Module 5- Ethics in International Business

ROOTS OF UNETHICAL BEHAVIOR

Examples are plentiful of international managers behaving in a manner that might be judged unethical in an
international business setting. Why do managers behave in an unethical manner? There is no simple answer to this
question because the causes are complex, but some generalizations can be made and these issues are rooted in Six
Determinants of Ethical Behavior: personal ethics, decision-making processes, organizational culture, unrealistic
performance goals, leadership, and societal culture.

• PERSONAL ETHICS
Societal business ethics are not divorced from personal ethics, which are the generally accepted principles of right
and wrong governing the conduct of individuals. As individuals, we are typically taught that it is wrong to lie and
cheat—it is unethical—and that it is right to behave with integrity and honor and to stand up for what we believe to be
right and true. This is generally true across societies. An individual with a strong sense of personal ethics is less likely
to behave in an unethical manner in a business setting. It follows that the first step to establishing a strong sense of
business ethics is for a society to emphasize strong personal ethics. Home-country managers working abroad in
multinational firms (expatriate managers) may experience more than the usual degree of pressure to violate their
personal ethics. They are away from their ordinary social context and supporting culture, and they are psychologically
and geographically distant from the parent company. They may be based in a culture that does not place the same
value on ethical norms important in the manager’s home country, and they may be surrounded by local employees
who have less rigorous ethical standards. The parent company may pressure expatriate managers to meet unrealistic
goals that can only be fulfilled by cutting corners or acting unethically. For example, to meet centrally mandated
performance goals, expatriate managers might give bribes to win contracts or might implement working conditions
and environmental controls that are below minimal acceptable standards. Local managers might encourage the
expatriate to adopt such behavior. Due to its geographic distance, the parent company may be unable to see how
expatriate managers are meeting goals or may choose not to see how they are doing so, allowing such behavior to
flourish and persist.
• DECISION-MAKING PROCESSES
Several studies of unethical behavior in a business setting have concluded that businesspeople sometimes do not
realize they are behaving unethically, primarily because they simply fail to ask, “Is this decision or action
ethical?”Instead, they apply a straightforward business calculus to what they perceive to be a business decision,
forgetting that the decision may also have an important ethical dimension. The fault lies in processes that do not
incorporate ethical considerations into business decision making.
Two assumptions must be taken into account. First, too often it is assumed that individuals in the workplace make
ethical decisions in the same way as they would if they were home. Second, too often it is assumed that people from
different cultures make ethical decisions following a similar process. Both of these assumptions are problematic.
First, within an organization, there are very few individuals who have the freedom (e.g., power) to decide ethical
issues independent of pressures that may exist in an organizational setting (e.g., should we make a facilitating payment
or resort to bribery?). Second, while the process for making an ethical decision may largely be the same in many
countries, the relative emphasis on certain issues is unlikely to be the same. Some cultures may stress organizational
factors (Japan), while others stress individual personal factors (United States), yet some may base it purely on
opportunity (Myanmar) and others base it on the importance to their superiors (India).

• ORGANIZATIONAL CULTURE
The culture in some businesses does not encourage people to think through the ethical consequences of business
decisions. This brings us to the third cause of unethical behavior in businesses: an organizational culture that
deemphasizes business ethics, reducing all decisions to the purely economic. The term organizational culture refers to
the values and norms that are shared among employees of an organization. Together, values and norms shape the
culture of a business organization, and that culture has an important influence on the ethics of business decision
making. For example, paying bribes to secure business contracts was long viewed as an acceptable way of doing
business within certain companies. It was, in the words of an investigator of a case against Daimler, “standard
business practice” that permeated much of the organization, including departments such as auditing and finance that
were supposed to detect and halt such behavior. It can be argued that such a widespread practice could have persisted
only if the values and norms of the organization implicitly approved of paying bribes to secure business.
• UNREALISTIC PERFORMANCE GOALS
A fourth cause of unethical behavior has already been hinted at: pressure from the parent company to meet
unrealistic performance goals that can be attained only by cutting corners or acting in an unethical manner. In these
cases, bribery may be viewed as a way to hit challenging performance goals. The combination of an organizational
culture that legitimizes unethical behavior, or at least turns a blind eye to such behavior, and unrealistic performance
goals may be particularly toxic. In such circumstances, there is a greater than average probability that managers will
violate their own personal ethics and engage in unethical behavior. Conversely, an organization culture can do just the
opposite and reinforce the need for ethical behavior. At Hewlett-Packard, for example, Bill Hewlett and David
Packard, the company’s founders, propagated a set of values known as The HP Way. These values, which shape the
way business is conducted both within and by the corporation, have an important ethical component. Among other
things, they stress the need for confidence in and respect for people, open communication, and concern for the
individual employee.
• LEADERSHIP
The Hewlett-Packard example suggests a fifth root cause of unethical behavior: leadership. Leaders help establish
the culture of an organization, and they set the example, rules, and guidelines that others follow as well as the
structure and processes for operating both 140 Part 2 National Differences strategically and in daily operations.
Employees often operate and work within a defined structure with a mindset very much similar to the overall culture
of the organization that employs them. Additionally, employees in a business often take their cue from business
leaders, and if those leaders do not behave in an ethical manner, the employees might not either. It is not just what
leaders say that matters but what they do or do not do. What message, then, did the leaders at Daimler send about
corrupt practices? Presumably, they did very little to discourage them and may have encouraged such behavior.
• SOCIETAL CULTURE
Societal culture may well have an impact on the propensity of people and organizations to behave in an unethical
manner. One study of 2,700 firms in 24 countries found that there were significant differences among the ethical
policies of firms headquartered in different countries. Using Hofstede’s dimensions of social culture, the study found
that enterprises headquartered in cultures where individualism and uncertainty avoidance are strong were more likely
to emphasize the importance of behaving ethically than firms headquartered in cultures where masculinity and power
distance are important cultural attributes.

Module 6- International Trade Theory

INTERNATIONAL TRADE THEORY

International Trade Theory (Classical)

International Trade refers to the exchange of goods and services between countries. Trade theories
guided countries that engage in trade and developing regulations for the countries they represent

Free Trade refers to a situation in which 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.

New Trade Theory stresses that in some cases, countries specialize in the production and export of
particular products not because of underlying differences in factor endowments but because in certain
industries the world market can support only a limited number of firms.

Mercantilism
 - Mercantilism makes a case for government involvement in promoting exports and limiting imports.
- The first theory of international trade, mercantilism, emerged in England in the mid sixteenth
century.
- The main tenet of mercantilism was that it was in a country’s best interests to maintain a trade
surplus, to export more than it imported.
- 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.)

Absolute Advantage

- Absolute Advantage in the production of a product when it is more efficient than any other
country at producing it.
- is the ability of an individual, company, regions, or country to produce a greater quantity of a good
or service with the same quantity of inputs per unit of time, or to produce the same quantity of a
good or service per unit of time using a lesser quantity of inputs, than its competitors.
- The book of Adam Smith attacked the mercantilist assumption that trade is a zero sum game.
Smith argued that counties differ in their ability to produce goods efficiently.
- ENGLISH had an absolute advantage in the production of textiles.
- FRENCH had an absolute advantage in the production of wine.

Comparative Advantage

According to Ricardo’s theory of Comparative Advantage, it makes sense for a country to specialize in
the production of those goods that it produces most efficiently and to buy the goods that it produces less
efficiently from other countries, even if this means buying goods from other countries that it could produce
more efficiently itself. Constant returns to specialization we mean the units of resources required to
produce a good are assumed to remain constant no matter where one is on a country’s production
possibility frontier (PPF)

Heckscher–Ohlin Theory

Factor endowments meant the extent to which a country is endowed with such resources as land, labor,
and capital.

NEW TRADE THEORIES

The Product Life-Cycle Theory

The product life cycle theory is based on the observation of the emergence of new products coming
from the United States. The large size of the United States wealth and markets gave incentives to firms to
produce new products.

Firms have to consider the cost of production and need to locate production to where labor cost is
lower. Products will re-enter the markets the US markets as an export to the United States

The Twenty-First Century

In conclusion, the evolution of the international trade pattern in photocopiers aligns with the predictions
of the product life-cycle theory, where mature industries tend to shift from developed countries to low
cost assembly locations. This is evidenced by the United States initially being an exporter of photocopiers
but later becoming an importer due to the rise of lower-cost foreign sources, especially Japan. However,
it should be acknowledged that the product life-cycle theory has weaknesses. One of these weaknesses
is that it is ethnocentric and increasingly outdated, as it assumes that most new products are developed
and introduced in the United States. In reality, there have always been significant exceptions to this
assumption

New Trade Theory

ECONOMIES OF SCALE- are unit cost reductions associated with a large scale of output.

- bEconomies of scale have a number of sources, including the ability to spread fixed costs over a
large volume and the ability of large-volume producers to utilize specialized employees and
equipment that are more productive than less specialized employees and equipment.

Economies of scale and first-mover advantage

- A second theme in new trade theory is that the pattern of trade we observe in the world economy
may be the result of economies of scale and first mover advantages.

- First-mover advantages are the economic and strategic advantages that accrue to early
entrants into an industry.

Strategic Trade Theory

Strategic Trade theory suggests that government intervention is certain. Industries can enhance the
chances of favored firms of international success.

National Competitive Advantage: Porter’s Diamond

Porter theorizes that four broad attributes of a nation shape the environment in which local firms compete,
and these attributes promote or impede the creation of competitive advantage

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

Michael Porter, recognizes factor hierarchies and distinguishes between basic factors (e.g., natural
resources, climate, location, and demographics) and advanced factors (e.g., communication infrastructure,
sophisticated and skilled labor, research facilities, and technological know-how).. He contends that
advanced factors are the most important for gaining a competitive advantage. The connection between
advanced and basics is complicated. Basic factors can provide an initial advantage, which can then be
reinforced and extended by investing in advanced factors. In contrast, disadvantages in basic factors can put
pressure on investors to invest in advanced factors.
 b. Demand conditions—the nature of home demand for the industry’s product or service.

According to Porter, a country's firms gain a competitive advantage if its domestic consumers are
advanced and demanding. Such customers put pressure on local businesses to meet high product
quality standards and to create innovative products.

c. Related and supporting industries—the presence or absence of supplier industries and

related industries that are internationally competitive.

Strong, interconnected industries and suppliers can promote innovation, efficiency, and specialization.
Competitive advantages in the supplier and supporting industries can be transferred to the primary
industries

d. Firm strategy, structure, and rivalry—the conditions governing how companies are created,
organized, and managed and the nature of domestic rivalry

In the fourth attribute, there are 2 points that Porter argued. First, different nations have different
management ideologies that either help or hinder the development of national competitive advantage. The
second point made by Porter is that there is a strong relationship between vigorous (healthy) domestic
rivalry and the creation and maintenance of competitive advantage in an industry. Domestic rivalry drives
firms to seek ways to improve efficiency, making them better international competitors. Domestic rivalry
puts pressure on businesses to innovate, improve quality, cut costs, and invest in advanced technology.

Porter speaks of these four attributes as constituting the diamond. He argues that firms are most likely to
succeed in industries or industry segments where the diamond is most favorable. He also argues that the
diamond is a mutually reinforcing system. The effect of one attribute is contingent on the state of others.

Porter's Diamond Model frequently includes two external, exogenous factors:

Government policies, regulations, and support can all have a significant impact on a country's
competitive advantage. Government policies that are effective and supportive of business can help to
create a more favorable business environment.

Chance: This factor reflects unforeseen circumstances and impacts that can have an impact on a
country's competitive position, such as technological breakthroughs or abrupt changes in the global
economy.

FOREIGN EXCHANGE MARKET: FUNCTIONS, THEORIES & IMPLICATIONS

2 main functions
 1. Currency conversion
2. Insurance against foreign exchange risk

Use of Foreign Exchange Market in International Business 4 uses of Currency conversion

1. Convert payments received from export and income received from foreign investment
2. IB uses the foreign exchange (FX) market to pay foreign companies for products in its domestic
currency.
3. FX market facilitates short term investments in money market securities in cases where spare
cash is available.
4. FX market is also used for currency speculation

Insurance against foreign exchange risk

Firms engage in hedging to minimize adverse consequences for the firm

- Spot exchange rate

- Forward exchange rate
- Currency swaps

Implications for Managers

- Transaction exposure
- Translation Exposure
- Economic Exposure

Global Monetary System

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.

The foreign exchange market is the lubricant that enables companies based in countries that use
different currencies to trade with each other.

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

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 France, Germany, and other members of the euro zone it
is the euro (€); in Japan, the yen(¥); and so on.

International businesses have three main uses of foreign exchange markets.

- 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.
- Second, international businesses use foreign exchange markets when they must pay a foreign
company for its products or services in its country's currency.
- Third, international businesses also use foreign exchange markets when they have spare cash that
they wish to invest for short terms in money markets.

INSURING AGAINST FOREIGN EXCHANGE RISK

A second function of the foreign exchange market 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 swap.

The Nature of the Foreign Exchange Market

The foreign exchange market is not located in any one place. It is a global network of banks, brokers, and
foreign exchange dealers connected by electronic communications systems. When companies wish to
convert currencies, they typically go through their own banks rather than entering the market directly.

Exchange Rates are determined by the demand and supply of one currency relative to the demand and
supply of another.

Three factors have an important impact on future exchange rate movements in a country's currency: the
country's price inflation, its interest rate, and market psychology
To understand how prices are related to exchange rate movements, we first need to discuss an economic
proposition known as the law of one price.

The Purchasing Power Parity (PPP) exchange rate could be found from any individual set of prices.
By comparing the prices of identical products in different currencies, it would be possible to determine
the

"real" or PPP exchange rate that would exist if markets were efficient.

PPP Theory predicts that changes in relative prices will result in a change in exchange rates.
Theoretically, a country in which price inflation is running wild should expect to see its currency
depreciate against that of countries in which inflation rates are lower.

When the foreign exchange market determines the relative value of a currency, we say that the country is
adhering to a floating exchange rate regime. Four of the world's major trading currencies -the U.S.
dollar, the European Union's euro, the Japanese yen, and the British pound-are all free to float against
each other. Thus, their exchange rates are determined by market forces and fluctuate against each other
day to day, if not minute to minute. However, the exchange rates of many currencies are not determined
by the free play of market forces; other institutional arrangements are adopted.
A Pegged Exchange Rate means the value of the currency is fixed relative to a reference currency, such
as the U.S. dollar, and then the exchange rate between that currency and other currencies is determined
by the reference currency exchange rate.

It is a Float because in theory, the value of the currency is determined by market forces, but it is a dirty
float (as opposed to a clean float) because the central bank of a country will intervene in the foreign
exchange market to try to maintain the value of its currency if it depreciates too rapidly against an
important reference currency.

Other countries have operated with a fixed exchange rate, in which the values of a set of currencies are
fixed against each other at some mutually agreed on exchange rate.

A country is said to be in balance-of-trade equilibrium when the income its residents earn from exports is
equal to the money its residents pay to other countries for imports (the current account of its balance of
payments is in balance).

A Currency Crisis occurs when a speculative attack on the exchange value of a currency results in a
sharp depreciation in the value of the currency or forces authorities to expend large volumes of
international currency reserves and sharply increase interest rates to defend the prevailing exchange rate.

A Banking Crisis refers to a loss of confidence in the banking system that leads to a run on banks, as
individuals and companies withdraw their deposits.

A Foreign Debt Crisis is a situation in which a country cannot service its foreign debt obligations,
whether private-sector or government debt.

BUSINESS STRATEGY

The volatility of the present global exchange rate regime presents a conundrum for international businesses.
Exchange rate movements are difficult to predict, and yet their movement can have a major impact on a
business's competitive position.

Maintaining strategic flexibility can take the form of dispersing production to different locations around
the globe as a real hedge against currency fluctuations.

Another way of building strategic flexibility and reducing economic exposure involves contracting out
manufacturing. This allows a company to shift suppliers from country to country in response to
changes in relative costs brought about by exchange rate movements.