production and marketing. It
leads to increased movement of goods and services, namely trade and investment, and
often of people via migration across the boundaries. It is driven by the actions of
individual economic actors – firms, banks, people – usually in the pursuit of profit and
often spurred by the pressures of competition. Thus, globalization looks at the world as
a whole and considers it as a single unified market. It often involves the creation of a
single strategy for a product or service by a company for the entire global market. It
encompasses many markets or countries simultaneously and is aimed at leveraging the
commonalities across many markets.

According to Theodore Leavitt (1983), the emergence of global markets has come up
because of advances in technology, communication, transport, etc. The global
corporations are geared to what he calls ‘the new reality’. These firms attempt to benefit
from enormous economies of scale in production, distribution, marketing and
management which can result in reduced prices for consumers all over the world. A
firm that is involved in global business is a global firm and is often characterized by
standardized products, specialized activities like R&D performed usually at the
headquarters, uniform market positioning, and an integrated competitive strategy across
the markets in the world.
40
A word of caution is in order. Though a global firm usually aims at standardization as a Process of Globalization
part of its corporate philosophy, however, in implementing such a strategy, firms are
careful and selective in their approach and recognize their limitations. Few companies
pursue the extreme position of complete standardization in regard to all the elements of
the marketing mix and business functions such as R&D, manufacturing and procurement
in countries throughout the world. Some degree of adaptation is likely to occur relative
to certain aspects of the firm’s operations or in certain geographic areas. In addition,
the feasibility of implementing a standardization strategy will depend on certain factors
which can be categorized into four major groups: market characteristics, industry
conditions, marketing institutions, and legal restrictions.

Having discussed the concept of globalization in sufficient detail, we now turn our
attention to another aspect, i.e., the origin and evolution of globalization.

Activity 1
Identify two firms which have expanded their operations from domestic to global market
and analyze how they have gained due to globalization.

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3.3 THE EVOLUTION OF GLOBALIZATION

Origin of Globalization
Globalization is the process which was completed in the 20th century when the Capitalist
world system had spread across the globe. Globalization is not a new phenomenon as
the world system has maintained some of its main features over several centuries. In
the beginning of 14th century modern world system originated in parts of Western Europe
which was experiencing long term crisis of feudalism. This paved the way to the rise of
market institutions and technological innovation. Europeans reached other parts of globe
through the long-distance trade and advances in production. Accumulation of wealth
took place in Europe as a result of superior military strength and improved means of
transportation which further facilitated in establishing economic ties.

During 16th century a process of colonization has started in which colonies provided
unskilled labour, raw material and market for goods while capital intensive production
was the prerogative of the Europeans who acted as capitalists. The Capitalists thus
succeeded in geographic and occupational division of labour.’ (Source:
www.sociology.emory.edu/globalization/theories01.html)

Stages of Globalization
There are various stages of globalization.

Cavusgil et. al., (2009) have identified four distinct stages of globalization beginning
the 1800s. Each stage of the evolution is marked by changes in technological innovations
and international trends.

41
Introduction to The first stage of globalization which started in 1830 became more stabilized by 1880.
International Business
This period was marked by the growth of global business due to development of railroads,
ocean transport, manufacturing and trading companies. Telegraph and telephone were
newly invented which gave further impetus to information flows between nations and
facilitated the management of supply chains by the companies.

The second stage of globalization which started around 1900 was marked by the increase
in electricity and steel production. This stage of globalization reached its climax during
the Great Depression of 1929. Western Europe was the most industrially developed
region of the world in 1900. Multinational firms were established as a result of European
colonization of Asia, Middle East and Africa. Companies like Seimens, Nestle,
Shell and British Petroleum had established their subsidiaries in various parts of the
world. Before 1914 (First World War), many companies were established at the global
level.

The third stage of globalization started around 1945 after World War II when Europe
and Japan were devastated by war and USA emerged as a dominant power. During the
war the trade barriers were high. Soon the developed countries wished to lessen the
barriers to international trade. This led to Bretton Woods Conference of 1947 in which
23 countries participated and culminated in the setting up of General Agreement on
Tariffs and Trade (GATT) which sought to liberalize trade and investment by reducing
barriers. This gave impetus to industrialization, modernization and improving the
standard of living. GATT was subsequently replaced by another multilateral agency,
that is, World Trade Organization (WTO) which was also established to regulate
international trade and investment and to introduce equity and fairness in global
exchange. To further facilitate international co-operation, two international organizations
- International Monetary Fund and World Bank - were set up. This was followed by the
rise of multinational corporations (MNC’s) like Coco-Cola, Philips and IBM who
established their global presence by the virtue of technological and competitive
advantages and started outsourcing their business to developing countries to reap the
benefits of cheap labour and easy access to wide markets.

By 1960’s the increase in the process of liberalization by removing trade barriers and
currency controls led to increase in international trade and investment and integrated
international financial markets. This was followed by increasing competition between
US, European and Japanese MNCs.

1980s marked the beginning of the fourth and present stage of globalization which
experienced increasing global trade and investment. This stage witnessed use of
computer, Internet, and development of information and communication technologies.
This period saw the disintegration of Soviet Union, emergence of market economies of
Europe and development of countries like China, Brazil, India and Mexico. Technological
advancements in transportation, information and communication led to integration of
world economy and also facilitated development of services like insurance, banking,
entertainment, retailing and tourism. This was followed by strategic alliances like mergers
and acquisitions among corporate units and the world came to be known as a ‘global
village’.

The four stages of globalization, with their triggers and key characteristics are presented
in Table 3.1.

42
 Table 3.1: Stages of Globalization Process of Globalization

Stages of Period Triggers Key Characteristics

Globalization

First Stage 1830 to late Introduction of Rise of manufacturing, cross-

1800s, railroads and ocean border trade of commodities,
peaking in transport largely by trading companies
1880

Second Stage 1900 to Rise of electricity Emergence and dominance of

1930 and steel production early multinational enterprises
(primarily European and North
American) in manufacturing,
extractive, and agricultural
industries

Third Stage 1948 to Formation of Concerted effort on the part of

1970s General Agreement industrializing Western
on Tariff and Trade countries to gradually reduce
(GATT); End of barriers to trade; rise of
World War II; multinational companies from
Marshall Plan to Japan; cross-border flow of
reconstruct Europe money paralleling the
development of global capital
markets.

Fourth Stage 1980s to the Radical advances in Unprecedented rate of growth

present information, in cross-border trade of
communication, products, services, and capital;
manufacturing, and participation in international
consultation business of small and large
technologies; companies by investors from
privatization of many companies; focus on
state-owned emerging markets for export,
enterprises in FDI, and sourcing activities.
developing
countries;
remarkable
economic growth in
emerging markets

Source: Cavusgil S.T, Knight G., Riesenberger J.R (2009), International Business: Strategy, Management
and the new Realities, Pearson.

Now you have a fair idea of how present day globalization evolved. We shall now
briefly discuss the effects of globalization.

3.4 EFFECTS OF GLOBALIZATION

In Section 3.2 we have examined several definitions of globalization given by various
thinkers. You might have noted a common feature of the definitions by these thinkers
who regard globalization as a process of increasing the economic, political, cultural
and technological interdependence among nations and countries. Globalization is a
process by which there is an increase in inter-connection and dependence between
43
Introduction to nations, people and businesses through greater cross-country mobility, communication
International Business
and cross-cultural exchanges. Thus globalization process has given impetus to greater
global production and distribution of products and services of a homogeneous kind on
a world-wide basis. Now we can demarcate the separate areas of the effects of the
process of globalization. These areas of effects of globalization are as follows:

1) Integration of Economies: This is due to the increase in interdependence between

countries on a world-wide basis.

2) Integration of Strategy: A global strategy would require establishing the brand

name and products in prominent markets world wide, in order to reap the benefits
of competitive advantage. This further facilitates integration of global vision,
business strategy and business activities throughout the world.

3) Integration of Industries: This facilitates the increase in integration of production

activity and distribution of value added goods world wide on the basis of competitive
advantage enjoyed. Global industries are interdependent industries which enjoy
location advantages by virtue of their presence in host, parent or third world
countries.

4) Integration of Markets: The name and brand of products are popularly known in
various markets. This has created homogeneity in tastes and liking of end users for
a product in specific markets.

The process of globalization integrates global economies, global strategy, global

industries, global markets, global drivers and global players in order to create
organizations for global environment. It has created integration of services, resources
and products thus creating a boundary-less environment (Grazina J., Marija K., 2006).

3.5 INDUSTRY GLOBALIZATION DRIVERS

An industry globalizes because of the occurrence of certain factors. From that standpoint
every industry cannot be a global one. There are certain drivers which determine the
potential for industry globalization.

There are four broad groups of industry globalization drivers – Market, Cost,
Government and Competition (Table-3.2). Together, these four sets of drivers cover
all the major critical industry conditions that affect the potential for globalization. The
drivers are primarily uncontrollable by the worldwide business. Each industry has a
level of globalization potential that is determined by these external drivers.

Table 3.2: Industry Globalization Drivers

Market Drivers Cost/ Economic Drivers

• Convergence of lifestyles & tastes • Continuing push for economies of
scale
• Increased travel creating global
consumer • Accelerating technological
innovation
• Growth of global and regional channels
• Advances in transportation
• Establishment of world brands
• Emergence of Newly Industrialized
• Push to develop global advertising Countries (NICs)
• Shortening product life cycle • Increasing cost of product
development

44
 Process of Globalization
Government Drivers Competitive Drivers
• Reduction of tariff barriers • Increase in level of world trade
• Creation of trading blocks • Increase in foreign acquisition of
corporations
• Decline in role of government
• Companies becoming globally centered
• Reduction in non-tariff barriers
• Increased formation of global strategic
• Shift in open market economies
alliances
• Globalization of financial markets

Source: Yip, G.S. (1992). Total Global Strategy: Managing for Worldwide Competitive Advantage.
Englewood Cliffs, NJ: Prentice Hall.

Proponents of global marketing argue that because market needs are homogenous,
country differences are less relevant to international marketing planning. Yet, others
assert that the existence of global markets is a “myth”. They point to the many
contradictory trends around the world, suggesting stark differences in national markets
and hence the need for adaptation and customization of international marketing, based
on individual country differences.

The removal of trade barriers and the growing similarity of national markets created
the potential for globalization of markets and competition. The development of MNCs,
or of global networks allying independent firms, and the technology of cheap, effective
transportation and communication provided the practical means necessary for the
integration of supply. These conditions were necessary, but not sufficient. Intense
competition in most industries was the driving force necessary for integration and
globalization.

A discussion on globalization (for example, Cavusgil and Zou, 1994) has shifted the
attention to a more fundamental issue: the underlying motives of the firm. Jain (1989)
asserts that strategy adaptation (versus globalization) is the means to an end - the
establishment of a firm’s economic assets and competitive position in the marketplace.
The fundamental question is ‘when a firm operates in an overseas market, what are its
ultimate objectives?’ The need to broaden the discussion to include the firm’s strategic
perspective in this debate has been articulated by several authors (e.g., Walters; Douglas
and Craig; and Szymanski, Bhardwaj and Vardarajan).

Until recently, studies have treated a firm’s choice of its global or local strategy, as the
outcome variable, that is the result of a firm’s marketing plan. Recent studies have
expanded this limited scope, to study how global or local strategies affect the overall
position of the firm. Douglas and Wind and Jain point out that one key payoff of the
decision on globalization and adaptation is the competitive advantage of the firm. While
discussing alternative product policy options for firms, Walters and Toyne, emphasize
the need to evaluate such options in the context of the competitive strategy of the firm.

The following four factors affect a company’s ability to formulate and implement global
strategy:

• Organization structure comprises the reporting relationships in a business - the

‘boxes and lines’.
• Management process comprises the activities such as planning and budgeting
that make the business run.
• People comprise the human resources of the worldwide business and include both
managers and all other employees. 45
Introduction to • Culture comprises the values and unwritten rules that guide behavior in a
International Business
corporation.

Figure 3.1 elaborates the above factors further. The figure gives an overview about the
external drives of industry potential for global strategy.

Market Factors

Potential for
Economic Global Environmental
Factors Strategy Factors

Competitive Factors

Figure 3.1: External Drivers of Industry Potential for Globalization

The potential for global strategy include following four factors:

• Market Factors: These include the homogenous market needs, the global
customers/consumers, transferable brands and promotional strategies and
internationalization of the distribution channels. These factors affect the
competitiveness of the industry.
• Economic Factors: These factors include the global economies of scale in
manufacturing and distribution, world wide sourcing efficiencies and significant
differences in country costs.
• Environmental Factors: The factors like falling transportation costs, improved
networking thereby improving the communication, changes in government policies
and frequent technological advances act as external drivers for the industry.
• Competitive Factors: The factors like competitive interdependence among
countries, global moves of competitors and the prevailing opportunities to pre-
empt the global moves of the competitors work as an aid for developing a global
strategy.
Besides these, to become globally competitive, the company needs to focus on the
following:
• Developing a marketing plan with universal appeal.
• Help employees understand the company’s global vision.
• Learning from mistakes that others have made in the past.
• Select the right partners for joint ventures overseas.
Activity 2
Identify a MNC of your choice and analyze the factors which helped it to formulate its
market plan and select partners for joint ventures.
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46
 Process of Globalization
3.6 STRATEGIC IMPLICATIONS OF
GLOBALIZATION
As pattern of international competition shifts towards globalization, there are many
implications for strategy formulation. In a global industry, functions of finance,
marketing, business and Government relationship change according to global
configuration and coordination.

a) International Alliances: International alliance is an implication of globalization.

International coalition, linking firms of the same industry based in different countries
have become an even more important part of global strategy.

b) Organizational Challenges : The need to configure and co-ordinate globally in

complex ways creates some obvious organizational challenges such as
organizational structure, reporting hierarchies, communication linkages and reward
mechanisms.

c) Relations with Government: In the globalized era, the selection of foreign markets
to enter and the mode of entry will, by and large, depend on the negotiations with
the foreign Government. The ‘muscle power’ of the global firm can be crucial in
determining the shift of power equilibrium. A global firm must ‘manage’ its
relationship with the foreign Government to its advantage. A shining example of
what happens if it fails to do so is Enron in India.

d) Competition: A global firm may be in a better position to compete with its global
rivals as it can augment its resources globally.

These implications of globalization will lead companies to take care of these issues
forcing them to formulate an appropriate strategy to handle them. Levitt (1983) has
given an illustration of various forces affecting global integration. These are summarized
in table 3.2.

Table 3.2: Forces Affecting Global Integration

Global Integration

Driving Forces (Drivers) Restraining Forces

Technology Culture
Culture Market Differences
Market needs Costs
Costs National Controls
Free Markets Nationalism
Economic Integration War
Peace Management Myopia
Management Vision Organization History
Strategic Intent Domestic Forces
Global Strategy and Action

The remarkable growth of the global economy over the past 50 years has been shaped
by the dynamic interplay of various driving and restraining forces. During most of
those decades, companies from different parts of the world in different industries
achieved great success by using global strategies. During the 1990s, changes in the
47
Introduction to business environment have presented a number of challenges to established ways of
International Business
doing business. Today, the growing importance of global business stems from the fact
that driving forces have more momentum than the restraining forces.

It is, however, important to recognize that in the near future financial and trade activities
will still be the dominant forces and features of globalization. Nevertheless, it is essential
to point out that trade is only one of the myriad of worldwide activities related to
globalization. Free movement of capital, goods, and labour and the establishment of a
civil society, where cultural and political tolerances are the norms, are the foundations
for true globalization.

3.7 SUMMARY
To sum up, the pillars of globalization are open trade and vital civil and legal institutions
that uphold individual and group rights while facilitating social and economic integration.
The benefits of international trade are numerous, e.g., job creation, improving customer
welfare, stimulating economic growth, and so on. Nevertheless, limiting globalization
only to trade and the profits associated with increasing trade volumes does not do
justice to growing beliefs and practices that aim at establishing a prosperous and stable
world. In other words, globalization cannot just be synonymous to trade volume and
export profits. It is an orientation that seeks to enhance and strengthen global
understanding and effective business, professional, and personal interactions. The focus
on trade volume and on export limits the ability and capacity of people to become
involved in activities that release energy and stimulate global thinking and behavior. In
addition, focusing on trade volume alone may prevent individuals and organizations
alike from moving forward in advancing causes and programs that are not profit-oriented.
While it is a misjudgment to discount the importance of profit-oriented activities in
furthering globalization aims, it is equally a mistake to disregard non-business activities.
These activities are expected to be crucial for strengthening global thinking and practice
in the decades to come.

3.8 KEY WORDS

Globalization : Globalization can be defined as the growth of economic
activity spanning politically defined national and regional
boundaries. It leads to the increased movement of goods
and services across boundaries, namely, trade and
investment, often of people via migration. It is driven by
the actions of individual economic actors – firms, banks,
and people – usually in the pursuit of profit and often
spurred by the pressures of competition.
Strategy : Actions managers take to attain the firm’s goals during a
particular period.
Standardization : As a policy, a MNE offers standardized, that is, same
marketing-mix (product, price, promotion and place)
across all the markets that it operates all over the world. It
considers world as a single market and hence offers
identical marketing-mix all over.
Adaptation Policy : Adaptation policy suggests that the country markets are
different due to socio-cultural, economic, political and
legal environmental forces. Hence, a firm must offer
differentiated marketing-mix as per the specific
48 requirements of the country market that it operates in.
 Process of Globalization
3.9 SELF-ASSESSMENT QUESTIONS
1) Define globalization in your own words.
2) Discuss the different stages of globalization and give two examples for each stage
that facilitated the process of globalization.
3) What have been the effects of globalization? Explain with examples.
4) “A global shampoo company should make a global shampoo, a global automobile
company should make a global car and a global tractor company should make a
global tractor”. Do you agree with this statement? Why or why not? Discuss in
terms of globalization.
5) What forces have been driving the development of globalization? Discuss.
6) How do global products, functional area and customer approaches to organizations
differ? How are they similar? Explain in relation to the industry globalization drivers.
7) What are the strategic implications of globalization? Discuss by citing a recent
example.
8) What are the main challenges that are faced by international managers in managing
and controlling a global business activity? What advice would you like to give to a
manager who is involved with global operations?

3.10 FURTHER READINGS

Cavusgil S. Tamer, Gary Knight, John R. Riesenberger (2009) International Business:
Strategy, Management, and the new realities. Pearson

Cavusgil, S. Tamer and Shaoming Zou (1994). Marketing Strategy-Performance

Relationship: An Investigation of the Empirical Link in Export Market Ventures, Journal
of Marketing, 58, (January), 1-21.

Czinkota, Michael R. and Ikko A. Ronkainen (1998). International Marketing. Fort

Worth, TX: Dryden Press.

Daniels, D.J., Radebaugh, L.H., Sullivan, D.P. (2002) Globalization and business.
Prentice Hall.

Food for thought, Thought for Action. Internet: http://www.unesco.org/most/

globalisation/Introduction.htm

Globalization Drivers and their Impact on Lithunian Economic Growth and Development
Grazina Jatuliaviciene, Marija Kucinskiene, ISSN 1392-1258 Ekonomika (2006).
Internet http://www.leidykla.eu/fileadmin/Ekonomika/73/Grazina_Jatuliaviciene__
Marija_Kucinskiene.pdf

The Globaliszation Website: Globalization Theories, World System Theory, Synopsis.

Internet

http://www.sociology.emory.edu/globalization/theories01.html
Internet : http://www.exampleessays.com/viewpaper/36306.html
Jain, Subhash C. (1989). Standardization of International Marketing Strategy: Some
Research Hypotheses, Journal of Marketing, 53, (January), 70-79.

Kluyver, C.A., Pearce, J. (2003). Strategy. A View from the Top. Prentice Hall.

49
Introduction to Krajewski, L.J., Ritman, L.P. (2005). Operations Management. Processes and Value
International Business
chains. Seventh ed. Pearson Prentice Hall

Levitt, T (1983). The Globalization of Markets, Harvard Business Review, (May-June),

92-102.

Onkvisit, Sak and John J. Shaw (1987). Standardized International Advertising: A Review
and Critical Evaluation of the Theoretical and Empirical Evidence, Columbia Journal
of World Business, 22, Fall: 43-55.

Onkvisit, Sak and John J. Shaw (1990). Global Advertising : Revolution or Myopia?
Journal of International Consumer Marketing, 2(3), 97-111.

Rugman, A. (1997). Canada. In J. Dunning (Ed.), Government, Globalization, and

International Business (pp.175-202). Oxford: Oxford University Press.

Rugman Alan M. (2001). The Myth of Global Strategy, International Marketing Review:
583 – 588.

Stonehouse, G., Campbell, D., Hamil, J., Purdie, T. (2004). Global and Transnational
Business: Strategy and Management. John Wiley and Sons, Ltd.

Szymanski, David M., Sundar G. Bharadwaj, and P. Rajan Varadarajan, (1993).

Standardization Versus Adaptation of International Marketing Strategy: An Empirical
Investigation, Journal of Marketing, 57, (October), 1-17.

Yip, George S., Pierre M. Loewe, Michael Y. Yoshino (1988). How to Take Your
Company to the Global Market. Columbia Journal of World Business (Winter 88): 37-
48.

Yip, G.S. (1992). Total Global Strategy: Managing for Worldwide Competitive
Advantage. Englewood Cliffs, NJ: Prentice Hall.

50