BCom IB Year 2 International Business Environment Semester 2 January 2021

Bachelor of Commerce
in International Business
INTERNATIONAL BUSINESS
ENVIRONMENT
Module Guide
Copyright © 2021
MANCOSA
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Bachelor of Commerce
in International Business
INTERNATIONAL BUSINESS ENVIRONMENT
List of Contents........................................................................................................................................ 1
Preface .................................................................................................................................................... 2
Unit 1: International Business and Globalisation................................................................................... 9
Unit 2: National Differences in Political, Economic and Legal Systems .............................................. 23
Unit 3: International Trade Theory ...................................................................................................... 33
Unit 4: Government Policy and International Trade ............................................................................ 47
Unit 5: Foreign Direct Investments...................................................................................................... 60
Unit 6: The Foreign Exchange Market ................................................................................................ 75
Unit 7: Exporting, Importing and Countertrade ................................................................................... 87
Bibliography ......................................................................................................................................... 108
i
International Business Environment
List of Contents
List of Tables
Table: 3.1 Unit of output per person at work ..................................................................................................... 38
Table 4.1 Summary of the key effects of an import quota................................................................................. 52
Table 6.1: Value of the U.S. Dollar Against Other Currencies, February 11, 2011 ........................................... 79
List of Figures
Figure 3.1 International Product Life Cycle ....................................................................................................... 41
1 MANCOSA – Bachelor of Commerce in International Business

Preface
A. Welcome
Dear Student
It is a great pleasure to welcome you to International Business Environment (IBE6). To make sure that you
share our passion about this area of study, we encourage you to read this overview thoroughly. Refer to it as often
as you need to, since it will certainly make studying this module a lot easier. The intention of this module is to
develop both your confidence and proficiency in this module.
The field of International Business Environment is extremely dynamic and challenging. The learning content,
activities and self- study questions contained in this guide will therefore provide you with opportunities to explore
the latest developments in this field and help you to discover the field of trade as it is practiced today.
This is a distance-learning module. Since you do not have a tutor standing next to you while you study, you need
to apply self-discipline. You will have the opportunity to collaborate with each other via social media tools. Your
study skills will include self-direction and responsibility. However, you will gain a lot from the experience! These
study skills will contribute to your life skills, which will help you to succeed in all areas of life.
We hope you enjoy the module.
MANCOSA does not own or purport to own, unless explicitly stated otherwise, any intellectual property
rights in or to multimedia used or provided in this module guide. Such multimedia is copyrighted by the
respective creators thereto and used by MANCOSA for educational purposes only. Should you wish to use
copyrighted material from this guide for purposes of your own that extend beyond fair dealing/use, you
must obtain permission from the copyright owner.
MANCOSA – Bachelor of Commerce in International Business 2

B. Module Overview
The purpose of this module is to introduce students to theory supporting how trade is conducted in an international
business environment. This module will introduce students to global economic theory by exploring how the themes
of continuity and change, formulate global theory. Historic events which assisted with the evolution of global politics
will be explored to assist students in formulating a link between past events and their impact on current events
relating to international trade. Finally, this module will assist students in identifying and analysing key developments
in global politics and describe major trends shaping the world today. The module is a 15 credit module at NQF
level 6
Exercises
Throughout this Module you will find exercises and think points with which you need to engage.
The purpose of these exercises and think points are to:
 Develop your critical and reflective thinking abilities
 Provide you with opportunities to apply your knowledge
 Assess what you have learnt
 Encourage you to read wider
 Develop your understanding of international trade
C. Exit Level Outcomes and Associated Assessment Criteria of the Programme

Exit Level Outcomes Associated Assessment Criteria
 Understand the role of management  The role of management and leadership in business is
and leadership in multinational described to understand international organisational
organisational success; success
 Employ integrated knowledge to solve  Integrated knowledge is applied on management theory
complex problems in an organisation; to exhibit practical context of international business
 Demonstrate an understanding of  Intercultural behaviour and sensitivity is explained to
intercultural behaviour and sensitivity; demonstrate methods of research used and its relation
to theory
 Understand the key aspects of  Globalization aspects are described to practice proper
globalisation so as to manage balance between theory and practice and its relevance
multinational organisations; to the level of international business
 Understand the interdependence of  Interdependency of multinational organisations is
multinational organisations; identified to outline the need for businesses partnerships

 Display an understanding of marketing,  Marketing, finance, supply chain, politics and law
finance, supply chain, politics and law principles and practices are demonstrated in an
principles and practices; international business concept to facilitate business
processes at different business settings
 Assess problems in organisations and  Assessment of problems is undertaken to probe causes
propose viable solutions; of business challenges and possibly propose viable
solutions
 Demonstrate an appreciation and  Ethics, accountability and corporate social responsibility
understanding of ethics, accountability in an international business environment is
and corporate social responsibility; demonstrated to emphasise the importance of
respectable employee behaviour
 Apply the concepts of economics and  Economics and Data analysis concepts are applied to
data analysis to process information for process information for decision making
decision making.
D. Learning Outcomes and Associated Assessment Criteria of the Module

LEARNING OUTCOMES OF THE MODULE ASSOCIATED ASSESSMENT CRITERIA OF THE MODULE
 Understand the themes of continuity and  Themes of continuity and change are analysed to
change; understand how these themes are applied to establish
a framework for global theory and politics
 Different world views are applied to understand
economic events in global theory
 Impact of the drivers of globalization are classified to
understand their impact on global business.
 Changing demographics of the global market are
interpreted to understand its impact on the global
economy.
 Understand global politics through a  National differences in political, economic and legal
historic approach; systems are compared to understand how past policy has
impacted the present.
 National differences in economic development and the
nature of economic transformation are analysed to
interpret its impact on the formation of global economic
policy.
 Cultural differences and their impact on globalization are

evaluated to form a framework for the development of

global economic policy
 Formulate the link between the past and  International trade theory is summarised to understand its
the present; impact on the pattern of international trade.
 Instruments of trade policy are applied to understand how
government economic policy is developed
 Current trends regarding foreign direct investments are
analysed to understand benefits and costs of foreign
direct investments to home and host countries
 Identify key developments in global  Functions of the foreign exchange market and the impact
politics; of economic theories on the exchange market are
applied in exchange rate forecasting to understand the
implications for international business on exchange rate
movements.
 Describe major trends shaping the world  Exporting, importing and countertrade philosophies are
today and understand the levels of applied to develop global strategy
analysis
E. Learning Outcomes of the Units

You will find the Unit Learning Outcomes on the introductory pages of each Unit in the Module Guide. The Unit
Learning Outcomes lists an overview of the areas you must demonstrate knowledge in and the practical skills you
must be able to achieve at the end of each Unit lesson in the Module Guide.
F. How to Use this Module

This Module Guide was compiled to help you work through your units and textbook for this module, by breaking
your studies into manageable parts. The Module Guide gives you extra theory and explanations where necessary,
and so enables you to get the most from your module.
The purpose of the Module Guide is to allow you the opportunity to integrate the theoretical concepts from the
prescribed textbook and recommended readings. We suggest that you briefly skim read through the entire guide
to get an overview of its contents. At the beginning of each Unit, you will find a list of Learning Outcomes and
Associated Assessment Criteria. This outlines the main points that you should understand when you have
completed the Unit/s. Do not attempt to read and study everything at once. Each study session should be 90
minutes without a break

This module should be studied using the prescribed and recommended textbooks/readings and the relevant
sections of this Module Guide. You must read about the topic that you intend to study in the appropriate section
before you start reading the textbook in detail. Ensure that you make your own notes as you work through both the
textbook and this module. In the event that you do not have the prescribed and recommended textbooks/readings,
you must make use of any other source that deals with the sections in this module. If you want to do further reading,
and want to obtain publications that were used as source documents when we wrote this guide, you should look
at the reference list and the bibliography at the end of the Module Guide.
G. Study Material
The study material for this module includes tutorial letters, programme handbook, this Module Guide, a list of
prescribed and recommended textbooks/readings which may be supplemented by additional readings.
H. Prescribed and Recommended Textbook/Readings

The prescribed and recommended readings/textbooks presents a tremendous amount of material in a simple,
easy-to-learn format. You should read ahead during your course. Make a point of it to re-read the learning content
in your module textbook. This will increase your retention of important concepts and skills. You may wish to read
more widely than just the Module Guide and the prescribed and recommended textbooks/readings, the
Bibliography and Reference list provides you with additional reading.
The prescribed and recommended textbooks/readings for this module is:

Prescribed Reading/Textbook
 Hill, C. W. L and Hult, G.T.M (2017) International business completing in the global marketplace.
11th Edition. United States of America: McGraw. Hill Education international edition
Recommended Readings
 Daniels, J.D. Radebaugh, L.H. Sullivan, D.P (2019) International business environments and
operations. 16th edition. Global Edition: Pearson
 Cavusgil, S.T. Knight, G. Riesenberger, J. (2017) International Business the new realities.4th edition.
Global Edition. Pearson.

I. Special Features
In the Module Guide, you will find the following icons together with a description. These are designed to help you
study. It is imperative that you work through them as they also provide guidelines for examination purposes.
Special Feature Icon Explanation
The Learning Outcomes indicate aspects of the particular Unit you have
LEARNING to master.
OUTCOMES
The Associated Assessment Criteria is the evaluation of the students’

ASSOCIATED
understanding which are aligned to the outcomes. The Associated
ASSESSMENT
Assessment Criteria sets the standard for the successful demonstration
CRITERIA
of the understanding of a concept or skill.
A Think Point asks you to stop and think about an issue. Sometimes you
THINK POINT are asked to apply a concept to your own experience or to think of an
example.
You may come across Activities that ask you to carry out specific tasks.
In most cases, there are no right or wrong answers to these activities.
ACTIVITY
The purpose of the activities is to give you an opportunity to apply what
you have learned.
At this point, you should read the references supplied. If you are unable
READINGS to acquire the suggested readings, then you are welcome to consult any
current source that deals with the subject.
PRACTICAL Practical Application or Examples will be discussed to enhance
APPLICATION understanding of this module.
OR EXAMPLES
KNOWLEDGE You may come across Knowledge Check Questions at the end of each
CHECK Unit in the form of Knowledge Check Questions (KCQ’s) that will test
QUESTIONS your knowledge. You should refer to the Module Guide or your
textbook(s) for the answers.
You may come across Revision Questions that test your understanding
REVISION
of what you have learned so far. These may be attempted with the aid
QUESTIONS
of your textbooks, journal articles and Module Guide.

Case Studies are included in different sections in this Module Guide.
CASE STUDY This activity provides students with the opportunity to apply theory to
practice.
You may come across links to Videos Activities as well as instructions
VIDEO ACTIVITY on activities to attend to after watching the video.

Unit
1: International Business
and Globalisation

Unit Learning Outcomes
CONTENT LIST LEARNING OUTCOMES OF THIS UNIT:
1.1 Introduction  Introduce topic areas for the unit
1.2 Globalization, International Business  Explain how globalization and international business relate to
and their relationship each other and why their study is important
1.3 The forces driving globalization and  Understand the forces driving globalization and International
IB Business
1.4. The criticisms of globalization  Explain the major criticisms of globalization
1.5. Why companies engage in IB  Explain the major reasons why companies seek to create value
by engaging in IB
 Explain the changing nature of the global economy
Prescribed and Recommended Textbooks/Readings
Prescribed Textbook:
 Hill, C. W. L and Hult, G.T.M (2017) International business completing
in the global marketplace. 11th Edition. United States of America:
McGraw. Hill Education international edition
Recommended Reading:
 Daniels, J.D. Radebaugh, L.H. Sullivan, D.P (2019) International
business environments and operations. 16th edition. Global Edition:
Pearson

1.1 Introduction
Over the past decades we have moved away from nations being self-sufficient, and isolated from each other by
trade barriers. And we are moving towards a world in which barriers to cross-border trade and investment are
declining. This process is referred to as globalisation.
Globalization refers to the widening set of interdependent relationships among people from different parts of a
world that happens to be divided into nations (Hill and Hult: 2017). The term sometimes refers to the elimination of
barriers to international movements of goods, services, capital, technology, and people that influence the
integration of world economies.
International business consists of all commercial transactions between two or more countries.
International Business (IB) is a mechanism to bring about globalization. International business consists of all
commercial transactions—including sales, investments, and transportation—that take place between two or more
countries Increasingly foreign countries are a source of both production and sales for domestic companies
Think Point
Learners are required to try and answer the questions set below.
Since waking up this morning, you have most likely consumed a series of different
products. Try and remember these products. Perhaps make a list of all the products you
have consumed today. You would have most likely consumed at least some of the
following products. Ask yourself where did these products originate from – that is the
product’s country of origin?
Product Country of origin

Tooth paste
Shampoo
Breakfast cereal
IPad/ I pod
Television
Motor vehicle
Computer
Cell phone

1. Having done the exercise, do you think that globalisation is on the increase or decrease?
2. What do you think are some of the impacts of globalisation?
The proliferation of globalisation in modern society makes is a key area of debate amongst economists. In
assessing the impacts of globalisation, observers look at the benefits and weaknesses of globalisation on modern
society. You are required to read all the prescribed literature, as well as other literature regarding the impacts of
globalisation and be able to provide a comprehensive overview of the benefits and weaknesses emanating from
globalisation. Listed below is a synthesis of some of the key impacts of globalisation.
1.2 Globalization, International Business and their relationship

According to Daniels, Radebaugh, and Sullivan (2019), globalization enables us to get more variety, better quality,
or lower prices. Our daily meals contain spices that aren’t grown domestically and fresh produce that’s out of
season in one local climate or another. Our cars cost less than they would if all the parts were made and the labour
performed in one place. All of these connections between supplies and markets result from the activities of
international business,
Private companies undertake such transactions for profit; governments may undertake them either for profit or for
other reasons.
Why should you study international business?

Simply, it makes up a large and growing portion of the world’s business. Global events and competition affect
almost all companies, large and small, regardless of industry. They sell output and secure supplies and resources
abroad, and they compete against products, services, and companies from foreign countries. Thus, most managers
need to take into account international business when setting their operating strategies and practices (Hill and Hult:
2017). They need to consider (1) where they can obtain the best required inputs at the best possible price and (2)
where they can best sell the product or service they have put together from those inputs.
Thus, studying international business is important because

 Most companies either are international or compete with international companies.
 Modes of operations may differ from those used domestically.
 The best way of conducting business may differ by country.
 An understanding helps you make better career decisions.
 An understanding helps you decide what governmental policies to support.

Think Point
What do you think the impact of globalization is on international business and
why are these concepts not the same?
1.3 The forces driving globalization and IB

Measuring globalization is problematic, especially for historical comparisons. Although hard to measure,
globalization has been growing, is less pervasive than generally thought, has economic and non-economic
dimensions and is stimulated by several factors.
Factors in increased globalization

Most analysts cite the following seven factors that have contributed to the growth of globalization in recent
decades:
1. Increase in and application of technology
2. Liberalization of cross-border trade and resource movements
3. Development of services that support international business
4. Growth of consumer pressures
5. Increase in global competition
6. Changes in political situations and government policies
7. Expansion of cross-national cooperation
1.3.1 Increase in and application of technology
Many of the “modern marvels” and efficient means of production have come about from fairly recent technical
advances. These include new products, such as hand-held mobile technology devices, as well as new applications
of old products, such as guar beans from India now being used in oil and natural gas mining. Thus, much of what
we trade today either did not exist or was unimportant in trade a decade or two ago. Technical developments have
increased so much because of rising productivity—taking fewer hours to produce the same thing— which frees up
more people to develop new products because fewer people can produce them. This rising productivity also means
that on average people can buy more, including the new products, by working the same number of hours.
1.3.2 Liberalization of cross-border trade and resource movements

To protect its own industries, every country restricts the movement across its borders of not only goods and
services but also the resources—workers, capital, tools, and so on—needed to produce them. Such restrictions,
of course, set limits on international business activities and, because regulations can change at any time, contribute
to a climate of uncertainty. Over time, however, most governments have reduced such restrictions, primarily for
three reasons:
 Their citizens want a greater variety of goods and services at lower prices.

 Competition spurs domestic producers to become more efficient.

 They hope to induce other countries to lower their barriers in turn.
1.3.3 Development of services that support international business

Companies and governments have developed a variety of services that facilitate global commerce. Today, because
of bank credit agreements—clearing arrangements that convert one currency into another and insurance that
covers such risks as non-payment and damage en route—most producers can be paid relatively easily for goods
and services sold abroad. When Nike sells sportswear to a French soccer team, a bank in France collects payment
in euros from the soccer team when the shipment arrives at French customs (probably from somewhere in Asia)
and pays Nike in U.S. dollars through a U.S. bank.
1.3.4 Growth of consumer pressures

More consumers know more today about products and services available in other countries, can afford to buy
them, and want the greater variety in quality, price, and characteristics that access to them offers. However,
because greater affluence is spread unevenly, both among and within countries as well as from year to year,
consumers’ ability to avail themselves of this variety differs substantially. As a result, more companies are now
responding to those markets where incomes and consumption are growing most rapidly, such as China.
1.3.5. Increase in global competition

The present and potential pressures of increased foreign competition can persuade companies to buy or sell
abroad. For example, a firm might introduce products into markets where competitors are already gaining sales,
or seek supplies where competitors are getting cheaper or more attractive products or the means to produce them.
1.3.6 Changes in political situations and government policies

For nearly half a century after World War II, business between Communist countries and the rest of the world was
minimal. Today, only a few countries do business almost entirely within a political alliance. In fact, political changes
sometimes open new frontiers for international business. Nevertheless, governments still prefer international
business with certain countries and even deny such business with others for political reasons, such as many
countries’ sanctions against doing business with Iran because of its efforts to develop nuclear capabilities.
1.3.7. Expansion of cross-national cooperation

Governments have come to realize that their own interests can be addressed through international cooperation by
means of treaties, agreements, and consultation. The willingness to pursue such policies is due largely to these
three needs:
 To gain reciprocal advantages
 To attack problems jointly that one country acting alone cannot solve
 To deal with areas of concern that lie outside the territory of any nation

1.4 The criticisms of globalization

Although we’ve discussed interrelated reasons for and the benefits from the rise in international business and
globalization, the consequences of the rise are controversial. Antiglobalisation forces regularly protest international
conferences and governmental policies. We focus here on three issues
 threats to national sovereignty,
 environmental stress, and
 growing income inequality and personal stress.
1.4.1 Threats to national sovereignty

You’ve probably heard the slogan “Think globally, act locally.” In essence, it means that local interests should be
accommodated before global ones. Some observers worry that the proliferation of international agreements,
particularly those that undermine local restrictions on how goods are produced and sold, will diminish a nation’s
sovereignty—its freedom to “act locally” and without externally imposed restrictions.
Countries seek to fulfil their citizens’ economic, political, and social objectives by setting rules reflecting national
priorities, such as those governing worker protection and environmental practices. However, some critics argue
that individual countries’ priorities are undermined by opening borders to trade. For example, if a country has
stringent regulations on labour conditions and requires clean production methods, cheaper production may occur
in countries with less rigorous rules. The result, by opening borders to trade, may be that the strict country must
either forgo its labour and environmental priorities to be competitive or face the downside of fewer jobs and
economic output. In addition, critics charge that globalization homogenizes products, companies’ work methods,
social structures, and even language, thus undermining the cultural foundation of sovereignty. In essence, they
argue that countries have difficulty maintaining the traditional ways of life that unify and differentiate their cultures.
1.4.2 Environmental stress

Much criticism of globalization revolves around the economic growth it brings. According to one argument, growth
consumes more non-renewable natural resources and increases environmental damage. despoliation through
toxic runoffs into rivers and oceans, air pollution from factory and vehicle emissions, and deforestation that can
affect weather and climate. In addition, globalization opponents contend that by buying from more distant locations,
the added transportation increases the carbon footprint, which refers to the total set of greenhouse gases emitted.
Not everyone agrees with such a conclusion. Others argue that globalization has positive results for both
sustaining natural resources and maintaining an environmentally sound planet

1.4.3 Growing income inequality and personal stress

In measuring economic well-being, we not only look at our absolute situations but also compare ourselves to
others. By various measurements, income inequality, with some notable exceptions, has been growing both among
and within a number of countries. Critics claim that globalization has affected this disparity by helping to develop a
global superstar system, creating access to a greater supply of low-cost labour, and developing competition that
leads to winners and losers. The superstar system is especially apparent in sports, where global stars earn far
more than the average professional player or professionals in sports with a more limited worldwide
following. It also carries over to other professions, such as business, where charismatic top people can command
many times what others can.
1.5 Why companies engage in International Business

Let’s now focus on some of the specific ways firms can create value by going global.
 Expanding sales:
A company’s sales depend on the desire and ability of consumers to buy its goods or services. Obviously,
there are more potential consumers in the world than found in any single country. Pursuing international
sales usually increases the potential market and potential profits. In fact, additional sales from abroad
may enable a company to reduce its per-unit costs by covering its fixed costs—say, up-front research
costs—over a larger number of sales. Because of lower unit costs, it can boost sales even more. So
increased sales are a major motive for expanding into international markets, and many of the world’s
largest companies—such as Volkswagen (Germany), Ericsson (Sweden), IBM (United States), Michelin
(France), Nestlé (Switzerland), and Sony (Japan) derive more than half their sales outside their home
countries.
 Acquiring resources
Producers and distributors seek out products, services, resources, and components from foreign
countries, sometimes because domestic supplies are inadequate (as with crude oil shipped to the United
States). They’re also looking for anything that will create a competitive advantage. This may mean
acquiring a resource that cuts costs, such as Rawlings’s reliance on labour in Costa Rica a country that
hardly plays baseball to produce baseballs. Sometimes firms gain competitive advantage by improving
product quality or differentiating their products from those of competitors; in both cases, they’re potentially
increasing market share and profits. Thus, foreign sources may give companies lower costs, new or better
products and additional operating knowledge.

 Reducing risk
Operating in countries with different business cycles can minimize swings in sales and profits. The key is
the fact that sales decrease or grow more slowly in a country that’s in a recession and increase or grow
more rapidly in one that’s expanding economically. Moreover, by obtaining supplies of products or
components both domestically and internationally, companies may be able to soften the impact of price
swings or shortages in any one country. Thus, International operations may reduce operating risk by
smoothing sales and profits and preventing competitors from gaining advantages
 Minimize Competitive Risk

Many companies enter into international business for defensive reasons. They want to counter
advantages competitors might gain in foreign markets that, in turn, could hurt them domestically. For
example, Company
A and Company B compete in the same domestic market. Company A may fear that Company B will
generate large profits from a foreign market if left alone to serve that market. Company B may then use
those profits in various ways (such as additional advertising or development of improved products)
to improve its competitive position in the domestic market. Companies harbouring such a fear may enter
foreign markets primarily to prevent a competitor from gaining advantages.
Case study: The Globalization of Starbucks
“Thirty years ago, Starbucks was a single store in Seattle's Pike Place Market selling premium-roasted coffee.
Today it is a global roaster and retailer of coffee with some 16,700 stores, 40 percent of which are in 50 countries
outside of the United States. Starbucks set out on its current course in the 1980s when the company's director
of marketing, Howard Schultz, came back from a trip to Italy enchanted with the Italian coffeehouse experience.
Schultz, who later became CEO, persuaded the company's owners to experiment with the coffeehouse format-
and the Starbucks experience was born. The strategy was to sell the company's own premium roasted coffee
and freshly brewed espresso-style coffee beverages, along with a variety of pastries, coffee accessories, teas,
and other products, in a tastefully designed coffeehouse setting. The company focused on selling "a third place
experience,'' rather than just the coffee. The formula led to spectacular success in the United States, where
Starbucks went from obscurity to one of the best-known brands in the country in a decade. Thanks to Starbucks,
coffee stores became places for relaxation, chatting with friends, reading the newspaper, holding business
meetings, or (more recently) browsing the web” Hill and Hult (2017).
“In 1995, with 700 stores across the United States, Starbucks began exploring foreign opportunities. The first
target market was Japan. The company established a joint venture with a local retailer, Sazaby Inc. Each
company held a 50 percent stake in the venture, Starbucks Coffee of Japan. Starbucks initially invested $10

million in this venture, its first foreign direct investment. The Starbucks format was then licensed to the venture,
which was charged with taking over responsibility for growing Starbucks' presence in Japan. To make sure the
Japanese operations replicated the "Starbucks experience" in North America, Starbucks transferred some
employees to the Japanese operation. The licensing agreement required all Japanese store managers and
employees to attend training classes similar to those given to U.S. employees. The agreement also required
that stores adhere to the design parameters established in the United States. In 2001, the company introduced
a stock option plan for all Japanese employees, making it the first company in Japan to do so. Sceptics doubted
that Starbucks would be able to replicate its North American success overseas, but by the end of 2009 Starbucks
had some 850 stores and a profitable business in Japan. After Japan, the company embarked on an aggressive
foreign investment program. In 1998, it purchased Seattle Coffee, a British coffee chain with 60 retail stores, for
$84 million. An American couple, originally from Seattle, had started Seattle Coffee with the intention of
establishing a Starbucks-like chain in Britain. In the late 1990s, Starbucks opened stores in Taiwan, China,
Singapore, Thailand, New Zealand, South Korea, and Malaysia. In Asia, Starbucks' most common strategy was
to license its format to a local operator in return for initial licensing fees and royalties on store revenues. As in
Japan, Starbucks insisted on an intensive employee training program and strict specifications regarding the
format and layout of the store” Hill and Hult (2017).
By 2002, “Starbucks was pursuing an aggressive expansion in mainland Europe. As its first entry point,
Starbucks chose Switzerland. Drawing on its experience in Asia, the company entered into a joint venture with
a Swiss company, Bon Appetit Group, Switzerland's largest food service company. Bon Appetit was to hold a
majority stake in the venture, and Starbucks would license its format to the Swiss company using a similar
agreement to those it had used successfully in Asia. This was followed by a joint venture in other countries” Hill
and Hult (2017). As it has grown its global footprint, Starbucks has also embraced ethical sourcing policies and
environmental responsibility. Now one of the world's largest buyers of coffee, in 2000 Starbucks started to
purchase Fair Trade Certified coffee. The goal was to empower small-scale farmers organized in cooperatives
to invest in their farms and communities, to protect the environment, and to develop the business skills
necessary to compete in the global marketplace. In short, Starbucks was trying to use its influence to not only
change the way people consumed coffee around the world, but also to change the way coffee was produced in
a manner that benefited the farmers and the environment. By 2010, some 75 percent of the coffee Starbucks
purchased was Fair Trade Certified, and the company has a goal of increasing that to 100 percent by 2015.80.
Source: Hill, C. W. L and Hult,G.T.M (2017) International business completing in the global marketplace

Revision questions based on case study

1. Where did the original idea for the Starbucks format come from? What lesson for international business can be
drawn from this?
2. What drove Starbucks to start expanding internationally? How is the company creating value for its shareholders
by pursuing an international expansion strategy?
3. Why do you think Starbucks decided to enter the Japanese market via a joint venture with a Japanese company?
What lesson can you draw from this?
4. Is Starbucks a force for globalization? Explain your answer.
5. When it comes to purchasing coffee beans, Starbucks adheres to a "fair trade" program. What do you think is
the difference between fair trade and free trade? How might a fair trade policy benefit Starbucks?
1.6 End of chapter questions
Question 1
Globalization refers to:
a) A more integrated and interdependent world
b) Less foreign trade and investment
c) Global warming
d) Lower incomes worldwide
Question 2
Which one of the following is a push factor in emigration?
a) Political freedom
b) Job opportunities in host country
c) Higher incomes in host country
d) War
Question 3
Which of the following do NOT facilitate globalization?
a) Improvements in communications
b) Barriers to trade and investment
c) Looser immigration controls
d) Removal of controls on movement of capital across borders

Question 4
Which of the following could be defined as a multinational company?
a) A firm that owns shares in a foreign company but does not participate in the company's decision making.
b) A UK based internet package holiday firm specializing in selling tours to Turkey to German customers.
c) A firm owning a chain of supermarket outlets outside its country of origin.
d) A finance company transferring its HQ and all its activities from the UK to the US.
Question 5
Which of the following is a driver of globalization?
a) Trade barriers and controls on inflows of foreign direct investment.
b) Weak competition.
c) Technological advance.
d) Economies of scale are being exploited to the maximum.
Question 6
Globalization is beneficial for firms because:
a) It protects them against foreign competition.
b) It cushions them from the effects of events in other countries.
c) It opens up new market opportunities.
d) It increases the risk and uncertainty of operating in a globalizing world economy.
Question 7
The internet facilitates globalization by:
a) Making it more difficult to contact potential customers abroad.
b) Cutting the cost for firms of communicating across borders.
c) Making it harder to send money from one country to another.
d) Making it easier for governments to censor the information received by their citizens from abroad.
Question 8
What might western food MNCs encounter when launching operations in Africa or the Middle East?
a) No language barriers.
b) Customer tastes the same as those of their domestic customers.
c) Corruption.
d) Well-developed road and rail links

Question 9
Globalization can create problems for business because:
a) It can result in more competition.
b) It reduces vulnerability to political risk and uncertainty when operating abroad.
c) It means that they can increase prices.
d) All of the options given are correct.
Short answer question
1.Define globalisation
2. Identify and explain the factors that result in globalisation
3. What are the criticisms of globalisation?
4. Why do companies engage in international business?
5.How does internet affect globalization and international business activity?
1.7 Solutions to case study

1. The original idea for the Starbucks format came from Italy. The founder of Starbucks, Howard Schultz,
was inspired to start the chain after experiencing Italy’s coffeehouses on a visit to the country. Most will
probably recognize that opportunities for international business exist everywhere. HowardSchultz for example,
was able to take a concept that had been popular in Italy for decades and successfully duplicate it in the
US, and then elsewhere in the world. Similarly, McDonald’s and KFC have been very successful at
creating a market for American fast food around the world. Students may also note that competition from
foreign markets can transform industries.
2. After Starbucks grew from a single store to more than 700 locations in just a decade, the company began
to explore growth opportunities elsewhere. Today, Starbucks operates more than 16,700 stores in some
50 countries. Not only has this strategy increased profits for the company, which is of course a clear
benefit for stockholders, it has also diversified the company’s earnings base providing another benefit to
stockholders.
3. Though Starbucks had revolutionised the way Americans consume coffee in United States, it remained
inexperienced on an international level. Partnering with a well-established Japanese would allow them to
be more successful in making the American Starbuck experience appealing to the Japanese.
Furthermore, Starbucks would minimise the risk, because “the Starbucks format was licensed to the
venture” and they would be responsible for its expansion in Japan. Since both companies were incredibly
successful in both expansion and creating profits, this could serve a valuable model for conducting
international business.

4. Starbucks is a force of globalisation because it has expanded worldwide and is bringing American ideas
with it. Going to Starbucks was an American thing, but it has expanded it became a worldwide place to
gather and drink coffee. Through its expansion Starbucks brought American culture to many other places,
by changing the way that people think
5. The difference between fair trade and free trade is that fair trade puts restrictions on the factors of
production of a product. These restrictions may do things like protect workers wage and make sure
working conditions are safe during the production process. Free trade however, reduces barriers between
countries creating a more open market where products can be more easily traded. Starbucks adheres to
a fair trade policy, which benefits them by giving them a more positive and environmentally friendly image
as accompany. It also raises the working conditions of those they buy their products from and empowers
small scale farmers which helps to ensure future business from those people and organizations.

Unit
2: National Differences in Political,
Economic and Legal Systems

2.2 Political systems  Understand how countries political systems differ
2.3 Economic systems  Explain the three broad types of economic systems
2.4 Legal systems  Explain the three main types of legal systems
2.5 Differences in culture  Explain the importance of culture in international business
2.6 Research task  Understand differences in culture and its impact in the
development of global policy
2.7 Summary  Summarise topic areas covered in unit
 Hill, C. W. L and Hult, G.T.M (2017) International business completing in the
global marketplace. 11th Edition. United States of America: McGraw. Hill
Education international edition
 Daniels, J.D. Radebaugh, L.H. Sullivan, D.P (2019) International business
environments and operations. 16th edition. Global Edition: Pearson
 Cavusgil, S.T. Knight, G. Riesenberger, J. (2017) International Business the
new realities.4th edition. Global Edition. Pearson

2.1 Introduction
Countries have different political, economic and legal systems and this has resulted in inter business to be more
complicated than domestic. Their level of future economic growth and economic development do vary. As a result,
this has resulted in major implications in international business. This unit develops an awareness of societal culture,
economic development, legal system, political system and economic development
2.2 Political systems

The political system of a country shapes its economic and legal systems. According to Hill and Hult (2017:47),
“political system means the system of government in a nation. Political systems can be assessed according to two
dimensions. The first is the degree to which they emphasize collectivism as opposed to individualism. The second
is the degree to which they are democratic or totalitarian. These dimensions are interrelated; systems that
emphasize collectivism tend be toward autocratic, whereas those that place a high value on individualism tend to
be democratic”.
2.2.1 Collectivism
According to Hill and Hult:2017 collectivism is defined as “a political system that stresses the primacy of collective
goals over individual goals”. The emphasises of collectivism results in society needs being more important than
individual freedoms. In such situations, an individual's right to do something may be restricted on the grounds that
it runs to "the good of society" or to "the common good"
Collectivistic cultures emphasize the needs and goals of the group as a whole over the needs and desires of each
individual. In such cultures, relationships with other members of the group and the interconnectedness between
people play a central role in each person's identity.
In collectivistic cultures, people are considered "good" if they are generous, helpful, dependable, and attentive to
the needs of others. This contrasts with individualistic cultures that often place a greater emphasis on
characteristics such as assertiveness and independence.
2.2.2 Individualism
Individualism is the opposite of collectivism and it refers to a “philosophy that an individual should have freedom in
his or her economic and political pursuits”. In contrast to collectivism, individualism stresses that the interests of
the individual should take precedence over the interests of the state.
According to Hill (2017), individualism is built on two central beliefs. “The first is an emphasis on the importance of
guaranteeing individual freedom and self-expression. The second belief of individualism is that the welfare of
society is best served by letting people pursue their own economic self-interest, as opposed to some collective
body (such as government) dictating what is in society's best interest. The central message of individualism,

therefore, is that individual economic and political freedoms are the ground rules on which a society should be
based. This puts individualism in conflict with collectivism. Collectivism asserts the primacy of the collective over
the individual; individualism asserts the opposite".
2.3 Economic Systems

The previous section highlighted the connection between political ideology and economic system. Countries that
emphasise the importance of individuals over collective goals are more likely to have market based economic
system. Whereas, countries that give pre-eminence to collective goals, the markets are restricted than free
because the government have taken control over many companies. Radebaugh, and Sullivan: 2019 identified three
broad types of economic systems-a mixed economy, command economy and market economy.
2.3.1 Market economy

In a market economy, there is no government involvement in the allocation of resources. All productive activities
are privately owned, as opposed to being owned by the state. The goods and services that a country produces are
not planned by anyone. Production is determined by the interaction of supply and demand and signalled to
producers through the price system. Daniels, Radebaugh, and Sullivan: 2019 pointed that “if demand for a product
exceeds supply, prices will rise, signalling producers to produce more. If supply exceeds demand, prices will fall,
signalling producers to produce less. In this system consumers are sovereign”.
For a market to work in this manner, there are not supposed to be any restrictions on supply. “A supply restriction
occurs when a single firm monopolizes a market. In such circumstances, rather than increase output in response
to increased demand, a monopolist might restrict output and let prices rise. This allows the monopolist to take a
greater profit margin on each unit it sells.” Although the monopolist enjoys the benefits, the consumer is affected
because they would have to pay higher prices. This in turn might affect the welfare of society. Since there is no
competition the monopolist no incentive to search for ways to lower production costs. Rather, they simply pass on
the increases in cost to consumers in the form of higher prices. According to Daniels, Radebaugh, and Sullivan
(2019), “the net result is that the monopolist is likely to become increasingly inefficient, producing high priced, low-
quality goods, and society suffers as a consequence”.
According to Hill and Hult (2017), in a market economy the government role is to encourage free and fair
competition between the participants. The government restricts business practise that results in monopoly in the
market. Private ownership promotes competition and efficiency and they ensure that entrepreneurs have a right to
their profits which they have generated with their own efforts. This in turn would act as an incentive to entrepreneurs
to serve the consumer needs effectively. They may introduce new products, develop efficient production processes
and manage their business more efficiently than their competitors. Hill and Hult (2017), further noted that constant
improvement on product and processes have an impact on economic growth and development.

2.3.2 Command economy

The government decides how resources are allocated to the production of particular products. According to Hill
and Hult (2017), in a pure command economy, “the government plans the goods and services that a country
produces, the quantity in which they are produced, and the prices at which they are sold Consistent with the
collectivist ideology, the objective of a command economy is for government to allocate resources for the good of
society. In addition, in a pure command economy, all businesses are state owned, the rationale being that the
government can then direct them to make investments that are in the best interests of the nation as a whole rather
than in the interests of private individuals”.
According to Daniels, Radebaugh, and Sullivan (2019), “historically, command economies were found in
communist countries where collectivist goals were given priority over individual goals. Since the demise of
communism in the late 1980s, the number of command economies has fallen dramatically. Some elements of a
command economy were also evident in a number of democratic nations led by socialist-inclined governments”.
France and India both experimented with extensive government planning and state ownership, although
government planning has fallen into disfavour in both countries.
In a command economy the main objective is the mobilisation of economic resources to the public, however, the
opposite has occurred. Companies that are owned by the government in a command economy they have little
incentive in controlling the costs and be efficient because they cannot go out of business. In addition, since private
ownership is abolished the individuals are not motivated to serve consumer needs effectively because there is no
incentive. Hence, in command economy there is no dynamism and innovation. Such economies remain stagnate
instead of growing and becoming prosperous.
2.3.3 Mixed economy

The government and the private sector, jointly solve economic problems in a mixed economy. Some sectors of the
economy have free market mechanisms and are run by private enterprises, other sectors have significant
government planning and are run by the state. According to Hill and Hult (2017), “mixed economies were once
common throughout much of the world although they are becoming much less so. Until the 1980s, Great Britain,
France, and Sweden were mixed economies, but extensive privatization has reduced state ownership of
businesses in all three nations. A similar trend occurred in many other countries where there was once a large
state-owned sector, such as Brazil, Italy, and India (there are still state-owned enterprises in all of these nations)”.
“In mixed economies, governments also tend to take into state ownership troubled firms whose continued operation
is thought to be vital to national interests. Consider, for example, the French automobile company Renault. The
government took over the company when it ran into serious financial problems. The French government reasoned
that the social costs of the unemployment that might result if Renault collapsed were

unacceptable, so it nationalized the company to save it from bankruptcy. Renault's competitors weren't thrilled by
this move because they had to compete with a company whose costs were subsidized by the state. Similarly, in
2008 and early 2009 the U.S. government took an 80 percent stake in AIG to stop that financial institution from
collapsing, the theory being that if AIG did collapse, it would have very serious consequences for the entire financial
system. The U.S. government usually prefers market-oriented solutions to economic problems, and in the AIG
case the intention was to sell the institution back to private investors as soon as possible” (Hill and Hult :2017).
The United States also took similar action with respect to a number of other troubled private enterprises, including
Citigroup and General Motors. In all of these cases, the government stake was seen as nothing more than a short-
term action designed to stave off economic collapse by injecting capital into troubled enterprises. As soon as it
was able to, the government sold these stakes (in early 2010, for example, it sold its stake in Citigroup, for a profit,
and in late 2010 it sold much of its stake in GM to public investors).
Think Point
Command economies stifle growth and free market economies stimulate
greater economic growth. Discuss.
2.4 Legal Systems

Hill and Hult (2017) defined legal system of a country “as the rules, or laws, that regulate behaviour along with the
processes by which the laws are enforced and through which redress for grievances is obtained. The legal system
of a country is of immense importance to international business”. A country's laws regulate business practice,
define the manner in which business transactions are to be executed, and set down the rights and obligations of
those involved in business transactions. The legal environments of countries differ in significant ways.
The prevailing political system does influence the country’s economic system. The legal framework within which
companies do business is defined by the government and also laws regulating the business reflects the ruling party
political ideology. For example, collectivist-inclined totalitarian states tend to enact laws that severely restrict private
enterprise, whereas the laws enacted by governments in democratic states where individualism is the dominant
political philosophy tend to be pro-private enterprise and pro-consumer.
2.4.1 Different legal systems

The three main types of legal systems in use around the world:
I. civil law, and
II. common law
III. theocratic law.

Common Law
Over a hundred years ago, the common law system evolved in England, but now it is found in are custom, tradition
former colonies of Great Britain. The basis of common law is custom, tradition and precedent. The way in which
laws are applied in specific situations is referred to as custom and the country’s legal history is referred to as
tradition. Past cases that have come before the court are referred to as precedent. When law courts interpret
common law, they do so with regard to these characteristics. This gives a common law system a degree of flexibility
that other systems lack. “Judges in a common law system have the power to interpret the law so that it applies to
the unique circumstances of an individual case. In tum, each new interpretation sets a precedent that may be
followed in future cases” Hill and Hukt (2017). As new precedents arise, laws may be altered, clarified, or amended
to deal with new situations.
Civil Law
“A civil law system is based on a detailed set of laws organized into codes. When law courts interpret civil law, they
do so with regard to these codes. More than 80 countries, including Germany, France, Japan, and Russia, operate
with a civil law system. A civil law system tends to be less adversarial than a common law system, since the judges
rely upon detailed legal codes rather than interpreting tradition, precedent, and custom” (Hill and Hult: 2017).
Judges under a civil law system have less flexibility than those under a common law system. Judges in a common
law system have the power to interpret the law, whereas judges in a civil law system have the power only to apply
the law.
Theocratic Law
Laws that are based on religious teachings are known as theoretical law system. In the modern world, the most
practised legal system is the Islamic, though the Jewish and the Hindu law have persisted in the twentieth century.
The Islamic law is intended to govern all aspects of life and is considered a moral rather than a commercial law.
Reading
The material discussed in this unit has two broad implications for international business. First.
the political, economic, and legal systems of a country raise important ethical issues that have
implications for the practice of international business.
Second, the political, economic, and legal environments of a country clearly influence the
attractiveness of that country as a market or investment site. The benefits, costs, and risks
associated with doing business in a country are a function of that country's political, economic,
and legal systems. The overall attractiveness of a country as a market or investment site
depends on balancing the likely long-term benefits of doing business in that country against
the likely costs and risks.

Other things being equal, a nation with democratic political institutions, a market-based
economic system, and strong legal system that protects property rights and limits corruption is
clearly more attractive as a place in which to do business than a nation that lack democratic
institutions, where economic activity is heavily regulated by the state, and where corruption is
rampant and the rule of law is not respected.
2.5 Differences in culture

Culture is a complex whole that includes knowledge, beliefs, art, morals, law, customs, and other capabilities
acquired by people as members of society. Values and norms are the central components of a culture.
“Values are abstract ideals about what a society believes to be good, right, and desirable. Norms are social rules
and guidelines that prescribe appropriate behaviour in particular situations. Values and norms are influenced by
political and economic philosophy, social structure, religion, language, and education” Hill and Hult (2017)
Doing business on a global basis requires a good understanding of different cultures. “Culture is very critical in
many foreign countries. Essentially, there are many differences between the South Africa and the rest of the world
when it comes to cultural norms. These differences range from common greetings to scheduling business meetings
and everything in between—each of which can make a huge difference when interacting with foreign partners,
clients, and customers.” Society’s culture has a significant importance on international business operations as it
affects the values found in the workplace. Hence, management practices need to be vary accordingly to culturally
determined work related values. For example, an international business with operations in South Africa and Kenya,
and the cultures in both countries result in different work-related values, the management process and practices
need to be varied to accordingly for these differences.
Activity
Identify two countries that are culturally diverse. Compare the cultures of those
countries and then indicate how cultural differences influence (a) the costs of
doing business in each country, (b) the likely future economic development of
that country, and (c) business practices..

Comment on Activity
The solution depends on the choice of the countries the student has chosen. The students are encouraged to
make comparisons between the two companies.
2.6 Research task

Differences in Culture
Exercise 1
“You are preparing for a business trip to Chile where you will need to interact extensively with local professionals.
Therefore, you should consider collecting information regarding local culture and business habits prior to your
departure. A colleague from Latin America recommends you visit the Centre for Intercultural Learning and read
through the country insights provided for Chile. Prepare a short description of the most striking cultural
characteristics that may affect business interactions in this country” Cavusgil, S.T. Knight, G. Riesenberger, J.
(2017.
Exercise 2
“Typically, cultural factors drive the differences in business etiquette encountered during international business
travel. In fact, Middle Eastern cultures exhibit significant differences in business etiquette when compared to
Western cultures. Prior to leaving for your first business trip to the region, a colleague informed you that a guide to
business etiquette around the world may help you. Using the globalEDGE website, find five tips regarding business
etiquette in the Middle Eastern country of your choice” Cavusgil, S.T. Knight, G. Riesenberger, J. (2017.
2.7 Summary
In this unit a discussion of the political, economic and legal systems and how they vary across countries was
presented. The unit made the following points; “political systems can be assessed according to two dimensions:
the degree to which they emphasize collectivism as opposed to individualism, and the degree to which they are
democratic or totalitarian. Collectivism is an ideology that views the needs of society as being more important than
the needs of the individual. Individualism is an ideology that is built on an emphasis of the primacy of the individual's
freedoms in the political, economic, and cultural realms”. A discussion of the three broad types of economic system
that is, the market economy, command economy and mixed economy was presented. A market economy is
whereby private ownership dominates and prices are free of controls. In the command economy, there is
government intervention and they are involved in setting the prices. Furthermore, they do not allow private
ownership. A mixed economy has both elements of command and market economy.


I. Identify and explain two dimensions of political systems.
2.Explain the three types of economic systems.
3.What influences the legal systems of a country?
4. What is capitalism? What is a planned economy? Compare and contrast the two forms of economic ideology
5.Does state-directed economies suppress growth whereas, free market economies promote economic growth.
Discuss.
6. For sustained economic progress a democratic political system is a necessary condition. Discuss.
7. You are the CEO of a company that has to choose between making a $350 million investment in India or Brazil.
Both investments promise the same long-run return, so your choice is driven by risk considerations. Assess the
various risks of doing business in each of these nations. Which investment would you favour and why?

Unit
3: International Trade Theory

3.2 Motivations of trade  Understand why nations trade with each other and explain the
benefits of trade
3.3 Theories of international trade  Understand the different theories of international trade
3.4 Mercantilist  Explain the theory of Mercantilism
3.5 Absolute advantage and  Explain the theory of absolute advantage and comparative
comparative advantage advantage
3.6 Heckscher-Ohlin Theory  Explain the theory of Heckscher-Ohlin
3.7 The product life cycle  Explain the theory of product life cycle
 Cavusgil, S.T. Knight, G. Riesenberger, J. (2017) International Business the
new realities.4th edition. Global Edition. Pearson

3.1 Introduction
When South Africa became a democracy in 1994, one of the key transitions that took place was within the economic
and financial sector of the country. In other words, South Africa having for many years being subjected to sanctions
(and other trade barriers), found itself on the cusp of a new era – the era of global trade.
South Africans could now freely import and export goods and services from/to the rest of the world. During the
apartheid era, South Africa had almost been totally isolated from the rest of the world and international trade was
minimal. Since then the quantum of international trade has been steadily growing.
3.2 Motivations for trade

One of the key questions under international trade is ‘why does any country trade?’ Asked differently, why do we
not produce whatever we need and consume it? The merits of international trade are often questioned given there
is often an inadvertent ‘loss’ to some member(s) of society.
For example, the merits of importing footwear and clothing from China into South Africa have often been questioned
given that local industries had to close down operations, given their inability to compete with world prices. According
to most economists, this argument is sadly an economic fallacy in that if a country is unable to produce something
efficiently, then the opportunity costs associated with producing that item is high (meaning that resources should
rather be moved to areas when one is more efficient).
Three strong economic arguments for international trade have been postulated. These are:
a) International trade allows a greater variety of good and services for the consumer,
b) A country may not have the necessary resources to produce a specific good or service, and
c) International trade leads to specialisation and overall lower prices.
Greater Variety – this argument is straightforward in that the variety of products available (as a result of trade)
substantially increases when a country trades. Imagine what would happen if most of the international brands were
not allowed into South Africa? The end result would be perhaps one or two (if at all) local brands being available
to the consumer.
Necessary Resources – this argument is also straightforward in that if a country does not have a necessary and
critical resource that is needed in the production of some good or service, then that good or service cannot be
produced locally. This is the very reason why South Africa is unable to produce certain goods (e.g. specialised
medical equipment) given we lack the necessary resources (skilled labour). In such cases these goods have to be
imported from other countries. Coupled with this is the fact that not all countries have access to the same level of
technology, or enjoy similar economies of scale.

Specialisation – a critical argument put forward for international trade is that it leads to specialisation in
production. This argument is best described by introducing two key concepts in Economics, namely Absolute
Advantage and Comparative Advantage which will be discussed later on.
3.3 Theories of international trade

This unit examines the three theories of international trade. These include the mercantilism which advocated that
countries should simultaneously encourage exports and discourage imports. The mercantilism advocated that
countries should simultaneously encourage exports and discourage imports. Next, we will look at Adam Smith's
theory of absolute advantage which was the first to explain why unrestricted free trade is beneficial to a country.
Free trade refers to a situation where a government does not attempt to influence through quotas or duties what
its citizens can buy from another country, or what they can produce and sell to another country.
A discussion of the theory of comparative advantage will follow. This theory is the intellectual basis of the modem
argument for unrestricted free trade.
3.4 Mercantilist
According to Cavusgil, S.T. Knight, G. Riesenberger, J. (2017, the first theory of international trade, mercantilism,
emerged in England in the mid sixteenth century. “The principle assertion of mercantilism was that gold and silver
were the mainstays of national wealth and essential to vigorous commerce. At that time, gold and silver were the
currency of trade between countries; a country could earn gold and silver by exporting goods”. According to (Hill
and Hult: 2017), there is an outflow of gold and silver to the countries that import goods. The mercantilism where
of the opinion that a country need to maintain a trade surplus, that is, export more than import this would result in
country accumulating more gold and silver and subsequently increases its national wealth, esteem and power.
“Consistent with this belief, the mercantilist doctrine advocated government intervention to achieve a surplus in the
balance of trade. The mercantilists saw no virtue in a large volume of trade. Rather, they recommended policies
to maximize exports and minimize imports. To achieve this, imports were limited by tariffs and quotas, while exports
were subsidized”, Cavusgil, S.T. Knight, G. Riesenberger, J. (2017.
Daniels, Radebaugh and Sullivan (2019), pointed out that the classical economist David Hume identified
inconsistency in the mercantilist doctrine in 1752. According to Hume, “if England had a balance-of-trade surplus
with France (it exported more than it imported) the resulting inflow of gold and silver would swell the domestic
money supply and generate inflation in England. In France, however, the outflow of gold and silver would have the
opposite effect. France's money supply would contract, and its prices would fall. This change in relative prices
between France and England would encourage the French to buy fewer English goods (because they were
becoming more expensive) and the English to buy more French goods (because they were becoming cheaper).
The result would be a deterioration in the English balance of trade and an improvement in France's trade balance,

until the English surplus was eliminated. Hence, according to Hume, in the long run no country could sustain a
surplus on the balance of trade and so accumulate gold and silver as the mercantilists had envisaged (Hill and
Hult: 2017).
The flaw with mercantilism was that it viewed trade as a zero-sum game. (A zero sum game is one in which a gain
by one country results in a loss by another.) It was left to Adam Smith and David Ricardo to show the short
sightedness of this approach and to demonstrate that trade is a positive-sum game, or a situation in which all
countries can benefit”.
3.5 Absolute advantage and comparative advantage

3.5.1 Absolute advantage
Adam Smith cited in (Schiller: 2013) attacked the mercantilist assumption that trade is a zero-sum game. “Smith
argued that countries differ in their ability to produce goods efficiently. In his time, the English, by virtue of their
superior manufacturing processes, were the world's most efficient textile manufacturers. Due to the combination
of favourable climate, good soils, and accumulated expertise, the French had the world's most efficient wine
industry. The English had an absolute advantage in the production of textiles, while the French had an absolute
advantage in the production of wine. Thus, a country has an absolute advantage in the production of a product
when it is more efficient than any other country in producing it.
Absolute Advantage is ‘the ability of a country to produce a specific good with fewer resources (per unit of
output) than other countries’ (Schiller 2013:773). Absolute advantage occurs when one country produces more of
a product than another using the same amount of resources.
According to Smith, countries should specialise in the production of goods for which they have an absolute
advantage and then trade these for goods produced by other countries. In Smith's time, this suggested the English
should specialize in the production of textiles while the French should specialize in the production of wine. England
could get all the wine it needed by selling its textiles to France and buying wine in exchange. Similarly, France
could get all the textiles it needed by selling wine to England and buying textiles in exchange. Smith's basic
argument, therefore, is that a country should never produce goods at home that it can buy at a lower cost from
other countries. Smith demonstrates that, by specializing in the production of goods in which each has an absolute
advantage, both countries benefit by engaging in trade”.
Assume that South Africa and Botswana produce wool and DVD players. One worker in South Africa can produce
100 kg wool and 4 DVD players whilst one worker in Botswana can produce 200 kg wool and 2 DVD players. We
say the South Africa has an absolute advantage in production of DVD players and Botswana has an absolute
advantage in production of wool.

3.5.2 Comparative Advantage

Comparative Advantage is ‘the ability of a country to produce a specific good at a lower opportunity cost than its
trading partners’ (Schiller 2013:772). By means of glasses, hotbeds and hot walls, very good grapes can be raised
in Scotland, and very good wine, too, can be made of them at thirty times the expense for which at least equally
good wine can be bought from foreign countries (Smith, 1776). The essence of comparative advantage is the idea
that nations, like individuals can carry out a particular economic activity (such as making a specific product) more
efficiently than another activity and therefore should concentrate on what they are best at producing. If one person
is an accomplished musician and the other a computer wizard, it is more efficient to allow each person to specialize
in one field rather than have each of them produce their own music as well as their own computer programmes
individually. By exporting each other’s services/skills to the other they will each benefit by ending up with more
goods/service than if they try making both goods/services individually. The same applies to nations.
The theory of comparative advantage states that: Each country will tend to specialize in and export those goods
for which it has a comparative advantage. Consider two countries, England and Portugal, each producing two
commodities, wine and clothing, as illustrated in the table below:
1Table: 3.1 Unit of output per person at work
From the table above it can be seen that:

 A worker in England can produce 3 units of wine or 3 units of clothing, i.e., one unit of clothing will
exchange for one unit of wine;
 A worker in Portugal can produce either 6 bottles of wine or 4 units of clothing i.e. one unit of clothing will
exchange for 1.5. units of wine;
 The Portuguese are therefore more productive in absolute terms in both industries than their English
counterparts; and
 Clothing is more expensive (and wine cheaper) in Portugal than England.
Suppose England takes two workers out of the wine industry and assigns them to work in the clothing industry.
This means that wine production falls by 6 units and clothing production increases by 6 units.
The 6 units of clothing are exported to Portugal. Given that, in Portugal, 1 unit of clothing exchanges for 1.5 units
of wine, the exporters of English clothing return with 9 units of wine. The net result is that England has gained 3
units of wine and Portugal is left exactly as well off as before.

The implications of this example, in the context of international trade theory, is that:
 A country can have an absolute advantage in all goods and yet gain from trade with a more efficient
partner;
 Gain that is realized through imports and exports are useful solely as a means of obtaining imports;
 The total gain from trade may be unevenly shared. In the above example England gets all the gain;
 Countries benefit most from trade by obtaining high prices for their exports and paying the lowest prices
for their imports; and
 Trade involves mutual gain.
To conclude this section, there is just one final point for you to ponder over!
Think Point
International trade will only occur if comparative advantage exists, that is, if the
opportunity costs differ between countries. Do you agree? Discuss the truth/
untruth of this statement with the aid of a suitable example. Refer to Mohr and
Fourie (2015:302).
3.6 Heckscher-Ohlin Theory

The Heckscher-Ohlin theory argues that trade occurs due to differences in labor, labor skills, physical capital,
capital, or other factors of production across countries.
 Countries have different relative abundance of factors of production.
 Production processes use factors of production with different relative intensity
The Heckscher-Ohlin theorem states that “a country which is capital-abundant will export the capital-intensive
good. Likewise, the country which is labour-abundant will export the labour-intensive good. In other words, the
Heckscher-Ohlin theory predicts that countries will export those goods that make intensive use of factors that are
locally abundant, while importing goods that make intensive use of factors that are locally scarce. Thus, the
Heckscher-Ohlin theory attempts to explain the pattern of international trade that we observe in the world economy.
Like Ricardo's theory, the Heckscher-Ohlin theory argues that free trade is beneficial. Unlike Ricardo's theory,
however, the Heckscher-Ohlin theory argues that the pattern of international trade is determined by differences in
factor endowments, rather than differences in productivity.
For example, the United States has long been a substantial exporter of agricultural goods, reflecting in part its
unusual abundance of arable land. In contrast, China excels in the export of goods produced in labour-intensive
manufacturing industries, such as textiles and footwear. This reflects China's relative abundance of low-cost labour.
The United States, which lacks abundant low-cost labour, has been a primary importer of these goods. Note that

it is relative, not absolute, endowments that are important; a country may have larger absolute amounts of land
and labour than another country, but be relatively abundant in one of them”.
3.7 The product life cycle

The product life-cycle theory was developed by Raymond Vernon in the mid-1960s. The theory presents an
insightful analysis as to why in the twentieth century a large number of new products in the world were developed
by the US firms and sold first in the US market.
The product life cycle described an internationalisation process wherein a local manufacturer in an advanced
country (Vernon regarded the United States of America as the principle source of inventions) begins selling a new,
technologically advanced product to high-come consumers in its home market (Hill and Hult:2017). Production
capabilities build locally to stay in close contact with its clientele and to minimize risk and uncertainty. As demand
from consumers in other markets rises, production increasingly shifts abroad enabling the firm to maximise
economies of scale and to bypass trade barriers. As the product matures and becomes more of a commodity, the
number of competitors increases. In the end, the innovator from the advanced nation becomes challenged in its
own home market making the advanced nation a net importer of the product. This product is produced either by
competitors in lesser developed countries or, if the innovator has developed into a multinational manufacturer, by
its foreign based production facilities.
The product life cycle consists of three stages:

Stage One: New product
The product life cycle begins when a company in a developed country wants to exploit a technological breakthrough
by launching a new, innovative product on its home market. Such a market is more likely to start in a developed
nation because more high-income consumers are able to buy and are willing to experiment with new, expensive
products (low price elastic). Furthermore, easier access to capital markets exists to fund new product development.
Production is also more likely to start locally in order to minimize risk and uncertainty.
Export to other industrial countries may occur at the end of this stage that allows the innovator to increase revenue
and to increase the downward descent of the products experience curve. Other advanced nations have consumers
with similar desires and incomes making exporting the easiest first step in an internationalisation effort. Competition
comes from a few local or domestic players that produce their own unique product variations.
Stage two: Maturing product

Exports to markets in advanced countries further increase through time making it economically possible and
sometimes politically necessary to start local production. The products design and production process becomes
increasingly stable. Foreign direct investments (FDI) in production plants drive down unit cost because labour cost
and transportation cost decrease. Offshore production facilities are meant to serve local markets that substitute

exports from the organisations home market. Production still requires high-skilled, high paid employees.
Competition from local firm’s jump start in these non-domestic advanced markets. Export orders will begin to come
from countries with lower incomes.
Stage 3: Standardised product

During this phase, the principal markets become saturated. The innovator's original comparative advantage based
on functional benefits has eroded. The firm begins to focus on the reduction of process cost rather than the addition
of new product features. As a result, the product and its production process become increasingly standardised.
This enables further economies of scale and increases the mobility of manufacturing operations. Labour can start
to be replaced by capital. If economies of scale are being fully exploited, the principal difference between any two
locations is likely to be labour costs. To counter price competition and trade barriers or simply to meet local
demand, production facilities will relocate to countries with lower incomes. As previously in advanced nations, local
competitors will get access to first-hand information and can start to copy and sell the product.
Figure 3.1 below shows the different stages that a local manufacturer in an advanced country goes through when
it begins selling a new, technologically advanced product to high-come consumers in its home market
1Figure 3.1 International Product Life Cycle

Source: Hill and Hult (2017)

Activity
1) With the aid of an example, distinguish between comparative advantage and
absolute advantage.
2) Using a hypothetical example of two countries of your choice, discuss the
theory of comparative advantage.
Comment on activity
1. Absolute advantage is when a Country can produce particular goods at a lower cost than another country.
It is easier to extract oil in Saudi Arabia than in any other country. The abundance of oil in Saudi Arabia
makes it easier as if it’s only drilling an oil whereas for other countries it involves exploration and drilling
cost.
Comparative advantage is based on the opportunity cost of producing a good. If a Country can produce
a particular good at a lower opportunity cost (by losing an opportunity for production of other goods) than
any other country, then it is said to have a comparative advantage.
2. If the US and Japan have an option to produce wheat or rice but not both. The US could produce 30 units
of wheat or 10 units of rice and Japan can produce 15 units of wheat or 30 units of rice. Thus, the
opportunity cost of wheat is 3 units of wheat for 1 unit of rice for the US whereas 0.5 units of wheat for
each unit of rice for Japan. Thus, Japan has a comparative advantage on the production of rice since it
has a lower opportunity cost.

Case Study
Source (Hill and Hult: 2017)

3.8 Revision questions based on case study

1.What are the benefits of the free trade agreement between Australia and China
2. What does the free agreement mean for Australia
3. How does free trade affect Australia
3.9 Revision questions

1. Assume that there are only two countries, Country A and Country B, producing only two goods, corn cereal and
designer jeans. The table here shows the production possibilities for these two countries.
Which of the following statements is correct?

a) Country A has an absolute advantage in the production of both goods.
b) Country B has an absolute advantage in both goods.
c) Country A has an absolute advantage in one good, but not both.
d) Country B has an absolute advantage in one good, but not both.
e) Neither country has an absolute advantage in the production of these two goods.
2.The following Table illustrates the maximum output in the production of Lumber and Wheat for
Country A and Country B assuming that only that one good is being produced.
Wheat Lumber
Country A Lumber = 0; wheat = 900 Lumber = 300; wheat = 0
Country B Lumber = 0; wheat = 1000 Lumber = 200; wheat = 0
Which country has the absolute advantage in Wheat production?
Which country has the absolute advantage in Lumber production?
Which country has the comparative advantage in Wheat production?
Which country has the comparative advantage in Lumber production?
3.The U.S. can produce 50 cars and 25 tools. Peru can produce 20 cars and 15 tools. What is the opportunity
cost of producing a car in the U.S.?

a) tools
b) cars
c) 75 cars
d) Tools
4. From the last question, who has the absolute advantage in tools?
a) Peru
b) U.S.
c) neither
d) not enough info
5. From the 1st question, who has the absolute advantage in the production of cars?
a) U.S.
b) Peru
c) neither
d) not enough info
6. Who has the comparative advantage in cars?

a) Peru
b) neither
c) U.S.
d) not enough info
7. What should the U.S. import?

a) cars
b) tools
c) both
d) not enough info
8. What should Peru export?

a) cars
b) tools
c) love
d) rainbows

9 Two countries A and B produce only two goods, motor cars and commercial trucks.
Maximum Country Country
outputs A B
Cars 30m 35m
Trucks 6m 21m
Which country has an absolute advantage in producing both goods?

Which country has a comparative advantage in producing trucks?

Unit
4: Government Policy
and International Trade

4.2 Instruments of trade policy  Explain the policy instruments used by government to
influence international trade flows
4.3 The case for government intervention  Understand why governments sometimes intervene in
international trade
 Explain the political arguments for government interventions
 Explain the economic arguments for government intervention
READINGS
 Cavusgil, S.T. Knight, G. Riesenberger, J (2017) International Business the
new realities.4th edition. Global Edition. Pearson.

4.1 Introduction
This unit looks at the political reality of international trade. Although many nations are nominally committed to free
trade, they tend to intervene in international trade to protect the interests of politically important groups or promote
the interests of key domestic producers. This unit explores the political and economic reasons that governments
have for intervening in international trade. When governments intervene, they often do so by restricting imports of
goods and services into their nation, while adopting policies that promote domestic production and exports.
Normally their motives are to protect domestic producers.
Think Point
We often hear the term “tariffs” on the television, government publications and
business articles.
What do you understand by the term “tariff”?
4.2 Instruments of trade policy

Trade policy uses seven main instruments. For the purpose of this study we are going to discuss tariffs, subsidies
and import quotas as instruments of trade policy.
4.2.1 Tariff
A tariff is a tax levied when a good is imported (Krugman, Obstfeld, & Melitz :2015). A tariff is a tax levied on
imports (or exports). Tariffs fall into two categories, specific and ad valorem tariffs.
Specific tariffs are levied as a fixed charge for each unit of a good imported. This tariff can vary according to the
type of good imported. For example, a country could levy a $15 tariff on each pair of shoes imported, but levy a
$300 tariff on each computer imported.
Ad valorem tariffs is levied on a good based on a percentage of that good's value. An example of an ad valorem
tariff would be a 15% tariff levied by Japan on U.S. automobiles. The 15% is a price increase on the value of the
automobile, so a $10,000 vehicle now costs $11,500 to Japanese consumers. This price increase protects
domestic producers from being undercut but also keeps prices artificially high for Japanese car shoppers.
In most cases, tariffs are placed on imports to protect domestic producers from foreign competition by raising the
price of imported goods. However, tariffs also produce revenue for the government. The important thing to
understand about an import tariff is who suffers and who gains. The government gains, because the tariff increases
government revenues. Domestic producers gain, because the tariff affords them some protection against foreign
competitors by increasing the cost of imported foreign goods. Unfortunately for consumers - both individual
consumers and businesses - higher import prices mean higher prices for goods. If the price of steel is inflated due

to tariffs, individual consumers pay more for products using steel, and businesses pay more for steel that they use
to make goods. In short, tariffs and trade barriers tend to be pro-producer and anti-consumer.
4.2.2 Subsidies
When a government pays a domestic producer this is known as a subsidy. According to Hill and Hult (2017),
subsidies have various forms and these include cash grants, government participation in domestic firms, tax breaks
and low interest. By reducing production costs, subsidies help domestic producers to compete against foreign
imports and gain market share. In most countries the largest beneficiary of subsidy is agriculture. The gains from
subsidies accrue to domestic producers who will ultimately have their international competitiveness increased.
Also, a subsidy can assist a firm in achieving a “first-mover” advantage in emerging industries. If this is achieved,
further gains to the domestic economy arise from the employment and tax revenues that a major global company
can generate. However, government subsidies must be paid for, typically by taxing individuals and corporation
Why might the government be justified in providing financial assistance to producers in certain markets
and industries? How valid are the arguments for government subsidies?
 To keep prices down and control inflation – in the last couple of years several countries have been offering
fuel subsidies to consumers and businesses in the wake of the steep increase in world crude oil prices.
 To encourage consumption of merit goods and services which are said to generate positive
externalities (increased social benefits). Examples might include subsidies for investment in
environmental goods and services
 Reduce the cost of capital investment projects – which might help to stimulate economic growth by
increasing long-run aggregate supply
 Subsidies to slow-down the process of long term decline in an industry e.g. fishing or mining
 Subsidies to boost demand for industries during a recession e.g. the car scrappage scheme
Think Point
Why does the government subsidise public transport such as local bus or rail
services?
Activity 1
Should subsidies be granted to car/ energy companies?.

Comment on activity
Cars and energy firms are responsible for many negative externalities from production of their goods/services. For
example, the manufacture of a car would incur third party costs such as air pollution and hazardous waste as a
result from the factory. When subsidising, governments need to consider the net social benefit of the intervention.
If the production externalities bring about severe costs to society’s welfare that potentially outweighs benefits, the
government should not subsidise at all.
Another benefit of subsidising these firms is the employment benefits that could potentially be brought to the
country. For example, Nissan has a production plant in Sunderland which could not have existed had it not been
for the government subsidies. This could lead to hundreds or thousands unemployed in that region and possibly
even more in related industries. The government must carefully calculate the potential benefits this employment
brings to the country.
Overall, subsidies can bring about positives and negatives to society. But there are a lot of factors that need to be
taken into account. The size of the subsidy needs to be carefully calculated according to what is the socially optimal
level of production. The government also needs to take into account how long the subsidy is granted to the firms
for. Too long, and the firms may become dependent on the subsidies which could give birth to inefficiencies in
production. “Too short, and the firm may not respond in a strong enough way to benefit society. In either of those
cases, the government would have failed.
The government also needs to assess the opportunity cost of the policy, and be sure that there exists no other
area where subsidies could bring about a higher net social benefit.
4.2.2 Import Quota

A quota is a government-imposed trade restriction that limits the number or monetary value of goods that a country
can import or export during a particular period. Countries use quotas in international trade to help regulate the
volume of trade between them and other countries. Countries sometimes impose them on specific products to
reduce imports and increase domestic production. In theory, quotas boost domestic production by restricting
foreign competition.
Quotas are different from tariffs or customs, which place taxes on imports or exports. Governments impose both
quotas and tariffs as protective measures to try to control trade between countries, but there are distinct differences
between them. Quotas focus on limiting the quantities (or, in some cases, cumulative value) of a particular good
that a country imports or exports for a specific period, whereas tariffs impose specific fees on those goods.

Governments design tariffs to raise the overall cost to the producer or supplier seeking to sell products within a
country. An import quota always raises the domestic price of an imported good. When imports are limited to a low
percentage of the market by a quota, the price is bid up for that limited foreign supply”.
2Table 4.1 Summary of the key effects of an import quota
Source: Jorge, (2019)
Activity 2
The European subsidiary of your company is considering exporting its
products to Egypt. Yet, management's current knowledge of this country's
trade policies and barriers is limited. Before your company's management
decides to export, a more detailed analysis of the political and economic
conditions in Egypt is required. In fact, you have heard that the Market
Access Database may be a good place to start. Begin your search and
identify Egypt's current import policies with respect to fundamental issues
such as tariffs and restrictions

4.3 The case of government intervention

Various trade policy instruments were reviewed, that is, the tariff, quotas and imports. This section focuses on
government intervention to international trade. The arguments for government intervention are grouped into:
political and economic.
Political arguments in a country interests of certain groups are protected (normally producers) at the expense of
other groups (normally consumers), or with achieving some political objective that lies outside the sphere of
economic relationships, such as protecting the environment or human rights.
Economic arguments are concerned in increasing the overall countries wealth. Both the producer and consumer
they all benefit.
4.3.1 Political arguments for intervention

According to Hill and Hult (2017), political arguments for government intervention “cover a range of issues,
including preserving jobs, protecting industries deemed important for national security, retaliating against unfair
foreign competition, protecting consumers from dangerous products, furthering the goals of foreign policy, and
advancing the human rights of individuals in exporting countries.
Protecting Jobs and Industries from unfair foreign competition. This is one of the most common political
argument for government intervention.
National Security it is important to protect certain industries like defence, because of their importance in national
security.
Protecting Consumers, the government put regulations to protect consumers from harmful products. This would
entail either a ban or limit of the importation of unsafe products.
Furthering Foreign Policy Objectives Governments sometimes use trade policy to support their foreign policy
objectives. A government may grant preferential trade terms to a country with which it wants to build strong
relations.
Protecting Human Rights Protecting and promoting human rights in other countries is an important element of
foreign policy for many democracies. Governments sometimes use trade policy to try to improve the human rights
policies of trading partners.

4.3.2 Economic arguments for intervention

With the development of the new trade theory and strategic trade policy, the economic arguments for government
intervention have undergone a rebirth in recent years.
The Infant Industry Argument governments should temporarily support new industries (with tariffs, import quotas,
and subsidies) until they have grown strong enough to meet international competition.
Strategic trade policy government use subsidies to support promising firms that are active in newly emerging
industries”.
Case Study: U.S. to Impose Tariff on Tires from China
By Peter Whoriskey and Anne Kornblut

Washington Post Staff Writers
In one of his first major decisions on trade policy, President Obama opted Friday to impose a tariff on tires from
China, a move that fulfils his campaign promise to "crack down" on imports that unfairly undermine American
workers but risks angering the nation's second-largest trading partner.
The decision is intended to bolster the ailing U.S. tire industry, in which more than 5,000 jobs have been lost
over the past five years as the volume of Chinese tires in the market has tripled. It comes at a sensitive time,
however. Leaders from the world's largest economies are preparing to gather in Pittsburgh in less than two
weeks to discuss more cooperation amid tensions over trade.
The tire tariff will amount to 35 percent the first year, 30 percent the second and 25 percent the third. Although
a federal trade panel had recommended higher levies -- of 55, 45 and 35 percent, respectively -- the decision
is considered a victory for the United Steelworkers union, which filed the trade complaint. "The president sent
the message that we expect others to live by the rules, just as we do," Leo W. Gerard, president of the union,
said Friday night.
China's government and its tire manufacturers, as well as tire importers and some U.S. tire makers with plants
overseas, had strenuously objected to the measure. "The President decided to remedy the clear disruption to
the U.S. tire industry based on the facts and the law in this case," the White House said in a statement released
Friday night.

Obama's decision signals a marked shift from the policy of the Bush administration, which had rejected taking
action in four similar cases it reviewed. The union complaint was filed under a law Congress passed in 2000
that allows the United States to impose tariffs and other trade protections if a surge in Chinese imports damages
a U.S. industry.
China agreed to the provision while negotiating to join the World Trade Organization, but until Friday the general
"safeguard" provisions of the law had never been invoked. Critics warned that if the general "safeguard," which
expires in four years, was never used to protect American workers from Chinese imports, then political support
for free trade would be eroded.
"Since China joined the WTO, American workers have not been assured that the government would defend
them against unfair trade," Sen. Sherrod Brown (D-Ohio) said. The tariff, which will take effect Sept. 26,
represents the first such case under the law for Obama, and his decision has been highly anticipated.
During the campaign, he had pledged to "crack down on China" and "work to ensure that China is no longer
given a free pass to undermine U.S. workers," as his Web site put it. But his commitment to that point of view
was thrown into doubt during the primaries when a Canadian official said an Obama adviser had privately
characterized his tough stance on the North American Free Trade Agreement as political posturing.
Marguerite Trossevin, who represents a coalition of U.S. tire companies that import Chinese tires, said the tariff
decision is "very disappointing." She predicted price increases for U.S. consumers and losses for U.S. tire
importers. "For the U.S. tire distributors and consumers, there's going to be a heavy burden to bear," she said.
"It sends the message that special interests will get protection if they ask for it -- regardless of what that means
for broader trade policy."
China's Ministry of Commerce said in a statement early Saturday that the move violated WTO rules. "China
strongly opposes this serious act of trade protectionism by the U.S," the ministry said, according to the
Associated Press. Not surprisingly, there were conflicting predictions about what effect the tariff might have on
the U.S. industry.
Supporters said the measure would have only a negligible effect on the price of tires and would lead U.S.
manufacturers to invest in their U.S. plants. The tariff's detractors said higher tire prices could lead some
consumers to wait longer before replacing tires, creating a safety risk. Moreover, they said, the tariff won't result
in more jobs. Tires will simply come in from other low-cost countries, they say, and U.S. manufacturers, keep
making their cheaper tires in China.

"U.S. tire manufacturers years ago decided to move production of low end tires off-shore," said David Spooner,
a lawyer representing the Chinese tire industry. "Frankly, a temporary tariff is not going to get them to change
their business plan."
Hill and Hult (2017)
Case Study
1. What was the main reason for U.S to impose tariffs on China
2. Explain the likely impact of the tariff on:
1. Chinese tyre manufacturers
2. US tyre manufacturers
3. US consumers
Activity 2
The European subsidiary of your company is considering exporting its
products to Egypt. Yet, management's current knowledge of this country's
trade policies and barriers is limited. Before your company's management
decides to export, a more detailed analysis of the political and economic
conditions in Egypt is required. In fact, you have heard that the Market
Access Database may be a good place to start. Begin your search and
identify Egypt's current import policies with respect to fundamental issues
such as tariffs and restrictions.
Prepare an executive summary of your findings.
4.4 Summary
Trade policies such as tariffs, subsidies, tend to be pro-producer and anti-consumer. Gains accrue to producers
(who are protected from foreign competitors), but consumers lose because they must pay more for imports.
There are two types of arguments for government intervention in international trade: political and economic.
Political arguments for intervention are concerned with protecting the interests of certain groups, often at the
expense of other groups, or with promoting goals with regard to foreign policy, human rights, consumer protection,
and the like. Economic arguments for intervention are about boosting the overall wealth of a nation. A common
political argument for intervention is that it is necessary to protect jobs. However, political intervention often hurts
consumers and it can be self-defeating. Countries sometimes argue that it is important to protect certain industries
for reasons of national security.


1. A _____ is a tax imposed by the government on imports coming into a country.
a) limit
b) quota
c) tariff
d) subsidy
2. A _____ sets a numerical limit on how much of a product can be imported into a country.
a) government protection
b) subsidy
c) free trade agreement
d) quota
3. How do quotas and tariffs impact the supply of goods available to consumers and domestic prices in general?
a) They increase the supply of goods and increase prices.

b) They decrease the supply of goods and increase prices.
c) They increase the supply of goods and decrease prices.
d) They decrease the supply of goods with no change in prices.
4.Free trade is based on the principle of:

a) Comparative advantage
b) Comparative scale
c) Economies of advantage
d) Production possibility advantage
5.Which of the following is not an economic argument for protectionism?

a) To protect infant industries
b) To increase the level of imports
c) To protect strategic industries
d) To improve the balance of payments

6.A tariff is:

a) A tax on domestic goods and service
b) A tax on foreign goods and services
c) A limit on the number of foreign goods entering a country
d) A limit on the number of foreign goods leaving a county
7.Tariffs:
a) Decrease the domestic price of a product
b) Increase government earnings from tax
c) Increase the quantity of imports
d) Decrease domestic production
8. What is the likely consequence of introducing a subsidy paid to domestic producers to protect against foreign
producers?
a) An increase the price in the market
b) It provides an incentive for producers to be efficient
c) It subsidizes inefficient domestic production
d) It will raise revenue for the government
9.A multinational enterprise is best described as:

a) A business that sells abroad
b) A business that buys from abroad
c) A business that intends to expand abroad
d) A business that has bases abroad
10.Typical problems of developing economies do NOT include:

a) Low levels of investment
b) Dependence on primary products
c) A highly skilled labour force
d) Undeveloped infrastructure
11.Tariffs are an example of:

a) An expenditure switching policy
b) An expenditure reducing policy
c) An expenditure expanding policy
d) An expenditure stabilization policy

12.Measures to reduce imports will:

a) Boost injections into an economy
b) Reduce withdrawals from an economy
c) Decrease injections into an economy
d) Increase withdrawals from an economy
13.Common arguments in favour of globalization do not usually include:

a) Greater inequality
b) Boost world economic growth
c) Shares technology
d) Greater access for consumers to wider range of products
4.5 Solutions to case study

1. The tariff was designed to protect American producers from low-cost Chinese imports, thereby helping to create
jobs in the U.S. tire industry. However, it may also have raised the average price of tires to American consumers,
leaving them with less money to spend on other goods and services. For its part, the Obama administration clearly
believes that the gains, in terms of jobs saved or created, outweigh any losses from higher prices.
2. The additional tax, or tariff, on imported goods can discourage Chinese tyre manufacturers to sell their products
in US. The additional taxes make the Chinese tyres either too expensive or not nearly as competitive as it would
be if the tariff didn't exist. This can lead to fewer choices of goods and a lower quality for consumers. The amount
of tyres you have to choose from are all subject to the effects of tariffs.
US tyre manufacturers benefit by ultimately facing reduced competition in their home market, which leads to lower
supply levels and higher prices for consumers. As you can see from the graph below, S0 and D0 represent the
original supply and demand curves, which intersect at (P0, Q0). St shows what the supply curve is with the
introduction of the tariff. The market then settles at (Pt, Qt). Less of the good is produced, and consumers pay
higher prices.
When a consumer does purchase a higher-priced imported tyres with a tariff imposed on it, the consumer now has
less money to spend on other things. This forces consumers to either buy less of the imported tyres or less of
some other good, ultimately lowering the purchasing power of consumers. It is important to remember that although
consumers may pay higher prices because of tariffs and have limited options, the potential benefit is that domestic
sales of goods can increase, ultimately leading to higher domestic sales and more jobs for companies inside the
country

Unit
5: Foreign Direct Investments

5.1 Introduction  Define foreign direct investments
5.2 Reasons for establishing foreign  Explain why firms establish operations abroad through
direct investments foreign direct investments
5.3 Benefits and costs of foreign direct  Identify the limitations of exporting and licensing
investments
 Articulate arguments of foreign direct investments
5.4 Government policy  Explore the benefits and costs of FDI to home and host
countries

5.1 Introduction
Foreign direct investment (FDI) occurs when a firm invests directly in facilities to produce or market a product in a
foreign country. According to SA Statistics (2016) a South Africa company is considered foreign controlled, if 10
percent or more of its stock are held by a foreign company. Similarly, a South Africa company is considered a
foreign direct investment if it owns more than 10 percent of a foreign firm. Once a firm undertakes FDI, it becomes
a multinational enterprise.
The controlling company is called the multinational parent, while the “controlled” company is called the multinational
affiliates (Krugman; Obstfeld & Melitz 2015). An example of FDI is Walmart who first became a multinational in the
early 1990s when it invested in Mexico.
Think Point
We often hear the term “Foreign Direct Investment” on the media.

What do you understand by the term “Foreign Direct Investment”?
Comment on Think Point

Foreign direct investment (FDI) may be defined as follows:
 “Foreign direct investment occurs when a firm invests directly in facilities to produce or market a product
in a foreign country” and requires “an interest of 10 percent or more in a foreign business entity” (Hill,
2009: 242).
 “Foreign direct investment refers to investment in which a firm in one country directly controls or owns a
subsidiary in another country” Krugman; Obstfeld & Melitz 2015).
Hill (2009: 242) distinguishes between two main forms of FDI - Greenfield investments and mergers:
 Greenfield Investment: involves the establishment of a new operation in a foreign country;
 Acquisitions and Mergers: involve the acquiring, or merging with, an existing organisation within a
foreign country (Hill, 2009: 242).
Activity 1
Identify 2 real world examples of greenfield investments

Comment on activity
Hyundai Motor Co. in Nošovice

“In 2006, Hyundai Motor Company received approval to make around $1 billion euros in a major greenfield
investment in Nošovice in the Czech Republic. The automaker established a new manufacturing plant that
employed up to 3,000 individuals in its first year of operation. The Czech Government provided tax relief and
subsidies to prompt the greenfield investment in hopes of boosting the country’s economy and lowering the
unemployment rate.
Toyota Motor Corp. in Mexico

In 2015, Toyota Motor Corporation announced plans to establish a new manufacturing facility in Mexico through
an investment of about US$1 billion. Slated to open in 2019, the facility is expected to produce up to 200,000 units
per year in conjunction with the currently established Tijuana plant.
The rationale behind Toyota’s greenfield investment is to improve competitiveness in North America – specifically
the United States. In addition, the low labour cost and the close proximity to US markets offer the Japanese
automaker an attractive country to establish a manufacturing facility.
5.1.1 Acquisitions versus greenfield investments

When contemplating FDI, why do firms apparently prefer to acquire existing assets rather than undertake greenfield
investments?
 First, mergers and acquisitions are quicker to execute than greenfield investments. This is an important
consideration in the modem business world where markets evolve very rapidly. Many firms apparently
believe that if they do not acquire a desirable target firm, then their global rivals will.
 Second, foreign firms are acquired because those firms have valuable strategic assets, such as brand
loyalty, customer relationships, trademarks or patents, distribution systems, production systems, and the
like. It is easier and perhaps less risky for a firm to acquire those assets than to build them from the ground
up through a greenfield investment.
 Third, firms make acquisitions because they believe they can increase the efficiency of the acquired unit
by transferring capital, technology, or management skills.
5.2 Reasons for establishing Foreign Direct Investments

Companies go through the trouble of opening new establishments in a foreign country through foreign direct
investment whilst there are other possibilities available to them, exporting and licensing, for exploiting the foreign
market.

Exporting involves the production of goods in the home country and ships them to other countries for sale.
Licensing involves granting a foreign company0 (the licensee) the right to produce and sell the firm's product in
return for a royalty fee on every unit sold.
5.2.1 Limitations of exporting

Competition: Competitors can typically not be avoided in export markets. The world is global and to stay
competitive specialty food and beverage providers need to understand their competitive advantages to stay ahead
of the competition and be successful abroad.
Extra Costs: Developing an export market takes time. It can also be costly to develop new promotional/marketing
materials, develop new packaging and assign new personnel to travel and undertake other administrative and
operational tasks. These can place severe strain on the financial resources of firms, especially the smaller firms.
Product Modification: In order to meet safety, security and other requirements in the export market, your product
may have to be modified. Some firms may not have the technical know-how where these modifications are
concerned and might have to incur the costs associated with hiring an expert. Having to modify your product for
the export market can also stretch the human and other operational resources of the firm.
Payment: Apart from the risk of non-payment, the complicated processes involved in the collection of payments
using the various methods (consignment, letter of credit etc.) can be time consuming. Firms with limited cash-flow
therefore need to fully understand the financial pitfalls associated with exporting.
The viability of an exporting strategy is often constrained by transportation costs and trade barriers. When
transportation costs are added to production costs, it becomes unprofitable to ship some products over a large
distance. This is particularly true of products that have a low value-to-weight ratio and that can be produced in
almost any location. For such products, the attractiveness of exporting decreases, relative to either FDI or licensing.
This is the case, for example, with cement. Thus Cemex, the large Mexican cement maker, has expanded
internationally by pursuing FDI, rather than exporting.
5.2.2 Limitations of licensing

The internalization theory seeks to explain why companies prefer FDI over licensing as a strategy for entering
foreign markets. According to Hill and Hult (2017), this approach is also known as the market imperfections
approach. According to internalization theory, licensing has three major drawbacks as a strategy for exploiting
foreign market opportunities.
 First, licensing may result in a firm's giving away valuable technological know-how to a potential foreign
competitor.

 A second problem is that licensing does not give a firm the tight control over manufacturing, marketing, and
strategy in a foreign country that may be required to maximize its profitability.
 A third problem with licensing arises when the firm's competitive advantage is based not as much on its
products as on the management, marketing, and manufacturing capabilities that produce those products.
The problem here is that such capabilities are often not amenable to licensing. While a foreign licensee may be
able to physically reproduce the firm's product under license, it often may not be able to do so as efficiently as the
firm could itself (Hill and Hult: 2017). As a result, the licensee may not be able to fully exploit the profit potential
inherent in a foreign market.
REFER TO PRESCRIBED TEXTBOOK FOR FURTHER EXPLANATIONS ON EXPORTING AND LICENSING.
Think Point
Why Companies go through the trouble of opening new establishments in a

foreign country through foreign direct investment whilst there are other
possibilities available to them, exporting and licensing?
Activity 2
The UNCTAD publishes the World Investment Report which provides electronic
access to wide-ranging statistics on the operations of the largest international
companies. Gather a list of the top 10 non-financial international companies
from developing countries. Provide a summary of the countries and industries
represented. Do you notice any common traits from your analysis?
5.3 Benefits and costs of foreign direct investments

We explore the benefits and costs of FDI, first from the perspective of a host (receiving) country, and then from the
perspective of the home (source) country.
5.3.1 Host-country benefits

The main benefits of inward FDI for a host country arise from resource-transfer effects, employment effects,
balance-of-payments effects, and effects on competition and economic growth.

Resource-Transfer Effects: Foreign direct investment can make a positive contribution to a host economy by
supplying capital, technology, and management resources that would otherwise not be available and thus boost
that country's economic growth rate.
Employment Effects: Foreign direct investments bring jobs to a host country that would otherwise not be created
there. The effects of FDI on employment are both direct and indirect. Direct effects arise when a foreign MNE
employs a number of host-country citizens. Indirect effects arise when jobs are created in local suppliers as a result
of the investment and when jobs are created because of increased local spending by employees of the MNE. The
indirect employment effects are often as large as, if not larger than, the direct effects (Cavusgil, Knight and
Riesenberger :2017). For example, more than 2000 new jobs were created by Toyota when it opened a new plant
in Prospecton in Durban.
Effect on Competition and Economic Growth: When FDI takes the form of a greenfield investment, the result
is to establish a new enterprise, increasing the number of players in a market and thus consumer choice. In turn,
this can increase the level of competition in a national market, thereby driving down prices and increasing the
economic welfare of consumers.
5.3.2 Host-country costs

Daniels, Radebaugh and Sullivan (2019), identified three costs of FDI concern host countries. They arise from
possible adverse effects on competition within the host nation, adverse effects on the balance of payments, and
the perceived loss of national sovereignty and autonomy.
Adverse Effects on Competition: Host governments sometimes worry that the subsidiaries of foreign MNEs may
have greater economic power than indigenous competitors. The foreign MNE may be able to draw on funds
generated elsewhere to subsidize its costs in the host market, which could drive indigenous companies out of
business and allow the firm to monopolize the market (Daniels, Radebaugh and Sullivan 2019).
Adverse Effects on the Balance of Payments concern arises when a foreign subsidiary imports a substantial
number of its inputs from abroad, which results in a debit on the current account of the host country's balance of
payments (Daniels, Radebaugh and Sullivan (2019).
National Sovereignty and Autonomy: Some host governments worry that FDI is accompanied by some loss of
economic independence. The concern is that key decisions that can affect the host country's economy will be
made by a foreign parent that has no real commitment to the host country, and over which the host country's
government has no real control.
5.3.3 Home-country benefits

According to Hill and Hult (2017), the benefits of FDI to the home (source) country arise from three sources.

 First, the home country's balance of payments benefits from the inward flow of foreign earnings.
FDI can also benefit the home country's balance of payments if the foreign subsidiary creates demands
for home-country exports of capital equipment, intermediate goods and complementary products.
 Second, benefits to the home country from outward FDI arise from employment effects. Positive
employment effects arise when the foreign subsidiary creates demand for home-country exports. Thus,
Toyota's investment in auto assembly operations in Europe has benefited both the Japanese balance-of-
payments position and employment in Japan, because Toyota imports some component parts for its
European-based auto assembly operations directly from Japan.
 Third, benefits arise when the home-country MNE learns valuable skills from its exposure to foreign
markets that can subsequently be transferred back to the home country. Through its exposure to a foreign
market, an MNE can learn about superior management techniques and superior product and process
technologies. These resources can then be transferred back to the home country, contributing to the
home country's economic growth rate.
5.3.4 Home-country costs

The most important concerns centre on the balance-of-payments and employment effects of outward FDI. The
home country's balance of payments may suffer in three ways.
 First, the balance of payments suffers from the initial capital outflow required to finance the FDI. This
effect, however, is usually more than offset by the subsequent inflow of foreign earnings.
 Second, the current account of the balance of payments suffers if the purpose of the foreign investment
is to serve the home market from a low-cost production location.
 Third, the current account of the balance of payments suffers if the FDI is a substitute for direct exports,
Daniels, Radebaugh and Sullivan (2019).
Activity 3
Discuss whether foreign direct investment is a force for good in developing countries.
Use examples from different countries to illustrate your answer.
Case study: Walmart in Japan

Japan has been a tough market for foreign firms to enter. The level of foreign direct investment (FDI) in Japan
is a fraction of that found in many other developed nations. In 2008, for example, the stock of foreign direct
investment as a percentage of GDP was 4.1 percent in Japan. In the United States, the comparable figure was
16 percent, in Germany 19.2 percent, in France 34. 7 percent, and in the United Kingdom 36.9 percent. Various
reasons account for the lack of FDI into Japan. Until the 1990s, government regulations made it difficult for

companies to establish a direct presence in the nation. In the retail sector, for example, the Large Scale Retail
Store Law, which was designed to protect politically powerful small retailers, made it all but impossible for foreign
retailers to open large-volume stores in the country (the law was repealed in 1994).
Despite deregulation during the 1990s, FDI into Japan remained at low levels. Some cite cultural factors in
explaining this. Many Japanese companies have resisted acquisitions by foreign enterprises (acquisitions are
a major vehicle for FDI). They did so because of fears that new owners would restructure too harshly, cutting
jobs and breaking long-standing commitments with suppliers. Foreign investors also state that it is difficult to
find managerial talent in Japan. Most managers tend to stay with a single employer for their entire career,
leaving very few managers in the labour market for foreign firms to hire. Furthermore, a combination of slow
economic growth, sluggish consumer spending, and an aging population makes the Japanese economy less
attractive than it once was, particularly when compared to the dynamic and rapidly growing economies of India
and China, or even the United States and the United Kingdom.
The Japanese government, however, has come around to the view that the country needs more foreign
investment. Foreign firms can bring competition to Japan where local ones may not because the foreign firms
do not feel bound by existing business practices or relationships. They can be a source of new management
ideas, business policies, and technology, all of which boost productivity. Indeed, a study by the Organization for
Economic Cooperation and Development (OECD)suggests that labour productivity at the Japanese affiliates of
foreign firms is as much as 60 percent higher than at domestic firms, and in services firms it is as much as 80
percent higher.
It was the opportunity to help restructure Japan's retail sector, boosting productivity, gaining market share, and
profiting in the process, that attracted Walmart to Japan. The world's largest retailer, Walmart entered Japan in
2002 by acquiring a stake in Seiyu, which was then the fifth-largest retailer in Japan. Under the terms of the
deal, Walmart increased its ownership stake over the next five years, becoming a majority owner by 2006. Seiyu
was by all accounts an inefficient retailer. According to one top officer, "Seiyu is bogged down in old customs
that are wasteful. Walmart brings proven skills in managing big supermarkets, which is what we would like to
learn to do." Walmart's goal was to transfer best practices from its U.S. stores and use them to improve the
performance of Seiyu. This meant implementing Walmart's cutting-edge information systems, adopting tight
inventory control, leveraging its global supply chain to bring low-cost goods into Japan, introducing everyday
low prices, retraining employees to improve customer service, extending opening hours, renovating stores, and
investing in new ones. It proved to be more difficult than Walmart had hoped. Walmart's entry prompted local
rivals to change their strategies. They began to make acquisitions and started to cut their prices to match
Walmart's discounting strategy. Walmart also found that it had to alter its merchandising approach, offering
more high-value items to match Japanese shopping habits, which were proving to be difficult to change. Also,

many Japanese suppliers were reluctant to work closely with Walmart. Despite this, after years of losses it
looked as if Seiyu would become profitable in 2010, indicating that Walmart might be able to ultimately reap a
return on its investment.
Case study questions

1.What are some of the challenges that made it difficult for foreign investments to penetrate Japan?
2.What are some of the benefits that Japan would realise as a result of foreign investments?
3. Walmart establishment was it going to benefit Japan?
4. Identify the challenges that Walmart faced after its establishment in Japan
5.4 Government policy

A host government's approach toward FDI should be an important variable in decisions about where to locate
foreign production facilities and where to make a foreign direct investment. Other things being equal, investing in
countries that have liberal policies toward FDI is clearly preferable to investing in countries that restrict FDI.
However, often the issue is not this straightforward. Despite the move toward a free market stance in recent years,
many countries still have a rather pragmatic stance toward FDI. In such cases, a firm considering FDI must often
negotiate the specific terms of the investment with the country's government (Hill and Hult: 2017. Such negotiations
centre on two broad issues.
If the host government is trying to attract FDI, the central issue is likely to be the kind of incentives the host
government is prepared to offer to the MNE and what the firm will commit in exchange. If the host government is
uncertain about the benefits of FDI and might choose to restrict access, the central issue is likely to be the
concessions that the firm must make to be allowed to go forward with a proposed investment. To a large degree,
the outcome of any negotiated agreement depends on the relative bargaining power of both parties. According to
Hill and Hult (2017), each side's bargaining power depends on three factors:
 The value each side places on what the other has to offer.
 The number of comparable alternatives available to each side.
 Each party's time horizon.
From the perspective of a firm negotiating the terms of an investment with a host government, the firm's bargaining
power is high when the host government places a high value on what the firm has to offer, the number of
comparable alternatives open to the firm is greater, and the firm has a long time in which to complete the
negotiations. The converse also holds. The firm's bargaining power is low when the host government places a low

value on what the firm has to offer, the number of comparable alternatives open to the firm is fewer, and the firm
has a short time in which to complete the negotiations, Hill and Hult (2017).
Case study: foreign direct investments by Cemex

a. Which theoretical explanation, or explanations, of FDI best explains Cemex's FDI?
b. What is the value that Cemex brings to a host economy? Can you see any potential drawbacks of inward
investment by Cemex in an economy?

c. Cemex has a strong preference for acquisitions over greenfield ventures as an entry mode. Why?
Activity 2
An integral part of successful foreign direct investment (FDI) is to understand the target
market as well as the nature of the possible investment sector. As such, your energy
company is seeking FDI opportunities in Jordan. The Multilateral Investment Guarantee
Agency has been identified as a resource to examine the energy industry internationally.
Based on the information available at this resource, prepare a report indicating recent and
important trends relevant to a possible FDI venture in Jordan.
5.5 Summary
The unit discussed FDI between countries and the following points were identified. High transportation costs or
tariffs imposed on imports help explain why many firms prefer FDI or licensing over exporting. Firms often prefer
FDI to licensing when: (a) a firm has valuable know-how that cannot be adequately, protected by a licensing
contract, (b) a firm needs tight control over a foreign entity in order to maximize its market share and earnings in
that country, and (c) a firm's skills and capabilities are not amenable to licensing. Benefits of FDI to a host country
arise from resource transfer effects, employment effects, and balance-of-payments effects. The costs of FDI to a
host country include adverse effects on competition and balance of payments and a perceived loss of national
sovereignty.

1. What is a greenfield investment?
2. Identify 5 advantages and 5 disadvantages of greenfield investments
3. What are the two forms of foreign direct investments?
4. What are three ways that a company in one country can serve (sell its product to) a market in a foreign
country?
5. How could U.S. firms doing FDI abroad cost jobs in the United States? How could it save jobs in the
United States?
6. Suppose that Mexico has previously had restrictions on inflows of foreign direct investment from all
sources, including the United States. Then suppose that they remove those restrictions on flows from the
United States in a particular industry, say hammocks. As a result, several hammock producers in the U.S.
move production to Mexico via FDI. Indicate for each of the groups below whether you expect them to
gain or to lose from this flow of investment.
a. Workers previously employed in hammock production in the U.S.
Gain / Loose

b. Workers previously employed in hammock production in Mexico.
Gain / Loose
c. Owners of firms that move production to Mexico.
Gain / Loose
d. Owners of U.S. hammock firms that do not move production to Mexico.
Gain / Loose
e. Owners of firms in Mexico that previously produced hammocks.
Gain / Loose
f. Consumers of hammocks (assume that there already was free trade in hammocks).
Gain / Loose
7.How can foreign direct investment (FDI) be best described?

A. When a government invests in another government
B. When a country looks for foreign aid
C. When you invest in a foreign stock market or buy foreign bonds
D. When an investor starts or acquires a business in a foreign country
8.Robert lives in America and he wants to make a greenfield investment in Mauritius, which is a developing country.
What type of investment does Robert want to make?
A. He will be investing in agriculture
B. He will be investing in clear-cutting rainforests
C. He will be creating a new foreign enterprise
D. He will be investing in an environmentally friendly enterprise
9. Identify two names used to indicate foreign direct investors:

A. International business firm and conglomerate
B. International conglomerate and multinational corporation
C. International enterprise and multinational business
D. Multinational corporation and multinational enterprise

10.Which of the following would be an example of foreign direct investment from the United States to Taiwan?
A. A U.S. bank buys bonds issued by a Taiwan computer manufacturer.
B. A U.S. car manufacturer enters into a contract with a Taiwan firm for the latter to make and sell it spark
plugs.
C. Microsoft hires a Taiwanese computer programmer to debug some software for it.
D. Warren Buffet (a U.S. citizen) buys a controlling share in a Taiwanese electronics firm.
5.8 Case study solution

Walmart entry in Japan
1. In the retail sector, for example, the Large Scale Retail Store Law, which was designed to protect politically
powerful small retailers, made it all but impossible for foreign retailers to open large-volume stores in the country.
Cultural factors were also one of the hindrances in attracting foreign investments.in explaining this. Many Japanese
companies have resisted acquisitions by foreign enterprises (acquisitions are a major vehicle for FDI). They did so
because of fears that new owners would restructure too harshly, cutting jobs and breaking long-standing
commitments with suppliers. Foreign investors also state that it is difficult to find managerial talent in Japan. Most
managers tend to stay with a single employer for their entire career, leaving very few managers in the labour
market for foreign firms to hire. Furthermore, a combination of slow economic growth, sluggish consumer spending,
and an aging population makes the Japanese economy less attractive than it once was, particularly when
compared to the dynamic and rapidly growing economies of India and China, or even the United States and the
United Kingdom.
2. The Japanese government, however, has come around to the view that the country needs more foreign
investment. Foreign firms can bring competition to Japan where local ones may not because the foreign firms do
not feel bound by existing business practices or relationships. They can be a source of new management ideas,
business policies, and technology, all of which boost productivity. Indeed, a study by the Organization for Economic
Cooperation and Development (OECD)suggests that labour productivity at the Japanese affiliates of foreign firms
is as much as 60 percent higher than at domestic firms, and in services firms it is as much as 80 percent higher. It
was the opportunity to help restructure Japan's retail sector, boosting productivity, gaining market share, and
profiting in the process, that attracted Walmart to Japan.
3.Walmart brings proven skills in managing big supermarkets, which is what we would like to learn to do." Walmart's
goal was to transfer best practices from its U.S. stores and use them to improve the performance of Seiyu. This
meant implementing Walmart's cutting-edge information systems, adopting tight inventory control, leveraging its
global supply chain to bring low-cost goods into Japan, introducing everyday low prices, retraining employees to
improve customer service, extending opening hours, renovating stores, and investing in new ones.

4. Walmart's entry prompted local rivals to change their strategies. They began to make acquisitions and started
to cut their prices to match Walmart's discounting strategy. Walmart also found that it had to alter its merchandising
approach, offering more high-value items to match Japanese shopping habits, which were proving to be difficult to
change. Also, many Japanese suppliers were reluctant to work closely with Walmart.
Foreign direct investments by Cemex

1. Internalization theory best explains CEMEX’s FDI because CEMEX entered into many countries and
bought domestic cement businesses instead of licensing. CEMEX has a great system and needs to
protect it from competitors.
2. The value is that CEMEX has a “Midas touch” that transforms a cement business into a thriving business.
This brings great stimulation to the host economy and also helps in the construction field, which in turn
helps to build cities and civilization. No, CEMEX would do well to invest inwardly, yet, CEMEX is better at
acquisitioning businesses.
3. Acquisitions are solid because the business in the host economy already knows the demographics and
the market. CEMEX just has to make the business better with little research. A greenfield venture would
prove risky and not cost effective.

Unit
6: The Foreign Exchange Market

6.2 Definition of foreign exchange market  Explain foreign exchange market
6.3 The functions of foreign exchange  Describe the functions of foreign exchange markets
market
 Explain the process of currency conversion
 Understand what is meant by spot exchange rate
 Explain the role played by forward exchange rates in insuring

against foreign exchange risk

6.1 Introduction
What happens in the foreign exchange market can have a fundamental impact on the sales, profits, and strategy
of an enterprise. Accordingly, it is very important for managers to understand the foreign exchange market, and
what the impact of changes in currency exchange rates might be for their enterprise.
With this in mind, the current unit has three main objectives. The first is to explain how the foreign exchange market
works. The second is to examine the forces that determine exchange rates, and to discuss the degree to which it
is possible to predict future exchange rate movements. The third objective is to map the implications for
international business of exchange rate movements.
6.2 Definition of foreign exchange market

The foreign exchange market is a market for converting the currency of one country into that of another country.
An exchange rate is simply the rate at which one currency is converted into another. For example, a South African
uses the foreign exchange market to convert the dollars it earns from selling its products in the United States into
South African Rand. Without the foreign exchange market, international trade and international investment on the
scale that we see today would be impossible; companies would have to resort to barter. The foreign exchange
market is the lubricant that enables companies based in countries that use different currencies to trade with each
other.
One function of the foreign exchange market is to provide some insurance against the risks that arise from such
volatile changes in exchange rates, commonly referred to as foreign exchange risk. Although the foreign exchange
market offers some insurance against foreign exchange risk, it cannot provide complete insurance. It is not unusual
for international businesses to suffer losses because of unpredicted changes in exchange rates. Currency
fluctuations can make seemingly profitable trade and investment deals unprofitable, and vice versa.
Think Point
What exchange rate policy is implemented in your country and why?
6.3 The functions of foreign exchange market

The foreign exchange market serves two main functions. The first is to convert the currency of one country into the
currency of another. The second is to provide some insurance against foreign exchange risk, or the adverse
consequences of unpredictable changes in exchange rates (Cavusgil, Knight and Riesenberger: 2017)
Foreign exchange risk refers to the losses that an international financial transaction may incur due to currency
fluctuations.

6.3.1 Currency conversion

Each country has a currency in which the prices of goods and services are quoted. In the United States, it is the
dollar ($); in Great Britain, the pound (£); in South Africa, Rand (R) and so on.
In general, within the borders of a particular country, one must use the national currency. A U.S. tourist cannot
walk into a store in Cape Town, South Africa, and use U.S. dollars to buy a bottle of wine. Dollars are not recognized
as legal tender in South Africa; the tourist must use South African rand. Fortunately, the tourist can go to a bank
and exchange her dollars for rand.
When a tourist changes one currency into another, she is participating in the foreign exchange market. The
exchange rate is the rate at which the market converts one currency into another. For example, an exchange rate
of $1 = R13.50 specifies that one dollar buys R13.50 S.A Rands. The exchange rate allows us to compare the
relative prices of goods and services in different countries (Hill and Hult: 2017).
Companies engaged in international trade and investment. International businesses have four main uses
of foreign exchange markets (Hill and Hult: 2017).
1. First, the payments a company receives for its exports, the income it receives from foreign investments,
or the income it receives from licensing agreements with foreign firms may be in foreign currencies. To
use those funds in its home country, the company must convert them to its home country's currency.
2. Second, international businesses use foreign exchange markets when they must pay a foreign company
for its products or services in its country's currency.
3. Third, international businesses also use foreign exchange markets when they have spare cash that they
wish to invest for short terms in money markets.
4. Currency speculation is another use of foreign exchange markets. Currency speculation typically
involves the short-term movement of funds from one currency to another in the hopes of profiting from
shifts in exchange rates.
6.3.2 Insuring against foreign exchange risk

Hill and Hult (2017), identified a second function of the foreign exchange market which is to provide insurance
against foreign exchange risk, which is the possibility that unpredicted changes in future exchange rates will have
adverse consequences for the firm. When a firm insures itself against foreign exchange risk, it is engaging in
hedging.
To explain how the market performs this function, we must first distinguish among spot exchange rates, forward
exchange rates, and currency swaps.

Spot Exchange Rates: When two parties agree to exchange currency and execute the deal immediately, the
transaction is referred to as a spot exchange. Exchange rates governing such "on the spot" trades are referred to
as spot exchange rates. The spot exchange rate is the rate at which a foreign exchange dealer converts one
currency into another currency on a particular day (Cavusgil, Knight and Riesenberger, 2017). Thus, when our
U.S. tourist in Cape Town goes to a bank to convert her dollars into pounds, the exchange rate is the spot rate for
that day.
Spot exchange rates are reported on a real-time basis on many financial websites. Table 6.1 below shows the
exchange rates for a selection of currencies traded in the New York foreign exchange market as of 11 a.m.
February 11, 2011. An exchange rate can be quoted in two ways: as the amount of foreign currency one U.S.
dollar will buy, or as the value of a dollar for one unit of foreign currency. Thus, one U.S. dollar bought €0.7379
at this point in time, and one euro bought $1.3553 U.S. dollars.
3Table 6.1: Value of the U.S. Dollar Against Other Currencies, February 11, 2011
Source: Hill and Hult, (2017)
The value of a currency is determined by the interaction between the demand and supply of that currency relative
to the demand and supply of other currencies. For example, if lots of people want U.S. dollars and dollars are in
short supply, and few people want British pounds and pounds are in plentiful supply, the spot exchange rate for
converting dollars into pounds will change. The dollar is likely to appreciate against the pound (or, the pound will
depreciate against the dollar). Imagine the spot exchange rate is £1 = $2.00 when the market opens. As the day
progresses, dealers demand more dollars and fewer pounds. By the end of the day, the spot exchange rate might
be £1 = $1.98. Each pound now buys fewer dollars than at the start of the day. The dollar has appreciated, and
the pound has depreciated (Hill and Hult: 2017).
Forward exchange rates: A forward exchange occurs when two parties agree to exchange currency and execute
the deal at some specific date in the future. Exchange rates governing such future transactions are referred to as
forward exchange rates. For most major currencies, forward exchange rates are quoted for 30 days, 90 days,
and 180 days into the future.

For example, if a Chinese electronics manufacturer has a large order to be shipped to America in one year, it might
engage in a currency forward and sell $20 million in exchange for Chinese yuan at a forward rate of $0.80 per
yuan. Therefore, the Chinese electronics manufacturer is obligated to deliver $20 million at the specified rate on
the specified date, six months from the current date, regardless of fluctuating currency rates (Cavusgil, Knight and
Riesenberger, J (2017)
Summing up, when a firm enters into a forward exchange contract, it is taking out insurance against the possibility
that future exchange rate movements will make a transaction unprofitable by the time that transaction has been
executed. Although many firms routinely enter into forward exchange contracts to hedge their foreign exchange
risk, there are some spectacular examples of what happens when firms don't take out this insurance.
Currency swap,
Hill and Hult (2017) defined currency swap as the simultaneous purchase and sale of a given amount of foreign
exchange for two different value dates. Swaps are transacted between international businesses and their banks,
between banks, and between governments when it is desirable to move out of one currency into another for a
limited period without incurring foreign exchange risk. A common kind of swap is spot against forward.
Consider a company such as Apple Computer. Apple assembles laptop computers in the United States, but the
screens are made in Japan. Apple also sells some of the finished laptops in Japan. So, like many companies,
Apple both buys from and sells to Japan. Imagine Apple needs to change $1 million into yen to pay its supplier of
laptop screens today. Apple knows that in 90 days it will be paid ¥120 million by the Japanese importer that buys
its finished laptops. It will want to convert these yen into dollars for use in the United States. Let us say today's
spot exchange rate is $1 = ¥120 and the 90-day forward exchange rate is $1 = ¥110. Apple sells $1 million to its
bank in return for ¥120 million. Now Apple can pay its Japanese supplier. At the same time, Apple enters into a
90-day forward exchange deal with its bank for converting ¥120 million into dollars. Thus, in 90 days Apple will
receive $1.09 million (¥120 million/110 = $1.09 million). Since the yen is trading at a premium on the 90-day forward
market, Apple ends up with more dollars than it started with (although the opposite could also occur). The swap
deal is just like a conventional forward deal in one important respect: It enables Apple to insure itself against foreign
exchange risk. By engaging in a swap, Apple knows today that the ¥120 million payment it will receive in 90 days
will yield $1.09 million (Hill and Hult: 2017).
6.4 Summary
This unit explained how the foreign exchange market works and the forces that determine exchange rates. One
function of the foreign exchange market is to convert the currency of one country into the currency of another. A
second function of the foreign exchange market is to provide insurance against foreign exchange risk. The spot
exchange rate is the exchange rate at which a dealer converts one currency into another currency on a particular

day. Foreign exchange risk can be reduced by using forward exchange rates. A forward exchange rate is an
exchange rate governing future transactions.
Case Study: Billabong

Billabong is a quintessential Australian company. The maker of "surf wear" from wet suits and board shorts to
T-shirts and watches has a powerful brand name that is recognized by surfing enthusiasts around the globe.
The company is a major exporter. Some 80 percent of its sales are generated outside of Australia through a
network of 10,0000 outlets in more than 100 countries. Not surprisingly given the history of surfing, the largest
foreign market for Billabong is the United States, which accounts for about 50 percent of the company's $800
million in annual sales. As a result, Billabong's fortunes are closely linked to the value of the Australian dollar
against the U.S. dollar. When the Australian dollar falls against the U.S. dollar, Billabong's products become
less expensive in U.S. dollars, and this can drive sales forward. Conversely, if the Australian dollar rises in
value, this can raise the price of Billabong's products in terms of U.S. dollars, which impacts sales negatively.
Billabong's CEO has stated that every 1 cent movement in the U.S. dollar / Australian dollar exchange rate
means a 0.6 percent change in profit for Billabong.
During the second half of 2008 it looked as if things were going Billabong's way. The Australian dollar fell rapidly
in value against the U.S. dollar. In June 2008 one Australian dollar was worth $0.97. By October 2008 it was
worth only $0.60. The fall in the value of the Australian dollar was in part due to a fear among currency traders
that as the world slipped into a recession, caused by the 2008-2009 global financial crisis, global demand for
many of the raw materials produced in Australia would decline, exports would slump, and Australia's trade
balance would deteriorate. In anticipation of this, institutions sold Australian dollars, driving down their value on
foreign exchange markets. For Billabong, however, this was something of a blessing. The cheaper Australian
dollar would give it a pricing advantage and help to promote sales in the United States and elsewhere.
Also, when sales in U.S. dollars were translated back into Australian dollars, their value increased as the
Australian dollar fell. Anticipating this, in February 2009 Billabong's CEO affirmed that he expected the company
to increase its profits by as much as 10 percent in 2009, despite the weak global retail environment. Currency
markets, however, can be difficult to predict, and sharp reversals do occur. Between March and November 2009
the Australian dollar surged in value, rising all the way back to $0.94 to one Australian dollar. The cause was
twofold. First, there was a global sell-off of the American dollar as the full impact of the global financial crisis
became apparent, and as the scale of debt in the United States became clearer. Second, despite a recession
in the United States and Europe, the emerging economies of China and India continued to grow, and this helped
to support demand for many of the basic commodities that Australia exports, which led to a strengthening of the
Australian dollar. For Billabong, the sharp reversal was an embarrassment. The strong Australian dollar

eradicated any pricing advantage Billabong might have enjoyed. Now the amount of Australian dollars that the
company received for every sale made in U.S. dollars was declining. In February 2009 every $1 earned in U.S.
currency could be exchanged for $1.66 in Australian dollars. By October 2009 every $1 earned in U.S. currency
could only be exchanged for $1.06 in Australian dollars. In May 2009, with the Australian dollar rising rapidly,
the CEO was forced to revise his previously bullish forecast for sales and earnings. Now, he said, a combination
of weaker than expected demand in the United States, plus a strengthening Australian dollar, would lead to a
10 percent decline in profits for 2009.
Daniels, J.D. Radebaugh, L.H. Sullivan, D.P (2019)

1. Why does a fall in the value of the Australian dollar against the U.S. dollar benefit Billabong?
2.Could the rise in the value of the Australian dollar that occurred in 2009 have been predicted?
3.What might Billabong had done in order to better protect itself against the unanticipated rise in the value of the
Australian dollar that occurred in 2009?
4.The Australian dollar continued to rise by another 20 percent against the U.S. dollar in 2010 and 2011. How
would this have affected Billabong? Is there anything that Billabong might have done to limit its long-term
economic exposure to changes in the value of the currency in its largest export market?
Volkswagen's Hedging Strategy

“In January 2004, Volkswagen, Europe's largest carmaker, reported a 95 percent drop in 2003 fourth-quarter
profits, which slumped from €1.05 billion to a mere €50 million. For all of 2003, Volkswagen's operating profit
fell by 50 percent from the record levels attained in 2002. Although the profit slump had multiple causes, two
factors were the focus of much attention—the sharp rise in the value of the euro against the dollar during 2003
and Volkswagen's decision to hedge only 30 percent of its foreign currency exposure, as opposed to the 70
percent it had traditionally hedged. In total, currency losses due to the dollar's rise are estimated to have reduced
Volkswagen's operating profits by some €1.2 billion ($1.5 billion). The rise in the value of the euro during 2003
took many companies by surprise. Since its introduction January 1, 1999, when it became the currency unit of
12 members of the European Union, the euro had recorded a volatile trading history against the U.S. dollar. In
early 1999, the exchange rate stood at €1 = $1.17, but by October 2000 it had slumped to €1 = $0.83. Although
it recovered, reaching parity of €1 = $1.00 in late 2002, few analysts predicted a rapid rise in the value of the
euro against the dollar during 2003. As so often happens in the foreign exchange markets, the experts were
wrong; by late 2003, the exchange rate stood at €1 = $1.25. For Volkswagen, which made cars in Germany and
exported them to the United States, the fall in the value of the dollar against the euro during 2003 was
devastating. To understand what happened, consider a Volkswagen Jetta built in Germany for export to the
United States” Hill and Hult (2017).

“Volkswagen could have insured against this adverse movement in exchange rates by entering the foreign
exchange market in late 2002 and buying a forward contract for dollars at an exchange rate of around $1 = €1
(a forward contract gives the holder the right to exchange one currency for another at some point in the future
at a predetermined exchange rate). Called hedging, the financial strategy of buying forward guarantees that at
some future point, such as 180 days, Volkswagen would have been able to exchange the dollars it got from
selling Jettas in the United States into euros at $1 = €1, irrespective of what the actual exchange rate was at
that time. In 2003, such a strategy would have been good for Volkswagen. However, hedging is not without its
costs. For one thing, if the euro had declined in value against the dollar, instead of appreciating as it did,
Volkswagen would have made even more profit per car in euros by not hedging (a dollar at the end of 2003
would have bought more euros than a dollar at the end of 2002). For another thing, hedging is expensive
because foreign exchange dealers will charge a high commission for selling currency forward. Volkswagen
decided to hedge just 30 percent of its anticipated U.S. sales in 2003 through forward contracts, rather than the
70 percent it had historically hedged. The decision cost the company more than €1 billion. For 2004, the
company reverted back to hedging 70 percent of its foreign currency exposure” Hill and Hult (2017).
Source: Hill and Hult (2017:329)

1.Why did Volkswagen suffer a 95% drop in its 4th quarter, 2003 profits?
2.Do you think the Volkswagen’s decision to hedge only 30% of its anticipated U.S. sales was a good? Why or
why not?
3. Apart from hedging through the foreign exchange market, what else can Volkswagen do to reduce its exposure
to future declines in the value of the U.S. dollar against the euro?

1. The statement “the yen rose today from 121 to 117” makes sense because
A. The U.S. gains when Japan loses.
B. These numbers measure yen per dollar, not dollars per yen.
C. These numbers are indexes, defined relative to a base of 100.
D. These numbers refer to time of day that the change took place.
E. The yen is a reserve currency.
2. The price at which one can enter into a contract today to buy or sell a currency 30 days from now is called a
A. Reciprocal exchange rate.
B. Effective exchange rate.
C. Exchange rate option.
D. Forward exchange rate.
E. Multilateral exchange rate.

3. Forward exchange rates are useful for those who wish to

A. Protect themselves from the risk that the exchange rate will change before a transaction is completed.
B. Gamble that a currency will rise in value.
C. Gamble that a currency will fall in value.
D. Exchange currencies at a point in time in the future.
E. All of the above.
4. According to the Purchasing Power Parity theory, the value of a currency should remain constant in terms of
what it can buy in different countries of
A. Bonds
B. Stocks
C. Goods
D. Labour
E. Land
5. Currency management has become an increasingly important issue for many organisations as they become
more dependent on purchasing goods and services on a global basis.
(a) Assess THREE main reasons for the volatility of exchange rates.
(b) Compare the use of spot and forward exchange rates in the management of currencies by organisations in a
supply chain.
6.5 Case study solutions

Case Study: Billabong
1. Well one reason that the fall in the value of the Australian dollar benefits Billabong is because the United States is
such a big part of Billabong’s foreign market (equates to roughly 50% of their sales), so Billabong’s fortunes are
very closely connected to the value of both currencies against one another. When the Australian dollar falls against
the U.S. dollar, Billabong’s products become less expensive in U.S. dollars and therefore there are more sales
because more Americans are buying Billabong’s products because it’s cheaper to them.
2. I would say that no, it could not have been predicted because currency markets are difficult to predict and sharp
reversals occur. It was difficult for Billabong to predict the rise of Australian dollar because the value of Australian
dollar was rapidly falling between June 2008 Oct 2008.
3. Even though, Billabong couldn’t have predicted the value of the Australian dollar to increase. Billabong should
have focus on looking at the forecasts of the current exchange rates, especially when the United States dollar
was lowered. Also the United States at the time in 2009 was in a bad situation economic wise, which didn’t help
Billabong. The company could have prevented this risk by paying attention to the exchange rates. Instead, they

shouldn’t have taken the risky of relying on the foreign currency rate. It would have been wise to do dollar
exchanges, in order to decrease the risk of doing business in Australia. Billabong could have foreseen the
business transactions between Australia and Asian countries.
4. When the value of Australian dollar will rise by another 20% it will cause Billabong’s profit to go down about
20 %. It will cause the value of product to rise in American market. When the price in American market increase,
buyer value decreases because of dollar losing its value. When sell decreases, profits for Billabong goes down.
Billabong could have prevented itself from the long term economic change by using forward currency exchange
rates and currency swaps. This way the company would not be affected when the Australian dollar gains its
value against U.S dollar value.
Volkswagen's Hedging Strategy

1. Two factors were the focus of much attention—the sharp rise in the value of the euro against the dollar during
2003 and Volkswagen's decision to hedge only 30 percent of its foreign currency exposure, as opposed to the
70 percent it had traditionally hedged. In total, currency losses due to the dollar's rise are estimated to have
reduced Volkswagen's operating profits by some €1.2 billion ($1.5 billion).
The rise in the value of the euro during 2003 took many companies by surprise. Since its introduction January 1,
1999, when it became the currency unit of 12 members of the European Union, the euro had recorded a volatile
trading history against the U.S. dollar. In early 1999, the exchange rate stood at €1 = $1.17, but by October 2000
it had slumped to €1 = $0.83. Although it recovered, reaching parity of €1 = $1.00 in late 2002, few analysts
predicted a rapid rise in the value of the euro against the dollar during 2003. As so often happens in the foreign
exchange markets, the experts were wrong; by late 2003, the exchange rate stood at €1 = $1.25. For
Volkswagen, which made cars in Germany and exported them to the United States, the fall in the value of the
dollar against the euro during 2003 was devastating
2. When Volkswagen decided to hedge just 30 percent of its foreign exchange exposure in 2003, the company
essentially gambled that the euro would decline in value relative to the dollar. The company hoped that by saving
the cost of the commission involved in selling a currency forward, it would increase its profit margin. This strategy
backfired.
3. Volkswagen could have insured against this adverse movement in exchange rates by entering the foreign
exchange market in late 2002 and buying a forward contract for dollars at an exchange rate of around $1 = €1
(a forward contract gives the holder the right to exchange one currency for another at some point in the future at
a predetermined exchange rate). Called hedging, the financial strategy of buying forward guarantees that at
some future point, such as 180 days, Volkswagen would have been able to exchange the dollars it got from
selling Jettas in the United States into euros at $1 = €1, irrespective of what the actual exchange rate was at that

time. In 2003, such a strategy would have been good for Volkswagen. However, hedging is not without its costs.
For one thing, if the euro had declined in value against the dollar, instead of appreciating as it did, Volkswagen
would have made even more profit per car in euros by not hedging (a dollar at the end of 2003 would have bought
more euros than a dollar at the end of 2002).

Unit
7: Exporting, Importing
and Countertrade

7.2 Exporting: Principles and Practices  Explain the concept of exporting
7.3 Types of exporters  Explain the three types of exporters
7.4 Exporting: Motivation and Methods  Explain the motivators of exporting which include
profitability, productivity and diversification.
7.5 The promise and pitfalls of exporting  Explain the promises and risks associated with exporting
7.6 Importing: motivation and methods  Explain the import drivers which include specialization of
7.7 Reasons for importing labour, input optimization, local unavailability and
diversification.
 Understand the problems that complicate international

trade.
7.8 Countertrade  Distinguish the principles and practices of countertrade

7.1 Introduction
Exports and imports have always been an important facet of the global economy. As globalization, free trade
agreements, and institutional development open the economies of more and more countries, the importance of
international trade increases. This unit It looks at how to export. The volume of export activity in the world economy
has increased as exporting has become easier. Nevertheless, exporting remains a challenge for many firms. The
firm wishing to export must identify foreign market opportunities, avoid a host of unanticipated problems that are
often associated with doing business in a foreign market, familiarize itself with the mechanics of export and import
financing, learn where it can get financing and export credit insurance, and learn how it should deal with foreign
exchange risk. The process can be made more problematic by currencies that are not freely convertible.
Think Point
Why do companies engage in international business?
7.2 Exporting: principles and practices

Exporting is the sale of goods or services produced by a firm based in one country to customers that reside in
another country (Radebaugh and Sullivan: 2019). The idea of exporting manufactured goods presents a clear
situation, as in the case of Indian carmaker Tata Motors shipping (exporting) automobiles made in Pune to
customers (importers) in South Africa. Hence, exports involve any good or service that is traded from sellers in one
country to buyers in another country.
Technically, a product need not physically leave a country to qualify as an export. Rather, it need only earn foreign
currency (Hill:2017).
7.3 Types of exporters

There are three types of exporters and these include:
Non-exporter Such a company commands little to no knowledge about exporting and often professes no intention
to engage in international trade at any time
Occasional exporter This type of company fills unsolicited orders from foreign buyers but investigates
international trade options passively, if at all.
Regular exporter A company that aggressively pursues export sales as a productive, profitable, strategic activity
is regarded as a regular exporter.

7.4 Exporting: motivation and methods

Several factors motivate export. Companies that are capital and research-intensive, such as those making
pharmaceuticals, export products to amortize the steep costs of development and production. Many, such as
advertisers, lawyers, and consultants, export their services to meet the needs of clients working abroad; they either
follow their clients there or risk losing them to the rival that does. “Smaller firms in their domestic markets may
export as an indirect way to counter the production volume advantage commanded by the industry leader. Finally,
some companies export rather than invest abroad because alternate modes such as licensing, joint ventures, and
FDI carry higher risks. Serving foreign markets from the home office imposes far fewer operational requirements
than other modes.
From this diverse set of scenarios, Radebaugh and Sullivan (2019) derived the three dimensions that drive export:
profitability, productivity, and diversification.
Profitability
The key advantage of exporting is the potential to become more profitable. Companies often sell their products for
higher prices abroad than at home. Foreign markets may lack competitive alternatives, or they may be in different
stages of the product’s life cycle. Mature products at home may trigger price competition, whereas growth stages
in foreign markets allow premium prices.
Productivity
Exporting helps companies improve productivity, which is often tied to increasing economies of scale. Exploiting
unused capacity or spreading research costs over more customers, helps companies improve their operational
efficiency. Hence, selling more products in more markets drives productivity gains, while the knowledge flows
between international buyers and foreign competitor’s spurs exporters to innovate. Participating in export markets
promotes a firm’s learning, thereby enhancing the potential for innovation.
Diversification
Exporting enables companies to diversify their activities, thereby fortifying their adaptability to market trends and
disruptive innovations. In the least, developing customers in different markets reduces a firm’s vulnerability to the
loss of a local buyer while improving its bargaining power with existing suppliers. Moreover, different growth rates
in different markets enables it to use strong sales in one country to offset weak sales in another.

7.5 The promise and pitfalls of exporting

The great promise of exporting is that large revenue and profit opportunities are to be found in foreign markets for
most firms in most industries. The international market is normally so much larger than the firm's domestic market
that exporting is nearly always a way to increase the revenue and profit base of a company. By expanding the size
of the market, exporting can enable a firm to achieve economies of scale, thereby lowering its unit costs. Firms
that do not export often lose out on significant opportunities for growth and cost reduction (Hill, 2017).
Studies have shown that while many large firms tend to be proactive about seeking opportunities for profitable
exporting, systematically scanning foreign markets to see where the opportunities lie for leveraging their
technology, products, and marketing skills in foreign countries, many medium-sized and small firms are very
reactive. Typically, such reactive firms do not even consider exporting until their domestic market is saturated and
the emergence of excess productive capacity at home forces them to look for growth opportunities in foreign
markets. Also, many small and medium-sized firms tend to wait for the world to come to them, rather than going
out into the world to seek opportunities. Even when the world does come to them, they may not respond.
One reason more firms are not proactive is that they are unfamiliar with foreign market opportunities; they simply
do not know how big the opportunities actually are or where they might lie Radebaugh and Sullivan (2019. Simple
ignorance of the potential opportunities is a huge barrier to exporting. Also, many would-be exporters, particularly
smaller firms, are often intimidated by the complexities and mechanics of exporting to countries where business
practices, language, culture, legal systems, and currency are very different from the home market.
Hill (2017) identified that many neophyte exporters run into significant problems when first trying to do business
abroad and this sours them on future exporting ventures. Common pitfalls include poor market analysis, a poor
understanding of competitive conditions in the foreign market, a failure to customize the product offering to the
needs of foreign customers, lack of an effective distribution program, a poorly executed promotional campaign,
and problems securing financing. Novice exporters tend to underestimate the time and expertise needed to
cultivate business in foreign countries. Few realize the amount of management resources that have to be dedicated
to this activity. Many foreign customers require face-to-face negotiations on their home turf. An exporter may have
to spend months learning about a country's trade regulations, business practices, and more before a deal can be
closed. The accompanying Management Focus, which documents the experience of FCX Systems in China,
suggests that it may take years before foreigners are comfortable enough to purchase in significant quantities.
Exporters often face voluminous paperwork, complex formalities, and many potential delays and errors. According
to a UN report on trade and development, a typical international trade transaction may involve 30 parties, 60
original documents, and 360 document copies, all of which have to be checked, transmitted, re-entered into various
information systems, processed, and filed. The United Nations has calculated that the time involved in preparing
documentation, along with the costs of common errors in paperwork, often amounts to 10 percent of the final value
of goods exported.

Activity 1
“You are the assistant to the CEO of a small textile firm that manufactures
quality, premium-priced, stylish clothing. The CEO has decided to see what the
opportunities are for exporting and has asked you for advice as to the steps the
company should take. What advice would you give the CEO?”
7.6 Importing: motivation and method

Importing is the purchase of a good or service by a buyer in one country, the importer from a seller in another the
exporter. Samsung’s shipment of a smart phone made in Seoul to a buyer in Belgium registers as an import for
Belgium and an export for South Korea. Service imports, given their intangibility, take various forms. Foreign banks,
like Royal Bank of Canada, that provide financial services to U.S. customers qualify as service imports. The
standard to keep in mind is that the import of a service consists of any transaction that (1) does not result in
ownership and (2) is rendered by non-residents to residents” Hill and Hult (2017).
Thus, a service import is a service transaction that does not result in ownership and is rendered by non-residents
to local residents.
There are three general types of importers:
Input optimizers This type uses foreign sourcing to optimize, in terms of price or quality, the inputs fed into its
supply chain. Essentially, a company scours the globe for optimal inputs, then directs them to
its various production points that it has configured worldwide.
Opportunistic These importers look for products around the world that they can import and profitably sell to local
citizens. They see a gap in the local marketplace, whether real (customers cannot find what they want) or perceived
(the presumption that products from some countries are intrinsically superior to local substitutes). They then
opportunistically exploit it by finding, buying, transporting, and distributing products available only from foreign
suppliers to local customers
Arbitrageur Arbitrageurs look to foreign sourcing to get the highest-quality product at the lowest possible price.
This motivation is timeless—an agent takes advantage of a price or quality difference between two or more
markets, transacting deals that exploit the imbalance, and profiting from the difference.

7.7 Reasons for importing

Several reasons motivate importing:
 Specialization of labour
 Global rivalry
 Local unavailability
 Diversification
7.7.1 Specialisation of Labour

Specialization of labour enables the organization of production to exploit location economics, especially different
wage rates and factor costs, across countries. Improved efficiencies reduce costs that encourage companies to
import cheaper products. For instance, Nike buys shoes manufactured by companies in several Asian countries,
where local companies make higher quality shoes for lower cost. Nike finds it impossible to manufacture the same
products in its home market, sell them at a reasonable price, and still make a profit; as a result, it imports shoes
made in Asian factories into markets worldwide. The same logic applies to the production of the iPad. Specifically,
Apple contracts with Foxconn to make the iPad in China, which is then imported into the United States and other
markets.
7.7.2 Global Rivalry

Industries with a high degree of global competitive rivalry, such as telecommunications, automobiles, and business
services, impose relentless cost pressures. Many products, such as aircraft or cars, rely on thousands of parts
produced in factories around the world. Companies use foreign suppliers in order to lower input costs or boost the
quality of finished products.
7.7.3 Local Unavailability

Companies import products they cannot obtain locally for geographic, regulatory, or developmental reasons.
Canada imports bananas from tropical climates because of its unsuitable climate; absent imports, Canadians would
not enjoy fresh bananas. The same goes for eating seasonal fruits and vegetables out-of-season: e.g., grapes
from Chile grace Christmas dinner in Denmark. Food is a rather obvious sector, but the same logic applies to an
endless range of products, including tablet computers, medical technology, and financial services.
7.7.4 Diversification
Importers, like exporters, diversify operating risks by tapping international markets. Developing alternative
suppliers makes a company less vulnerable to the dictates of a local supplier. For example, customers of U.S.
steelmakers, such as automobile companies, have diversified their purchases to include European, Indian, and
South Korean suppliers. This strategy reduces the risk of supply shortages or unilateral price hikes by U.S.
steelmakers.

7.8 Countertrade
Cavusgil, S.T. Knight, G. Riesenberger, J. (2017) identified countertrade is an “alternative means of structuring an
international sale when conventional means of payment are difficult, costly, or non-existent. Countertrade denotes
a whole range of barter like agreements, its principle is to trade goods and services for other goods and services
when they cannot be traded for money”. Some examples of countertrade are:
 Qatar agreed to buy 15 000 aircrafts from China with payment in crude oil at a discount of 12% below the
world oil prices.
 Simons Electrical won a contract for a $200 million electronic generators project in Greece by agreeing
to market $200 million of Greece products in markets to which Greece had no access to.
7.8.1 Types of countertrade

Countertrade is categorized as five distinct types of trading arrangements: compensation or buyback, barter, switch
trading, counter purchase and offset. Many countertrade deals do involve more than one element.
 Barter
 Counter purchase
 Offset
 Switch trading
 Buyback
Refer to prescribed textbook for further explanation on countertrade, Hill (2017, pp. 545-546)
7.8.2 The pros and cons of countertrade
Pros to Countertrade
Regardless of the complexity, companies still use countertrade as a strategy for growth because:
 Countertrade's main attraction is that it can give a firm a way to finance an export deal when other means
are not available
 Allows for entry into difficult markets
 Increases company sales where you might not otherwise have business
 Overcomes credit difficulties
 Allows for disposal of declining or surplus products
 Gains competitive advantage over competition (you don’t want to lose a market share as a result of
competitors)

Cons to Countertrade
A disadvantage to countertrade is that the value of a deal—the goods being exchanged—may be uncertain,
causing significant price volatility. Other disadvantages include, but are not limited to:
 Time-consuming. As in any unconventional tactic, there will be haggling over the good trades, so expect
a long, drawn-out negotiation until all parties are satisfied
 Complexity in the nature of the negotiations. What should you do with the goods being offered?
 Higher transaction costs (including brokerage, for instance). Costs can quickly add up, especially while
looking for a buyer for the goods, commissions to middlemen and so forth
 Greater uncertainty on the value of the goods being traded and uncertainty on the quality of the goods
Activity 2
Identify the definitions of the following terms related to exporting and importing:
ad valorem tariff, consignment, global quota, invisible barriers to trade, letter of
credit and mercantilism.
7.9 Summary
Exporting refers to the sale of goods or services produced by a company based in one country to customers that
reside in another. Importing is the opposite: the purchase of a product by a buyer in one country from a seller in
another. A service import does not result in ownership and is rendered by non-residents to the local residents in a
country. The macro and micro benefits of international trade spur governments to help potential and active
exporters. Countertrade is any one of several different arrangements by which products are traded in transactions
that do not involve cash or credit.
Case study: MD International

“Al Merritt founded MD International in 1987. A former salesman for a medical equipment company, Merritt saw
an opportunity to act as an export intermediary for medical equipment manufacturers in the United States. He
chose to focus on Latin America and the Caribbean, a region that he already had experience in. Also, trade
barriers were starting to fall throughout the region as Latin governments embraced a more liberal economic
ideology, creating an opening for entrepreneurs such as Merritt. Local governments were also expanding their
spending on health care, creating an opportunity that Merritt was poised to exploit. Merritt located his company
in south Florida to be close to his market. Since then, the company has grown to become the largest intermediary
exporting medical devices to the region. Today the company sells the products of more than 30 medical
manufacturers to some 600 regional distributors. While many medical equipment manufacturers don't sell
directly to the region because of the sizable marketing costs, MD can afford to because it goes into those
markets with a broad portfolio of products” Hill and Hult (2017).

“The company's success is in part due to its deep-rooted knowledge and understanding of the Latin American
market. MD works very closely with teams of doctors, biomedical engineers, microbiologists, and marketing
managers across Latin America to understand their needs and what the company can do for them. The sale of
products to customers is typically only the beginning of a relationship. MD International also provides training to
medical personnel in the use of devices and extensive after-sale service and support. Along the way to
becoming a successful exporter, MD International has leaned heavily upon export assistance programs
established by the U.S. government. For example, in the early 2000s a shipment to Venezuela was held up by
the Venezuelan customs seeking proof that the medical devices were not intended for military use.
Within two days, staff at the U.S. Export Assistance Centre in Miami arranged for the U.S. embassy in Venezuela
to have a letter written and delivered to the customs officials, assuring them that the products had no military
applications, and the shipment was released. Merritt has also worked extensively with the Export Import Bank
to gain financing for its exports (the company needs to finance the inventory that it exports)” Hill and Hult (2017).
“Despite these advantages, it has not all been easy going for MD International. Latin American economies have
often been highly cyclical, and MD International has ridden those cycles with them. In 2001, for example, after
several years of solid growth, an economic crisis in both Argentina and Brazil, coupled with a slowdown in
Mexico, resulted in losses for the year and forced Merritt to lay off one-third of his staff and cut the pay of others,
which included a 50 percent pay cut for himself. Things started to improve in 2002, and the weak dollar in the
mid-2000s also helped to boost export sales. However, the global financial crisis of 2008 ushered in another
tough period; although prior experience suggests that MD International can not only survive such downturns,
but also come out stronger as weaker competitors fall by the wayside” Hill and Hult (2017).

1. How does an intermediary such as MD International create value for the manufacturers that use it to sell medical
equipment in foreign markets? Why do they want to use MD International rather than export directly themselves?
2. Why did MD International focus on Latin America? What are the benefits of this regional approach? What are
the potential drawbacks?
3. What would it take for MD International to start exporting to other regions such as Asia or Europe? Given this,
would you advise Al Merritt to continue his regional focus going forward or to add other regions?

1.Identify three types of exporters
2.Establish the three dimensions that drive exports
3. Identify and explain the three general types of importers
4. With examples, define countertrade
5. What are the advantages of countertrade?

7.10 Case study solution

1.Companies like MD International that act as intermediaries between sellers in one country and buyers in another
provide many valuable services for their clients. Manufacturers can expand their sales through MD International
without committing the time and other resources that would be required to develop a market for their products in
Latin America. MD International has knowledge of the market and its regulations, can provide assistance with
financing strategies, has relationships with buyers in the region, and so on. All of these areas of expertise take
time and money to develop. By hiring MD International manufacturers can access the expertise they need, yet still
concentrate on what they do best – manufacturing.
2.When Al Merritt founded MD International in 1987 he chose to focus on Latin America. Merritt was familiar with
the area and he wanted to take advantage of changing government regulations in the region. Many Latin American
countries were opening their markets at the time and also expanding their health care spending. Together, these
created an ideal situation for MD International to expand. While focusing on a single region allows MD International
to be an expert in the market place and capitalize on economies of scale and scope, it also limits the company’s
ability to diversify when conditions in the local market change. MD International found this out the hard when in
2001 when economic crises in Brazil and Argentina and a slowdown in Mexico forced the company to make pay
cuts and lay off one third of its workforce.
3.While expanding into Asia or Europe would allow MD International to diversify and avoid some of the problems
associated with focusing on a single region, it would also be costly. MD International is currently able to offer
assistance to sellers as an expert in the region and is also able to gain the economies associated with operating
in a single location. If MD international chooses to expand its services it will need to develop the type of knowledge
and connections in the new region that it has in Latin America. Some students may suggest that the company
consider joining forces with a distributor in the new region as a way to speed up the process and lower the cost of
expansion. Other students however may wonder whether such a move could ultimately damage MD International’s
reputation as an expert in Latin America.

Answers to Revision Question
Unit 1
MULTIPLE CHOICE
1. A
2. D
3. B
4. C
5. C
6. C
7. B
8. C
9. A
SHORT ANSWER QUESTIONS
1. Globalization refers to the widening set of interdependent relationships among people from different parts of a
world that happens to be divided into nations (Hill and Hult: 2017
2. Increase in and application of technology

Liberalization of cross-border trade and resource movements
Development of services that support international business
Growth of consumer pressures
Increase in global competition
Changes in political situations and government policies
Expansion of cross-national cooperation
3. Threats to national sovereignty

Some observers worry that the proliferation of international agreements, particularly those that undermine local
restrictions on how goods are produced and sold, will diminish a nation’s sovereignty—its freedom to “act
locally” and without externally imposed restrictions. The result, by opening borders to trade, may be that the
strict country must either forgo its labour and environmental priorities to be competitive or face the downside of
fewer jobs and economic output. In addition, critics charge that globalization homogenizes products,
companies’ work methods, social structures, and even language, thus undermining the cultural foundation of
sovereignty. In essence, they argue that countries have difficulty maintaining the traditional ways of life that
unify and differentiate their cultures.

Environmental stress
According to one argument, growth consumes more non-renewable natural resources and increases
environmental damage. despoliation through toxic runoffs into rivers and oceans, air pollution from factory and
vehicle emissions, and deforestation that can affect weather and climate. In addition, globalization opponents
contend that by buying from more distant locations, the added transportation increases the carbon footprint,
which refers to the total set of greenhouse gases emitted.
Growing income inequality and personal stress

In measuring economic well-being, we not only look at our absolute situations but also compare ourselves to
others. By various measurements, income inequality, with some notable exceptions, has been growing both
among and within a number of countries. Critics claim that globalization has affected this disparity by helping
to develop a global superstar system, creating access to a greater supply of low-cost labour, and developing
competition that leads to winners and losers.
4. Expanding sales:
A company’s sales depend on the desire and ability of consumers to buy its goods or services. Pursuing
international sales usually increases the potential market and potential profits. So increased sales are a major
motive for expanding into international markets, and many of the world’s largest companies—such as
Volkswagen (Germany), Ericsson (Sweden), IBM (United States), Michelin (France), Nestlé (Switzerland), and
Sony (Japan) derive more than half their sales outside their home countries.
Acquiring resources
Producers and distributors seek out products, services, resources, and components from foreign countries,
sometimes because domestic supplies are inadequate (as with crude oil shipped to the United States). They’re
also looking for anything that will create a competitive advantage. This may mean acquiring a resource that
cuts costs. Thus, foreign sources may give companies lower costs, new or better products and additional
operating knowledge.
Reducing risk
Operating in countries with different business cycles can minimize swings in sales and profits. Moreover, by
obtaining supplies of products or components both domestically and internationally, companies may be able to
soften the impact of price swings or shortages in any one country. Thus, International operations may reduce
operating risk by smoothing sales and profits and preventing competitors from gaining advantages
Minimize Competitive Risk

Many companies enter into international business for defensive reasons. They want to counter advantages
competitors might gain in foreign markets that, in turn, could hurt them domestically.

5. Multinational enterprise (MNE) is any business that has productive activities in two or more countries. Based on
statement above, we can see that people who work for large multinational enterprise will have greater success
compare to the people who work for small firms or mini-multinational enterprise. Actually, I’m disagree with the
statement above which there is no relevance for individual who are going to work in small business because we
are in the new era which is globalization era. Globalization is the world that moving away from self-contained
national economies toward an interdependent and integrated global economic system. In addition, supposedly
every business should consider about economic and the economic depend on the situation. Therefore, the study
of international business is needed to be understood on both large multinational enterprise and small firm or mini-
multinational enterprise.
6.Technological change is important for both globalizations of markets and production because through technological
change the globalization can become reality. There are many technological change occurs such as
communications, the Internet and World Wide Web, and transportation technology that connect many nations in the
world closer enough. These can lead to create global markets and allow firms to better respond to customer
demands.
7. Internet plays a dominant role in today’s world. When it comes to international business, the role of internet
becomes more important. The business transactions take place faster with the help of internet. Companies who
invest in other countries need some connectivity which is established through internet.
Following are the uses of internet on internet business:
 Fast process of transactions. The transactions are expedited because of the use of internet. It helps the
users to process the transactions faster than before. The companies at the other end in some country gets
information the very same day
 Delivery and logistics is improved. The delivery of eth material, documents etc. are completed facts with the
help of internet. This happens because logistics are improved by using latest internet communications.
Unit 2
1. Collectivism
In collectivistic cultures, people are considered "good" if they are generous, helpful, dependable, and
attentive to the needs of others. This contrasts with individualistic cultures that often place a greater emphasis
on characteristics such as assertiveness and independence.
Individualism
“The opposite of collectivism, individualism refers to a philosophy that an individual should have freedom in his
or her economic and political pursuits. In contrast to collectivism, individualism stresses that the interests of
the individual should take precedence over the interests of the state. The central message of individualism,
therefore, is that individual economic and political freedoms are the ground rules on which a society should

be based. This puts individualism in conflict with collectivism. Collectivism asserts the primacy of the collective
over the individual; individualism asserts the opposite” Hill and Hult (2017).
2. There are three types of economic systems (Daniels, Radebaugh, and Sullivan: 2019).
In a market economy, the government plays no role in allocating resources. Instead, markets allocate
resources to the production of various products. Production is determined by the interaction of supply and
demand and signalled to producers through the price system.
In a command economy, the government decides how resources are allocated to the production of particular
products. the objective of a command economy is for government to allocate resources for "the good of society."
In addition, in a pure command economy, all businesses are state owned, the rationale being that the
government can then direct them to make investments that are in the best interests of the nation as a whole
rather than in the interests of private individual
In a mixed economy, the government and the private sector jointly solve economic problems. In a mixed
economy, certain sectors of the economy are left to private ownership and free market mechanisms while other
sectors have significant state ownership and government planning.
3. Like the economic system of a country, the legal system is influenced by the prevailing political system. The
government of a country defines the legal framework within which firms do business, and often the laws that
regulate business reflect the rulers' dominant political ideology.
4. Capitalism is an economic system in which the means of production are owned and controlled privately. In
contrast a planned economy is one in which the government or state directs and controls the economy.
5. A democratic political system is a government system that entirely relies upon elections and thus has a principle
of majority rule which is based on the participation of all its citizens.
A democratic political system is essential for sustained economic growth. Democracy is characterized by lower
inflation, high economic freedom, and high human capital accumulation. In other words, the decisions made by
the people during political elections directly impact financial resources like educations systems, communication,
and transport infrastructures, among others. For example, in developing countries, while democracy grows, the
education system grows too; therefore, the education levels go up. As the system gets better, it ends up
producing fresh empowered workers who end up demanding better healthcare facilities, improved living
conditions, easy access to clean water, better working conditions, and so forth. A democratic political system
contributes directly to life expectancy progress, which, on the other hand, leads to improved productivity.

6. International Business is evolved from international trade and international marketing. Russia has undergone
significant changes since the collapse of the Soviet Union, moving from a globally-isolated, centrally-planned
economy towards a more market-based and globally-integrated economy, but stalling as a partially reformed,
statist economy with a high concentration of wealth in officials’ hands.
Poland has the largest economy in Eastern Europe, and one of the highest levels of foreign investment at $13.9
billion as of 2006. Poland’s economy has been growing quickly, at about 6%, for the past 5 years, and was
growing at an even faster pace before this. Despite its GDP growth, Poland faces numerous economic issues; it
has chronic high unemployment, low wages despite significant increase of productivity, massive flight of educated
population abroad, and low level of innovativeness and highest percentage of people working for national
minimum wage among countries of European Union Both countries have positives and negatives aspect of
investment. But after assessing risks Quotient in these two countries one can conclude that it is difficult to set up
new facility in Russia. Because there are more factors affecting risk perception in Russia as compared to risk
perception in Poland.
Unit 3
1.A
2. A
3 B, A, B, A
4. C
5. A
6.A
7.C
8.B
9.B
10. country B has the absolute advantage in producing both products, but it has a comparative advantage in trucks
because it is relatively better at producing them.
Unit 4
1.C
2.B
3.B
4. A
5. B
6. B
7.B
8.C

9.D
10.C
11.A
12.B
13.A
Unit 5
1.In economics, a greenfield investment (GI) refers to a type of foreign direct investments (FDI) where a company
establishes operations in a foreign country. In a greenfield investment, the company constructs new facilities (sales
office, manufacturing facility, etc.) cross-border from the ground up.
2.Advantages of a Greenfield Investment

 High level of control over business operations
 High quality control over the manufacturing and sale of products and/or services
 High control over brand image and staffing
 Economies of scale and economies of scope can be achieved in terms of marketing, research and
development, and production
 Bypassing trade restrictions
 Creating jobs for the economy where the greenfield investment is taking place
Disadvantages of a Greenfield Investment

 An extremely high-risk investment – a greenfield investment is the riskiest form of foreign direct
investments
 Potentially high market entry cost (barriers to entry)
 Government regulations that may prevent foreign direct investments
 High fixed costs involved in establishing a greenfield location
3.The two forms of FDI are greenfield investments and mergers and acquisitions
4. Exporting (produce its product at home and export it to the foreign country) Licensing (license a foreign company
to produce it there, paying a fee or royalty to the home country) FDI (engage in foreign direct investment to
establish a subsidiary in the foreign country to produce the product.
5.FDI could cost jobs if a U.S. firm moves production abroad that it would otherwise have continued to do in the
U.S. It could save jobs if moving part of a firm’s operations abroad permits it to stay in business when it
otherwise would not, thus saving the jobs of those it continues to employ in the U.S.
6. Loose
Gain

Gain
Loose
Loose
Gain
7.D
8.C
9.D
10.D
Unit 6
1. B
2.D
3.E
4.C
5 (a) This question requires candidates to assess three main reasons for the volatility of exchange rates. There
are many reasons for the volatility of exchange rates and to achieve the required standard, candidates can
draw their answers from the following points although other reasons can be made relevant to answer this
question. Higher grade marks will be awarded to those candidates that provide a justification and a clear
explanation on the reasons for the volatility in exchange rates.
Supply and demand: Like any commodity, the value of a currency rises and falls in response to the forces of
supply and demand. Businesses and consumers need to spend, and consumer spending directly affects the money
supply and so exchange rates are primarily driven by the supply and demand in foreign exchange markets.
The level of interest rates: Central banks and governments influence interest rates that regulate borrowing in an
economy. Interest rates set the base rates for banks and other financial institutions to charge customers to borrow
money. For instance, if the economy is underperforming, central banks may lower interest rates to make it cheaper
to borrow; this often boosts consumer spending, which may help expand the economy.
Employment Outlook: Employment levels can usually have an immediate impact on economic growth. As
unemployment increases, consumer spending falls because jobless workers have less money to spend on non-
essentials. Those still employed tend to reduce their spending and save more of their income. An increase in
unemployment signals a slowdown in the economy and a possible devaluation of a country’s currency because of
declining confidence and lower demand.

Economic growth expectations: To meet the needs of a growing population, an economy must expand. An
expanding economy will generally lead to a strengthening of their currency. However, if growth occurs too rapidly,
the higher growth creates higher inflation, and this trend can weaken the country’s exchange rate. Deflation is the
opposite of inflation; it occurs during times of recession and is a sign of economic stagnation and this can lead to
a fall in the value of currency against stronger countries.
The balance of trade: A country’s balance of trade is measured by the total value of its exports, minus the total
value of its imports. If this number is positive, the country is said to have a favourable balance of trade. If the
difference is negative, the country has a trade gap, or trade deficit. The trade balance then impacts on supply and
demand for a currency.
5(b) This question focuses on a comparison of the use of spot and forward exchange rates in the management of
currencies by organisations in a supply chain. To achieve a pass grade, to achieve a pass mark, it is necessary
for candidates to provide an examination of both spot rates and forward contracts.
A spot rate is the exchange rate that is being offered at the current time for an immediate transaction. The spot
foreign exchange (forex) rate differs from the forward rate in that it prices the value of currencies compared to
foreign currencies today, rather than at some time in the future. The spot rate in forex currency trading is the rate
that most traders use when trading with an online retail foreign exchange broker.
A currency futures or forward contract is a legally binding contract that obligates the two parties involved to trade
a particular amount of a currency pair at a predetermined price (the stated exchange rate) at some point in the
future. Assuming that the seller does not prematurely close out the position, they can either choose to own the
currency at the time the future is written, or may speculate that the currency will be cheaper in the spot market
some time before the settlement date. Higher grades will be awarded to candidates that offer a clear explanation
of the use of currency options. These allow the right to buy or sell a specific exchange rate at a future date. A future
option allows the option holder the right to either buy or sell a currency in the future depending on the movement
of exchange rates.
Unit 7
1.Non-exporter Such a company commands little to no knowledge about exporting and often professes no
intention to engage in international trade at any time
Occasional exporter This type of company fills unsolicited orders from foreign buyers but investigates
international trade options passively, if at all.
Regular exporter A company that aggressively pursues export sales as a productive, profitable, strategic activity
is regarded as a regular exporter.

2.Profitability
The key advantage of exporting is the potential to become more profitable. Companies often sell their products for
higher prices abroad than at home. Foreign markets may lack competitive alternatives, or they may be in different
stages of the product’s life cycle. Mature products at home may trigger price competition, whereas growth stages
in foreign markets allow premium prices.
Productivity
Exporting helps companies improve productivity, which is often tied to increasing economies of scale. Exploiting
unused capacity or spreading research costs over more customers, helps companies improve their operational
efficiency. Hence, selling more products in more markets drives productivity gains, while the knowledge flows
between international buyers and foreign competitor’s spurs exporters to innovate. Participating in export markets
promotes a firm’s learning, thereby enhancing the potential for innovation.
Diversification
Exporting enables companies to diversify their activities, thereby fortifying their adaptability to market trends and
disruptive innovations. In the least, developing customers in different markets reduces a firm’s vulnerability to the
loss of a local buyer while improving its bargaining power with existing suppliers. Moreover, different growth rates
in different markets enables it to use strong sales in one country to offset weak sales in another.
3. Input optimizers This type uses foreign sourcing to optimize, in terms of price or quality, the inputs fed into its
supply chain. Essentially, a company scours the globe for optimal inputs, then directs them to its various production
points that it has configured worldwide.
Opportunistic These importers look for products around the world that they can import and profitably sell to local
citizens. They see a gap in the local marketplace, whether real (customers cannot find what they want) or perceived
(the presumption that products from some countries are intrinsically superior to local substitutes). They then
opportunistically exploit it by finding, buying, transporting, and distributing products available only from foreign
suppliers to local customers
Arbitrageur Arbitrageurs look to foreign sourcing to get the highest-quality product at the lowest possible price.
This motivation is timeless—an agent takes advantage of a price or quality difference between two or more
markets, transacting deals that exploit the imbalance, and profiting from the difference.
4. Countertrade is an alternative means of structuring an international sale when conventional means of payment
are difficult, costly, or non-existent. Countertrade denotes a whole range of barter like agreements, its principle is
to trade goods and services for other goods and services when they cannot be traded for money. Some examples
of countertrade are:

 Saudi Arabia agreed to buy 10 747 jets from Boeing with payment in crude oil, discounted at 10 percent
below posted world oil prices.
5. Countertrade advantages
 Allows for entry into difficult markets.
 Increases company sales where you might not otherwise have business.
 Overcomes credit difficulties.
 Allows for disposal of declining or surplus products.
 Gains competitive advantage over competition (you don’t want to lose a market share as a result of
competitors).
Countertrade disadvantages
 Time-consuming. As in any unconventional tactic, there will be haggling over the good trades, so expect
a long, drawn-out negotiation until all parties are satisfied.
 Complexity in the nature of the negotiations. What should you do with the goods being offered?
 Higher transaction costs (including brokerage, for instance). Costs can quickly add up, especially while
looking for a buyer for the goods, commissions to middlemen and so forth.
 Greater uncertainty on the value of the goods being traded and uncertainty on the quality of the goods.

Bibliography
 Appleyard, D. & Field, A. (2014). International Economics. 8th Edition. McGraw-Hill
 Chan, B. (2010) World Trade Organization Upholds American Tariffs on Imports of Tires from China. The
New York Times,
 Cavusgil, S.T; Knight, G. and Riesenberger, J. (2017) International Business the new realities.4th edition.
Global Edition. Pearson.
 Daniels, J.D. Radebaugh, L.H. Sullivan, D.P (2019) International business environments and operations.
16th edition. Global Edition: Pearson
 Doorey, David J., International Business and Globalization (May 22, 2012). Business Ethics: Concepts,
Cases, and Canadian Perspectives, P. Kissick (ed) (Emond Montgomery, 2012). Available at
SSRN: https://ssrn.com/abstract=2064822
 Freedman, J.M (2010) WTO Rules US Tariffs on Chinese Tire Imports Legal. Bloomberg Businessweek
 Hill, C. W. L and Hult, G.T.M (2017) International business completing in the global marketplace. 11th
Edition. United States of America: McGraw. Hill Education international edition
 Jorge, M. M. (2019) Overcoming Absolute and Comparative Advantage: A Reappraisal of the Relative
Cheapness of Foreign Commodities as the Basis of International Trade.
 Krugman, P., Obstfeld, M. & Melitz, M. (2015). International Trade: Theory and Policy. 10th Edition.
Person
 Landler, M. (2004) As Exchange Rates Swing, Car Makers Try to Duck,’ The New York Times
 Boudette, N. (2004) Volkswagen Posts 95% Drop in Net, The Wall Street Journal
 Mohr, P. & Fourie, L. (2015) Economics for South African Students. 5th edition. Pretoria: Pretoria. Van
Schaik
 Mulugeta, D. (2017) International trade theories and its trends
 Markus Bauernfeind ) Bau2005, Drivers of Globalization: Integration of Theories and Models, Munich,
GRIN Verlag, https://www.grin.com/document/57026

 Marius-Răzvan Surugiu, Camelia Surugiu, International Trade, Globalization and Economic

Interdependence between European Countries: Implications for Businesses and Marketing Framework,
Procedia Economics and Finance, Volume 32, 2015, Pages 131-138.
 Winkler, V.A. and Bouncken, R.B. (2011) How Does Cultural Diversity in Global Innovation Teams Affect
the Innovation Process? Engineering Management Journal 23(4) (December 2011).


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Bachelor of Commerce

Unit 1: International Business and Globalisation................................................................................... 9

Unit 2: National Differences in Political, Economic and Legal Systems .............................................. 23

Unit 3: International Trade Theory ...................................................................................................... 33

Unit 4: Government Policy and International Trade ............................................................................ 47

Unit 5: Foreign Direct Investments...................................................................................................... 60

Unit 6: The Foreign Exchange Market ................................................................................................ 75

Unit 7: Exporting, Importing and Countertrade ................................................................................... 87

Bibliography ......................................................................................................................................... 108

Table: 3.1 Unit of output per person at work ..................................................................................................... 38

Table 4.1 Summary of the key effects of an import quota................................................................................. 52

Figure 3.1 International Product Life Cycle ....................................................................................................... 41

1 MANCOSA – Bachelor of Commerce in International Business

We hope you enjoy the module.

MANCOSA – Bachelor of Commerce in International Business 2

C. Exit Level Outcomes and Associated Assessment Criteria of the Programme

3 MANCOSA – Bachelor of Commerce in International Business

D. Learning Outcomes and Associated Assessment Criteria of the Module

MANCOSA – Bachelor of Commerce in International Business 4

evaluated to form a framework for the development of

E. Learning Outcomes of the Units

F. How to Use this Module

5 MANCOSA – Bachelor of Commerce in International Business

H. Prescribed and Recommended Textbook/Readings

The prescribed and recommended textbooks/readings for this module is:

MANCOSA – Bachelor of Commerce in International Business 6

Special Feature Icon Explanation

The Associated Assessment Criteria is the evaluation of the students’

PRACTICAL Practical Application or Examples will be discussed to enhance

APPLICATION understanding of this module.

7 MANCOSA – Bachelor of Commerce in International Business

Case Studies are included in different sections in this Module Guide.

You may come across links to Videos Activities as well as instructions

VIDEO ACTIVITY on activities to attend to after watching the video.

MANCOSA – Bachelor of Commerce in International Business 8

9 MANCOSA – Bachelor of Commerce in International Business

Unit Learning Outcomes

CONTENT LIST LEARNING OUTCOMES OF THIS UNIT:

1.1 Introduction  Introduce topic areas for the unit

1.4. The criticisms of globalization  Explain the major criticisms of globalization

 Explain the changing nature of the global economy

Prescribed and Recommended Textbooks/Readings

MANCOSA – Bachelor of Commerce in International Business 10

Product Country of origin

11 MANCOSA – Bachelor of Commerce in International Business

2. What do you think are some of the impacts of globalisation?

1.2 Globalization, International Business and their relationship

Why should you study international business?

Thus, studying international business is important because

MANCOSA – Bachelor of Commerce in International Business 12

1.3 The forces driving globalization and IB

Factors in increased globalization

1.3.1 Increase in and application of technology

1.3.2 Liberalization of cross-border trade and resource movements

13 MANCOSA – Bachelor of Commerce in International Business

 Competition spurs domestic producers to become more efficient.

1.3.3 Development of services that support international business

1.3.4 Growth of consumer pressures

1.3.5. Increase in global competition

1.3.6 Changes in political situations and government policies

1.3.7. Expansion of cross-national cooperation

MANCOSA – Bachelor of Commerce in International Business 14

1.4 The criticisms of globalization

1.4.1 Threats to national sovereignty