CRD-MODULE5-AE5-IBT1 Lecture

Unit REGULATORY, LEGAL, AND ECONOMIC ISSUES
INTERNATIONAL TRADE INSTITUTIONS AND

Module AGREEMENTS, METHODS OF TAXATION AND
ECONOMIC INDICATORS
AE5-IBT INTERNATIONAL BUSINESS & TRADE Units: Page |1
INFORMATION SHEET
INTERNATIONAL TRADE INSTITUTIONS AND AGREEMENTS, METHODS OF TAXATION AND ECONOMIC
INDICATORS
LESSON OBJECTIVES
This unit discusses the impact of government regulation and the economic environment on business. By
the end of the lesson, students should be able to:
1. Describe the major organizations and treaties that affect international trade and the trade
restrictions that they attempt to reduce.
2. Discuss various tax structures and their effects on business.
3. Define the key economic indicators such as the gross domestic product and other national income
concepts, various forecasting measures, inflation indexes, the balance of payments, and the
definitions of the money supply.
INTRODUCTION
This study unit discusses the impact of government regulation and the economic environment on
business. The first subunit covers major organizations and treaties that affect international trade and the
trade restrictions that they attempt to reduce. The next subunit discusses various tax structures and
their effects on business. The third subunit describes key economic indicators such as the gross domestic
product and other national income concepts, various forecasting measures, inflation indexes, the
balance of payments, and the definitions of the money supply. The fourth subunit outlines the legal
rules of evidence. The next subunit addresses the nature and essential elements of contract-based
agreements. The final subunit applies to internal audit engagements for monitoring and evaluating the
performance of certain contracts.
INTERNATIONAL TRADE INSTITUTIONS AND AGREEMENTS

1. International Monetary System
a. Subsequent to World War II, international monetary crises have periodically been in the news.
Economic conditions have changed rapidly. Following is a brief description of events that have
helped shape today’s monetary situation.
1) Prior to 1944, the world was on a gold standard under which the basic unit of currency
was equal to and exchangeable for a specified amount of gold. The monetary system that
prevailed in the post-World War II period was devised in 1944. It was a system of fixed
exchange rates based on a modified gold standard. International reserves in this system
included foreign currencies and the right to borrow in specified situations. The
International Monetary Fund (IMF) was created and is still active today.
a) Resources of the IMF consist of a pool of currency from which participating countries
can draw during short-term balance of payments difficulties.
b) The World Bank was created at the same time as the IMF. Its purpose is to provide
credit for development purposes to underdeveloped countries.
2) In the post-war years, the U.S. dollar became the world’s key currency used for
transactions and reserves.
PREPARED BY: APPROVED FOR IMPLEMENTATION:

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QUARTER CHRISTOPHER R. DULCE MR. WILBERT A. MAÑUSCA
Subject Teacher School Administrator
ECONOMIC INDICATORS
3) By the mid-1950s, fixed exchange rates and changing economic conditions turned the
dollar shortage into a dollar glut. Holders tried to convert dollars to other currencies,
causing the dollar to decline in value.
4) In the early 1970s, convertibility of gold into dollars was abolished by the U.S., breaking
down the entire fixed-rate international system. Most countries agreed to allow the
currencies to float to determine the new rates, but these countries would frequently
intervene in support of their currencies.
5) In 1976, the leading noncommunist nations developed a system called the Jamaica
Agreement. This agreement moved the world to a system of managed floating exchange
rates. Each country had greater autonomy in managing its exchange rate.
b. Eurodollars are U.S. dollars held at banks outside of the U.S., either foreign banks or branches
of U.S. banks. The growth in the use of Eurodollars has been spectacular because they
facilitate the exchange of goods between other nations (often the exchanges use dollars even
if the U.S. is not involved in the transaction).
1) Because it is outside the direct control of the U.S. monetary authorities, the Eurodollar
market has lower costs. For example, U.S. reserve requirements and Federal Deposit
Insurance Corporation (FDIC) premium payments do not apply in this market. A lower cost
market can offer depositors higher interest rates.
2) Eurobonds are sold in one country but denominated in the currency of another country.
Their advantage is that they are usually less stringently regulated than most other bonds.
Thus, transaction costs are lower. They are not always denominated in Eurodollars.
c. The euro is the new common currency adopted by most members of the European Union. Its
phase-in period began in 1999. In 2002, national notes and coins were withdrawn from use
and replaced with euro notes and coins.
2. Multinational Corporations
a. The home country benefits from multinational operations because of improved earnings and
exports of products to foreign subsidiaries. A multinational corporation may also be better
able to obtain scarce resources than a domestic corporation. The existence of multinationals
tends to benefit everyone to the extent they foster more international trade, freer trading
policies, a better international monetary system, and improved international understanding.
1) The home country, however, may suffer adverse balance of payments effects as a result
of investment in foreign nations. Jobs may be lost to foreign subsidiaries, unions
weakened, and tax revenues diminished. The multinational may also have a competitive
advantage over domestic rivals. Furthermore, multinationals incur greater risk of
expropriation and reduced flexibility of operation in a foreign political system.
b. The host country for a multinational operation reaps the advantages of the investment of
capital, technology, and management abilities. Output and efficiency often improve along with
exports and the balance of payments. The presence of a multinational may stimulate
competition, increase tax revenues, and produce a higher standard of living.

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1) But payment of royalties, dividends, and profits can result in a net capital outflow.
Multinationals sometimes establish economically unreasonable transfer prices among
subsidiaries so that profits will be earned where taxes are lowest or restrictions on the
export of profits are least stringent. Moreover, multinationals may engage in
anticompetitive activities, such as formation of cartels.
3. International trade agreements provide regulatory authority for businesses in international trade.
Until recently, the broadest and most important of these agreements was the General Agreement
on Tariffs and Trade (GATT). Under GATT, the signatory countries agreed to equal treatment of all
member nations, multilateral negotiations to reduce tariffs, and the abolition of import quotas.
a. However, GATT was replaced by the World Trade Organization (WTO). The WTO, which was
established on January 1, 1995, is the product of the Uruguay Round of international trade
negotiations. It is a permanent body with a secretariat based in Geneva, Switzerland.
1) The WTO Agreement is a permanent set of commitments by more than 120 nations
designed to prohibit trade discrimination among member nations and between imported
and domestic products. Most of the rules of GATT are still applicable with respect to trade
in goods.
a) The WTO Agreement applies to trade in services and intellectual property as well as
goods. In addition to market access, the WTO’s mandate also extends to
antidumping rules, subsidies and countervailing measures, import licensing, rules of
origin, technical barriers to trade, sanitary measures, emergency protection from
imports (“safeguards”), and preshipment inspection.
b) A multilateral dispute settlement apparatus has been established. If bilateral
consultations and mediation efforts fail, a panel is established to examine the case
and make recommendations. If a violation is found, trade retaliation by the
complainant against an offending country may be approved if that country does not
comply with the recommendations.
4. The North American Free Trade Agreement (NAFTA) was enacted in late 1993. The agreement
essentially provides for free trade among the U.S., Canada, and Mexico. The pact creates the
world’s largest free trade zone, stretching from the Yukon to the Yucatan. Three nations and 360
million people are linked into one economic unit.
a. The consensus is that Mexico will benefit the most by the agreement because many U.S. firms
are likely to transfer assembly operations to Mexican subsidiaries with lower labor costs.
1) NAFTA is intended to correct the disparities between the open markets of the U.S. and
the relatively closed markets of Mexico. U.S. companies should be able to sell more goods
to Mexico because Mexicans will have greater disposable income because new industries
will relocate there.
2) The biggest objection to NAFTA in the U.S. is that it causes the loss of jobs to Mexico due
to the lower labor costs and the more lax environmental standards. Supporters of NAFTA
claim that the pact will create more jobs in the U.S. than it eliminates, because of the
increase in exports. However, trade between the U.S. and Mexico has increased, with the
U.S. now exporting considerably more to Mexico.

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3) The U.S. financial services industry, such as mutual funds, banks, and brokers, should
benefit by NAFTA because the agreement allows U.S. financial firms, for the first time, to
have easy access to Mexican investors. Also, with the opening of Mexico’s financial
markets, more opportunities for U.S. investors should emerge.
4) American industries such as shoe makers, apparel manufacturers, and farmers, may be
hurt by increased competition from cheaper Mexican products.
5) High-tech firms in the U.S. may benefit because there will be few Mexican products to
compete against and exports will expand. Moreover, NAFTA establishes uniform legal
standards for the protection of intellectual property.
b. Transition rules. NAFTA ended tariffs on about half of the more than 9,000 products covered
by the agreement. Tariffs on another 15% of the goods were to end in 1998, and the rest of
the products are to be duty-free by 2008.
1) One of the biggest controversies during negotiations was determining the products to be
protected with the longest tariff phase-outs. The U.S. won long phase-outs for such items
as sneakers, household glassware, asparagus, broccoli, peanuts, and orange juice
concentrate.
2) Negotiation of import and export restrictions was an important aspect of setting the
transition rules for NAFTA. For example, the “infant-industry argument” contends that
protective tariffs are needed to allow new domestic industries to become established.
3) An extension of the infant-industry argument is the “strategic trade policy argument,”
which contends that a government should use trade barriers strategically to reduce the
risk of product development borne by domestic firms, particularly for products involving
advanced technology.
c. The theory behind free trade zones is that they benefit consumers by lowering prices and that
manufacturers and workers gain from expanded markets for the items each country produces
most efficiently.
5. Trade Restrictions
a. Even though individuals (as a whole) are best off under free trade, governments often
establish protectionist policies designed to block or restrict the importation of certain
products, to encourage exports, or even to restrict exports.
1) Tariffs are taxes designed to restrict imports and lower consumption.
a) Antidumping rules prevent foreign producers from selling excess goods on the
domestic market at less than cost to eliminate competitors.
2) Import quotas set fixed limits on different products. In the short run, they help a country’s
balance of payments by increasing domestic employment, but the prices of the products
produced will also increase.
a) An embargo is a total ban on some kinds of imports.
3) Domestic content rules require that at least a portion of any imported product be
constructed from parts manufactured in the importing nation. This rule is sometimes used
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by capital-intensive nations. Parts can be produced using idle capacity and then sent to a
labor-intensive country for final assembly.
4) Exchange controls limit the amount of foreign currency transactions. They also set
exchange rates with other currencies. These controls limit the ability of a firm selling in a
country to repatriate its export earnings.
5) Export subsidies are payments by the government to producers in certain industries in an
attempt to increase exports. A government may also impose countervailing duties on
imports if those goods were produced in a foreign country with the aid of a subsidy.
6) Special tax benefits to exporters are an indirect form of export subsidy. For example,
Foreign Sales Corporations (FSCs) are entities located in U.S. possessions or in countries
with tax information exchange agreements with the U.S. About 15% of their qualified
export income is exempt.
7) Certain exports may require licenses. For example, sales of technology with military
applications are limited by western nations that are members of the Coordinating
Committee for Multilateral Export Controls. The related U.S. legislation is the Export
Administration Act of 1979.
8) In the U.S., the Export Trading Company Act of 1982 permits competitors to form export
trading companies without regard to antitrust legislation.
b. The economic effect of trade barriers is to shift workers from relatively efficient export
industries into less efficient protected industries. Real wage rates will decline as a result, as will
total world output. Domestic producers are not subject to the restrictions and will therefore
have an advantage over their foreign competitors. However, absent such competition, the
domestic price of the item will be higher. Domestic producers will sell more at a higher price,
and domestic consumers will consume less following the price increase.
c. A major reason for trade restrictions is that the costs of competition are direct and
concentrated (people lose jobs and firms go out of business), but benefits of unrestricted trade
are less noticeable and occur in the future (lower prices, higher wages, more jobs in export
industries).
1) Special-interest groups are strong and well organized, and they lobby effectively for
legislation that is harmful to free trade.
2) Economic integration is the joining of the markets from two or more nations into a free-
trade zone. Examples of economic blocs of trading nations are the European Union and
the North American Free Trade Agreement (NAFTA). The trading bloc ordinarily provides
trading incentives to member nations and discriminates against nonmember nations.
6. International Tax Considerations

a. Multinational corporations frequently derive income from several countries. The government
of each country in which a corporation does business may enact statutes imposing one or
more types of tax on the corporation.
b. Treaties. To avoid double taxation, two or more countries may adopt treaties to coordinate or
synchronize the effects of their taxing statutes.
1) Treaties are also used to integrate other governmental goals, e.g., providing incentive for
desired investment.
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2) For example, if a U.S. statute and a treaty to which the U.S. is a party conflict, the one
enacted or adopted last controls.
3) A treaty might modify the rules in a country’s statutes that designate the country that
income is sourced to or the country a firm is a resident of.
c. Multinational corporations
1) Most countries tax only the income sourced to that country.
2) The U.S. taxes worldwide income (from whatever source derived) of a domestic
corporation. Double taxation is avoided by allowing a credit for income tax paid to foreign
countries or by treaty provisions.
3) In the case of foreign corporations, the U.S. taxes only income sourced to the U.S.
Ordinarily, such income is effectively connected with engaging in a trade or business of
the U.S. Certain U.S. source income, e.g., gain on the sale of most stock, is not taxed by
the U.S.
4) Transfer pricing is an important aspect of the tax calculation for multinational
corporations that transfer inventories between branches in different countries. For
example, U.S. tax laws limit the amount of profit that can be transferred from a U.S.
parent to a foreign subsidiary or branch. Although there are exceptions, the basic transfer
pricing rules limit the amount of taxable income that can be claimed by the foreign
subsidiary to no more than 50% of the total taxable income. Thus, transfer prices charged
to foreign subsidiaries may differ substantially from those charged to domestic
subsidiaries.
5) There are also nontax aspects of transfer pricing. For example, limitations on taking
profits out of a foreign country, or currency restrictions, can be avoided by charging the
foreign subsidiary a higher transfer price than that charged to domestic subsidiaries. The
reason is that because firms in developing countries are allowed to pay their accounts
payable to foreign vendors, but they are not allowed to distribute profits to foreign
owners.
6) The existence of tariffs in the foreign country may necessitate a lower transfer price to
reduce a tariff based on the inventory value.
METHODS OF TAXATION
1. Government, at all levels, finances its expenditures by taxation. Thus, taxes generate government
revenues. National governments also use taxation as a means of implementing fiscal policy
regarding inflation, full employment, economic growth, etc.
2. One rationale for taxation is that individuals should pay tax based on the benefits received from the
services (e.g., paying for the use of a public park or swimming pool). Another view is that
consumers should pay taxes based on their ability to pay (e.g., taxes on income and wealth).
3. Tax-Rate Structures
a. Progressive. With a higher income, individuals pay a higher percentage of their income in
taxes.
1) Indexing is a means of avoiding the unfairness that results when inflation increases
nominal but not real taxable income, thereby subjecting it to higher tax rates. Adjusting

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tax bracket, deduction, and exemption amounts by reference to some index of inflation
avoids this problem.
b. Proportional. At all levels of income, the percentage paid in taxes is constant (e.g., a flat tax on
income).
c. Regressive. As income increases, the percentage paid in taxes decreases (e.g., sales, payroll,
property, or excise taxes). For example, an excise tax is regressive because its burden falls
disproportionately on lower-income persons. As personal income increases, the percentage of
income paid declines because an excise tax is a flat amount per quantity of the good or service
purchased.
4. The marginal tax rate is the rate applied to the last dollar of taxable income.
a. The average tax rate is the total tax liability divided by the amount of taxable income.
b. The effective tax rate is the total tax liability divided by total economic income (includes
amounts that do not have tax consequences).
5. Direct taxes are imposed upon the taxpayer and paid directly to the government, e.g., the personal
income tax.
a. Indirect taxes are levied against others and therefore only indirectly on the individual taxpayer,
e.g., corporate income taxes.
6. The incidence of taxation refers to who actually bears a particular tax. Accordingly, the person who
actually bears an indirect tax may not be the one who pays the tax to the government.
a. The incidence of taxation becomes important when a government wants to change the tax
structure. Because taxation is a form of fiscal policy, the government needs to know who will
actually bear the incidence of taxation, not just who will statutorily pay the tax.
b. Taxes such as the corporate income tax and corporate property and excise taxes are often
shifted to the consumer in the form of higher prices.
1) However, sellers ordinarily must bear part of the burden. Passing on the entire tax might
reduce unit sales unacceptably by raising the price too high. Thus, the effect of the tax is
to reduce supply (because suppliers’ costs increase) and quantity demanded by buyers
(because the price increases). The combined loss of sellers and buyers is called the
deadweight loss or excess burden of taxation.
c. Taxes such as windfall profits taxes are not shifted to the consumer via higher prices. This type
of one-time-only tax levied on part of the output produced does not increase the equilibrium
price of the taxed good.
d. Supply-side economists use the Laffer Curve to attempt to explain how people react to varying
rates of income taxation. For example, if the income tax rate is 0%, zero revenue will be raised.
Similarly, if the tax rate is 100%, income tax revenue will probably be zero because an earner
who faces a tax rate of 100% will not work.
1) The optimal income tax rate will bring in the most revenue possible. A rate that is either
too high or too low will generate less than optimal tax revenues.

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2) Supply-side economists do not state that lowering income tax rates will bring in more
revenue. Instead, they claim that, if the rates are too high, lowering rates will bring in
more revenue because output and national income will increase. This result, in theory,
should follow because of increased incentives to work, invest, and save.
3) However, economic policy should not be confused with political considerations. There are
obvious political reasons for having higher or lower tax rates on certain income levels.
Thus, the theory underlying the Laffer Curve does not address questions of
redistributionist politics.
4) A criticism of the Laffer Curve is that it does not prescribe the optimal tax rate. The only
way to know if the current tax rates are too high or too low is to change them and see if
revenues increase. Critics also have observed that the incentives provided by tax cuts may
have relatively small supply-side effects and that those effects may be felt only in the very
long run. Still another potential problem is that cutting taxes in an expanding economy
may overstimulate demand, thereby increasing inflation.
7. Many major industrial nations have already adopted a value-added tax (VAT).
a. The tax is levied on the value added to goods by each business unit in the production and
distribution chain. The amount of value added is the difference between sales and purchases.
Each firm in the chain collects the tax on its sales, takes a credit for taxes paid on purchases,
and remits the difference to the government.
b. The consumer ultimately bears the incidence of the tax through higher prices.
c. A VAT encourages consumer savings because taxes are paid only on consumption, not on
savings. Because the VAT is based on consumption, people in the lower income groups spend a
greater proportion of their income on this type of tax. Thus, the VAT is regressive.
d. Only those businesses that make a profit have to pay income taxes. The VAT, however,
requires all businesses to pay taxes, regardless of income.
e. The VAT tax is not a useful tool for fiscal policy purposes.
ECONOMIC INDICATORS
1. National income accounting measures the output and performance of the economy. The gross
domestic product (GDP) is the principal measure. It is the total market value of all final goods and
services produced within the boundaries of a country, whether by domestic or foreign-owned
sources, during a specified period of time (usually a year). GDP is calculated without regard to the
ownership of productive resources. Thus, the value of the output of a factory abroad is excluded
regardless of its ownership, but the output of a foreign-owned factory is included in the host
country’s GDP.
a. Income approach. GDP equals the sum of the items below, minus income earned abroad.
1) Employee compensation, interest, and rents
2) Proprietors’ income
3) Depreciation (consumption of fixed capital)
4) Indirect business taxes (e.g., sales taxes) and corporate income taxes
5) Dividends
6) Undistributed corporate profits

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b. Expenditure approach. GDP is also the sum of

1) Personal consumption expenditures
2) Gross private domestic investment
3) Government purchases
4) Net exports
c. To avoid double counting, the value added to each good or service at each stage of production
over the period must be summed. Alternatively, the total market value of all final goods and
services may be added.
d. GDP is not an ideal measure of economic well-being.
1) GDP is a monetary measure; therefore, comparing GDP over a period of time requires
adjustment for changes in the price level. The GDP deflator is a price index used to
convert nominal GDP to real GDP.
2) Increases in GDP often involve environmental damage such as noise, congestion, or
pollution.
3) GDP is not adjusted for changes in the population (which changes per capita income).
4) Changes in the value of leisure time are not considered.
5) Some nonmarket transactions are excluded, e.g., the value of homemakers’ work.
6) Military expenditures are included at cost, not incremental total value.
e. Other national income concepts

1) Net domestic product (NDP) = GDP — depreciation
2) National income (NI) = NDP + net income earned abroad — indirect business taxes (e.g.,
sales taxes)
a) NI is the income earned by a nation’s resources, whether located at home or abroad.
3) Personal income (PI) = NI — corporate income taxes and undistributed profits — required
contributions to governmental social security programs + transfer payments (public and
private)
4) Disposable income = PI — personal income taxes
f. Real per capita output is GDP divided by population, adjusted for inflation. It is used as a
measure of the standard of living.
2. Other Economic Indicators. Economists use a variety of economic measures to forecast turns in the
business cycle. They are variables that have had a high correlation with aggregate economic
activity. The best known are the composite indexes calculated by The Conference Board, a private
research group with a worldwide membership.
a. The Conference Board’s leading indicators include
1) Average workweek for production workers
2) Prices of 500 common stocks
3) Average weekly initial unemployment insurance claims
4) New orders for consumer goods and materials (1996 U.S. dollars)
5) New orders for nondefense capital goods
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AE5-IBT INTERNATIONAL BUSINESS & TRADE Units: P a g e | 10
6) Building permits for homes

7) Vendor performance (slower deliveries diffusion index)
8) Money supply (M 2 in 1996 U.S. dollars)
9) Index of consumer expectations (1966 base year)
10) Interest rate spread (10-year U.S. Treasury bonds-federal funds rate)
b. The Conference Board’s lagging indicators include

1) Average duration of unemployment in weeks
2) Change in index of labor cost per unit of output
3) Average prime rate charged by banks
4) Ratio of manufacturing and trade inventories to sales (1996 U.S. dollars)
5) Commercial and industrial loans outstanding (1996 U.S. dollars)
6) Ratio of consumer installment credit outstanding to personal income
7) Change in CPI for services
c. The Conference Board’s coincident indicators include

1) Employees on nonagricultural payrolls
2) Personal income minus transfer payments (1996 U.S. dollars)
3) Industrial production (based on value added and physical output)
4) Manufacturing and trade sales (1996 U.S. dollars)
3. Measuring Inflation
a. The consumer price index (CPI) measures inflation by a monthly pricing of items on a typical
household shopping list.
1) The current index uses a base year as a reference point. The price in the current year of a
market basket of goods and services is determined relative to the same basket for the
base year.
2) Price of Market Basket in a Given Year/ Price of the Same Market Basket in the Base Year
b. The wholesale price index (WPI) measures increases in prices at the wholesale level. It is often
accepted as a proxy for future inflation.
c. The GDP deflator is a price index that includes every item produced in the economy at the
price at which it entered the GDP account. Nominal GDP is stated at the actual prices at time
of measurement. Real GDP, after application of the deflator, is stated in base-year dollars.
4. The balance of payments includes all international payments made by one nation to another,
including those for imports, exports, investments, unilateral transfers, and capital movements. The
principal accounts are the current account and the capital account.
a. The current account records
1) Exports (credits) and imports (debits) of goods
a) The balance of trade is the difference between total exports and total imports of
goods.
b) A trade deficit occurs when a country imports more goods than it exports.

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2) Exports (credits) and imports (debits) of services

a) The balance on goods and services is the difference between total exports and total
imports of goods and services.
3) Interest and dividends received on investments abroad (credits) and interest and
dividends paid on foreign investments at home (debits)
4) Net unilateral transfers, e.g., foreign aid, pension payments, and remittance to relatives
(credits or debits depending on whether the flow is into or out of the country,
respectively)
5) The balance on the current account
b. The capital account records capital flows resulting from the purchase and sale of fixed or
financial assets.
1) Inflows of foreign capital (credits) are effectively exports of stocks and bonds and
therefore result in inflows of foreign currencies.
2) Outflows of capital (debits) use up supplies of foreign currencies.
3) A capital account surplus therefore indicates that inflows exceeded outflows.
c. The balance of payments deficit or surplus is the net of the current and capital account
balances.
d. A third account is the official reserves account, which keeps track of transactions involving the
central bank and its official reserve assets, such as gold and foreign currencies.
1) Also included among a central bank’s reserves are special drawing rights, or SDRs, which
are accounting entries established by the International Monetary Fund.
e. The references to debits and credits treat the balance of payments account as if it were a
revenue or expense account. In other words, a debit is similar to an expense in that it is
unfavorable for the country’s balance of payments position.
1) EXAMPLE: A debit (such as an import) is undesirable because it contributes to an
unfavorable balance of payments. The U.S. has an unfavorable balance of payments when
payments by the U.S. to foreign countries exceed the payments made from foreign
countries to the U.S. It is also unfavorable because foreign currency reserves held by the
U.S. must be given up to correct the imbalance.
a) A credit in the balance of payments account is desirable (exports, for instance)
because foreigners will be paying more to the U.S. than the U.S. is paying out. Thus,
the foreign currency reserves available to the U.S. increase.
f. Domestic effects. In addition to decreasing the reserves of foreign currencies held by a

country, an unfavorable balance of payments can also affect the domestic economy.
1) EXAMPLE: An excess of imports can cause an unfavorable balance of payments. At the
same time, consumers may not be buying domestic products, which may result in
domestic layoffs and production cutbacks. These in turn will mean less investment
opportunity domestically, and investors will begin sending their investment dollars
overseas. The flow of capital overseas compounds the balance of payments problem
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because investing in a foreign country is essentially the same as importing a product (i.e.,
the investor is importing foreign stocks and bonds).
2) Steps to correct an unfavorable balance of payments
a) Establish import quotas.
i. One country’s unfavorable balance of payments may be caused by another
nation’s import quotas. For example, if the U.S. has a continuing unfavorable
balance of payments with Japan, it might be possible to encourage Japan to
remove the trade barriers set up to keep U.S. electronics products out. The
removal of Japan’s trade restrictions would help the U.S. balance of payments
(but might result in an unfavorable balance of payments for Japan).
b) Provide export incentives.

i. EXAMPLE: The U.S. tax law provisions for Domestic International Sales
Corporations (DISCs) and Foreign Sales Corporations (FSCs) permit exporters to
postpone or avoid income taxes on export-related income as long as that
income is reinvested in export-related assets.
c) Develop substitutes for products currently being imported.

i. EXAMPLE: The U.S. has tried to develop substitutes or local sources for imported
oil.
3) An automatic correction results when a debtor nation’s monetary unit declines relative to
that of a creditor nation.
g. A balance of payments deficit (imbalance) must be equalized by shipments of goods or

reductions in reserves.
1) Gifts and grants are also used.
h. In the 1980s, the U.S. became the nation with the largest foreign debt. The reasons include the
following:
1) Federal budget deficits financed by foreigners
2) Growth in the economy that attracted foreign investors
3) High real interest rates
4) A strengthened dollar in the early 1980s that encouraged imports
5) The shift from a manufacturing to a service economy
6) A decrease in exports of agricultural goods
i. The following are the actual or potential effects of the U.S.’s debt:
1) An increase in the percentage of the GDP used for debt service
2) Reduced reserves leading to a devalued dollar, inflation, and increased exports
3) A decline in net imports and improvement in the trade balance
4) Increased savings as a result of economic uncertainty
5) Increased pressure for trade protectionism

FIRST
WEEK Meeting
ECONOMIC INDICATORS
6) Potentially high interest rates to curtail inflation and tighten the money supply, with the
consequent incentive for foreign investment
5. Definitions of money are important because tools for expanding or contracting the money supply
are methods of managing a nation’s economy.
a. M1 includes
1) Coins and currency
2) Checking deposits (including travelers’ checks)
b. The U.S. Federal Reserve’s targets for monetary growth emphasize M2. which includes
1) Coins and currency
2) Checking deposits
3) Nonchecking savings
4) Small (less than $100,000) time deposits
5) Money market accounts and money market mutual funds
c. M1 and M2 are the most common measures of money and are reported weekly in the Wall
Street Journal.
d. M3 includes M2 Plus large ($100,000 or more) time deposits.

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WEEK Meeting

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Unit REGULATORY, LEGAL, AND ECONOMIC ISSUES

INTERNATIONAL TRADE INSTITUTIONS AND

INTERNATIONAL TRADE INSTITUTIONS AND AGREEMENTS

PREPARED BY: APPROVED FOR IMPLEMENTATION:

PREPARED BY: APPROVED FOR IMPLEMENTATION:

PREPARED BY: APPROVED FOR IMPLEMENTATION:

6. International Tax Considerations

PREPARED BY: APPROVED FOR IMPLEMENTATION:

PREPARED BY: APPROVED FOR IMPLEMENTATION:

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b. Expenditure approach. GDP is also the sum of

e. Other national income concepts

6) Building permits for homes

b. The Conference Board’s lagging indicators include

c. The Conference Board’s coincident indicators include

PREPARED BY: APPROVED FOR IMPLEMENTATION:

2) Exports (credits) and imports (debits) of services

f. Domestic effects. In addition to decreasing the reserves of foreign currencies held by a

b) Provide export incentives.

c) Develop substitutes for products currently being imported.

g. A balance of payments deficit (imbalance) must be equalized by shipments of goods or

PREPARED BY: APPROVED FOR IMPLEMENTATION:

PREPARED BY: APPROVED FOR IMPLEMENTATION:

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