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1Copyright 2002 Pearson Education Australia Pty Ltd
CHAPTER TWO
APPRECIATING THE
INTERNATIONAL
ECONOMIC AND
FINANCIALENVIRONMENT
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Appreciating the InternationalEconomic and Financial
EnvironmentLearning Objectives
After studying this chapter, you should be able to:
Identify ways of segmenting the global economicenvironment and appreciate the ways in which
countries differ from each other in terms of economicvariables;
Measure international markets to predict likelyoutcomes of involvement;
Appreciate how the international financial systemoperates;
Recognise how foreign exchange variations impacton the successful undertaking of internationalbusiness;
Identify the role of aid in international businessopportunities.
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Introduction
It is estimated that one fifth of the worldspopulation lives on less than one dollar aday. Farmers in poor countries not onlyhave to compete against subsidised foodexports, they also face high importbarriers.
Developing countries are finding it easierto compete in international markets, butstill face higher barriers to entry thanmore developed economies.
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The Global Economic Scene
When discussing the globaleconomic scene we will look at:
Recent trends
Economic Systems
Economic Structure
Stages of Economic Growth
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Recent Trends
Keegan and Green (2000) suggested thatthe world economy has changedsignificantly due to the emergence ofglobal markets and the development ofglobal competitors.
The emergence of international marketshas been accompanied by a reduction oftariffs and non tariff barriers.
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Recent Trends
Domestic markets are therefore faced withincreased import competition. This can beattributed to four factors:
1. Capital movements rather than trade, are now thedriving force in the world economy.
2. Production is no longer directly linked toemployment.
3. The world economy has more impact on economicoutcomes within a country than the national state.
4. The contest between capitalism and socialism isover the economies of socialist countries becomingincreasingly market orientated.
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Economic Systems
Since World War II, countries havebeen classified according to theireconomic system. They were
classified as:
Market Allocation System
Command Allocation Mixed System
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Economic Structure
Another method of classifying countriesis according to their economic structure.
The classification reflects the relativedominance in the economy of the countryin the following:
Agriculture Industrial
Services
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Stages of Market Development
This involves grouping countriesaccording to GNP per capita.
For example:
Low income countries
Lower middle income countries
Upper middle income countries
High income countries
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International EconomicEnvironment
Historically, countries have beendominated by a desire to protectdomestic industry from foreign
competition. There have beenmany attempts to regulate theinternational economicenvironment in the interests of
freeing up trade betweencountries.
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International EconomicEnvironment
In recent years trade barriers havefallen in most countries, howeverthey have been replaced by non
tariff barriers, including:
Import Licensing
Tariff Quotas
Quarantine Restrictions
Standards (e.g quality)
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The World Trade Organisation
The World Trade Organisation wasformed in1974 and involves 142 countries (although moreare joining regularly).
GATT established guidelines for the conduct ofinternational trade and provided a forum for thenegotiations of multi lateral reductions in tariffsand non tariff barriers.
The WTO, accounts for in excess of 80% of worldtrade. It has endeavored to address theshortcomings of GATT through broadening itscoverage of international trade to includeagriculture, investment and intellectual property.
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The World Trade Organisation
Since the end of World War II, there has been amove towards economic integration.
Integration can be categorised as:
Preferential trading arrangements
Free trade areas
Customs Unions
Economic Unions
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Other Trading Groups
Over the years a number of other trading groupshave emerged:
ASEAN (Asian Region Group)
APEC (Another Asian group which includesAustralia)
OECD (Organisation of Economic Co-operation)
EU (European Union)
NAFTA
This is by no means a complete list of economicgroups around the world.
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Trade Patterns
Trade patterns are usuallymeasured in terms of a countrysbalance of payments.
The balance of payments is dividedinto:
Current Account
Capital Account
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Consumption Patterns
Both income and population impacton consumption patterns. Engleslaw states that as income rises
above a certain minimum,expenditure on food as apercentage of total incomedecreases.
Another issue is that productsaturation levels increase as percapita national income increases.
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Merchandise Trade
Since the end of World War II,merchandise has grown at a fasterrate than world production and it is
the high income countriesresponsible for more than 80% ofimports and exports ofmerchandise.
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Services Trade
Services is the fastest growingsector in international trade. Thegrowth in services trade is one
possible explanation for theincreasing disparity in world tradebetween the developed anddeveloping nations.
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Trading Environment
The trading environment governswhat firms can and cannot dowhen they go offshore. Trading
environments are regulated bygovernments. Most governmentswish to control the internationalflow of trade into and out of their
countries.
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Trading Environment
International flow of trade ismotivated by :
Financial issues
Security issues
Safety issues
Health issues
Protectionist issues
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Measuring Markets:Income
Countries are often classifiedaccording to levels of income andmeasured by GNP per head:
Low income countries US$9,266 perhead
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Measuring Markets:Population
The fact is: the larger thepopulation, the more attractive themarket is in terms of potential.
Distribution of population issignificant in terms of:
Age
Location
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Measuring Markets:Physical Quality of life
Economic advancement is usuallyaccompanied by a price tag. Whilewealthy countries have the luxury
of being able to trade offdevelopment for quality of life, thisluxury eludes many less developedcountries.
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Measuring Markets:Infrastructure
Infrastructure in very generalterms refers to:
Facilities and services necessary for
functioning of the economy. Transport and communications.
Commercial and financial services.
Infrastructure impacts on physicaldistribution as well as on the ability offirms to supply international markets.
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Measuring Markets:Debt
Debt is another key indicator ofeconomic difference between
countries. In many developingcountries, interest on debtconsumes a major percentage ofexport receipts.
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Measuring Markets:Resources
Resource endowment varies fromcountry to country andtraditionally was an indicator of
relative prosperity as reflected incommodity exports. In somecountries the wealth is almosttotally dependent on a single
resource (e.g oil).
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Financial Environment:Foreign Exchange Issues
The foreign exchange market is a marketfor currencies through which thecurrency of one country is exchanged forthe currency of another.
Key issues in foreign exchange include:
Dynamics
Forecasting Managing exchange risk
Multiple exchange rates
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Foreign Exchange Issues:Dynamics
One of the problems which facesinternational business is thefluctuations that occur in exchange
rates. The sometimes extremefluctuation in rates has, and willcontinue to have, an affect onprofits of large global firms.
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Foreign Exchange Issues:Forecasting
There are a number of factors thatinfluence the forecasting of exchangerates.
Economic factors: these factors are, policy andperformance, real interest rates and theimportance of the currency in the worldsfinancial system.
Political factors: are important in the valueattributed to a currency. These include, partyphilosophy, stability of Governments, nature ofunderpinning power, sources of impendingchange and the nature of Government.
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Foreign Exchange Issues:Managing Foreign Exchange Risk
When a firm undertakes transactions inforeign currencies, the firm runs the riskof losses or gains from change in thevalue of the currency involved.
The exposure takes three forms:
1. Transaction exposure
2. Translation exposure
3. Economic exposure
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Foreign Exchange Issues:Multiple Exchange Rates
When there is a differencebetween the official rate ofexchange and what people think itis worth, a black market forcurrency is possible.
Often this is caused by:
Government setting rate. Balance of payment reasons.
Currency may be pegged to another
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Financial Management:Sources of Funds
Some of the common sources of funds:
Banks
Government Forfeiting and factoring
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Financial Management:Types of Financial Risk
There are a number of differentsources of financial risk, including:
Commercial risk Political risk
Foreign exchange risk
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Financial Management:Coping with Recession
The Asian currency crisis and theJapanese recessionmake it imperative for international marketers to haveavailable plans to cope with recession. Kotabe andHelsen (2000) propose eight strategies:
Pull out
Emphasize a products value
Change the product mix
Repackage goods
Maintain stricter inventory
Look outside the region for expansion opportunities
Increase advertising in region
Increase local procurement
Th I t ti l Fi i l
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The International FinancialSystem:
International Monetary FundThe IMF has six objectives:
1. Promote international cooperation amongmembers on international monetary issues.
2. Facilitate the balanced growth of internationaltrade and contribute to high levels of real
income, employment and production.3. Promote exchange stability and orderly exchange
arrangements and avoid competitive currencydevaluation.
4. Foster multilateral system of payments and
transfers, and eliminate exchange restrictions.5. Make financial resources available to all
members
6. Seek a reduction of imbalances in payments.
The International Financial
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The International FinancialSystem:
The World Bank
The world bank has approximately150 members and had traditionallyoperated as a development bank,
channeling technical assistanceand finance to developingcountries. The primary focus of itslending program until recently, has
been on project financing foreconomic and social infrastructure.
The International Financial
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The International FinancialSystem:
International Aid
The motives underlying aid vary, theyinclude:
Political
Financial Altruistic
Aid can also take many forms including:
Multilateral aid Bilateral aid
Non Government aid