Overview of International business

• Motives
• Reduction in trade restrictions
• Cheap and easier access to international capital markets
• Advanced hedging techniques for risk management
• Availability of cheap transport, telecommunication and information
systems
• Convertibility of different currency
International business
• Motives
• Reduction in trade restrictions
• Cheap and easier access to international capital markets
• Advanced hedging techniques for risk management
• Availability of cheap transport, telecommunication and information
systems
• Convertibility of different currency
Balance of payments
• The balance of payment of a country is a systematic record of all economic
transactions between the residents of the reporting country and the rest of the
world over a specific period of time
• The rest of the world implies that the balance of payments is a record of all
multilateral trading and financial transactions.
• The labelling of these transactions as economic is essential to stress that what is
recorded on the balance of payments statements are transactions involving
exchange of value
• Eg transfer of ownership of goods, transfer of money and other financial assets
• The concept of resident applies to individuals and institutions. Why resident is
important?
• An important point is that the BOP measures flows not stocks
Structure of the BOP
• Differ from one country to another but let us use the IMF
• 1. The Current Account (CA)
• The CA records current transactions involving trade in goods and services a s well as
unilateral transfers.
• It has three components
• (1)the trade account
• (2) the service account and
• (3) the unilateral account
The trade account is also called the visible account or merchandise a/c.
It covers current transactions involving the purchase and sale of tangible goods cleared
through customs. The trade account over the period is calculated as the difference between
exports (credit) and imports (debits)
The services account
• Also known as the invisible account, covers current transactions involving the purchase
and sale of intangible services such as shipping, insurance, air travel and consultancy
• Also included in this account are payments and receipts associated with the
employment of factors of production; labour and capital
• Thus interest and dividends earned by Zimbabwean holding foreign bonds and shares
constitute a credit item in the Zimbabwean service account(hence the current account)
• Interest and dividends made out to foreigners holding Zimbabwe securities are a debit
account.
• It is important to note that transactions involving the actual purchase and sale of
securities, real estate and other investment type assets are not recorded in the current
account but rather in the capital account.
The current account records only net income earned.
Unilateral transfers
• Also known as unrequited transfers are payments made by foreigners
to local residents and vice versa.
• The distinguishing feature is the payments are made or received
without any offsetting of goods and services eg. gifts, donations and
remittances from diaspora
The capital account
• The capital accounts records changes in the levels of foreign assets and liabilities.
• The capital account distinguishes between direct investment and portfolio
investments and between short-term and long-term capital flows.
• Direct investment is mostly associated with physical capital such as acquisition of
foreign projects and the establishment of affiliates, subsidiaries and JVs with
foreign companies
• It also includes buying out large portions of the equity capital of foreign
companies
• The important feature of direct investment is that the ownership of the
asset(company)is maintained for a long period of time due to controlling influence
• In contrast portfolio investment is carried out by buying and selling of securities.
• For the purpose of BOP the criterion used to distinguish between direct
investment and portfolio investment is the degree of control
• The capital account is the balance of short term and long term capital flows
The balance of payments
• It is the sum of the capital account ad the current account
• Since short-term capital flows are more volatile than long term capital flows, a distinction is made between
the basic balance and the overall balance
• The basic balance is the sum of the current account and long term capital account.
• The overall balance of payments is the sum of the basic balance and short term capital flows that is sum of
capital and current account
• The overall balance of payments can be in deficit or in surplus
• It is in deficit if the current account registers a greater(smaller) deficit(surplus) than the surplus (deficit) on
the capital account.
• Conversely it will be in surplus if the current account registers a smaller (greater) deficit than the surplus
(deficit) on the capital account.
• Countries with a capital account surplus are capital exporters (creditor nations)
• Those with a capital account deficit are capital importers.
• If the overall balance of payments is in deficit or surplus there must be a corresponding changes in the
official reserve account
The official reserve account
• The official reserve account measures changes in international
reserves owned by the Reserve Bank of Zimbabwe.
• The official reserves consists of gold and foreign exchange reserves.
• NB this account does not include private sector’s holdings of gold and
foreign assets
• If the overall balance is in deficit, this deficit will be financed by
drawing on official reserves
The balancing item
• In theory the overall balance and the changes in official reserves
should always be equal.
• In practice, do not balance because
• BOP accounts normally suffer from unreported transactions and
timing problems with some the transactions that are reported
• Hence a balancing item called errors and ommissions are often added
to balance the balance of payments
Factors affecting the Current Account
• The balance of payments of a country at a particular point in time can
be in equilibrium, deficit or surplus
• It can also change by a number of factors
• (1) ECONOMIC GROWTH
• If a country has a higher growth rate than its trading partners, its
demand of goods and services(including imported goods) will rise
faster than the demand of trading partners for its goods and services.
• Holding other factors constant the country with higher growth rate
will experience a deterioration in its current account
The exchange rate
• The effect of exchange rate on the current account emanates from the
effect of changes in the exchange rate on prices and therefore the
demand for domestic and foreign goods.
• When the exchange rises (the domestic currency depreciates), prices of
exports in foreign currency terms falls while prices of imports in
domestic currency terms rise
• If the elasticities of demand for exports and imports are sufficiently high,
then the demand for imports falls and the demand for exports rise,
leading to an improvement in the current account
• This chain of reasoning is the basis of using devaluation to correct a
balance of payment deficit
inflation
• A country with higher inflation rate than its trading partners will suffer from a
deterioration of the current account. This is because inflation erodes the competitive
position of the economy making goods less competitive in foreign markets
• If the domestic inflation is higher than the foreign inflation rate, this leads to a
decline in exports and an increase in imports, and hence to a deterioration in the
current account
• 3 Trade restrictions
• One reason for imposing trade restrictions such as tariffs, quotas etc is to protect the
current account
• The effect of these restrictions is to reduce imports and hence produce an
improvement in the current account. This not always feasible as other countries may
retaliate
Study question
• Using appropriate models explain how a country of your choice can
solve its balance of payment problems
• Explain the major factors affecting a country’s Balance of Payments
Position.
presentations
Group 1
The elasticities approach to exchange rate depreciation considers the problem of devaluation and
balance of payments adjustment in terms of the supply and demand of exports and imports.
Discuss
Group 2
A system of dirty floating exchange rate fails when the government ignores the verdict of the
exchange markets on trade policies and resort to direct controls over trade and capital flows.
Discuss
Group 3
(a) Discuss four internal and three external techniques of exposure management that
companies in a country of your choice can employ to reduce trade costs.(10 marks)
(b) Discuss the strategic implications of the coronavirus on the growth of Zimbabwe trade (10
marks).
Individual assignment
Analyse the processes, contents, importance, challenges and future of the African free Continental
Trade Agreement (AfCFTA) in the context of trade and economic development of a country of your
choice.
The absorption Approach
• The elasticities approach to exchange rate depreciation considers the
problem of devaluation and balance of payments adjustment in terms
of the supply and demand of exports and imports. Discuss
The IS/LM approach
• Students to research on this approach
Economic Theories of International Trade
• Theory of Absolute Advantage
• Theory of Comparative Advantage
• Heckscher-Ohlin Theory of facto Endowment
• International Product Life Cycle (IPLC)
 FOREIGN DIRECT INVESTMENT
• DEFINATION:
• The present study defines private foreign direct investment inflows (FDI) inflows in at least five different ways:

• The IMF (1977) enduring definition which describes foreign direct investment as an investment that is made any
investor in order to acquire a lasting interest in an enterprises operating in an economy other than of the investor.

• The investor’s main target is to be able to control the management of the local enterprise. Having management
control over the acquired subsidiary implies that the foreign firm is able to govern the financial and operating
policies of the firm in order to obtain paybacks from the operations of the subsidiary firm.

• Second, FDI is also defined as portfolio investment that occurs when a firm or investor purchases non-controlling
interests in foreign companies usually through buying corporate debentures, preference debentures, and equity.

• However, the firm’s voting power is so inconsequential when compared to the overall number of outstanding
shares such that the investor does not have controlling authority over the operations of the firm.
FDI
• Third, we also define FDI inflows as foreign bank lending to private
firms which take the form of direct bank loans, deposit holdings by
foreigners and other indirect loans to domestic firms;
• and fourth, as official investments which takes the form of
development assistance such as aid flows which developed countries
give to developing countries normally to enhance public investments.
Theories of FDI
• Theories of FDI include
• Dunning OLI Paradigm
• The Flying Geese Theory
• the gravity model,
• the Hymer-Kindleberger theory,
• Heckscher-Ohlin model,
• and the Ricardian theory.
Dunning (OLI)
• Dunning provided an FDI framework that grouped micro- and macro-
level determinants of FDI inflows and analysed why, where and how
multinational companies (MNCs) invest abroad.
• Ownership advantages
• Localisational Advantages
• Internalisation Advantages
Ownership advantages
• The ownership advantages answers the question: why should firms invest abroad?
• The ownership advantages hypothesises that firms invest abroad to accrue specific
competitive advantages such as acquiring intangible knowledge based assets like
trade patents.
• Some firms may want to realise economies of scale and scope in their business
operations as well as acquiring product innovations.
• Some may want to diversify portfolio risks by investing in different financial
markets.
• Other firms want to ensure production process enhancements or acquire marketing
Ownership advantages
• In all these cases ownership advantages may emerge from the international firm’s
capability to coordinate complementary activities such as manufacturing, quality
optimisation, production, accounting, marketing, sales, warehousing and distribution
activities.

• Above all, ownership advantages in a firm entail acquiring the ability to effectually
exploit the differences between countries competitive advantages.
 Location advantages
• Dunning (1977; 1993), claims the locational advantages are those that make the
chosen foreign country attractive for FDI inflows and respond to the question: where
should the firm invest?
• Dunning demonstrates that firms consider issues like the availability of cheap but
skilled labour, natural resource endowments, trade barriers that restrict imports, gains
in trade costs and other strategic competitive advantages in deciding where to invest.
• The works of Marshall (1920) is probably considered as an early and influential
economic analysis on the effect of localisation of international firms on domestic
firms.
Location advantages
• Marshall identifies three major externalities that stem from the localisation of international firm as:

• (a) localisation provides a pooled market for workers with specialized skills that benefits both workers
and international firms,

• (b) localization enables domestic firms to benefit from technological spill-overs, and

• (c) localization of international firm creates a pool of specialized intermediate inputs for an industry in
greater variety and at lower cost. The positive externalities suggest that both international and domestic
firms have the potential to enhance their performance owing to locational advantages.
Internalisation advantages
• The last issue which Dunning suggested is what are called
internalisation advantages that arise from FDI inflows.
• Locational advantages addresses the question: how should the firm
invest?
• It is important to note that Dunning’s theory of internalisation
advantages is rooted on the transaction cost approach first initiated by
Coase (1937).
• As far back in history, Coarse observed that firms that operated in
imperfect markets faced informational asymmetry between the nature
and the value of their products, the transaction costs that arose from
enforcement of contracts with trading partners and monitoring the
quality of intermediate products.
internalisation
• Therefore, according to Dunning, securing internalization advantages are likely to be an important strategy
by which a market-seeking firm can guarantee the quality of the final products it offers to customers.

• In seeking internalisation advantages, Dunning (1993) claims that under internalisation advantages,
manufacturing firms consider issues like network related advantages arising from the exploitation of
imperfections in external markets and reduction of state-generated imperfections such as tariffs, foreign
exchange controls and subsidies.

• The extent and type of industrial districts and external economies allow participating firms, foreign
affiliates and cross-border alliances and network relationships to better tap into and exploit the
comparative technological and organisational advantages to host countries (Aliber, 1970; Dunning, 1995).
Firm-Specific Advantages
• Other than ownership, locational and internalisation advantages,
foreign private inflows are also motivated by the nature of the firm
seeking to expand its business to overseas.
• For instance, resource-seeking firms may want to address labour force,
access to capital markets and financial services, access to physical
infrastructure or address raw material resources, (e.g. timber in DRC,
tobacco in Zimbabwe, oil in Nigeria, gas in Mozambique, Copper in
Zambia and gold in Ghana).
Firm specific advantages-marketing seeking;
efficient seeking and marketing seeking
• According to Barney (1991), efficiency-seeking firms pursuing, for example a
vertical strategy, may want to take advantage of lower labour costs in
developing countries or seek cost efficiency by locating their factories close
to sources of raw material (reason why Nike has factories in Indonesia).
• Efficient-seeking FDI inflows are motivated by the need to create new
sources of competitiveness for firms and strengthening existing ones hence,
are emerging as the most important type of private FDI inflows.
• Strategic-asset seeking firms following for example a horizontal strategy, may
want access to research and development, innovation and advanced
technology (may explain the existence of foreign companies in South Africa).
• Market-seeking firms pursuing a horizontal strategy may want to access the
host country domestic market or locate in a country with high growth
potential or provide access to other to regional markets (Dunning, 1993).
Motives of FDI
• Increasing profits and Sales by
(a) Enter new markets
(b) faster growing markets
(c) Higher overseas Profits as an Investment Motive
• improved communications
• Seeking Growth through exports, frachising, licensing rather than
organic
• Seeking Competitive Advantages eg raw material seeking, efficiency
seeking, and markets seeking
research
• Students to research on other theories
Entry choice strategy
• The choice of entry Strategy depends on:
– Market Size and Growth
– Risk
– Government Regulations
– Competitive Environment
– Local Infrastructure
– Company Objectives
– Need for Control
– Internal Resources, Assets and Capabilities
– Flexibility
Why is foreign Direct investment important
• Enable domestic integration in the global world
• Insures against domestic market and limited credit creation in times of crises
• Diffusion of new innovative technology
• Augmenting domestic savings, foreign exchange earnings, tax revenue gaps and
export receipts,
• Demonstration/imitation channels-firms copying new technologies introduced by
foreign firms
• Labour mobility channels- new quality employment as works want to work for
MNCs
• Increases efficiencies of local firms as a result of increased competition.
• Creation of backward and forward linkages with domestic firms
• Improved capital intensity in the economy
• There is a direct link between FDI, domestic savings and economic growth
Disadvantages of Foreign direct Investment
• Increased domestic competition, hence crowding out effect of FDI on
local firms
• Decreased demand of local products due to dumping
Parity conditions
• What are parity conditions?
• The are economic relations that help to explain the movement of
exchange rates
Parity conditions in the Exchange rate
markets
Purchasing Power Parity theory (PPPT)
• PPPT says arbitrage forces will lead to equalisation of prices of goods
internationally
• The exchange rate between home country currency and foreign
country currency will always adjust to reflect changes or expected
changes in the prices of goods of the two countries.
• The equation of PPPT says that inflation differentials between two
countries will cause the demand of exports of a country with higher
inflation currency to fall and that with a lower inflation currency to
rise.
• This will force the currency of the country with high inflation to
depreciate in order to maintain exports competitiveness.
Two versions of the PPPT
The relative version of the PPPT
Relative version cont.
Practice question
Interest rate Parity theory
Assumptions IRPT
Practice questions
International fisher’s effect
question
Forecasting movement in Exchange rates
Transaction Exposure
Transaction exposure is concerned with how changes in inexchange
rates affect the value in home currency terms, of anticipated cash flows
denominated in foreign currency relating to transactions entered to