 Freedom of movement.
Chapter 5:  Freedom from political repression.
Ethics, Corporate Social
Responsibility, and Sustainability
Ethics, corporate social responsibility, and sustainability
are “social” issues that arise frequently in international
business.
 Ethics are the core starting point.
 Business ethics are the accepted principles of
right or wrong that govern the conduct of
businesspeople.
 Ethical strategy refers to a strategy, or course of
action, that does not violate a company’s
business ethics
Ethics and International Business
Many ethical issues rooted in differences in political
systems, laws, economic development, and culture.
 Might be normal in one country and illegal in
another.
 Incredibly difficult to come up with global
standards.
 Most common ethical issues involve:
 Employment practices.
 Human rights.
 Environmental regulations.
 Corruption.
 Moral obligations of multinational corporations.
Employment Practices
 Suppose work conditions in a host nation are inferior
to those in a multinational’s home nation.
 Which standards should apply?
 Home or host nation or something between?
 Nike case:
 Nike did not break the law, but the case raised
questions regarding the ethics of using sweatshop
labor.
 To guard against ethical abuses, firms should:
o Establish minimal acceptable standards that
safeguard the basic rights and dignity of
employees.
o Audit foreign subsidies and contractors regularly to
ensure standards are being met.
o Take corrective action as necessary.
Human Rights
 Basic human rights found in developed nations are
not universally accepted worldwide.
 Freedom of association.
 Freedom of speech.
 Freedom of assembly.
• Apartheid system in South Africa:
 Mandated segregation and prohibited blacks from
managing whites.
 Businesses from developed countries questioned
the ethics of doing business in South Africa.
 United Nation’s Sustainable Development Goals
2030.
• General Motors adopted the Sullivan principles.
 Company should not obey the apartheid rules in
its operation in South Africa.
 Company should promote abolition of apartheid
laws.
• Repressive regimes still exist in the world.
 Is it ethical for multinational corporations to do
business with repressive regimes?
 Does multinational investment bring change to
these regimes and foster economic growth and
raise living standards?
 Are some regimes so repressive that investment
cannot be justified on ethical grounds?
Ethics and International Business
Environmental Pollution
• Problems occur when environmental regulations differ
between host nations and home nation.
 Tragedy of the commons occurs when a resource
held in common by all but owned by no one is
overused by individuals, resulting in its
degradation.
 Global tragedy of the commons enhanced by
corporations that move production locations where
they are free to pump pollutants into the
atmosphere or dump them in oceans or rivers,
thereby harming these valuable global commons.
• Is it ethical for a company to escape regulations by
moving production to a nation with lax regulations?
Corruption
• Corruption has been a problem in almost every society
in history and continues to be one today.
• U.S. Foreign Corrupt Practices Act (FCPA).
 Regulates conduct of international business in the
taking of bribes and other unethical actions.
 Amended to allow for “facilitating payments.”
• The Convention on Combating Bribery of Foreign
Public Official in International Business Transactions.
  Makes the bribery of foreign officials a criminal
offense
• Ethical implications of corruption:
 Are bribes the price to pay to do a greater good?
 Do bribes reduce businesses’ incentive to invest?
• Some multinationals adopting a zero-tolerance policy.
 BP and Dow Corning
Ethical Dilemmas
Ethical obligations of multinational corporations are not
always clear-cut.
• How should corporations handle ethical dilemmas
regarding employment, human rights, corruption, and
environmental pollution?
 Pressure from customers and stakeholders to be
transparent in ethical decision making.
 No universal worldwide agreement about what
constitutes accepted ethical principles.
• Ethical
dilemmas are
situations in
which none of
the available
alternatives
seem ethically
acceptable.
Roots of Unethical Behavior
Why do managers behave unethically?
• Six determinants of ethical behavior:
 Personal ethics.
 Decision-making processes.
 Organizational culture.
 Unrealistic performance goals.
 Leadership.
 Societal culture.
Personal Ethics
 The generally accepted principles of right and
wrong governing the conduct of individuals.
 Formation of ethics is guided by our parents, our
schools, our religion, and the media.
 Expatriate managers may face pressure to violate
their personal ethics because they are away from
their ordinary social context and culture.
 Parent company may pressure managers to meet
unrealistic goals that can only be fulfilled by acting
unethically.
Decision-Making Processes
 Businesspeople may act unethically when they fail
to ask “Is this decision or action ethical?”
 Problems arise in processes that do not
incorporate ethical considerations into business
decision making.
 Need to better understand how individuals make
decisions that are ethical or unethical in an
organizational environment.
Organizational Culture
• The values and norms shared among an organization’s
employees.
• Culture in some organizations does not encourage
people to think through ethical consequences of
decisions.
Unrealistic Performance Goals
• Pressure from parent company to meet unrealistic
performance goals by cutting corners or acting
unethically.
Leadership
• Helps to establish the culture of an organization and
set the examples that others follow.
• Employees often take their cue from business leaders.
Societal Culture
• Cultures that emphasize individualism and uncertainty
avoidance are more likely to stress ethical behavior than
cultures where masculinity and power distance are
emphasized.
Philosophical Approaches to Ethics 1
Straw Men
 Offer inappropriate guidelines for ethical decision
making.
 The Friedman Doctrine―“the social responsibility
of business is to increase profits,” so long as the
company stays within the rules of law.
 Cultural relativism―ethics are reflection of culture.
 When in Rome, do as the Romans do.
• Righteous moralist―home-country standards of ethics
should be followed in foreign countries.
 Typically associated with managers from
developed nations.
 Criticized for its proponents going too far.
• Naïve immoralist―if a manager of a multinational
sees that firms from other nations are not following
ethical norms in a host nation, that manager should not
either.
Utilitarian and Kantian Ethics
• Utilitarian approaches to ethics:
• Philosophers David Hume, Jeremy Bentham, and John
Stuart Mill.
 Actions are desirable if they lead to the best
possible balance of good consequences over bad
consequences.
 Best decisions are those that produce the greatest
good for the greatest number of people.
• Drawbacks:
 Difficult to measure benefits, costs, and risks of an
action.
 It fails to consider justice.
Kantian ethics:
• Based on the philosophy of Immanuel Kant.
• People should be treated as ends and never purely as
means to the ends of others.
• People have dignity and need to be respected.
• Contemporary moral philosophers view Kantian ethics
as incomplete.
• System has no place for moral sentiments such as
sympathy or caring.
Kantian ethics:
• Based on the philosophy of Immanuel Kant.
• People should be treated as ends and never purely as
means to the ends of others.
• People have dignity and need to be respected.
• Contemporary moral philosophers view Kantian ethics
as incomplete.
• System has no place for moral sentiments such as
sympathy or caring.
Rights Theories
 Human beings have fundamental rights and
privileges that transcend national borders and
cultures.
 Moral theorists argue that fundamental human
rights form the basis for a moral compass that
managers can use in ethical decision making.
 Universal Declaration of Human Rights
 Adopted by the United Nations and ratified by
almost every country.
 Lays down principles that should be adhered to
irrespective of the culture in which one is doing
business.
 Along with rights come obligations.
 We have the right to free speech and must respect
the free speech of others.
 Obligations fall on more than one class of moral
agents – any person or institution that is capable
of moral action.
 This includes governments and corporations.
Justice Theories
• Focus on the attainment of a just distribution of
economic goods and services.
• A just distribution is a distribution of goods and services
that is considered fair and equitable.
• John Rawls argued that all economic goods and
services should be distributed equally except when an
unequal distribution would work to everyone’s
advantage.
• Veil of ignorance.
• Difference principle
Focus on Managerial Implications
Making Ethical Decisions Internationally
1. Hiring and Promotion:
 Hire and promote people with a well-grounded
sense of personal ethics.
 Refrain from promoting individuals who have acted
unethically.
 Try to hire only people with strong ethics.
 Prospective employees should find out as much
as they can about the ethical climate in an
organization prior to taking a position.
2. Organizational Culture and Leadership:
 Build an organizational culture that places a high
value on ethical behavior.
 Articulate values that place a strong emphasis on
ethical behavior.
 Emphasize the importance of a code of ethics.
 Implement a system of incentives and rewards
that recognize people who engage in ethical
behavior and sanction those who do not.
3. Decision-Making Processes:
 Put decision-making processes in place that
require people to consider the ethical dimension of
business decisions.
 Does the decision fall within the accepted values
of standards that typically apply in the
organizational environment?
 Is there a willingness to see the decision
communicated to all stakeholders affected by it?
 Would people close to me (family members,
friends, colleagues) approve of the decision?
Making Ethical Decisions Internationally
• Five-step process to think through ethical problems:
• Step 1: Identify which stakeholders a decision would
affect and in what ways.
• Internal stakeholders.
• External stakeholders.
• Stakeholder analysis involves moral imagination –
standing in the shoes of the stakeholder and asking how
a proposed decision might impact that stakeholder.
Five-step process to think through ethical problems
• Step 2: Determine whether a proposed decision would
violate the fundamental rights of any stakeholders.
• Step 3: Establish moral intent - place moral concerns
ahead of other concerns in cases where either the
fundamental rights of stakeholders or key moral
principles have been violated.
• Step 4: Engage in ethical behavior.
• Step 5: Audit decisions to make sure they are
consistent with ethical principles.
Ethics Officers:
 Institute ethical officers to:
 Assess the needs and risks that an ethics program
must address.
 Develop and distribute a code of ethics.
 Conduct training programs for employees.
 Establish and maintain confidentiality of employees.
 Comply with government laws and regulations.
 Monitor and audit ethical conduct.
 Take action, where appropriate.
 Periodically reviewing and updating the code of
ethics
Moral Courage:
• Enables managers to walk away from a decision that is
profitable but unethical.
• Gives an employee the strength to say no to a superior
who instructs employee to pursue actions that are
unethical.
• Gives employees the integrity to go public to the media
and blow the whistle on persistent unethical behavior in
a company.
6. Corporate Social Responsibility:
• Multinationals have the social responsibility to give
something back to the societies that enable them to
grow and prosper.
• Advocates argue that businesses need to recognize
their noblesse oblige and give something back to the
societies that have made their success possible.
• Power can be used in a positive way to increase social
welfare, which is ethical, or used in a manner that is
ethically and morally suspect.
7. Sustainability:
• Pursue sustainable strategies that not only help the
firm make good profits but do so without harming the
environment.
• Core idea is that an organization’s actions do not exert
a negative impact on the ability of future generations to
meet their own economic needs.
• Actions impart long-run economic and social benefits
on stakeholders.
Chapter 6:
International Trade Theory
Free Trade
• 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.
• Adam Smith’s theory of absolute advantage.
• David Ricardo’s theory of comparative advantage.
• Heckscher-Ohlin theory.
The Benefits of Trade
• Trade theories show why some international trade is
beneficial even for products a country can produce
itself.
• Allows specialization.
• Limits on imports are often in the interests of
domestic producers but not domestic consumers.
The Pattern of International Trade
 Much of the observed pattern of international trade
is difficult to explain.
 Ricardo’s theory of comparative advantage focuses
on differences in labor productivity.
 Heckscher-Ohlin theory focuses on factors of
production.
 Vernon’s product life-cycle theory focuses on
production location changes as products become
more widely accepted.
 Krugman’s new trade theory focuses on first-mover
advantages.
Trade Theory and Government Policy
 Mercantilism advocates government involvement in
promoting exports and limiting imports.
 Smith, Ricardo, and Heckscher-Ohlin:
 Argument for unrestricted free trade.
 New trade theory and Porter:
 Justify limited government intervention for certain
export-oriented industries.
Mercantilism
 Emerged in 16th century England.
 Gold and silver are mainstays of national wealth.
 It is in a country’s best interest to maintain a trade
surplus—to export more than it imports.
 Advocates government intervention to achieve a
surplus in the balance of trade.
 Mercantilism views trade as a zero-sum game—one
in which a gain by one country results in a loss by
another
Absolute Advantage
Adam Smith (1776) The Wealth of Nations
 Attacked the mercantilist assumption of zero-sum
game.
 Promoted absolute advantage:
 Country has an absolute advantage in producing a
product when it is more efficient than any other
country at producing it.
 Countries should specialize in the production of
goods for which they have an absolute advantage
and then trade these goods for goods produced by
other countries.
 Both countries benefit from specialization and trade
Comparative Advantage 1
David Ricardo (1817) Principles of Political Economy
• Promoted comparative advantage.
• A country should specialize in the production of those
goods that it produces most efficiently and buy the
goods that it produces less efficiently from other
countries, even if it can produce those goods more
efficiently itself.
The Gains from Trade
 Potential world production is greater with
unrestricted free trade than it is with restricted trade.
 The theory of comparative advantage suggests that
trade is a positive-sum game in which all countries
that participate realize economic gains.
Qualifications and Assumptions
 Simple world with two countries and two goods.
 No transportation costs.
 No differences in price of resources.
 Resources can move freely.
 Constant returns to scale.
 Each country has a fixed stock of resources and
free trade does not change the efficiency with
which a country uses its resources.
 No effects of trade on income distribution within a
country.
Extensions of the Ricardian Model
• Immobile Resources:
• Resources do not always move easily from one
economic activity to another.
• Political opposition to the adoption of a free trade
regime typically comes from those whose jobs are most
at risk.
Extensions of the Ricardian Model
 Diminishing Returns:
 Comparative advantage model assumes constant
returns to specialization.
 More realistic to assume diminishing returns to
specialization.
 Not all resources are the same quality.
 Different goods use resources in different
proportions.
Dynamic Effects and Economic Growth:
• Trade can result in two types of dynamic gains:
1. Free trade might increase a country’s stock of resources
as increased supplies of labor and capital from abroad
become available for use within the country.
2. Free trade might also increase the efficiency with which
a country uses its resources.
• Dynamic gains in both the stock of a country’s resources
and the efficiency with which resources are utilized will
cause a country’s PPF to shift outward.

 Trade, Jobs, and Wages: The Samuelson Critique.
 What happens when a rich country (U.S.) enters into
a free trade agreement with a poor country (China)
that rapidly improves its productivity after the
introduction of a free trade regime?
 Lower prices may not make up for lower wages in
the U.S.
 Concerned with offshoring of service jobs.
 Historically, free trade has benefited wealthy
countries.
 Introducing protectionist measures may be harmful
to U.S
Evidence for the Link between Trade and Growth.
• Countries that adopt a more open stance toward
international trade enjoy higher growth rates than those
that close their economies to trade.
• Sachs and Warner created a measure of how “open” to
international trade an economy was.
Heckscher-Ohlin Theory 1
Factor Endowments
• Comparative advantage arises from differences in
national factor endowments.
• The extent to which a country is endowed with
resources such as land, labor, and capital.
• Countries will export those goods that make intensive
use of factors that are locally abundant.
• Countries will also import goods that make intensive
use of factors that are locally scarce.
The Leontief Paradox
• Raised questions about the validity of the Heckscher-
Ohlin theory.
• Found that U.S. exports were less capital intensive
than U.S. imports.
The Product Life-Cycle Theory 1
Raymond Vernon proposed life-cycle theory in the mid-
1960s.
 Most new products were developed and first sold in
the U.S.
 The wealth and size of the U.S. market gave U.S.
firms a strong incentive to develop new consumer
products.
 The high cost of U.S. labor gave U.S. firms an
incentive to develop cost-saving process
innovations.
 Over time, demand grows in other countries, and
price becomes the main competitive weapon.
Product Life-Cycle Theory in the Twenty-First
Century
 Historically, an accurate theory.
 Now seems ethnocentric and increasingly dated.
New Trade Theory 1
Economies of Scale
• Cost reductions associated with large-scale production.
• The ability of firms to gain economies of scale can have
important implications for international trade.
• Trade can increase the variety of goods available to
consumers and decrease the average cost of those goods.
• In those industries in which the output required to attain
economies of scale represents a significant proportion of
total world demand, the global market may be able to
support only a small number of enterprises.
Increasing Product Variety and Reducing Costs
o What would happen in a world without trade?
o The variety of goods that a country can produce,
and the scale of production are limited by the size of
the market.
o What happens in a world with trade?
o Individual national markets are combined into a
larger world market.
o Each nation can increase the variety of goods
available to its consumers and lower the costs of
those goods.
Economies of Scale, First-Mover Advantages, and
the Pattern of Trade
o First-mover advantages:
o Economic and strategic advantages accruing to the
first to enter a market.
o Can gain a scale-based cost advantage that later
entrants find almost impossible to match.
Implications of New Trade Theory
• Nations may benefit from trade even when they do not
differ in resource endowments or technology.
• A country may predominate in the export of a good
simply because it was lucky enough to have one or more
firms among the first to produce that good.
• Useful in explaining trade patterns.
• Luck, entrepreneurship, and innovation give a firm first-
mover advantages.
National Competitive Advantage: Porter’s Diamond
Porter believed existing theories only told part of the
story.
• Wanted to explain why a nation achieves international
success in a particular industry.
• Four broad attributes of a nation shape the
environment in which local firms compete:
1. Factor endowments.
2. Demand conditions.
3. Related and supporting industries.
4. Firm strategy, structure, and rivalry.
Porter’s four attributes constitute a diamond.
 Firms are most likely to succeed in industries or
industry segments where the diamond is most
favorable.
 The diamond is a mutually reinforcing system.
 Two additional variables can influence the national
diamond.
1. Chance.
2. Government.
Factor Endowments
 Basic factors:
 Natural resources, climate, location, demographic.
 Advanced factors:
 Communication infrastructure, sophisticated and
skilled labor, research facilities, and technological
know-how.
 Advanced factors are a product of investment by
individuals, companies, and governments.
Demand Conditions
• Firms gain competitive advantage if their domestic
consumers are sophisticated and demanding.
Related and Supporting Industries
• The benefits of investments in advanced factors of
production by related and supporting industries can spill
over into an industry, thereby helping it achieve a strong
competitive position internationally.
Firm Strategy, Structure, and Rivalry
• Different nations are characterized by different
management ideologies, which may or may not help
them build national competitive advantage.
• There is a strong association between vigorous
domestic rivalry and the creation and persistence of
competitive advantage in an industry.
Evaluating Porter’s Theory
• Government policy can influence supporting and
related industries through regulation and influence firm
rivalry through such devices as capital market regulation,
tax policy, and antitrust laws.
• Porter’s theory has not been subjected to detailed
empirical testing.
Location, First-Mover Advantages, and Government
Policy
• Location: from a profit perspective, firms should
disperse production to countries where they can be
performed most efficiently.
• First-mover advantages: it pays to invest substantial
financial resources in trying to build an early advantage.
• Government policy: according to Porter, government
should invest in education, infrastructure, and basic
research.
Chapter 7:
Government Policy and International
Trade
Free trade occurs when governments do not attempt to
restrict what citizens can buy from another country or
what they can sell to another country.
• Nations nominally committed to free trade but intervene
to protect interests of politically important groups.
• Modern international trading system is based on
General Agreement on Tariffs and Trade (GATT) and the
World Trade Organization (WTO).
Instruments of Trade Policy 1
Tariffs
 Taxes levied on imports.
 Specific tariffs levied as a fixed charge for each unit
of imported good.
 Ad valorem tariffs levied as a proportion of the value
of an imported good.
 Impact:
 Increase government revenues.
 Force consumers to pay more for certain imports.
 Are pro-producer and anti-consumer.
 Reduce the overall efficiency of the world economy.
Instruments of Trade Policy
Subsidies
• Government payment to a domestic producer.
1. Cash grants.
2. Low-interest loans.
3. Tax breaks.
4. Government equity participation.
• Help domestic producers compete against foreign
imports and gain export markets.
• Domestic producers gain while consumers typically
absorb the costs.
Import Quotas and Voluntary Export Restraints
 Import quotas are direct restrictions on quantity of
some good that may be imported.
 Tariff rate quotas provide a lower tariff rate to imports
within the quota than those over the quota.
 Voluntary export restraint (VER) is a quota on trade
imposed by the exporting country.
 Quota rent refers to the extra profit producers make
when supply is artificially limited by an import quota.
Export Tariffs and Bans
 Export tariff is a tax placed on the export of a good.
 Goal is to discriminate against exporting in order to
ensure that there is sufficient supply of a good within
a country.
 Export ban is a policy that partially or entirely
restricts the export of a good.
 Example: 1975 ban on U.S. crude oil exports.
Local Content Requirements
 Some fraction of a good must be produced locally.
 Expressed in either physical or value terms.
 Protects domestic producers.
 Consumers face higher prices.
Administrative Policies
 Bureaucratic rules designed to make it difficult for
imports to enter a country.
 Hurt consumers by limiting choice.
Antidumping Policies
 Dumping occurs when companies sell goods in a
foreign market at below their costs of production or
below their “fair” market value.
 A way to unload excess production.
 Antidumping policies punish foreign firms that
engage in dumping and thereby protect domestic
producers from unfair foreign competition.
 Also known as countervailing duties.
The Case for Government Intervention 1
Political Arguments for Intervention
• Protecting Jobs and Industries.
 Most common political reason for government
intervention.
 Critics say claims of unfair competition are
overstated for political reasons.
• Protecting National Security.
• Certain industries, like defense-related ones, must be
protected.
 Retaliating.
 Government should use threat of intervention as
bargaining tool to open foreign markets.
 May liberalize trade and result in economic gains.
 Risky strategy.
 Protecting Consumers.
 Protect consumers from unsafe products.
 Indirect effect is limit or ban of imports
• Furthering Foreign Policy Objectives.
 Government may grant preferential trade terms to a
country where it wants to build strong relations.
 Trade policy can be used to punish “rogue states.”
• Protecting Human Rights.
 Government trade policy used to improve human
rights policies of trading partners.
 Example: apartheid.
Economic Arguments for Intervention
• The Infant Industry Argument.
• Governments should temporarily support new
industries until they have grown strong enough to meet
international competition.
• Support comes through tariffs, import quotas,
subsidies.
• Two criticisms:
1. Protection of manufacturing from foreign competition
does no good unless the protection helps make the
industry efficient.
2. Assumes firms are unable to make efficient long-term
investments by borrowing money from the domestic or
international capital market.
Strategic Trade Policy.
• Government can help raise national income when a
domestic firm gains first-mover advantages.
• Might pay for a government to intervene in an industry
by helping domestic firms overcome the barriers to entry
created by foreign firms that have already reaped first-
mover advantages.
• Both arguments support government intervention in
international trade.
The Revised Case for Free Trade
Retaliation and Trade War
 Krugman – strategic trade policies aimed at
establishing domestic firms in a dominant position in
a global industry boost national income at the
expense of other countries.
 These policies will probably provoke retaliation.
 Help establish antidumping policies and rules that
minimize trade-distorting subsidies.
Domestic Policies
 Governments don’t always act in the national
interest.
 Interest groups may influence policy.
 Krugman concludes that strategic trade policy is
almost certain to be captured by special-interest
groups which will Distort it to their own ends.
Development of the World Trading System 1
Strong economic arguments for unrestricted free trade.
• Governments unwilling to unilaterally lower trade
barriers for fear others might not follow suit.
• General Agreement on Tariffs and Trade (GATT).
• World Trade Organization (WTO).
From Smith to the Great Depression
 Case for free trade dates to late 18th century work of
Adam Smith and David Ricardo.
 First embraced by Great Britain in 1846.
 Corn Laws.
 Major trading partners did not reciprocate in free
trade.
 Smoot-Hawley Act created a wall of tariff barriers
against imports into the United States.
1947 to 1979: GATT, Trade Liberalization, and
Economic Growth
 Following the Great Depression, U.S. embraced free
trade.
 GATT was designed to liberalize trade by eliminating
tariffs, subsidies, import quotas, etc.
 Tariff reduction was spread over eight rounds with
great success.
1980 to 1993: Protectionist Trends
• Three reasons for increased protectionism:
• Japan’s perceived protectionist (neo-mercantilist)
policies created intense political pressures in other
countries.
• Persistent trade deficits in the U.S.
• Use of non-tariff barriers increased (VERs)
The Uruguay Round and the World Trade
Organization
• Uruguay Round sought to:
• Extend GATT rules to cover trade in services.
• Develop rules on intellectual property.
• Reduce agricultural subsidies.
• Strengthen GATT’s monitoring and enforcement
The World Trade Organization:
• Encompasses GATT and two other groups:
• General Agreement on Trade in Services (GATS).
• Agreement on Trade-Related Aspects of Intellectual
Property Rights (TRIPS).
WTO: Experience to Date
 By 2019, 164 members that account for 98 percent
of world trade.
 Strong early start, but since late 1990s unable to get
agreements to further reduce barriers.
 Limited protectionism returned following global
financial crisis of 2008 to 2009.
 The Brexit vote and election of Donald Trump also
suggest a move toward greater protectionism.
WTO: Experience to Date continued
• WTO as Global Police:
• Enforcement mechanisms appear to be having a
positive effect.
• Countries involved have mostly adopted WTO’s
recommendations.
Expanded Trade Agreements:
• Global telecommunication and financial services
industries.
• Foreign direct investment
The Future of the WTO: Unresolved Issues and the
Doha Round
• The current agenda of the WTO focuses on:
1. The rise of anti-dumping policies.
2. The high level of protectionism in agriculture.
3. The lack of strong protection for intellectual property
rights in many nations.
4. Continued high tariffs on nonagricultural goods and
services in many nations.
Antidumping Actions:
• Vague definition of what constitutes “dumping” is a
loophole many countries are exploiting.
• Concentrated in certain sectors: metal industries,
chemicals, plastics, and machinery and electrical
equipment.
Protectionism in Agriculture:
• Tariff rates generally much higher on agricultural
products.
• Reflects desire to protect domestic agriculture and
traditional farming communities.
• Net effect is to raise consumer prices.
Protection of Intellectual Property:
• TRIPS agreement obliges WTO members to grant and
enforce patents lasting at least 20 years and copyrights
lasting 50 years.
• Inadequate protections would reduce the incentive for
innovation.
Market Access for Nonagricultural Goods and
Services:
 Most developed nations have average tariff rates of
under 4 percent of value.
 Certain imports still have high tariffs, which limits
market access and economic growth.
 Tariffs higher on services than industrial goods.
 WTO goal is to reduce tariff rates to zero
A New Round of Talks: Doha.
 Have been ongoing since 2001, currently stalled.
 Agenda includes:
 Cut tariffs on industrial goods and services.
 Phase out subsidies to agricultural producers.
 Reduce barriers to cross-border investment.
 Limit use of antidumping laws.
Multilateral and Bilateral Trade Agreements
• Reciprocal trade agreements between two or more
partners.
• Created in response to failed Doha Round progress.
• Designed to capture gain from trade beyond WTO
treaties.
The World Trading System Under Threat
• Two events challenged belief or global consensus to
embrace free trade and lower barriers to cross-border
flow of goods and services.
1. British withdrawal from the European Union.
2. Election of Donald J. Trump.
Trade Barriers, Firm Strategy, and Policy
Implications
• Why should an international manager care about
political economy of free trade?
• Trade Barriers and Firm Strategy:
• Trade barriers raise the cost of exports which can
create a competitive disadvantage.
• Quotas may limit a firm’s ability to serve a country from
locations outside the country.
• Local content requirements might raise costs.
• Firm might want to locate production activities in
another country to reduce threat of future trade barriers
Policy Implications:
• Three drawbacks to government intervention:
• Tends to protect the inefficient rather than help firms
become efficient global competitors.
• Might invite retaliation and trigger a trade war.

• Unlikely to be well executed with the opportunity for it

to be captured by special-interest groups.

Chapter 8:
Foreign Direct Investment
The Direction of FDI

Foreign Direct Investment (FDI)  Historically, mostly directed at developed nations.

• Occurs when a firm invests directly in new facilities to
produce or market a good or service in a foreign country.
• 10 percent or greater interest.
• Once a firm undertakes FDI, it becomes a multinational
enterprise.
Foreign Direct Investment in the World Economy
 U.S. has been a target for FDI inflows:
 Large and wealthy domestic markets.
 Dynamic and stable economy.
 Favorable political environment and openness to
FDI.
 Inflows directed at developing nations and transition
economies over the past decade.
 Growing importance of China as recipient of FDI.

Flow of FDI

• The amount of FDI undertaken over a given time

period.

• Stock of FDI—total accumulated value of foreign-

owned assets at a given time.

• Outflows―flows of FDI out of a country.

• Inflows―flows of FDI into a country.

Trends in FDI

• Increase in both flow and stock of FDI over past 25

years.

• Growing more rapidly than world trade and world
output.
• It is a way to circumvent trade barriers.
• Driven by political and economic changes.
• Shift toward democratic political institutions and free
market economies.
• Globalization has had a positive effect.
The Source of FDI
• U.S. is the largest source since WWII.
• Six countries (U.S., U.K., France, Germany, Japan, and
the Netherlands) account for 60 percent of all FDI
outflows from 1998 to 2018.
• China became a major foreign investor around 2005,
especially in less developed nations.

The Form of FDI: Acquisitions versus Greenfield
Investments
 A greenfield investment establishes a new operation
in a foreign country.
 Acquire or merge with an existing company.
 Quicker to execute.
 Can acquire valuable strategic assets.
 Can increase the efficiency of the acquired unit by
transferring capital, technology, or management
skills.
Theories of Foreign Direct Investment 1
Three complementary perspectives:
1. Seeks to explain why a firm will favor direct
investment as a means of entering a foreign market
when two other alternatives, exporting and licensing, are
open to it.
2. Attempts to explain the observed pattern of foreign
direct investment flows.
3. The eclectic paradigm, attempts to combine the two
other perspectives into a single holistic explanation of
foreign direct investment.
Why Foreign Direct Investment?
• There are two alternatives to FDI:
• Exporting: producing goods at home and shipping to
receiving country for sale.
• Licensing: granting a foreign entity the right to produce
and sell a firm’s product in return for a royalty fee.
• FDI is expensive and risky compared with exporting
and licensing.
Limitations of Exporting:
• Transportation costs and trade barriers.
• By limiting imports through quotas and tariffs,
governments increase the attractiveness of FDI and
licensing.
Limitations of Licensing:
• Internalization theory used to explain why firms prefer
FDI gives three major drawbacks to licensing:
• Licensing may result in a firm’s giving away valuable
technological know-how to a
potential foreign competitor.
• Licensing does not give a firm the tight control over
production, marketing, and strategy in a foreign country
that may be required to maximize its profitability.
• The firm’s competitive advantage is based on the
management, marketing, and manufacturing capabilities,
which are not amenable to licensing.
Advantages of Foreign Direct Investment:
• When transportation costs or trade barriers make
exporting unattractive.
• When a firm wishes to maintain control over its
technological know-how, or over its operations and
business strategy, or when the firm’s capabilities are
simply not amenable to licensing.
The Pattern of Foreign Direct Investment
• Strategic Behavior:
• Knickerbocker—relationship between FDI and rivalry in
oligopolistic industries.
• Oligopoly is an industry with a limited number of large
firms.
• Interdependence between firms in an oligopoly leads to
imitative behavior.
• Imitative behavior also occurs in FDI.
• Multipoint competition occurs when two or more
enterprises encounter each other in different regional or
national markets.
The Eclectic Paradigm
• British economist John Dunning.
• Location-specific advantages explain rationale for FDI.
• Difficult for a firm to license its own unique capabilities
and know-how.
• Combining location-specific assets or resource
endowments with the firm’s own unique capabilities often
requires foreign direct investment.
• Firms can benefit from externalities by locating close to • Brings jobs to a host country that would otherwise not
their source. be created there.

• May be offset by loss of jobs in home country.

Political Ideology and Foreign Direct Investment Balance-of-Payments Effects:

The Radical View • Balance of payments accounts track payments to and

• Roots in Marxist political and economic theory.
• The multinational enterprise (MNE) is an instrument of
imperialist domination.
• Influential view from 1945 to 1980s.
• No longer widely accepted.
The Free Market View
• Roots in classical economic theory and trade theories
of Adam Smith and David Ricardo.
• International production should be distributed among
countries according to the theory of comparative
advantage.
receipts from other countries.
• Current account tracks exports and imports.
• A current account deficit, or trade deficit, arises when a
country is importing more goods and services than it is
exporting
• Countries prefer to run a current account surplus.
• FDI helps with a current account surplus:
• By substituting for imports.
• When the MNE uses a foreign subsidiary to export
goods and services to other countries.
Host-Country Benefits

• FDI is a benefit to both the source country and the host • Effect on Competition and Economic Growth:
country.
• Greenfield investment creates new enterprise.
Pragmatic Nationalism
• Increases number of players in a market and thus
• FDI has both benefits and costs. consumer choices.

• Pursue policies designed to maximize the national
benefits and minimize the national costs.
• Tendency to aggressively court FDI believed to be in
the national interest.
• This is done through tax breaks or grants
Shifting Ideology
• Services where exporting is not an option.
• Increases competition, stimulates investment, lower
prices.
Adverse Effects on Competition:
• Subsidiaries of foreign MNEs may have greater
economic power than indigenous competitors.

• Decline in radical ideology. • Greenfield investments increase competition, but this

not as clear with an acquisition.
• Increase in free market ideology, more liberal foreign
investment regime. Host-Country Costs

• Surge in FDI worldwide. • Adverse Effects on the Balance of Payments:

• China, Vietnam, India. • Subsequent capital outflow.

• Some nations more hostile to FDI. • Imports of substantial inputs from abroad.

• Venezuela and Bolivia • Possible Effects on National Sovereignty and

Autonomy:
Benefits and Costs of FDI 1
• A loss of economic independence.
Host-Country Benefits
Home-Country Benefits
• Resource-Transfer Effects:
• The home country’s balance of payments benefits from
• Supplies capital, technology, management resources. the inward flow of foreign earnings.
• Employment Effects: • Employment effects.

• Reverse resource-transfer effect.

• MNE learns valuable skills from its exposure to foreign • World Trade Organization formed in 1995.
markets that can subsequently be transferred back to
the home country • Push for liberalization of regulations governing FDI.

Home-Country Costs • Two extensive multinational agreements were reached

in 1997 to liberalize trade in telecommunications and
• Balance-of-payments effects suffer in three ways: financial services.

• Initial capital outflow needed to finance FDI. FDI and Government Policy

• 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.
• The current account of the balance of payments suffers
if the FDI is a substitute for direct exports.
• Employment effects when FDI is a substitute for
domestic production.
International Trade Theory and FDI
• Offshore production is FDI undertaken to serve the
home market.
• The Theory of FDI.
• Dunning’s locations specific advantages argument
explains the direction of FDI, but not why firms prefer
FDI to exporting or licensing.
• Internalization theories identify the relative profitability
of FDI, exporting, and licensing
The Theory of FDI:
• Licensing not a good option in three types of industries:
• High-technology.

• May stimulate economic growth in home country. • Global oligopolies.

• May result in lower prices. • Industries facing intense cost pressures.

• Makes a company more competitive. Government Policy:

Home-Country Policies • Investing in countries that have permissive policies

generally preferable than those that restrict FDI.
 Encouraging Outward FDI:
• Many countries still display a pragmatic stance.
 Government-backed insurance programs.
 Government loans. • Bargaining power dependent on three factors:
 Elimination of double taxation of foreign income.
 Relaxation of restrictions on FDI by host countries. 1. Value each side places on what the other has to offer.

Home-Country Policies 2. Number of comparable alternatives available to each

side.
• Restricting Outward FDI:
3. Each party’s time horizon.
• Limit capital outflows.

• Manipulate tax rules.

• Prohibit investment for political reasons

Host-Country Policies

• Encouraging Inward FDI:

• Incentives such as tax concessions, low-interest loans,

grants or subsidies.

• Restricting Inward FDI:

• Ownership restraints.

• Performance requirements.
Chapter 9:
International Institutions and the Liberalization of
FDI Regional Economic Integration
Regional trade blocs promote regional economic • Venezuela accepted for membership but was
integration. suspended due to undemocratic policies.

• WTO must be notified. Economic Union

• Economists believe free trade agreements produce
gains from trade for all member countries.
• GATT and WTO seek to reduce trade barriers but
reaching agreements is difficult.
• Requires a high degree of integration, a coordinating
bureaucracy, and the sacrifice of national sovereignty to
the bureaucracy.
• European Union (EU).

• EU has been the most ambitious move toward regional Political Union
economic integration.
• Central political apparatus coordinates economic,
• NAFTA, USMCA, Mercosur. social, and foreign policy of member states.

Levels of Economic Integration 1 • EU headed toward at least partial political union, and
the U.S. is an even closer example of political union.
Several levels of economic integration are possible in
theory.

• From least to most integrated:

• Free trade area.

• Customs union.

• Common market.

• Economic union.

• Political union.

Free Trade Area The Case for Regional Integration 1

• Eliminates all barriers to the trade of goods and The Economic Case for Integration
services among member countries.
• All countries gain from free trade and investment—a
• Each country allowed to determine its own trade positive-sum game.
policies regarding nonmembers.
• Assumes an absence of barriers.
• Most enduring: European Free Trade Association
(EFTA)—Norway, Iceland, Liechtenstein, Switzerland. • Motivated by desire to exploit gains from free trade and
investment.
• NAFTA and USCMA.
The Political Case for Integration
Customs Union
• Linking countries together, making them more
• Eliminates trade barriers between member countries dependent on each other, promotes political cooperation.
and adopts a common external trade policy.
• Reduces the likelihood of violent conflict.
• The EU began as a customs union.
• Gives countries greater political clout when dealing with
• Andean Community (formerly the Andean Pact) other nations.
includes Bolivia, Colombia, Ecuador, Peru.
Impediments to Integration
Common Market
• Two reasons it has not been easy to achieve
• No restrictions on immigration, emigration, or cross- integration:
border flows of capital among member countries.
1. While a nation as a whole may benefit from a regional
• Requires harmony and cooperation on fiscal, monetary, free trade agreement, certain groups will lose.
and employment policies.
2. It implies a loss of national sovereignty.
• Mercosur (Argentina, Brazil, Paraguay, Uruguay) is
hoping to establish a common market.
Regional economic integration is only beneficial if
the amount of trade it creates exceeds the amount it
diverts.
 Trade creation.
 Trade diversion.
 WTO rules should ensure that a free trade
agreement does not result in trade diversion
 However, GATT and WTO do not cover some
nontariff barriers
Europe has two trade blocs:
1. European Union (EU):
• 28 members.
• Britain has voted to exit.
2. European Free Trade Association (EFTA):
• 4 members.
Evolution of the European Union
• Product of two political factors:
1. The devastation of western Europe during two world
wars and the desire for a lasting peace.
2. The European nations’ desire to hold their own on the
world’s political and economic stage.
• Treaty of Rome established the European Community.
• Provided for the creation of a common market.
• Later became the EU
Political Structure of the European Union
• European Commission:
• Proposes EU legislation, implements it, and monitors
compliance.
• Run by commissioners appointed by member countries
and approved by the European Parliament.
• Role has become increasingly important in business.
• European Council:
• The ultimate controlling authority within the EU.
• One representative from the government of each
member state.
European Parliament:
• 751 members elected by the member states.
• Debates legislation proposed by the commission and
forwarded to it by the council.
• Treaty of Lisbon increased power of the parliament.
Court of Justice:
• One judge from each country.
The Single European Act
• The Objectives of the Act:
• Remove all frontier controls among EC countries.
• Apply the principle of “mutual recognition” to product
standards.
• Institute open public procurement to nonnational
suppliers.
• Lift barriers to competition in the retail banking and
insurance businesses.
• Remove all restrictions on foreign exchange
transactions between member countries by the end of
1992.
• Abolish restrictions on cabotage by the end of 1992.
Impact:
• Impetus for restructuring of substantial sections of
industry.
• Fostered faster economic growth.
• Established legal, cultural, and language differences
creates uneven implementation.
The Establishment of the Euro
• Maastricht Treaty:
• Committed the EU to adopt a single currency (euro).
• Used by 19 of 28 member states (the euro zone).
• Second most widely-traded currency after U.S. dollar.
• Great Britain, Denmark, Sweden don’t use euro.
Benefits of the Euro:
• Savings from handling a single currency.
• Makes it easier to compare prices across Europe.
• Producers forced to look for ways to reduce production
costs.
• Boosts development of highly liquid pan-European
capital market.
• The biggest effort is the North American Free Trade
Agreement (NAFTA), currently superseded by the
USMCA.
• Other efforts include the Andean Community and
Mercosur.

• Increases investment options.

Costs of the Euro:

• Loss of control over national monetary policy.

• EU is not an optimal currency area.

The Euro Experience:

• Volatile trading history since establishment in 1999.

• Euro has weakened since 2008.

• Slow economic growth and large budget deficits among

several states.

• Bailout package to rescue Greece in 2010.

North American Free Trade Agreement
• Some newer nations have put plans to adopt euro on
hold. • Free trade area among Canada, Mexico and the U.S.

Enlargement of the European Union • Abolished tariffs on 99 percent of goods traded

• Expansion into eastern Europe:
• 13 additional countries applied by end of the 1990s.
• Had to establish stable democratic governments.
• Show respect for human rights.
• New members had to wait to adopt euro.
• Eastern European countries only account for 5 percent
of the GDP of current EU members.
• Turkey denied entry because of human rights
concerns.
British Exit from the European Union (Brexit)
• British electorate voted to leave in 2016.
• Based on loss of national sovereignty, immigration
issues.
• Treaty of Lisbon: Britain had two years to negotiate
terms of exit.
• Britain’s exit is a concern; seen as a counterweight to
economic power of Germany.
• For Britain to benefit, it must be able to negotiate trade
deals with the EU.
between members.
• Removed barriers on the cross-border flow of services.
• Protects intellectual property rights.
• Removes most restrictions on FDI between members.
• Allows each country to apply environmental standards.
• Established two commissions to impose fines and
remove trade privileges when environmental standards
or legislation involving health and safety, minimum
wages, or child labor are ignored.
The Case for NAFTA
• Mexico would benefit from:
• Increased jobs as low-cost production moves south
and more rapid economic growth as a result.
• U.S. and Canada would benefit from:
• Access to a large and increasingly prosperous market.
• Lower prices for consumers from goods produced in
Mexico.
• Low-cost labor and ability to be competitive in world
markets.
• Increased imports by Mexico.

The Case against NAFTA

There is a move toward greater regional economic
integration in the Americas.
• Jobs would be lost and wage levels would decline in • Costa Rica, El Salvador, Guatemala, Honduras, and
the U.S. and Canada. Nicaragua.

• Pollution would increase due to Mexico's more lax • Collapsed in 1969 due to war.
standards.
• Central America Free Trade Agreement (CAFTA) 2005.
• Mexico would lose its sovereignty.
• U.S. and Central American Common Market.
NAFTA: The Results
CARICOM:
• NAFTA’s early impact was subtle, and both advocates
and detractors may have been guilty of exaggeration. • Established in 1973.

• Overall impact small, but positive. • English-speaking Caribbean countries.

The United States-Canada-Mexico Agreement • Repeatedly failed to achieve economic integration.

Caribbean Single Market and Economy (CSME):

 Politicians on both sides have taken aim at NAFTA
saying it has created job losses in the U.S. • Established in 2006.
 NAFTA renegotiated to the USCMA.
 Automakers must produce 75 percent of content in • Modeled on the EU’s single market.
North America. Association of Southeast Asian Nations (ASEAN)
 By 2023, 40 percent of parts for tariff-free vehicles
must come from “high wage” factory. • Formed in 1967.
 To become law, must be ratified by legislators in all
• Currently includes Brunei, Indonesia, Malaysia,
three countries.
Philippines, Singapore, Thailand, Vietnam, Myanmar,
The Andean Community Laos, and Cambodia.

 Formed in 1969 based on EU model.
 Had failed to achieve objectives by the mid-1980s.
 Was re-launched in 1990.
 Goal to become a common market by 1995 not
reached.
 Renamed the Andean Community in 1997.
 Signed an agreement in 2005 with Mercosur to
restart negotiations towards the creation of a free
trade area.
• Foster freer trade between member countries and
achieve cooperation in their industrial policies.
• ASEAN Free Trade Area (AFTA) between the six
original members of ASEAN came into effect in 2003.
• ASEAN and AFTA moving towards establishing a free
trade zone.

Mercosur

• Originated in 1988 as a free trade pact between Brazil

and Argentina.

• Expanded in 1990 to include Paraguay and Uruguay

and in 2012 with the addition of Venezuela.

• Venezuela then suspended in 2016.

• May be diverting trade rather than creating trade, and

local firms are investing in industries that are not
competitive on a worldwide basis.
Regional Trade Blocs in Africa
• Efforts stalled on reducing trade barriers between
member states • 19 trade blocs on the African continent.
Central American Common Market, CAFTA, and • Since many countries support the use of trade barriers
CARICOM to protect their economies from foreign competition,
meaningful progress is slow.
• Central American Common Market 1960s.
• The East African Community (EAC) re-launched in
2001.

• Established a common market in 2010 and is moving

toward goal of monetary union.

• Plan for Tripartite Free Trade Area (TFTA) began in

2015.

Other Trade Agreements

• Renewed emphasis on bilateral and multilateral trade

agreements since collapse of Doha Round talks.

• Trans Pacific Partnership (TPP).

• Transatlantic Trade and Investment Partnership (TTIP)

Focus on Managerial Implications

Opportunities

• Regional economic integration opens new markets.

• Allows firms to realize cost economies by centralizing

production in those locations where the mix of factor
costs and skills is optimal.

• Enduring cultural differences and competitive practices

might limit ability of companies to realize cost
economies.

Threats

• Business environment becomes competitive.

• Competitors might become more efficient.

• There is a risk of being shut out of the single market by

the creation of a “trade fortress.”

• Growing opposition to free trade areas.

• NAFTA in the U.