IB - Answers

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Q1. What are the various entry methods for International Business?

Export

Exporting is the most traditional way of entering into International Business. Export can bedone in two ways:

1. Direct Export Products are sold directly to buyers in target markets either throughlocal sales representatives or distributors. Sales representatives promote theircompanys products and do not take title to the merchandise. Distributors takeownership of the goods (and the accompanying risk) and usually on-sell throughwholesalers and retailers to end-users.

Advantages of Direct Exports:

Give a higher return on your investment than selling through an agent or distributor Allows the exporting company to set lower prices and be more competitive Gives the company a close contact with its customers

Disadvantages of Direct Exports:

The company may not have the services of a foreign intermediary, so it may needmore time to become familiar with the market

The customers or clients may take longer to get to know the company and itsproducts, and such familiarity is often important when doing business internationally

2. Indirect Export - Products are sold through intermediaries such as agents and tradingcompanies. Agents may represent one or more indirect exporters in return forcommission on sales.

Foreign direct Investment

FDI are investments made to acquire a lasting interest by a resident entity in one economyin an enterprise resident in another economy. FDI has come to play a major role in the

internationalization of business. This has happened due to changes in technologies,improved trade and investment policies of governments, regulatory environment in terms ofliberalization and easing of restrictions on foreign investments and acquisitions, andderegulation and privatization of many industries.

Advantages:

It can provide a firm with new markets and marketing channels, cheaper productionfacilities, access to new technologies, capital process, products, organizationaltechnologies and management skills.

FDI can provide a strong impetus to economic development of the host country. This isall the more true when large MNCs enter developing nations through FDI.

FDI allows companies to avoid foreign government pressure for local production.

It allows making the move from domestic export sales to a locally based national salesoffice. Capability to increase total production capacity.

Depending on the industry sector and type of business, a foreign direct investment may bean attractive and viable option. With rapid globalization of many industries and verticalintegration rapidly taking place on a global level, at a minimum a firm needs to keepabreast of global trends in their industry. From a competitive standpoint, it is important tobe aware of whether a companys competitors are expanding into a foreign market and how

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they are doing that. Often, it becomes imperative to follow the expansion of key clientsoverseas if an active business relationship is to be maintained.

New market access is also another major reason to invest in a foreign country. At somestage, export of product or service reaches a critical mass of amount and cost where foreignproduction or location begins to be more cost effective. Any decision on investing is thus a

combination of a number of key factors including: Assessment of internal resources Competitiveness Market Analysis Market expectations

Licensing

Licensing is a legal agreement between the owner of intellectual property such as acopyright, patent or trademark and someone who wants to use that IP. The licensee paysrent to the licensor for the use of an idea/product/process that is otherwise protected byIP law. Like a lease on a building, the license is for a specific period of time. The licenseeuses that idea/product/process to sell products or services and earns money.

Advantages:

Licensing appeals to prospective global players because it does not require large capitalinvestment not detailed involvement with foreign customers. By generating royaltyincome, licensing provides an opportunity to exploit research and development alreadyconducted. After initial costs, the licensor can reap benefits until the end of licensecontract period.

It reduces the risk of expropriation because the licensee is a local company that canprovide leverage against government action.

Helps avoid host country regulations that are more prevalent in equity ventures. Provides a way of testing foreign markets without significant resources.

Can be used as preemption major in new market before the entry of competition.

Limitations:

Limited form of market entry which does not guarantee a basis for expansion. Licensor may create more competition in exchange of royalty.

Franchising

Franchising involves granting of rights by a parent company to another (franchisee) to dobusiness in a prescribed manner. This right can take the form of selling the franchisersproducts, using its name, production and marketing techniques or using its general businessapproach.

It allows provides a network of interdependent business relationships that allows

a number of people to share:

Brand identification Successful method of doing business Proven marketing and distribution system

Franchise agreement typically requires the payment of a fee upfront and then a percentageon sales. In return, the franchiser provides assistance and at times may require thepurchase of goods or supplies to ensure the same quality of goods or services worldwide.

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Franchising is adaptable to international arena and requires minor modification for the localmarket. It can be beneficial to both groups. Franchiser has a new stream of income and thefranchisee gets time proven concept/product which can be quickly bought to the market.

Major Forms of Franchising:

manufacturer-retailer system (e.g. car dealership)

manufacturer-wholesaler system (e.g. soft-drink companies) service firm retailer system (fast-food, hotel) e,g, McDonalds, Burger King

Joint VenturesA joint venture is an agreement involving two or more organizations that arrange toproduce a product or service through a collectively owned enterprise. It has been one of themost popular way of entering a new market.

Typically, it is a 50-50 joint venture in which each of the party holds 50% ownership stakeand contributes a team of managers to share operating control. At times, this stake can bea majority one so as to ensure tighter control.

Advantages: Domestic company brings in the knowledge of the domestic market. The risk is divided between joint-venture partners. Normally, foreign partner has an option to sell its stake in the venture to another entity.

Limitations:

Limited control over business approach for foreign entity. Profits have to be shared.

E.g. Danone-Brittania, Hero Honda, Maruti Suzuki

Wholly Owned SubsidiariesIn a wholly owned subsidiary, the company owns 100% of the equity. Establishing a wholly

owned subsidiary in a foreign market can be done in 2 ways:1. Set up of new operation2. Acquisition of established firm.

WOS allows a foreign firm complete control and freedom to execute its business strategy inthe foreign country. This freedom is accompanied by a greater risk due to lack of knowledgeof the market. Acquisition of an established company can reduce this risk to an extent.

Q2. Influence of PEST Factors on International BusinessAny business is affected by its external environment. The major macroeconomic factors inthe external environment that affect the business are political, environmental, social andtechnological.

A. Political Environment

The political environment of a country greatly influences the business operating in thosecountries or business trading with those countries. The success and growth of internationalbusiness depends on the stable, collaborative, conducive and secure political system in thecountry. The following factors affect the political environment in a country.

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1. Tax Policy : The tax policy of a country affects the profitability of the business there.The Corporate Taxation laws affect the profitability directly. The direct taxation lawsalso affect the business because it influences consumer spending. The structure ofindirect taxation in a country like its excise duty structure, customs and sales taxgreatly affects the input costs of a business.

For e.g. Countries like UAE have very low direct taxation levels inducing great spending andhence trading and marketing based business are successful. But due to very high indirecttaxation levels the manufacturing business is not very successful.

2. Government support : One of the most important political factor is the Governmentsupport to international businesses. Business can be successful only if the localgovernment provides support in terms o infrastructure, license clearing if required,transparent policy and quick dispute resolution mechanism. Also the nature of thepolitical system i.e. democracy, communism etc. in the country influences theGovernment support.

For e.g. the RBI has provided single window clearance for FDI and hence has greatlyincreased the FDI levels in our country.

3. Labor Laws : the labor laws in a country affect the viability of a business in thatcountry. The pension laws also play a critical role especially in cross borderacquisitions. Many businesses had to be withdrawn or closed because of the laborunrest in the country.

For e.g.: Withdrawal of Premier Automobiles due to union strikes in our country.

The problems faced by doctors and nurses in UK due to the restrictive laws in that country.

4. Environmental policy : The countries environmental policy (under the KyotoProtocol or otherwise) affects many business like chemicals, refineries and heavyengineering.

5. Tariffs and duty structure : The level of duties and tariffs that are imposed by thecountry influence its imports and exports greatly. Some countries follow a

protectionist policy to the domestic industry by raising import barriers For e.g. Indiain the pre liberalization era, Russia.

6. Political stability and political milieu : Political stability greatly affects thelongevity of the businesses in a country. Political risk assessment should be done todetermine the country risk on the basis of following parameters :

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6.a.Confiscation: the nationalization of businesses without compensation. For e.g.India during the nationalist wave during Indira Gandhis tenure.

6.b. Nationalization : Resource nationalization is a major risk for businessesinvolving local resources like oil, minerals etc. For e.g. the resource

nationalization in Columbia.

6.c.Instability risk : The possibility of military takeovers or huge governmentchanges. For e.g. the coups in Thailand or in Fiji has affected the profits ofbusinesses there by as much as 60% due to work stoppage and propertydestruction.

6.d. Domestication : The global company relinquishing control in favor ofdomestic investors. For e.g. Barclays bank in South Africa

B. Economic factors

The economic factors in a country greatly influence the business in that country. Thefollowing factors are important in the macroeconomic environment.

1. Economic system : the economic system in a country i.e. capitalism/ communism/mixed economy (India) is important for deciding the nature of the businesses. Thenature of the system decides the allocation of resources. Due to globalization there isa gradual shift toward market forces to allocate resources even in the communistcountries like China.

2. Interest rates : The interest rates in the country affect the cost of capital (if raisedlocally) and the operational costs. Interest rates also determine the confidence of theGovernment in the economy and consumer spending.

3. Exchange rates : The exchange rates affect international trade and capital inflows inthe country.

4. Income levels and spending pattern : Though it is more of a demographic

parameter has is very important bearing on the sell side of all internationalbusinesses. For e.g. In a country like India, with rising aspirer population there is amarket opportunity for products like IPod (considered luxury items till now)

C. Social factors

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Businesses are driven by people both as human capital and as consumers. It is necessaryfor an international businessman to understand the social and cultural aspects of thecountry they operate in. The following are the important social factors.

1. Age distribution : the age distribution of the population is important to consider the

consumption patterns in the markets. Age distribution also determines the mindsetof the market and helps segmentation of the market accordingly. It also has abearing on the employee quality. A young population also determines a workforce.

2. Family system : the family system has a bearing on the decision makers inconsumption. For e.g. in Islamic countries women have a less say in makingconsumption decisions. In emerging economies like India children are gainingimportant role in consumption. This helps in positioning of products.

3. Cultural aspects : The cultural aspects influence the way the business is conducted

in countries. In Japan there is a different way in which contracts are signed andexecuted. In Russia being a communist oriented mindset the business is conductedin a closed manner. Italians have a seemingly lazy way of doing business and henceit is very difficult to conduct business in the pacy US way.

4. Career attitudes : the career attitude of the workforce is important social aspect.

D. Technological Factors

Technology has a very important role to play in determining the success of international

businesses because technology has made international business possible. The following arethe technological factors that influence the business.

1. R&D : the support that the Government gives to R&D encourages setting up R&Dbusiness levels. Also the ease of a qualified local workforce influence business. Fore.g. the semiconductor industry in Taiwan

2. Technology transfer : The ease of technology transfer influences the businessclimate. The environment where the technology transfer is not viable gradually losesout on business from emerging countries that seek technology transfers. For e.g. in

the early 40s countries like Czechoslovakia (the Czech Republic) was a verytechnologically advanced country but had very low business interest due to the lesschances of technology transfers. For e.g. GE withdrew operations from a JV as thereas they could not access local expertise)

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Q3. Trade Theories

1. Classical Country-Based Theories1.1.Mercantilism (pre-16th century)

This theory takes an us-versus-them view of trade; other countrys gain is ourcountrys loss.

Neo-mercantilism views persist today. A nations wealth depends on accumulated treasure.

Theory says you should have a trade surplus. Maximize exports through subsidies. Minimize imports through tariffs and quotas.

Flaw: Zero-sum game.Mercantilism- Zero-Sum Game

In 1752, David Hume pointed out that: Increased exports lead to inflation and higher prices Increased imports lead to lower prices

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Result: Country A sells less because of high prices and Country B sellsmore because of lower prices

In the long run, no one can keep a trade surplus.

1. Free Trade supporting theoriesThis theory shows that specialization of production and free flow of goods grow all tradingpartners economies

1.1..Absolute Advantage (Adam Smith, The Wealth of Nations, 1776)

Mercantilism weakens a country in the long run and enriches only a few segments; itrobs individuals of the ability to trade freely.

Adam Smith claimed market forces, not government controls, should

determine the direction, volume and composition of international trade. Under free (unregulated) trade each nation should specialize in producing those

goods it could produce most efficiently.

This theory states that a country is capable of producing more of a good with the

same input than another country. Hence, a country should specialize in and exportproducts for which it has absolute advantage; import others.

A country has absolute advantage - either natural or acquired when it is moreproductive than another country in producing a particular product.

Trade between countries is, therefore, beneficial.Assume that there are just two countries in the world, the India and Japan. Pretend alsothat they produce only two goods, shoes and shirts. The resources of both countries can beused to produce either shoes or shirts. Both countries make both products, spending half oftheir working hours on each. But India makes more shoes than shirts, and Japan makesmore shirts than shoes.TABLE A

Shoes ShirtsIndia 100 75

Japan 80 100Total 180 175

What will happen when each country specializes and spends all its working hours makingone product? It will make twice as much of that product and none of the other, as shown inTable B.TABLE B

Shoes Shirts

India 200 0Japan 0 200Total 200 200

The world now has both more shoes and more shirts. India can trade 100 units of shoes for100 units of shirts, and both countries will benefit.In this example, India could make more shoes than Japan with the same resources. It hasan absolute advantage at shoemaking. Japan, on the other hand, had an absoluteadvantage at shirt making.

Assumptions:

Perfect competition and no transportation costs in a world of two countries and twoproducts

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One unit of input (combination of land, labor, and capital) Each nation has two input units it can use to produce either rice or automobiles Each country uses one unit of input to produce each product

1.2. Comparative Advantage (David Ricardo, Principals of Political Economy,

1817) Also known as Opportunity Cost Theory David Ricardo, in his theory of comparative costs, suggested that countries will

specialize and trade in goods and services in which they have a comparativeadvantage.

A country has a comparative advantage in the production of a good or service that itproduces at a lower opportunity cost than its trading partners.

The theory of comparative costs argues that, put simply, it is better for a countrythat is inefficient at producing a good to specialize in the production of that good it isleast inefficient at, compared with producing other goods.

Now suppose one country has an absolute advantage in both products. Table C shows whatproduction might be like if India had an absolute advantage at making both shoes andshirts.

TABLE CShoes Shirts

India 100 80China 80 75Total 180 155

In this case, the India can produce more of each good with the same set of resources thanChina can. The India could produce either 200 units of shoes or 160 units of shirts. Chinacould produce either 160 units of shoes or 150 units of shirts. If the India produces onlyshoes, it gives up 80 units of shirts to gain 100 units of shoes. If China produces only shoes,

it gives up 75 units of shirts to gain 80 units of shoes. For India, the opportunity cost ofproducing shirts is higher and the opportunity cost of producing shoes is lower; vice-versafor China. Hence, India has a comparative advantage in shoemaking and China has acomparative advantage in shirt making.

Table D shows what happens when each country specializes in the product in which it has acomparative advantage.

TABLE D

Shoes Shirts

India 200 0

China 0 150Total 200 150

By specializing in this way, the India and China have increased the production of shoes bytwenty units over what they produced before, from 180 to 200. But the world has lost fiveunits of shirts, going from 155 to 150.

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Production in the India could be adjusted to make up the difference. For example, if theIndia gave up 10 units of shoes, it could produce 8 units of shirts. Table E shows the resultsof such a tradeoff.

TABLE E

Shoes Shirts

India 190 8China 0 150Total 190 158

In this way, the total production of both goods could be increased.For India, the opportunity cost of choosing to produce 80 units of shirts was the 100 units ofshoes that could have been produced with the same resources. In the like manner, China'sopportunity cost of producing 80 units of shoes was 75 units of shirts.

In the terms of trade each reduce each country's opportunity cost of acquiring the goodtraded for, trade will take place. In this example, China will not accept fewer than 80 unitsof shoes for 75 units of shirts and the India will not pay more than 100 units of shoes for 80units of shirts. Both countries must benefit for trade to occur.The real world is much more complex than this two-country, two-product mode. Tradeinvolves many different countries and products. And it is not always clear where a country'scomparative advantage lies.

Summary

Country should specialize in the production of those goods in which it is relativelymore productive, even if it has absolute advantage in all goods it produces.

This extends free trade argument. Efficiency of resource utilization leads to more productivity.

2. Free Trade refined2.1..Factor-proportions (Heckscher-Ohlin, 1919)

Eli Heckscher and Bertil Ohlin developed the theory of relative factorendowments, now often referred to as the Heckscher-Ohlin theory. The theorystates that the pattern of international trade depends on differences in factorendowments not on differences in productivity.

Relative endowments of the factors of production (land, labour, and capital)determine a country's comparative advantage.

Countries have comparative advantage in those goods for which the required factorsof production are relatively abundant. This is because the prices of goods are

ultimately determined by the prices of their inputs. Goods that require inputs that are locally abundant will be cheaper to produce than

those goods that require inputs that are locally scarce.

For example, a country where capital and land are abundant but labour is scarce will havecomparative advantage in goods that require lots of capital and land, but little labour -grains, for example.

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Since capital and land are abundant, their prices will be low. Those low prices will ensurethat the price of the grain that they are used to produce will also be low - and thusattractive for both local consumption and export.

Labor intensive goods on the other hand will be very expensive to produce since labor isscarce and its price is high. Therefore, the country is better off importing those goods.

Summary Factor endowments vary among countries Products differ according to the types of factors that they need as inputs A country has a comparative advantage in producing products that intensively use

factors of production (resources) it has in abundance

Assumptions

A given technology was universally available. Relative factor endowments are different in each country Tastes and preferences are identical in both countries A given product was either labor- or capital-intensive The theory ignored transportation costs.

1.3. Product Life Cycle (Ray Vernon, 1966)

As products mature, both location of sales and optimal production changes Affects the direction and flow of imports and exports Globalization and integration of the economy makes this theory less valid

Classic Theory Limitations:All the classical theories are based on the following assumptions that no longer hold true

Simple world (two countries, two products) No transportation costs No price differences in resources Resources immobile across countries Constant returns to scale Each country has a fixed stock of resources & no efficiency gains in resource use

from trade

Full employment.

2. Modern Trade Theory

In industries with high fixed costs: Specialization increases output, and the ability to enhance economies of scale

increases Learning effects are high. These are cost savings that come from learning by doing

New Trade Theory-Applications

Typically, requires industries with high, fixed costs World demand will support few competitors Competitors may emerge because of First-mover advantage

Economies of scale may preclude new entrants Role of the government becomes significant

Some argue that it generates government intervention and strategic trade policy

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Theory of National Competitive Advantage

The theory attempts to analyze the reasons for a nations success in a particularindustry

Porter studied 100 industries in 10 nations Postulated determinants of competitive advantage of a nation were based on

four major attributes

Factor endowments Demand conditions Related and supporting industries Firm strategy, structure and rivalry

Factor endowments: A nations position in factors of production such as skilled labor orinfrastructure necessary to compete in a given industry

Basic factor endowments Advanced factor endowments

Basic Factor Endowments

Basic factors: Factors present in a country Natural resources Climate Geographic location Demographics

While basic factors can provide an initial advantage they must be supported byadvanced factors to maintain success

Advanced Factor Endowments

Advanced factors: The result of investment by people, companies, andgovernment are more likely to lead to competitive advantage

If a country has no basic factors, it must invest in advanced factors Communications

Skilled labor Research Technology Education

Porters Theory-Predictions

Porters theory should predict the pattern of international trade that we observe inthe real world.

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Countries should be exporting products from those industries where all fourcomponents of the diamond are favorable, while importing in those areas where thecomponents are not favorable.

3. Other Theories:

3.1.The productivity theory by H. Myind

It is criticized that the comparative cost theories are not applicable to developingcountries. Hence, H. Myint proposed productivity theory and the vent for surplustheory.

The productivity theory points toward indirect and direct benefits. This theoryemphasizes that the process of specialization involves adapting and reshaping theproduction structure of a trading country to meet the export demands.

Countries increase productivity in order to utilize the gains of exports. This theoryencourages the developing countries to go for cash crops, increase productivity byenhancing the efficiency of human resources, adapting latest technology etc.

Limitations:

Labor productivity did not increase after certain level Increase in working hours

Increase in proportion of gainfully employed labour in proportion to disguisedunemployed labour

3. The vent for surplus theory

International trade absorbs the output of unemployed factors. If the countries produce more than the domestic requirements, they have to export

the surplus to other countries. Otherwise, a part of the productive labour of thecountry must cease and the value of its annual Produce diminishes.

In the absence of foreign trade, they would be surplus productive capacity in thecountry. This surplus productive capacity is taken by another country and in turngives the benefit under international trade.

Appropriateness of this Theory for Developing Countries: According to this theory, the factors of production of developing countries are fully

utilized. The unemployed labour of the developing countries is profitably employed when the

vent for surplus is exported.

4. Mills theory of reciprocal demand

Comparative cost advantage theories do not explain the ratios at which commoditiesare exchanged for one another. J.S. Mill introduced the concept of reciprocaldemand to explain the determinations of the equilibrium terms of trade.

Reciprocal demand indicates a countrys demand for one commodity in terms of theother commodity; it is prepared to give up in exchange. It determines the terms oftrade and relative share of each country.

Equilibrium:Quality of a product exported by country A = Quality of another product exported bycountry BAssumptions:

Existence of two countries Trade in only two goods both the goods are produced under the law of constant

returns Absence of transportation Costs.

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Existence of perfect competition Existence of full employment

Q4. Ten reasons why FDI happens

1. Foreign Direct Investments (FDI) as defined in the BOP Manual, are investments made

to acquire a lasting interest by a resident entity in one economy in an enterprise residentin another economy. The purpose of the investor is to have a significant influence, aneffective voice in the management of the enterprise. The definition of the Organizationfor Economic Cooperation and Development (OECD) which considers as directinvestment enterprise an incorporated or unincorporated enterprise in which a directinvestor who is resident in another economy owns ten percent or more of the ordinaryshares or voting power (for incorporated enterprise) or the equivalent (for anunincorporated enterprise).

2. It provides a firm with new markets and marketing channels, cheaper productionfacilities, access to new technology, products, skills and financing. For a host country or

the foreign firm which receives the investment, it can provide a source of newtechnologies, capital, processes, products, organizational technologies and managementskills, and as such can provide a strong impetus to economic development.

3. FDI inflows are considered as channels of entrepreneurship, technology, managementskills, and of resources that are scarce in developing countries. Hence, they could helptheir host countries in their industrialization.

4. For small and medium sized companies, FDI represents an opportunity to become moreactively involved in international business activities. In the past 15 years, the classicdefinition of FDI as noted above has changed considerably, over 2/3 of direct foreign

investment is still made in the form of fixtures, machinery, equipment and buildings.

5. FDI is viewed as a basis for going global. FDI allows companies to accomplish followingtasks:

Avoiding foreign government pressure for local production Circumventing trade barriers, hidden and otherwise Making the move from domestic export sales to a locally-based national sales office Capability to increase total production capacity. Opportunities for co-production, joint ventures with local partners, joint marketing

arrangements, licensing, etc6. Foreign direct investment is viewed as a way of increasing the efficiency with which the

world's scarce resources are used. A recent and specific example is the perceived role ofFDI in efforts to stimulate economic growth in many of the world's poorest countries.Partly this is because of the expected continued decline in the role of developmentassistance (on which these countries have traditionally relied heavily), and the resultingsearch for alternative sources of foreign capital.

7. FDI enables the firm owns assets to be profitably exploited on a comparatively largescale, including intellectual property (such as technology and brand names),

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organizational and managerial skills, and marketing networks. And it is more profitablefor the production utilizing these assets to take place in different countries than toproduce in and export from the home country exclusively.

8. FDI may result in a greater diffusion of know-how than other ways of serving the

market. While imports of high-technology products, as well as the purchase or licensingof foreign technology, are important channels for the international diffusion oftechnology, FDI provides more scope for spillovers. For example, the technology andproductivity of local firms may improve as foreign firms enter the market anddemonstrate new technologies, and new modes of organization and distribution, providetechnical assistance to their local suppliers and customers, and train workers andmanagers who may later be employed by local firms.

9. FDI increases employment in host country. Inflows of FDI also increase the amount ofcapital in the host country. Even with skill levels and technology constant, this will eitherraise labor productivity and wages, allow more people to be employed at the same levelof wages, or result in some combination of the two.

10.Proponents of foreign investment point out that the exchange of investment flowsbenefits both the home country (the country from which the investment originates) andthe host country (the destination of the investment). Opponents of FDI note thatmultinational conglomerates are able to wield great power over smaller and weakereconomies and can drive out much local competition. The truth might lie somewhere inbetween but they surely become reasons for companies to invest in foreign markets.

Q5. WTO Rounds wrt India

The WTO came into being on January 1, 1995, and is the successor to the GeneralAgreement on Tariffs and Trade (GATT), which was created in 1948. India was one of the 76countries that signed the accession to the WTO and is one of the founder members of theWTO.

Trade implications of signing the WTO for India:

The implications of signing the WTO agreement for Indian trade have been mixed. Indiahas benefited in the areas of garment exports, agricultural products exports and in marketaccess to foreign markets in automobiles and electronics. India has a disadvantage mainlyin areas of TRIPs, drug prices, patents in agriculture, TIS ( trade in services ) and TRIMSespecially in biomedical areas, AoA export subsidies etc.

Benefits:

1. Garment exports : The Multi Fiber Arrangement (MFA) that required Indian garmentexporters to have quotas for exporting to developed countries was phased out in 2005.The readymade garment exports from India has reached Rs 800 crores in 2007 andexpected to reach Rs 1000 crores in 2008. This is thrice the exports in 2004-05.

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2. Market access: as a signatory to the WTO India automatically gets the MFN ( mostfavored nation ) status. This gives India access to markets in Europe and US in sectorslike automobiles and engineering. India also benefits from the clauses related to tradewithout discrimination and benefit from capital good exports.

3. Anti Dumping measures: India suffered from persistent dumping by Romanian andRussian steel majors in the areas of steel casings, pipes affecting Indian domesticindustry greatly. Also India suffered from dumping by Chinese steel industry. The antidumping provisions and countervailing duties lend security to Indias domesticindustries.

4. The Agreement on Agriculture : the AoA stipulates that the developed countries willreduce tariffs on agriculture imports (up to 35%) thus helping Indias agricultureexports. It also promises reduction of domestic subsidies in the developed countrieshelping exports from India.

5. Competitive advantage : India has competitive advantage in the areas of merchandisetrade. India can utilize its competitive advantage in processing, beverages, gems andjeweler compared to the traditional centers in Europe like Amsterdam or Manchester etcincreasing its trade with both the Euro region and the US.

Disadvantages:

1. TRIPS : the Indian Patent Act is not compatible with the TRIPS agreement under the

WTO. The Indian Patent Act allows only process patents in areas of foods, chemicals andmedicines. Under the TRIPS the IPA will have to modify to allow product patents also.Also products developed outside India can claim international patents applicable toIndia. This will hurt our agriculture foods. E.g. the Alphanso mango and the Basmatistrand controversy.

2. Drug prices: the granting of the product patents in India will hurt the Indian genericdrugs industry and benefit the foreign pharma companies that own the formulationpatents. This will lead to increase in drug prices in India. (This resulted in regulatoryintervention in the recent budget in life saving drugs) e.g. the Pfizer controversy

3. Genetics: Indian seed and genetic research organizations are Government funded andwill not be able to compete with the MNCs like Montessanto etc that have economies ofscale. This will increase seed prices for Indian farmers and also lend our geneticresources to the MNCs

4. Services : the opening up of the banking sector in 2009 will affect Indian banks due tothe foreign banks with huge balance sheets.

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5. TRIMS : the Trade Related Investment Measures resulted in problems in trade ininvestment issues like transit charges, formalities etc. together called as Singaporeissues. Indian companies would have to lose in the differential charges that are applied.These issues were dropped in the Chachun ministerial conferences.

6. Anti dumping: the anti dumping rules were imposed on Indian linen in EU. SimilarlyIndian textiles faced anti dumping regulations in US. There is no mechanism to resolveanti dumping duties issues.

Indias stand in the Doha round and the following ministerial conferences:

1. Doha round: The Doha Development Round commenced at Doha, Qatar in

November 2001 and is still continuing. Its objective is to lower trade barriers around theworld, permitting free trade between countries of varying prosperity. As of 2008, talkshave stalled over a divide between the developed nations led by the European Union,the United States and Japan and the major developing countries (represented by theG20 developing nations), led and represented mainly by India, Brazil, China and SouthAfrica.

Issues: Singapore issues: the issues related to the trade facilitation and differentialcharges in investment vehicles affected Indian investment and venture companies. Thisaffected the Indian services.

Agricultural subsidies: the EU, US and Japan support domestic agriculture by subsides. Thiswas opposed by countries like India and Brazil.

2. Cancun conference 2003 :

The objective of this conference was to forge the agreement discussed in Doha.

Issues: market access to foreign markets. This agreement on market access for thedeveloping countries in capital and industrial goods increased strength of G20 countries.

India benefited greatly in the capital goods export.

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The Singapore issues were resolved that resulted in removing the undue advantage forcountries like US and Japan in investment arena. This also benefited the Indian financialsector internationally.

3. Geneva 2004: In Geneva conference the developed nations reduced subsidiaries onmanufactured goods. This resulted in Indian small manufacturers like steel forging,casting to export largely and benefit from the construction boom in US.

4. Paris 2005: France reduced subsidies on farm products. However US and Japan did notrelent.Hong Kong 2006 and Potsdam 2007 talks failed in resolving the farm subsidies.

So the recent rounds are in a stalemate situation from Indias point of view.

Q6. Discuss NAFTA/ EU/ ASEAN/ SAARC/ MERCUSOR MercosurMercosur is a regional trade agreement among Argentina, Brazil ,Paraguay & Uruguayfounded in 1991 by the Treaty of Asuncin, which was later amended and updated by the1994 Treaty of Ouro Preto. Its purpose is to promote free trade and the fluid movement ofgoods, people, and currency. Bolivia, Chile, Colombia, Ecuador and Peru currently haveassociate member status. Venezuela signed a membership agreement on 17 June 2006, butbefore becoming a full member its entry has to be ratified by the Paraguayan and theBrazilian parliaments.The bloc comprises a population of more than 263 million people, and the combined GrossDomestic Product of the full-member nations is in excess of US$2.78 trillion a year(Purchasing power parity, PPP) according to International Monetary Fund (IMF) numbers,making Mercosur the fifth largest economy in the World.

Objectives of MERCOSUR

Free transit of production goods, services and factors between the member states withinter alia, the elimination of customs rights and lifting of nontariff restrictions on thetransit of goods or any other measures with similar effects;

Fixing of a common external tariff (TEC) and adopting of a common trade policy withregard to nonmember states or groups of states, and the coordination of positions inregional and international commercial and economic meetings;

Coordination of macroeconomic and sectorial policies of member states relating toforeign trade, agriculture, industry, taxes, monetary system, exchange and capital,

services, customs, transport and communications, and any others they may agree on, inorder to ensure free competition between member states; and

The commitment by the member states to make the necessary adjustments to their lawsin pertinent areas to allow for the strengthening of the integration process. The AsuncionTreaty is based on the doctrine of the reciprocal rights and obligations of the memberstates.

MERCOSUR initially targeted free-trade zones, then customs unification and, finally, acommon market, where in addition to customs unification the free movement of manpowerand capital across the member nations' international frontiers is possible, and depends on

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equal rights and duties being granted to all signatory countries. During the transition period,as a result of the chronological differences in actual implementation of trade liberalization bythe member states, the rights and obligations of each party will initially be equivalent butnot necessarily equal. In addition to the reciprocity doctrine, the Asuncion Treaty alsocontains provisions regarding the most-favored nation concept, according to which themember nations undertake to automatically extend--after actual formation of the common

market--to the other Treaty signatories any advantage, favor, entitlement, immunity orprivilege granted to a product originating from or intended for countries that are not partyto ALADI.

SAARC

The South Asian Association for Regional Cooperation (SAARC) is an economic and politicalorganization of eight countries in Southern Asia. It was established on December 8, 1985 byIndia, Pakistan, Bangladesh, Sri Lanka, Nepal, Maldives and Bhutan. In April 2007, at theAssociation's 14th summit, Afghanistan became its eighth member.Sheelkant Sharma is thecurrent secretary & Mahinda Rajapaksa is the current chairman of SAARC which isheadquartered at Kathmandu.

Objectives of SAARC:

to promote the welfare of the peoples of South Asia and to improve their quality oflife;

to accelerate economic growth, social progress and cultural development in theregion and to provide all individuals the opportunity to live in dignity and to realizetheir full potential;

to promote and strengthen collective self-reliance among the countries of SouthAsia;

to contribute to mutual trust, understanding and appreciation of one another'sproblems;

to promote active collaboration and mutual assistance in the economic, social,cultural, technical and scientific fields;

to strengthen cooperation with other developing countries; to strengthen cooperation among themselves in international forums on matters of

common interest; and to cooperate with international and regional organizations with similar aims and

purposes.

Free Trade Agreement

Over the years, the SAARC members have expressed their unwillingness on signing a freetrade agreement. Though India has several trade pacts with Maldives, Nepal, Bhutan and SriLanka, similar trade agreements with Pakistan and Bangladesh have been stalled due topolitical and economic concerns on both sides. India has been constructing a barrier acrossits borders with Bangladesh and Pakistan. In 1993, SAARC countries signed an agreement

to gradually lower tariffs within the region, in Dhaka. Eleven years later, at the 12th SAARCSummit at Islamabad, SAARC countries devised the South Asia Free Trade Agreement whichcreated a framework for the establishment of a free trade area covering 1.4 billion people.This agreement went into force on January 1, 2006. Under this agreement, SAARC memberswill bring their duties down to 20 per cent by 2007.The last summit (15th) was held in Colombo where four major agreements - the SAARCdevelopment fund, the establishment of a SAARC standard organization, the SAARCconvention on mutual legal assistance in criminal matters, and the protocol on Afghanistan's

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admission to the South Asia Free Trade Agreement (SAFTA) were adopted with emphasis onregion-wide food security.

NAFTA

The North American Free Trade Agreement (NAFTA) is a trilateral trade bloc in North

America created by the governments of the United States, Canada, and Mexico. In terms ofcombined purchasing power parity GDP of its members, as of 2007 the trade bloc is thelargest in the world and second largest by nominal GDP comparison. It also is one of themost powerful, wide-reaching treaties in the world.

The North American Free Trade Agreement (NAFTA) has two supplements, the NorthAmerican Agreement on Environmental Cooperation (NAAEC) and the North AmericanAgreement on Labor Cooperation (NAALC).Implementation of the North American Free Trade Agreement (NAFTA) began on January 1,1994. This agreement will remove most barriers to trade and investment among the UnitedStates, Canada, and Mexico.Under the NAFTA, all non-tariff barriers to agricultural trade between the United States andMexico were eliminated. In addition, many tariffs were eliminated immediately, with othersbeing phased out over periods of 5 to 15 years. This allowed for an orderly adjustment tofree trade with Mexico, with full implementation beginning January 1, 2008.The agricultural provisions of the U.S.-Canada Free Trade Agreement, in effect since 1989,were incorporated into the NAFTA. Under these provisions, all tariffs affecting agriculturaltrade between the United States and Canada, with a few exceptions for items covered bytariff-rate quotas, were removed by January 1, 1998.Mexico and Canada reached a separate bilateral NAFTA agreement on market access foragricultural products. The Mexican-Canadian agreement eliminated most tariffs eitherimmediately or over 5, 10, or 15 years.U.S. trade with Mexico and Canada has grown more rapidly than total U.S. trade since1994. The automotive, textile, and apparel industries have experienced the most significantchanges in trade flows, which may also have affected employment levels in these industries.

The five major U.S. industries that have high volumes of trade with Mexico and Canada areautomotive industry, chemicals and allied products, computer equipment, textiles andapparel, and microelectronics.The effects of NAFTA, both positive and negative, have been quantified by severaleconomists. Some argue that NAFTA has been positive for Mexico, which has seen itspoverty rates fall and real income rise (in the form of lower prices, especially food), evenafter accounting for the 19941995 economic crisis. Others argue that NAFTA has beenbeneficial to business owners and elites in all three countries, but has had negative impactson farmers in Mexico who saw food prices fall based on cheap imports from U.S.agribusiness, and negative impacts on U.S. workers in manufacturing and assemblyindustries who lost jobs. Critics also argue that NAFTA has contributed to the rising levels ofinequality in both the U.S. and Mexico.

EU

The European Union (EU) is a political and economic union of 27 member states, locatedprimarily in Europe. The EU generates an estimated 30% share of the world's nominal grossdomestic product (US$16.8 trillion in 2007). Thus EU presents an enormous export andinvestor market that is both mature and sophisticated.

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The EU has developed a single market through a standardised system of laws which apply inall member states, guaranteeing the freedom of movement of people, goods, services andcapital. It maintains a common trade policy. Fifteen member states have adopted a commoncurrency, the euro.

Objectives of the EU: Its principal goal is to promote and expand cooperation among

members states in economics, trade, social issues, foreign policies, security, defense, andjudicial matters. Another major goal of the EU is to implement the Economic and MonetaryUnion, which introduced a single currency, the Euro for the EU members.The single market refers to the creation of a fully integrated market within the EU, whichallows for free movement of goods, services and factors of production. The EU, inconjunction with Member States, has a number of policies designed to assist the functioningof the market. Some of the policies are given below:Competition Policy: The main competition lied in energy and transport sector. The uniondesigned this strategy to prevent price fixing, collusion (secret agreement), and abuse ofmonopoly.Free movement of goods: A custom union covering all trade in goods was established anda common customs tariff was adopted with respect to countries outside the union.Services: Any member nation has a right to provide services in other Member States.Free movement of persons: Any citizen of EU member state can live work in any otherEU member stateCapital: There are no restrictions on the movement of capital and on payments with the EUand between member states and third countries.

Trade between the European Union and India:

India was one of the first Asian nations to accord recognition to the European Community in1962. The EU is Indias largest trading partner and biggest source of FDI. It is a majorcontributor of developmental aid and an important source of technology. Over the years, EU India trade has grown from 4.4 bn to 28.4 bn US$.

Top items of trade between India and EUIndias exports to EU % Indias Imports from EU %

Textile and clothing 35 Gemstones and jewellery 31

Leather and leather products 25 Power generating equipment 28

Gemstones and jewelery 12 Chemical products 15

Agriculture products 10 Office machinery 10

Chemical products 9 Transport equipment 6

India is EUs 17th largest supplier and 20th largest destination for exports. Tariff and non-tariffs have been reduced, but compared to International standards they

are still high. Under the Bilateral trade between India and EU, it accounts for 26% of Indias exports

and 25% of its imports. The European Union (EU) and India agreed on September 29,2008 at the EU-India

summit in Marseille, France's largest commercial port, to expand their cooperation in thefields of nuclear energy and environmental protection and deepen their strategicpartnership.

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Trade between India and the 27-nation EU has more than doubled from 25.6 billioneuros ($36.7 billion) in 2000 to 55.6 billion euros last year, with further expansion to beseen.

ASEAN

The Association of Southeast Asian Nations or ASEAN was established on 8 August 1967 inBangkok by the five original Member Countries, namely, Indonesia, Malaysia, Philippines,Singapore, and Thailand. Brunei Darussalam joined on 8 January 1984, Vietnam on 28 July1995, Laos and Myanmar on 23 July 1997, and Cambodia on 30 April 1999.

OBJECTIVESThe ASEAN Declaration states that the aims and purposes of the Association are:(i) To accelerate the economic growth, social progress and cultural development in the

region through joint endeavors.(ii) To promote regional peace and stability through abiding respect for justice and the

rule of law in the relationship among countries in the region and adherence to theprinciples of the United Nations Charter.(iii) To maintain close cooperation with the existing international and regional

organizations with similar aims.

WORKING OF ASEANThe member countries of ASEAN have Preferential Trading Arrangements (PTA), whichreduces tariffs on products traded among member countries. In 1992, ASEAN developed aCommon Effective Preferential Tariffs (CEPT) plan to reduce tariffs systematically formanufactured and processed products.The members have also established a series of co-operative efforts to encourage jointparticipation in industrial, agricultural and technical development projects and to increaseforeign investments in their economies. These efforts include an ASEAN finance corporation,the ASEAN Industrial Joint Ventures Programme (AJIV) etc. ASEAN nations have introducedsome programmers for greater diversification in their economies.

India and ASEAN

India is interested in maintaining close economic relations with the members of ASEAN, asthese countries are closer to India. The ASEAN countries are offering co-operation to Indiain the field of trade, investment, science and technology and training of personnel. Also,Indias trade with ASEAN countries is satisfactory in recent years.

Q7. Effect of Current Economic Meltdown on International Business

1. Slower global growth: Global growth stood at 5 percent in 2007, but the IMF expectsworld growth to slow to 3 percent in 2009 - 0.9 percentage points lower than forecastedin July 2008.

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2. Economic contraction in some countries: In G7 countries except for the UnitedStates and Canada, GDP growth was slower in Q2 of 2008 compared to Q1. Three majorEuropean economies (Italy, France and Germany) experienced negative GDP growth inQ2, and forecasts are for a continued decline in Q3. The IMF forecasts around 0 percentgrowth for advanced economies in 2009.

3. Depth of slowdown: It is observed that economic slowdowns, preceded by financialstress tend to be more severe. Although employment has contracted in several countriesin recent months, it has not been as severe as that during 1990-91.

4. Financing challenges for governments: State and local governments may be facedwith financial crisis. Even administrative costs may be difficult to come by. Thegovernments would be hard pressed for funds for guarantees and development work.For e.g. In the case of Iceland the banking sector has assets of around 300% of GDP,something no government could ever guarantee, at least not on a short-term basis.

5. Rising unemployment: According to IMF, unemployment in the advanced economieswill rise from 5.7 percent in 2008 to 6.5 percent in 2009.

6. Large employment losses in sectors: Some sectors like construction, real estateservices will experience disproportionate employment declines. In addition there will besignificant job losses in the financial sector.

7. Reduced world trade volume: According to the IMF, the world trade will grow only atthe rate of 1.9% as against the earlier estimate of 4.1% for 2009. A drop in exports, aswell as capital inflow, may trigger a falloff in investments.

8. Rising income insecurity and disproportionate impact on low-income groups: Asstock markets around the world have eroded trillions of dollars in wealth and rolled backsome of the investment gains of the past 5 years, the investment and retirementsavings of many individuals have lost significant value. There is a risk that low-incomecountries and lower-income groups within countries will bear the brunt of challenges, asthe most poor are the most defenseless, says World Bank President Robert Zoellick.

9. Return to Tariff and Non-Tariff Barriers: Developed economies in order to ward offunemployment and financial crisis may erect barriers to free trade. This might start a

local business environment. For e.g. President-elect Barrack Obama has alreadyannounced his intention to reduce outsourcing from US by 30%.

10. Surplus Production Capacities: In line with demand destruction, many brandedproducts may face surplus capacities. For e.g. Car, Steel & Aircrafts manufacturers arealready staring at excess capacity.

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11.Increase in Government Controls: In order to bail out sinking Corporates thegovernments, would buy out or control the operations of large companies. For e.g. AIGand Citibank

12.Impact on India:

12.a. BPO Operations: India is likely to face a severe crunch on the IT and ITesservices, rendered by Indian BPO Companies.

12.b. Increase in Trade Deficit: Already in the last quarter, Indias trade deficit hasgrown where exports are not meeting the set targets while imports continue to grow.

12.c. Falling Currency: as the demand for dollars increases the Indian rupee islikely to weaken. The rupee has already depreciated to Rs. 50 a dollar.

12.d. Pressure on Services Sector: As the demand for services is destroyed, thesesunshine industries such as BPOs, Airlines, and Telecommunication etc. will facesalary and employment cutbacks.

Q8. Organizational Structures in International Business

Douglas Wind and Pelmutter advocated four approaches of international business. They are:

1. Echnocentric Approach

The domestic companies normally formulate their strategies, their product design andtheir operations towards the national markets, customers and competitors. But, theexcessive production more than the demand for the product, either due to competitionor due to changes in customer preferences push the company to export the excessiveproduction to foreign countries. The domestic company continues the exports to theforeign countries and views the foreign markets as an extension to the domestic marketsjust like a new region. The executives at the head office of the company make thedecisions relating to exports and, the marketing personnel of the domestic companymonitor the export operations with the help of an export department. The company

exports the same product designed for domestic markets to foreign countries under thisapproach. Thus, maintenance of domestic approach towards international business iscalled ethnocentric approach.

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Fig: Organization Structure of an Echnocentric Company

2. Polycentric Approach

The domestic companies, which are exporting to foreign countries using the ethnocentricapproach, find at the latter stage that the foreign markets need an altogether differentapproach. Then, the company establishes a foreign subsidiary company and

decentralists all the operations and delegate decision making and policy-makingauthority to its executives. In fact, the company appoints executives and personnelincluding a chief executive who reports directly to the Managing Director of thecompany. Company appoints the key personnel from the home country and the peopleof the host country fill all other vacancies.

Fig: Organization Structure of a Polycentric Company

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3. Regiocentric ApproachThe company after operating successfully in a foreign country thinks of exporting to theneighboring countries of the host country. At this stage, the foreign subsidiary considers theregions environment (for example, Asian environment like laws, culture, policies etc.) forformulating policies and strategies. However, it markets more or less the same productdesigned under polycentric approach in other countries of the region, but with different

market strategies.

Fig: Organization Structure of a Regiocentric Company

4. Geocentric approach

Under this approach, the entire world is just like a single country for the company. Theyselect the employees from the entire globe and operate with a number of subsidiaries.The headquarters coordinate the activities of the subsidiaries. Each subsidiary functionslike an independent and autonomous company in formulating policies, strategies,

product design, human resource policies, operations etc.

Fig: Organization Structure of a Geocentric Company

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Q9. Discuss Swaps, Options, Futures

Swaps

a) A swap is a derivative in which two counterparties agree to exchange one stream of

cash flows against another stream. These streams are called the legs of the swap.

b) The cash flows are calculated over a notional principal amount, which is usually notexchanged between counterparties. Consequently, swaps can be used to createunfunded exposures to an underlying asset, since counterparties can earn the profit orloss from movements in price without having to post the notional amount in cash orcollateral.

c) Swaps can be used to hedge certain risks such as interest rate risk, or to speculate onchanges in the underlying prices.

d) Most swaps are traded over-the-counter (OTC), "tailor-made" for the counterparties.Some types of swaps are also exchanged on futures markets such as the ChicagoMercantile Exchange Holdings Inc., the largest U.S. futures market, the Chicago BoardOptions Exchange and Frankfurt-based Eurex AG.

e) The five generic types of swaps, in order of their quantitative importance, are: interestrate swaps, currency swaps, credit swaps, commodity swaps and equity swaps.

Futures

a) A futures contract is a standardized contract, traded on a futures exchange, to buy orsell a standardized quantity of a specified commodity of standardized quality at a certaindate in the future, at a price determined by the instantaneous equilibrium between theforces of supply and demand among competing buy and sell orders on the exchange atthe time of the purchase or sale of the contract.

b) The future date is called the delivery date or final settlement date. The official priceof the futures contract at the end of a day's trading session on the exchange is calledthe settlement price for that day of business on the exchange.

c) A futures contract gives the holder the obligation to make or take delivery under theterms of the contract,

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d) Both parties of a "futures contract" must fulfill the contract on the settlement date. Theseller delivers the underlying asset to the buyer, or, if it is a cash-settled futurescontract, then cash is transferred from the futures trader who sustained a loss to theone who made a profit. To exit the commitment prior to the settlement date, the holderof a futures position has to offset his/her position by either selling a long position orbuying back (covering) a short position, effectively closing out the futures position and

its contract obligations.

e) Futures contracts, or simply futures, are exchange traded derivatives. The exchange'sclearinghouse acts as counterparty on all contracts, sets margin requirements, andcrucially also provides a mechanism for settlement.

Options

a) An option is a contract written by a seller that conveys to the buyer the right but notthe obligation to buy (in the case of a calloption) or to sell (in the case of a putoption) a particular asset, such as a piece of property, or shares of stock or some otherunderlying security, such as, among others, a futures contract. In return for granting theoption, the seller collects a payment (thepremium) from the buyer.

b) For example, buying a call option provides the right to buy a specified quantity of asecurity at a set strike price at some time on or before expiration, while buying a putoption provides the right to sell. Upon the option holder's choice to exercise the option,the party who sold, or wrote, the option must fulfill the terms of the contract.

c) The theoretical value of an option can be evaluated according to several models. Thesemodels, which are developed by quantitative analysts, attempt to predict how the valueof the option will change in response to changing conditions. Hence, the risks associatedwith granting, owning, or trading options may be quantified and managed with a greaterdegree of precision, perhaps, than with some other investments.

d) Exchange-traded options form an important class of options which have standardizedcontract features and trade on public exchanges, facilitating trading among independentparties. Over-the-counter options are traded between private parties, often well-capitalized institutions that have negotiated separate trading and clearing arrangementswith each other.

e) Another important class of options, particularly in the U.S., are employee stock options,which are awarded by a company to their employees as a form of incentivecompensation

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f) Other types of options exist in many financial contracts, for example real estate optionsare often used to assemble large parcels of land, and prepayment options are usuallyincluded in mortgage loans.

Documents

IB - Answers