Intro to International Business

International Business Competing in the Global Marketplace

C h a r l e s W . L . H i l l U N I V E R S I T Y O F W A S H I N G T O N

G . To m a s M . H u l t M I C H I G A N S T A T E U N I V E R S I T Y

International Business Competing in the Global Marketplace

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INTERNATIONAL BUSINESS: COMPETING IN THE GLOBAL MARKETPLACE, TWELFTH EDITION

Published by McGraw-Hill Education, 2 Penn Plaza, New York, NY 10121. Copyright © 2019 by McGraw-Hill Education. All rights reserved. Printed in the United States of America. Previous editions © 2017, 2015, and 2013. No part of this publication may be reproduced or distributed in any form or by any means, or stored in a database or retrieval system, without the prior written consent of McGraw-Hill Education, including, but not limited to, in any network or other electronic storage or transmission, or broadcast for distance learning.

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F o r m y m o t h e r J u n e H i l l , a n d t h e m e m o r y o f m y f a t h e r,

M i k e H i l l — C h a r l e s W . L . H i l l

F o r G e r t & M a r g a r e t a H u l t , m y p a r e n t s — G . To m a s M . H u l t

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about the AUTHORS C h a r l e s W . L . H i l l U n i v e r s i t y o f W a s h i n g t o n

Charles W. L. Hill is the Hughes M. and Katherine Blake Professor of Strategy and International Business at the Foster School of Business, University of Washington. The Foster School has a Center for International Business Education and Research (CIBER), one of only 17 funded by the U.S. Department of Education, and is con- sistently ranked as a Top-25 business school. Learn more about Professor Hill at foster.uw.edu/faculty-research/directory/charles-hill A native of the United Kingdom, Professor Hill received his PhD from the University of Manchester, UK. In addition to the University of Washington, he has served on the faculties of the University of Manchester, Texas A&M University, and Michigan State University. Professor Hill has published over 50 articles in top academic journals, including the Academy of Management Journal, Academy of Management Review, Strategic Management Journal, and Organization Science. Professor Hill has also published several textbooks including International Business (McGraw-Hill) and Global Busi- ness Today (McGraw-Hill). His work is among the most widely cited in the world in international business and strategic management. Beginning in 2014, Dr. Hill partnered with Dr. Tomas Hult in a formidable co-authorship of the IB franchise of textbooks (International Business, Global Business Today). This brought together two of the most cited international business scholars in history. Professor Hill has taught in the MBA, Executive MBA, Technology Management MBA, Management, and PhD programs at the University of Washington. During his time at the University of Washington he has received over 25 awards for teaching excellence, including the Charles E. Summer Outstanding Teaching Award. Professor Hill works on a private basis with a number of organizations. His clients have included Microsoft, where he has been teaching in-house executive education courses for two decades. He has also consulted for a variety of other large companies (e.g., AT&T Wireless, Boeing, BF Goodrich, Group Health, Hexcel, Microsoft, Philips Healthcare, Philips Medical Systems, Seattle City Light, Swedish Health Services, Tacoma City Light, Thompson Financial Services, WRQ, and Wizards of the Coast). Professor Hill has also served on the advisory board of several start-up companies. For recreation, Professor Hill enjoys skiing, and competitive sailing!

G . T o m a s M . H u l t M i c h i g a n S t a t e U n i v e r s i t y

G. Tomas M. Hult is the John W. Byington Endowed Chair, professor of marketing and international business, and director of the International Business Center in the Eli Broad College of Business at Michigan State University. The Broad College has a Center for International Business Education and Research (CIBER), one of only 17 funded by the U.S. Department of Education, and is consistently ranked as a Top-25 business school. Learn more about Professor Hult at broad.msu.edu/ facultystaff/hult A native of Sweden, Professor Hult received a mechanical engineer degree in Sweden before obtaining a PhD at The University of Memphis. In addition to Michigan State University, he has served on the faculties of Florida State University

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and the University of Arkansas at Little Rock. Dr. Hult holds visiting professorships in the International Business group of his native Uppsala University, Sweden (since 2013) and the International Business division of Leeds University, UK (since 2010). Michigan State, Uppsala, and Leeds are all ranked in the top 10 in the world in international business research. Several studies have ranked Professor Hult as one of the most cited scholars in the world in business and management. He served as editor of Journal of the Academy of Marketing Science, a Financial Times Top-50 business journal, and has published more than 70 articles in premier business journals, including Journal of International Business Studies, Academy of Management Journal, Strategic Management Journal, Journal of Management, Journal of Marketing, Journal of the Academy of Marketing Science, Journal of Retailing, Journal of Operations Management, Decision Sciences, and IEEE. He has also published several textbooks including International Business (McGraw-Hill) and Global Business Today (McGraw-Hill). Dr. Hult’s other books include Second Shift: The Inside Story of the Keep GM Movement, Global Supply Chain Management, Total Global Strategy, and Extending the Supply Chain. He is a regular contributor of op-ed and articles in the popular press (e.g., Time, Fortune, World Economic Forum, The Conversation). Professor Hult is a well-known keynote speaker on international business, interna- tional marketing, global supply chain management, global strategy, and marketing strat- egy. He teaches in doctoral, master’s, and undergraduate programs at Michigan State University. He also teaches frequently in executive development programs and has developed a large clientele of the world’s top multinational corporations (e.g., ABB, Albertsons, Avon, BG, Bechtel, Bosch, BP, Defense Logistics Agency, Domino’s, FedEx, Ford, FreshDirect, General Motors, GroceryGateway, HSBC, IBM, Michigan Economic Development Corporation, Masco, NASA, Raytheon, Shell, Siemens, State Farm, Steelcase, Tech Data, and Xerox). Tomas Hult is an elected Fellow of the Academy of International Business (AIB), one of only about 90 scholars worldwide receiving this honor, and serves as the executive director and foundation president of AIB. He also serves on the U.S. District Export Council and holds board member positions on the International Trade Center of Mid-Michigan and the Sheth Foundation. Tomas enjoys tennis, golf, and traveling as his favorite recreational activities.

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brief CONTENTS

part one Introduction and Overview Chapter 1 Globalization 2

part two National Differences Chapter 2 National Differences in Political, Economic, and

Legal Systems 38

Chapter 3 National Differences in Economic Development 62

Chapter 4 Differences in Culture 90

Chapter 5 Ethics, Corporate Social Responsibility, and Sustainability 128

part three The Global Trade and Investment Environment Chapter 6 International Trade Theory 158

Chapter 7 Government Policy and International Trade 192

Chapter 8 Foreign Direct Investment 222

Chapter 9 Regional Economic Integration 252

part four The Global Monetary System Chapter 10 The Foreign Exchange Market 286

Chapter 11 The International Monetary System 312

Chapter 12 The Global Capital Market 340

part five The Strategy and Structure of International Business Chapter 13 The Strategy of International Business 362

Chapter 14 The Organization of International Business 392

Chapter 15 Entry Strategy and Strategic Alliances 430

part six International Business Functions Chapter 16 Exporting, Importing, and Countertrade 460

Chapter 17 Global Production and Supply Chain Management 486

Chapter 18 Global Marketing and R&D 516

Chapter 19 Global Human Resource Management 552

Chapter 20 Accounting and Finance in the International Business 582

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part seven Integrative Cases Global Medical Tourism 609

Venezuela under Hugo Chávez and Beyond 611

Political and Economic Reform in Myanmar 612

Will China Continue to Be a Growth Marketplace? 613

Lead in Toys and Drinking Water 614

Creating the World’s Biggest Free Trade Zone 616

Sugar Subsidies Drive Candy Makers Abroad 617

Volkswagen in Russia 618

The NAFTA Tomato Wars 619

Subaru’s Sales Boom Thanks to the Weaker Yen 620

The IMF and Ukraine’s Economic Crisis 621

The Global Financial Crisis and Its Aftermath: Declining Cross-Border Capital Flows 622

Ford’s Global Platform Strategy 624

Philips’ Global Restructuring 625

General Motors and Chinese Joint Ventures 626

Exporting Desserts by a Hispanic Entrepreneur 627

Apple: The Best Supply Chains in the World? 628

Domino’s Global Marketing 630

Siemens and Global Competitiveness 632

Microsoft and Its Foreign Cash Holdings 633

Glossary 635

Organization Index 645

Name Index 650

Subject Index 652

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THE PROVEN CHOICE FOR INTERNATIONAL BUSINESS

RELEVANT. PRACTICAL. INTEGRATED.

It is now more than a quarter of a century since work be- gan on the first edition of International Business: Compet- ing in the Global Marketplace. By the third edition the book was the most widely used international business text in the world. Since then its market share has only in- creased. The success of the book can be attributed to a number of unique features. Specifically, for the twelfth edition we have developed a learning program that

∙ Is comprehensive, state of the art, and timely. ∙ Is theoretically sound and practically relevant. ∙ Focuses on applications of international business

concepts. ∙ Tightly integrates the chapter topics throughout. ∙ Is fully integrated with results-driven technology. ∙ Takes full and integrative advantage of

globalEDGE.msu.edu—the Google-ranked #1 web resource for “international business resources.”

International Business, now in its twelfth edition, co- authored by Charles W. L. Hill and G. Tomas M. Hult, is a compre- hensive and case-oriented version of our text that lends itself to the core course in international business for those courses that want a deeper focus on the global monetary system, structure of international business, international accounting, and international finance. We cover more and integrated cases in International Business 12e and we provide a deeper treatment of the global capital market, the organization of an international business, interna- tional accounting, and international finance—topics that are allocated chapters in International Business 12e but are not attended to in the shorter treatment of IB in Global Business Today 10e. Like our shorter text, Global Business Today 10e (2017), International Business 12e, focuses on being current, rele- vant, application rich, accessible, and student focused. Our goal has always been to cover macro and micro is- sues equally and in a relevant, practical, accessible, and student focused approach. We believe that anything short of such a breadth and depth of coverage is a serious defi- ciency. Many of the students in these international busi- ness courses will soon be working in global businesses,

and they will be expected to understand the implications of international business for their organization’s strategy, structure, and functions in the context of the global mar- ketplace. We are proud and delighted to have put together this international business learning experience for the leaders of tomorrow. Over the years, and through now 12 editions, Dr. Charles Hill has worked hard to adhere to these goals. Since Global Business Today 9e (2015), and International Business 11e (2017), Charles’s co-author, Dr. Tomas Hult, follows the same approach. As a team, we have been guided not only by our own reading, teaching, and re- search but also by the invaluable feedback we received from professors and students around the world, from re- viewers, and from the editorial staff at McGraw-Hill Edu- cation. Our thanks go out to all of them.

RELEVANT AND COMPREHENSIVE

To be relevant and comprehensive, an international busi- ness package must

∙ Explain how and why the world’s cultures, coun- tries, and regions differ.

∙ Cover economics and politics of international trade and investment.

∙ Tackle international issues related to ethics, corpo- rate social responsibility, and sustainability.

∙ Explain the functions and form of the global mon- etary system.

∙ Examine the strategies and structures of interna- tional businesses.

∙ Assess the special roles of an international busi- ness’s various functions.

This text has always endeavored to be relevant, practical, and integrated. Too many other products have paid insuf- ficient attention to some portion of the topics mentioned, being skewed toward a particular portion of international business. Relevance and comprehensiveness also require cover- age of the major theories. It has always been a goal to incorporate the insights gleaned from recent academic scholarship into the book. Consistent with this goal,

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insights from the following research, as a sample of theoretical streams used in the book, have been incorporated:

∙ New trade theory and strategic trade policy. ∙ The work of Nobel Prize–winning economist

Amartya Sen on economic development. ∙ Samuel Huntington’s influential thesis on the

“clash of civilizations.” ∙ Growth theory of economic development champi-

oned by Paul Romer and Gene Grossman. ∙ Empirical work by Jeffrey Sachs and others on

the relationship between international trade and economic growth.

∙ Michael Porter’s theory of the competitive advan- tage of nations.

∙ Robert Reich’s work on national competitive advantage.

∙ The work of Nobel Prize–winner Douglass North and others on national institutional structures and the protection of property rights.

∙ The market imperfections approach to foreign direct investment that has grown out of Ronald Coase and Oliver Williamson’s work on transac- tion cost economics.

∙ Bartlett and Ghoshal’s research on the transna- tional corporation.

∙ The writings of C. K. Prahalad and Gary Hamel on core competencies, global competition, and global strategic alliances.

∙ Insights for international business strategy that can be derived from the resource-based view of the firm and complementary theories.

∙ Paul Samuelson’s critique of free trade theory. ∙ Conceptual and empirical work on global supply

chain management—logistics, purchasing (sourcing), operations, and marketing channels.

In addition to including leading-edge theory, in light of the fast-changing nature of the international business environment we have made every effort to ensure that this product was as up-to-date as possible when it went to press. A significant amount has happened in the world since we began revisions of this book. By 2018, more than $4 trillion per day was f lowing across na- tional borders and, as we will see in Chapter 1, trade across borders has almost exponentially increased in the last 15 years. The size of such f lows fueled concern about the ability of short-term speculative shifts in global capital markets to destabilize the world economy.

What’s New in the Twelfth Edition

The world continued to become more global. Several Asian economies, most notably China and India, contin- ued to grow their economies at a rapid rate. New multina- tionals continued to emerge from developing nations in addition to the world’s established industrial powers. Increasingly, the globalization of the world economy affected a wide range of firms of all sizes, from the very large to the very small. And unfortunately, global terrorism and the attendant geopolitical risks keep emerging in various places glob- ally, many new and inconceivable just a decade ago. These represent a threat to global economic integration and activity. Plus, with the avenue of the United Kingdom opting to vote to leave the European Union, the election of President Donald Trump in the United States, and several elections around the world, the globe—in many ways—has paid more attention to nationalistic issues over trade. These topics and much more are integrated into this text for maximum learning opportunities. The success of the first eleven editions of International Business was based in part on the incorporation of leading- edge research into the text, the use of the up-to-date ex- amples and statistics to illustrate global trends and enterprise strategy, and the discussion of current events within the context of the appropriate theory. Building on these strengths, our goals for the twelfth edition have focused on the following:

1. Incorporate new insights from scholarly research.

2. Make sure the content covers all appropriate issues.

3. Make sure the text is up-to-date with events, statis- tics, and examples.

4. Add new and insightful opening and closing cases.

5. Incorporate value-added globalEDGE features in every chapter.

6. Connect every chapter to a focus on managerial implications.

7. Provide 20 new integrated cases that can be used as additional cases for specific chapters but, more importantly, as learning vehicles across multiple chapters.

As part of the overall revision process, changes have been made to every chapter in the book. All statistics have been updated to incorporate the most recently available data. As before, we are the only text in International Busi- ness that ensures that all material is up-to-date on virtu- ally a daily basis. The copyright for the book is 2019 but you are likely using the text in 2018, 2019, or 2020—we

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keep it updated to each semester you use the text in your course! We are able to do this by integrating globalEDGE features in every chapter. Specifically, the Google number-one-ranked globaledge.msu.edu site (for “interna- tional business resources”) is used in each chapter to add value to the chapter material and provide up-to-date data and information. This keeps chapter material constantly and dynamically updated for teachers who want to infuse globalEDGE material into the chapter topics, and it keeps students abreast of current developments in inter- national business. In addition to updating all statistics, figures, and maps to incorporate the most recently published data, a chapter-by-chapter selection of changes for the eleventh edition include the following:

Chapter 1: Globalization ∙ New opening case: Globalization of BMW,

Rolls-Royce, and the MINI ∙ New materials on international trade, trade agree-

ments, world production, and world population ∙ Explanations of differences in cross-border trade

and in-country production; the value of trade agreements; and population implications related to resource constraints

∙ New closing case: Uber: Going Global from Day One

Chapter 2: National Differences in Political, Economic, and Legal Systems

∙ New opening case: The Decline of Zimbabwe ∙ Updated section on Pseudo-Democracies ∙ Updated data and figure on corruption ∙ New country focus: Corruption in Brazil ∙ New closing case: Economic Transformation in

Vietnam

Chapter 3: National Differences in Economic Development

∙ New opening case: Economic Development in Bangladesh

∙ Updated data, maps and discussion on Differences in Economic Development

∙ Updated data, maps and discussion on the spread of democracy and market-based economic systems.

∙ New closing case: The Political and Economic Evolution of Indonesia

Chapter 4: Differences in Culture ∙ New opening case: The Swatch Group and Cultural

Uniqueness ∙ New management focus: China and Its Guanxi ∙ Deeper treatment of culture, values, and norms ∙ Worked with the foundation that most religions are

now pro-business ∙ Updated the Hofstede culture framework with new

research ∙ New closing case: The Emirates Group and

Employee Diversity

Chapter 5: Ethics, Corporate Social Responsibility, and Sustainability

∙ New opening case: Woolworths Group’s Corporate Responsibility Strategy 2020

∙ New management focus: “Emissionsgate” at Volkswagen

∙ Deeper focus on corporate social responsibility and sustainability at the country, company, and customer levels

∙ New closing case: UNCTAD Sustainable Develop- ment Goals

Chapter 6: International Trade Theory ∙ New opening case: Donald Trump on Trade ∙ Added discussion of Donald Trump’s views on

trade at appropriate points in the chapter. ∙ Expanded discussion of David Autor’s important

research on trade and employment in U.S. counties impacted by trade with China.

∙ New closing case: The Trans Pacific Partnership (TPP)

Chapter 7: Government Policy and International Trade

∙ New opening case: Boeing and Airbus Are in a Dogfight over Illegal Subsidies

∙ New section, The World Trading System under Threat, discussing the possible implications of BREXIT and the election of Donald Trump (who appears to hold mercantilist views on trade).

∙ New closing case: Is China Dumping Excess Steel Production?

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Chapter 8: Foreign Direct Investment ∙ New opening case: Foreign Direct Investment in

Retailing in India ∙ Updated data and discussion on FDI trends on the

world economy. ∙ New closing case: Burberry Shifts Its Strategy in

Japan

Chapter 9: Regional Economic Integration ∙ New opening case: Renegotiating NAFTA ∙ New section discussing the implications of

BREXIT for Britain and the European Union ∙ New section on the future of NAFTA in light of

Donald Trump’s election as president ∙ New closing case: The Push toward Free Trade in

Africa

Chapter 10: The Foreign Exchange Market ∙ New opening case: The Mexican Peso, the Japanese

Yen, and Pokemon Go ∙ New closing case: Apple’s Earnings Hit by Strong

Dollar

Chapter 11: The International Monetary System

∙ New opening case: Egypt and the IMF ∙ Updated discussion of exchange rates since 1973 to

reflect recent exchange rate movements. ∙ New closing case: China’s Exchange Rate Regime

Chapter 12: The Global Capital Market ∙ New opening case: Saudi Aramco ∙ New closing case: Alibaba’s Record-Setting IPO

Chapter 13: The Strategy of International Business

∙ New opening case: Sony’s Global Strategy ∙ Deeper discussion of the rise of regionalism ∙ Integration of global strategy thoughts ∙ New closing case: IKEA’s Global Strategy

Chapter 14: The Organization of International Business

∙ Revised opening case: Unilever’s Global Organization

∙ Revised Management Focus: Walmart International

∙ Revised Management Focus: Lincoln Electric and Culture

∙ New closing case: Organizational Architecture at P&G

Chapter 15: Entry Strategy and Strategic Alliances

∙ New opening case: Gazprom and Global Strategic Alliances

∙ Deeper treatment of entry modes and global strategic alliances

∙ Revised closing case: Starbucks’ Foreign Entry Strategy

Chapter 16: Exporting, Importing, and Countertrade

∙ New opening case: Tata Motors and Exporting ∙ globalEDGE-related material on company readi-

ness to export and company readiness to import material

∙ Revised management focus: Ambient Technologies and the Panama Canal

∙ New and revised material on globalEDGE Diagnostic Tools; focusing on CORE-Company Readiness to Export

∙ New closing case: Embraer and Brazilian Importing

Chapter 17: Global Production and Supply Chain Management

∙ New opening case: Alibaba and Global Supply Chains

∙ Revised and new material on global logistics, global purchasing, and global operations.

∙ Revised sections on Strategic Roles for Production Facilities, Make-or-Buy Decisions, and Global Supply Chain Functions

∙ New text for the sections on Role of Information Technology, Coordination in Global Supply Chains, and Interorganizational Relationships

∙ New closing case: Amazon’s Global Supply Chains

Chapter 18: Global Marketing and R&D ∙ New opening case: ACSI and Satisfying Global

Customers

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∙ Revised sections on Globalization of Markets and Brands, Configuring the Marketing Mix (with a great summary table and sample measures), and International Market Research

∙ Revised positioning of the Product Development section

∙ New closing case: Global Branding, Marvel Studios, and Walt Disney Company

Chapter 19: Global Human Resource Management

∙ New opening case: Building a Global Diverse Workforce at Sodexo

∙ New section: Building a Diverse Global Workforce ∙ New closing case: AstraZeneca

Chapter 20: Accounting and Finance in the International Business

∙ Revised opening case: Shoprite—Financial Success of a Food Retailer in Africa

∙ Revised materials on global accounting standards and organizations

∙ Revised closing case: Tesla, Inc.—Subsidizing Tesla Automobiles Globally

Integrated Cases

All of the 20 integrated cases are new for International Business 12e. Many of these cases build on previous open- ing and closing chapter cases that have been revised, up- dated, and oftentimes adopted a new angle or focus. A unique feature of the opening and closing cases for the chapters as well as the integrated cases at the back-end of the text is that we cover all continents of the world and we do so with regional or country issues and large, me- dium, and small company scenarios. This makes the 60 total cases we have included in International Business 12e remarkable wealthy as a learning program. As a heads up for teachers (and students), the Domino’s case is the lengthiest and most in-depth in the twelfth edition.

∙ Global Medical Tourism ∙ Venezuela under Hugo Chávez and Beyond

∙ Political and Economic Reform in Myanmar ∙ Will China Continue to be a Growth Marketplace ∙ Lead in Toys and Drinking Water ∙ Creating the World’s Biggest Free Trade Zone ∙ Sugar Subsidies Drive Candy Makers Abroad ∙ Volkswagen in Russia ∙ The NAFTA Tomato Wars ∙ Subaru’s Sales Boom Thanks to the Weaker Yen ∙ The IMF and Ukraine’s Economic Crisis ∙ The Global Financial Crisis and Its Aftermath:

Declining Cross-Border Capital Flows ∙ Ford’s Global Platform Strategy ∙ Philips’ Global Restructuring ∙ General Motors and Chinese Joint Ventures ∙ Exporting Desserts by a Hispanic Entrepreneur ∙ Apple: The Best Supply Chains in the World? ∙ Domino’s Global Marketing ∙ Siemens and Global Competitiveness ∙ Microsoft and Its Foreign Cash Holdings

Beyond Uncritical Presentation and Shallow Explanation

Many issues in international business are complex and thus necessitate considerations of pros and cons. To dem- onstrate this to students, we have adopted a critical ap- proach that presents the arguments for and against economic theories, government policies, business strate- gies, organizational structures, and so on. Related to this, we have attempted to explain the com- plexities of the many theories and phenomena unique to international business so the student might fully compre- hend the statements of a theory or the reasons a phenom- enon is the way it is. We believe that these theories and phenomena are explained in more depth in this work than they are in the competition, which seem to use the rationale that a shallow explanation is little better than no explanation. In international business, a little knowledge is indeed a dangerous thing.

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We have always believed that it is important to show students how the material covered in the text is rele- vant to the actual practice of international business. This is explicit in the later chapters of the book, which focus on the practice of international business, but it is not always ob- vious in the first half of the book, which considers many macroeconomic and political issues, from international trade theory and foreign direct investment flows to the IMF and the influence of inflation rates on foreign exchange quo- tations. Accordingly, at the end of each chapter in Parts Two, Three, and Four—where the focus is on the environment of international business, as opposed to particular firms—there is a section titled Focus on Managerial Implications. In this section, the managerial implications of the material discussed in the chapter are clearly explained.

Another tool that we have used to focus on managerial implica- tions is the Management Focus box. Most chapters have at least one Management Focus. Like the opening cases, the purpose of these boxes is

to illustrate the relevance of chapter material for the practice of international business.

Practical and Rich Applications

National Differences in Political, Economic, and Legal Systems Chapter 2 57

PRODUCT SAFETY AND PRODUCT LIABILITY

Product safety laws set certain safety standards to which a product must adhere. Prod- uct liability involves holding a firm and its officers responsible when a product causes in- jury, death, or damage. Product liability can be much greater if a product does not conform to required safety standards. Both civil and criminal product liability laws exist. Civil laws call for payment and monetary damages. Criminal liability laws result in fines or imprison- ment. Both civil and criminal liability laws are probably more extensive in the United States than in any other country, although many other Western nations also have compre- hensive liability laws. Liability laws are typically the least extensive in less developed na- tions. A boom in product liability suits and awards in the United States resulted in a dramatic increase in the cost of liability insurance. Many business executives argue that the high costs of liability insurance make American businesses less competitive in the global marketplace.

In addition to the competitiveness issue, country differences in product safety and lia- bility laws raise an important ethical issue for firms doing business abroad. When product safety laws are tougher in a firm’s home country than in a foreign country or when liability laws are more lax, should a firm doing business in that foreign country follow the more relaxed local standards or should it adhere to the standards of its home country? While the ethical thing to do is undoubtedly to adhere to home-country standards, firms have been known to take advantage of lax safety and liability laws to do business in a manner that would not be allowed at home.

TEST PREP Use SmartBook to help retain what you have learned. Access your instructor’s Connect course to check out SmartBook or go to learnsmartadvantage.com for help.

F O C U S O N M A N A G E R I A L I M P L I C AT I O N S

THE MACRO ENVIRONMENT INFLUENCES MARKET ATTRACTIVENESS

The material discussed in this chapter has two broad implications for international business. First, the political, economic, and legal systems of a country raise impor- tant ethical issues that have implications for the practice of international business. For example, what ethical implications are associated with doing business in

totalitarian countries where citizens are denied basic human rights, corruption is rampant, and bribes are necessary to gain permission to do business? Is it right to oper-

ate in such a setting? A full discussion of the ethical implications of country differences in political economy is reserved for Chapter 5, where we explore ethics in international business in much greater depth. Second, the political, economic, and legal environments of a country clearly influence the attractiveness of that country as a market or investment site. The benefits, costs, and risks associated with doing business in a country are a function of that country’s political, eco- nomic, and legal systems. The overall attractiveness of a country as a market or investment site depends on balancing the likely long-term benefits of doing business in that country against the likely costs and risks. Because this chapter is the first of two dealing with issues of political economy, we will delay a detailed discussion of how political economy impacts the benefits, costs, and risks of doing business in different nation-states until the end of the next chapter, when we have a full grasp of all the relevant variables that are important for assessing benefits, costs, and risks. For now, other things being equal, a nation with democratic political institutions, a market- based economic system, and strong legal system that protects property rights and limits corruption is clearly more attractive as a place in which to do business than a nation that lacks democratic institutions, where economic activity is heavily regulated by the state, and where corruption is rampant and the rule of law is not respected. On this basis, for example,

LO 2- 4 Explain the implications for management practice of national differences in political economy.

hiL29442_ch02_038-061.indd 57 12/29/17 11:48 AM

M A N A G E M E N T F O C U S

In the early 2000s, Walmart wanted to build a new store in San Juan Teotihuacan, Mexico, barely a mile from ancient pyramids that drew tourists from around the world. The owner of the land was happy to sell to Walmart, but one thing stood in the way of a deal: the city’s new zoning laws. These prohibited commercial development in the historic area. Not to be denied, executives at the headquarters of Walmart de Mexico found a way around the problem: They paid a $52,000 bribe to a local official to redraw the zon- ing area so that the property Walmart wanted to purchase was placed outside the commercial-free zone. Walmart then went ahead and built the store, despite vigorous local opposition, opening it in late 2004. A former lawyer for Walmart de Mexico subsequently contacted Walmart executives at the company’s corporate headquarters in Bentonville, Arkansas. He told them that Walmart de Mexico routinely resorted to bribery, citing the altered zoning map as just one example. Alarmed, execu- tives at Walmart started their own investigation. Faced with growing evidence of corruption in Mexico, top Walmart executives decided to engage in damage control, rather than coming clean. Walmart’s top lawyer shipped the case files back to Mexico and handed over responsibility for the investigation to the general council of Walmart de Mexico. This was an interesting choice as the very same general council was alleged to have authorized bribes. The gen- eral council quickly exonerated fellow Mexican executives, and the internal investigation was closed in 2006. For several years nothing more happened; then, in April 2012, The New York Times published an article detailing bribery by Walmart. The Times cited the changed zoning map and several other examples of bribery by Walmart: for example, eight bribes totaling $341,000 enabled Walmart to build a Sam’s Club in one of Mexico City’s most densely

Did Walmart Violate the Foreign Corrupt Practices Act? populated neighborhoods without a construction license, an environmental permit, an urban impact assessment, or even a traffic permit. Similarly, thanks to nine bribe pay- ments totaling $765,000, Walmart built a vast refrigerated distribution center in an environmentally fragile flood basin north of Mexico City, in an area where electricity was so scarce that many smaller developers were turned away. Walmart responded to The New York Times article by ramping up a second internal investigation into bribery that it had initiated in 2011. By mid-2015, there were reportedly more than 300 outside lawyers working on the investiga- tion, and it had cost more than $612 million in fees. In addi- tion, the U.S. Department of Justice and the Securities and Exchange Commission both announced that they had started investigations into Walmart’s practices. In Novem- ber 2012, Walmart reported that its own investigation into violations had extended beyond Mexico to include China and India. Among other things, it was looking into the alle- gations by the Times that top executives at Walmart, includ- ing former CEO Lee Scott Jr., had deliberately squashed earlier investigations. While the investigations are still on- going, in late 2016 people familiar with the matter stated that the federal investigation had not uncovered evidence of widespread bribery. Nevertheless, the company was ap- parently negotiating a settlement with the U.S. government that was estimated to be at least $600 million.

Sources: David Barstow, “Vast Mexican Bribery Case Hushed Up by Wal-Mart after Top Level Struggle,” The New York Times, April 21, 2012; Stephanie Clifford and David Barstow, “Wal-Mart Inquiry Reflects Alarm on Corruption,” The New York Times, November 15, 2012; Nathan Vardi, “Why Justice Department Could Hit Wal-Mart Hard over Mexican Bribery Allegations,” Forbes, April 22, 2012; Phil Wahba,”Walmart Bribery Probe by Feds Finds No Major Misconduct in Mexico,” Fortune, October 18, 2015; T. Schoenberg and M. Robinson, “Wal-Mart Balks at Paying $600 Million in Bribery Case,” Bloomberg, October 6, 2016.

international trade) to keep detailed records that would reveal whether a violation of the act has occurred. In 2012, evidence emerged that in its eagerness to expand in Mexico, Walmart may have run afoul of the FCPA (for details, see the Management Focus feature).

In 1997, trade and finance ministers from the member states of the Organisation for Economic Co-operation and Development (OECD), an association of 34 major econo- mies including most Western economies (but not Russia, India or China), adopted the Convention on Combating Bribery of Foreign Public Officials in International Business Transactions.20 The convention obliges member states to make the bribery of foreign pub- lic officials a criminal offense.

Both the U.S. law and OECD convention include language that allows exceptions known as facilitating or expediting payments (also called grease payments or speed money),

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In addition, each chapter begins with an opening case that sets the stage for the chapter content and familiarizes students with how real international companies conduct business.

part two National Dif ferences

3National Differences in Economic Development L E A R N I N G O B J E C T I V E S Af ter reading this chapter, you will be able to:

LO3 -1 Explain what determines the level of economic development of a nation.

LO3-2 Identify the macropolitical and macroeconomic changes occurring worldwide.

LO3-3 Describe how transition economies are moving toward market-based systems.

LO3-4 Explain the implications for management practice of national difference in political economy.

©Shafiqul Alam/Corbis News/Getty Images©Shafiqul Alam/Corbis News/Getty Images

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part seven cases

Integrative Cases For International Business, 12e, we have again included a set of 20 cases as value- added materials at the end of the text in addition to the 40 cases—opening and clos- ing cases—that appear in the 20 chapters. We started this practice of including short but integrative cases in the 11th edition to provide instructors and students with a bet- ter platform for learning across chapters.

The end-of-the-book cases fill strategically aligned objectives for the core features of In- ternational Business 12e. Specifically, we are able to build on and enhance the worldwide market leadership of our text and its focus on current, application-rich, relevant, and

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Global Medical Tourism 1 4, 5 X X

Venezuela under Hugo Chávez and Beyond 2 3, 6 X X X

Political and Economic Reform in Myanmar 3 6, 7 X X X

Will China Continue to Be a Growth Marketplace? 4 7, 8 X X X

Lead in Toys and Drinking Water 5 4, 13 X X X

Creating the World’s Biggest Free Trade Zone 6 7, 8, 9 X X

Sugar Subsidies Drive Candy Makers Abroad 7 2, 3, 6 X X X

Volkswagen in Russia 8 7, 17 X X X

The NAFTA Tomato Wars 9 4, 6, 7 X X X

Subaru’s Sales Boom Thanks to the Weaker Yen 10 11, 12 X X

The IMF and Ukraine’s Economic Crisis 11 3, 12 X X X

The Global Financial Crisis and Its Aftermath: Declining Cross-Border Capital Flows

12 6, 8 X X X

Ford’s Global Platform Strategy 13 14, 17 X X X

Philips’ Global Restructuring 14 13 X X

General Motors and Chinese Joint Ventures 15 13, 14 X X

Exporting Desserts by a Hispanic Entrepreneur 16 15 X X X

Apple: The Best Supply Chains in the World? 17 13, 14, 15 X X X

Domino’s Global Marketing 18 16, 17 X X X

Siemens and Global Competitiveness 19 14 X X X

Microsoft and Its Foreign Cash Holdings 20 12, 14, 15 X X X X

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Globalization Chapter 1 35

r e s e a r c h t a s k g l o b a l e d g e . m s u . e d u

Use the globalEDGETM website (globaledge.msu.edu) to complete the following exercises:

1. As the drivers of globalization continue to pres- sure both the globalization of markets and the globalization of production, we continue to see the impact of greater globalization on worldwide trade patterns. HSBC, a large global bank, ana- lyzes these pressures and trends to identify op- portunities across markets and sectors through its trade forecasts. Visit the HSBC Global Con- nections site and use the trade forecast tool to identify which export routes are forecasted to see the greatest growth over the next 15 to 20 years. What patterns do you see? What types of coun- tries dominate these routes?

2. You are working for a company that is consider- ing investing in a foreign country. Investing in countries with different traditions is an impor- tant element of your company’s long-term strate- gic goals. As such, management has requested a report regarding the attractiveness of alternative countries based on the potential return of FDI. Accordingly, the ranking of the top 25 countries in terms of FDI attractiveness is a crucial ingre- dient for your report. A colleague mentioned a potentially useful tool called the Foreign Direct Investment (FDI) Confidence Index. The FDI Confidence Index is a regular survey of global executives conducted by A.T. Kearney. Find this index and provide additional information regard- ing how the index is constructed.

Uber, the controversial San Francisco–based ride-for-hire service, has made a virtue out of disrupting the estab- lished taxi business. From a standing start in 2009, the company has spread across the globe like wildfire. Uber’s strategy has been to focus on major metropolitan areas around the world. This strategy has so far taken Uber into about 600 cities in more than 80 countries. The privately held company is rumored to be generating annual reve- nues of around $10 billion. At the core of Uber’s business is a smartphone app that allows customers to hail a ride from the comfort of their own home, a restaurant, or a bar stool. The app shows cars in the area, notifies the rider when a car is on the way, and tracks the progress of the car on screen using GPS map- ping technology. The rider pays via the app using a credit card, so no cash changes hands. The driver takes 80 per- cent of the fee and Uber 20 percent. The price for the ride is determined by Uber using an algorithm that sets prices in order to match the demand for rides with the supply of cars on the road. Thus, if demand exceeds supply, the price for a ride will rise, inducing drivers to get on the road. Uber does not own any cars. Its drivers are independent contrac- tors with their own vehicles. The company is, in effect, a twenty-first-century version of an old-style radio taxi dis- patch company. Interestingly, Uber’s founders got their idea for the app-based service one snowy night in Paris when they were unable to find a taxi.

Historically, taxi markets around the globe have been tightly regulated by metropolitan authorities. The stated purpose of these regulations has often included (1) limit- ing the supply of taxis in order to boost demand for other forms of public transportation, (2) limiting the supply of taxis in order to reduce traffic congestion, (3) ensuring the safety of riders by only allowing licensed taxis to offer rides, (4) ensuring that the prices charged are “fair,” and (5) guaranteeing a reasonable rate of return to the owners of taxi licenses. In practice, widespread restrictions on the supply of taxi licenses have created shortages in many cities, making it dif- ficult to find a taxi, particularly at busy periods. In New York, the number of licenses barely increased from 11,787 in 1945 to 13,587 in 2017, even though the population ex- panded significantly. In Paris, the number of licenses was 14,000 in 1937 and had only increased to 17,137 by 2017, even though both the population and the number of visitors to the city had surged. The number of taxis in Milan was frozen between 1974 and 2014, despite Milan having a ratio of taxis to inhabitants that was one of the lowest for any major city. Whenever metropolitan authorities have tried to increase the number of taxis in a city, they have often been meet by strong resistance from established taxi companies. When the French tried to increase the number of taxis in Paris in 2007, a strike among transportation workers shut down the city and forced the government to back off.

C L O S I N G C A S E

Uber: Going Global from Day One

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The Part Seven Integrated Cases are somewhat longer, allowing a more in- depth study of international companies. These cases can be used as stand-alone cases, in conjunction with a specific chap- ter, and also as integrated cases covering relevant and practical material from several chapters. The introduction to the Part Seven section discusses and lays out topics covered in each case.

A closing case to each chapter is designed to illustrate the rele- vance of chapter material for the practice of international busi- ness and provide continued in- sight into how real companies handle those issues.

xvii

To help students go a step further in expanding their application-level understanding of international business, each chapter incorporates two globalEDGE research tasks designed and written by Tomas Hult, Tunga Kiyak, and the team at Michigan State University’s International Business Center and their globaledge.msu.edu site. The exercises dovetail with the content just covered.

INTEGRATED PROGRESSION OF TOPICS

A weakness of many texts is that they lack a tight, inte- grated flow of topics from chapter to chapter. This book explains to students in Chapter 1 how the book’s topics are related to each other. Integration has been achieved by organizing the material so that each chapter builds on the material of the previous ones in a logical fashion.

Part One

Chapter 1 provides an overview of the key issues to be addressed and explains the plan of the book. Globaliza- tion of markets and globalization of production is the core focus.

Part Two

Chapters 2 through 4 focus on country differences in political economy and culture, and Chapter 5 on ethics, corporate social responsibility, and sustainability issues in international business. Most international business textbooks place this material at a later point, but we believe it is vital to discuss national differences first. After all, many of the central issues in international trade and investment, the global monetary system, international business strategy and structure, and international busi- ness functions arise out of national differences in politi- cal economy and culture.

Part Three

Chapters 6 through 9 investigate the political economy of global trade and investment. The purpose of this part is to describe and explain the trade and investment environ- ment in which international business occurs.

Part Four

Chapters 10 through 12 describe and explain the global monetary system, laying out in detail the monetary frame- work in which international business transactions are conducted.

Part Five

In Chapters 13 through 15 attention shifts from the envi- ronment to the firm. In other words, we move from a

macro focus to a micro focus at this stage of the book. We examine strategies and structures that firms adopt to compete effectively in the international business environment.

Part Six

In Chapters 16 through 20 the focus narrows further to investigate business functions and related operations. These chapters explain how firms can perform their key functions—exporting, importing, and countertrade; global production; global supply chain management; global marketing; global research and development (R&D); human resource management; accounting; and finance—to compete and succeed in the international business environment. Throughout the book, the relationship of new material to topics discussed in earlier chapters is pointed out to the students to reinforce their understanding of how the material comprises an integrated whole. We deliber- ately bring a management focus to the macro chapters (Chapters 1 through 12). We also integrate macro themes in covering the micro chapters (Chapters 13 through 20). Part Seven with its integrated cases also provides a great learning vehicle to better understand macro and micro issues.

ACCESSIBLE AND INTERESTING

The international business arena is fascinating and excit- ing, and we have tried to communicate our enthusiasm for it to the student. Learning is easier and better if the subject matter is communicated in an interesting, infor- mative, and accessible manner. One technique we have used to achieve this is weaving interesting anecdotes into the narrative of the text, that is, stories that illustrate theory. Most chapters also have a Country Focus box that pro- vides background on the political, economic, social, or cultural aspects of countries grappling with an interna- tional business issue.

McGRAW-HILL CONNECT INTERNATIONAL BUSINESS

Applied

Application Exercises A variety of interactive assignments within Connect re- quire students to apply what they have learned in a real- world scenario. These online exercises help students assess their understanding of the concepts at a higher level. Exer- cises include video cases, decision-making scenarios/cases from real-world companies, case analysis exercises, busi- ness models, processes, and problem-solving cases.

xviii

TEACHING SUPPORT

Within the Connect International Business’ Instructor Re- sources you can find a complete package to prepare you for your course.

∙ Instructor’s Manual. The Instructor’s Manual is a comprehensive resource designed to support you in effectively teaching your course. It includes course outlines; chapter overviews and outlines, teaching suggestions, chapter objectives, teaching suggestions for opening cases, lecture outlines, answers to critical discussion questions, teaching suggestions for the closing case, and two student activities; and video notes with discussion ques- tions for each video. The answers to globalEDGE research tasks are included.

∙ Test Bank. Approximately 100 true-false, multiple- choice, and essay questions per chapter are in- cluded in the test bank. We’ve aligned our test bank questions with Bloom’s Taxonomy and AACSB guidelines, tagging each question accord- ing to its knowledge and skill areas. Each test bank question also maps to a specific chapter learning objective listed in the text.

∙ PowerPoint Presentations. The PowerPoint pro- gram consists of one set of slides for every chapter, which include key text figures, tables, and maps. Quiz questions to keep students on their toes during classroom presentations are also included, along with instructor notes.

∙ International Business Video Program. McGraw-Hill offers the most comprehensive, diverse, and current video support for the International Business class- room. Updated monthly, our video program is the most current on the market. Additionally, video-based application exercises are assignable within Connect.

COURSE DESIGN AND DELIVERY

cesim GlobalChallenge Simulation

cesim is an international business simulation designed to develop student under-

standing of the interaction and complexity of various business disciplines and concepts in a rapidly evolving, competitive business environment. The simulation has a particular focus on creating long-term, sustainable, and profitable growth of a global technology company. Student teams make decisions about technology-based product roadmaps and global market and production strategies involving economics, finance, human re- sources, accounting, procurement, production, logistics, research and innovation, and marketing. cesim improves

the knowledge retention, business decision making, and teamwork skills of students.

CREATE

Instructors can now tailor their teaching resources to match the way they teach! With McGraw-Hill Create, www.mcgrawhillcreate.com, instructors can easily rearrange chapters, combine mate- rial from other content sources, and quickly upload and integrate their own content, such as course syllabi or teaching notes. Find the right content in Create by search- ing through thousands of leading McGraw-Hill textbooks. Arrange the material to fit your teaching style. Order a Create book and receive a complimentary print review copy in three to five business days or a complimentary electronic review copy via e-mail within one hour. Go to www.mcgrawhillcreate.com today and register.

TEGRITY CAMPUS

Tegrity makes class time available 24/7 by automati- cally capturing every lecture in a searchable format for students to review when they study and complete assignments. With a simple one-click start-and-stop process, you capture all computer screens and corresponding audio. Students can replay any part of any class with easy-to-use browser-based viewing on a PC or Mac. Educators know that the more students can see, hear, and experience class resources, the better they learn. In fact, studies prove it. With patented Tegrity “search anything” technology, students instantly recall key class moments for replay online or on iPods and mo- bile devices. Instructors can help turn all their students’ study time into learning moments immediately supported by their lecture. To learn more about Tegrity, watch a two- minute Flash demo at http://tegritycampus.mhhe.com.

BLACKBOARD® PARTNERSHIP

McGraw-Hill Education and Blackboard have teamed up to simplify your life. Now you and your students can access Con- nect and Create right from within your Blackboard course— all with one single sign-on. The grade books are seamless, so when a student completes an integrated Connect as- signment, the grade for that assignment automatically (and instantly) feeds your Blackboard grade center. Learn more at http://www.mheducation.com/highered/services/ mhcampus.html.

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McGRAW-HILL CAMPUS™

McGraw-Hill Campus is a new one-stop teaching and learning experience available

to users of any learning management system. This institu- tional service allows faculty and students to enjoy single sign-on (SSO) access to all McGraw-Hill Higher Educa- tion materials, including the award-winning McGraw-Hill Connect platform, from directly within the institution’s website. With McGraw-Hill Campus, faculty receive in- stant access to teaching materials (e.g., eTextbooks, test

banks, PowerPoint slides, animations, learning objectives, etc.), allowing them to browse, search, and use any in- structor ancillary content in our vast library at no addi- tional cost to instructor or students. In addition, students enjoy SSO access to a variety of free content (e.g., quiz- zes, flash cards, narrated presentations, etc.) and sub- scription-based products (e.g., McGraw-Hill Connect). With McGraw-Hill Campus enabled, faculty and stu- dents will never need to create another account to access McGraw-Hill products and services. Learn more at www.mhcampus.com.

■ Connect content is authored by the world’s best subject matter experts, and is available to your class through a simple and intuitive interface.

■ The Connect eBook makes it easy for students to access their reading material on smartphones and tablets. They can study on the go and don’t need internet access to use the eBook as a reference, with full functionality.

■ Multimedia content such as videos, simulations, and games drive student engagement and critical thinking skills. ©McGraw-Hill Education

■ Connect’s assignments help students contextualize what they’ve learned through application, so they can better understand the material and think critically.

■ Connect will create a personalized study path customized to individual student needs through SmartBook®.

■ SmartBook helps students study more efficiently by delivering an interactive reading experience through adaptive highlighting and review.

McGraw-Hill Connect® is a highly reliable, easy-to- use homework and learning management solution that utilizes learning science and award-winning adaptive tools to improve student results.

73% of instructors who use Connect

require it; instructor satisfaction increases by 28% when Connect

is required.

Homework and Adaptive Learning

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Education products more intelligent, reliable, and precise.

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■ Connect Insight® generates easy-to-read reports on individual students, the class as a whole, and on specific assignments.

■ The Connect Insight dashboard delivers data on performance, study behavior, and effort. Instructors can quickly identify students who struggle and focus on material that the class has yet to master.

■ Connect automatically grades assignments and quizzes, providing easy-to-read reports on individual and class performance.

■ Connect integrates with your LMS to provide single sign-on and automatic syncing of grades. Integration with Blackboard®, D2L®, and Canvas also provides automatic syncing of the course calendar and assignment-level linking.

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■ If you’re looking for some guidance on how to use Connect, or want to learn tips and tricks from super users, you can find tutorials as you work. Our Digital Faculty Consultants and Student Ambassadors offer insight into how to achieve the results you want with Connect.

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CONTENTS

part one Introduction and Overview

C H A P T E R 1 Globalization 2 Opening Case Globalization of BMW, Rolls-Royce, and the MINI 3

Introduction 4

What Is Globalization? 6 The Globalization of Markets 6 The Globalization of Production 8

Management Focus Boeing’s Global Production System 9

The Emergence of Global Institutions 10

Drivers of Globalization 11 Declining Trade and Investment Barriers 11 Role of Technological Change 15

The Changing Demographics of the Global Economy 17

The Changing World Output and World Trade Picture 17 The Changing Foreign Direct Investment Picture 18

Country Focus India’s Software Sector 19

The Changing Nature of the Multinational Enterprise 20

Management Focus Wanda Group 22

The Changing World Order 22 Global Economy of the Twenty-First Century 23

The Globalization Debate 24 Antiglobalization Protests 24 Globalization, Jobs, and Income 25

Country Focus Protesting Globalization in France 26

Globalization, Labor Policies, and the Environment 28 Globalization and National Sovereignty 29 Globalization and the World’s Poor 30

Managing in the Global Marketplace 31

Chapter Summary 33

Critical Thinking and Discussion Questions 34

Research Task 35

Closing Case Uber: Going Global from Day One 35

Endnotes 36

part two National Differences

C H A P T E R 2 National Differences in Political, Economic, and Legal Systems 38 Opening Case The Decline of Zimbabwe 39

Introduction 40

Political Systems 41 Collectivism and Individualism 41 Democracy and Totalitarianism 43

Country Focus Putin’s Russia 44

Economic Systems 46 Market Economy 46 Command Economy 47 Mixed Economy 48

Legal Systems 48 Different Legal Systems 49 Differences in Contract Law 50 Property Rights and Corruption 50

Country Focus Corruption in Brazil 53

Management Focus Did Walmart Violate the Foreign Corrupt Practices Act? 54

The Protection of Intellectual Property 55

Management Focus Starbucks Wins Key Trademark Case in China 56

Product Safety and Product Liability 57

Focus on Managerial Implications: The Macro Environment Influences Market Attractiveness 57

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Chapter Summary 58

Critical Thinking and Discussion Questions 59

Research Task 59

Closing Case Economic Transformation in Vietnam 59

Endnotes 61

C H A P T E R 3 National Differences in Economic Development 62 Opening Case Economic Development in Bangladesh 63

Introduction 64

Differences in Economic Development 64

Map 3.1 GNI per capita, 2016 65 Map 3.2 GNI PPP per capita, 2016 66 Map 3.3 Average annual growth rate in GDP (%),

2007–2016 67 Broader Conceptions of Development: Amartya Sen 68

Map 3.4 Human Development Index, 2015 69

Political Economy and Economic Progress 69 Innovation and Entrepreneurship Are the Engines of Growth 69 Innovation and Entrepreneurship Require a Market Economy 70 Innovation and Entrepreneurship Require Strong Property Rights 70 The Required Political System 71

Country Focus Emerging Property Rights in China 72

Economic Progress Begets Democracy 72 Geography, Education, and Economic Development 72

States in Transition 73 The Spread of Democracy 73

Map 3.5 Freedom in the world, 2017 74 The New World Order and Global Terrorism 76 The Spread of Market-Based Systems 77

Map 3.6 Index of economic freedom, 2017 78

The Nature of Economic Transformation 78 Deregulation 78 Privatization 79

Country Focus India’s Economic Transformation 80

Legal Systems 81

Implications of Changing Political Economy 81

Focus on Managerial Implications: Benefits, Costs, Risks, and Overall Attractiveness of Doing Business Internationally 82

Chapter Summary 86

Critical Thinking and Discussion Questions 86

Research Task 87

Closing Case The Political and Economic Evolution of Indonesia 87

Endnotes 89

C H A P T E R 4 Differences in Culture 90 Opening Case The Swatch Group and Cultural Uniqueness  91

Introduction 92

What Is Culture? 93 Values and Norms 93 Culture, Society, and the Nation-State 95 Determinants of Culture 96

Social Structure 96 Individuals and Groups 97 Social Stratification 99

Country Focus India and Its Caste System 100

Religious and Ethical Systems 102

Map 4.1 World Religions 103 Christianity 103 Islam 104

Country Focus Secularism in Turkey 107

Hinduism  108 Buddhism 109 Confusianism 110

Management Focus China and Its Guanxi 111

Language 112 Spoken Language 112 Unspoken Language 113

Education 113

Culture and Business 114

Cultural Change 117

Focus on Managerial Implications: Cultural Literacy and Competitive Advantage 119

Chapter Summary 121

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part three The Global Trade and Investment Environment

C H A P T E R 6 International Trade Theory 158 Opening Case Donald Trump on Trade 159

Introduction 160

An Overview of Trade Theory 160 The Benefits of Trade 161 The Pattern of International Trade 162 Trade Theory and Government Policy 162

Mercantilism 163

Country Focus Is China Manipulating Its Currency in Pursuit of a Neo-Mercantilist Policy? 164

Absolute Advantage 164

Comparative Advantage 166 The Gains from Trade 167 Qualifications and Assumptions 168 Extensions of the Ricardian Model 169

Country Focus Moving U.S. White-Collar Jobs Offshore 173

Heckscher–Ohlin Theory 174 The Leontief Paradox 175

The Product Life-Cycle Theory 176 Product Life-Cycle Theory in the Twenty-First Century 176

New Trade Theory 177 Increasing Product Variety and Reducing Costs 177 Economies of Scale, First-Mover Advantages, and the Pattern of Trade 178 Implications of New Trade Theory 179

National Competitive Advantage: Porter’s Diamond 180

Factor Endowments 181 Demand Conditions 181 Related and Supporting Industries 181 Firm Strategy, Structure, and Rivalry 182 Evaluating Porter’s Theory 182

Focus on Managerial Implications: Location, First-Mover Advantages, and Government Policy 183

Critical Thinking and Discussion Questions 122

Research Task 123

Closing Case The Emirates Group and Employee Diversity 123

Endnotes 124

C H A P T E R 5 Ethics, Corporate Social Responsibility, and Sustainability 128 Opening Case Woolworths Group’s Corporate Responsibility Strategy 2020 129

Introduction 130

Ethics and International Business 131 Employment Practices 131

Management Focus “Emissionsgate” at Volkswagen 132

Human Rights 133 Environmental Pollution 134 Corruption 135

Ethical Dilemmas 136

Roots of Unethical Behavior 137 Personal Ethics 137 Decision-Making Processes 138 Organizational Culture 139 Unrealistic Performance Goals 139 Leadership 139 Societal Culture 140

Philosophical Approaches to Ethics 140 Straw Men 140 Utilitarian and Kantian Ethics 142 Rights Theories 143 Justice Theories 144

Focus on Managerial Implications: Making Ethical Decisions Internationally 145

Management Focus Corporate Social Responsibility at Stora Enso 150

Chapter Summary 152

Critical Thinking and Discussion Questions 153

Research Task 154

Closing Case UNCTAD Sustainable Development Goals 154

Endnotes 155

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The Future of the WTO: Unresolved Issues and the Doha Round 210

Country Focus Estimating the Gains from Trade for America 213

Multilateral and Bilateral Trade Agreements 214 The World Trading System under Threat 214

Focus on Managerial Implications: Trade Barriers, Firm Strategy, and Policy Implications 215

Chapter Summary 217

Critical Thinking and Discussion Questions 218

Research Task 218

Closing Case Is China Dumping Excess Steel Production? 219

Endnotes 220

C H A P T E R 8 Foreign Direct Investment 222 Opening Case Foreign Direct Investment in Retailing in India 223

Introduction 224

Foreign Direct Investment in the World Economy 224

Trends in FDI 224 The Direction of FDI 225 The Source of FDI 226

Country Focus Foreign Direct Investment in China 227

The Form of FDI: Acquisitions versus Greenfield Investments 228

Theories of Foreign Direct Investment 228 Why Foreign Direct Investment? 228

Management Focus Foreign Direct Investment by Cemex 230

The Pattern of Foreign Direct Investment 232 The Eclectic Paradigm 233

Political Ideology and Foreign Direct Investment 234 The Radical View 234 The Free Market View 235 Pragmatic Nationalism 235 Shifting Ideology 236

Benefits and Costs of FDI 237 Host-Country Benefits 237 Host-Country Costs 239 Home-Country Benefits 240

Chapter Summary 184

Critical Thinking and Discussion Questions 185

Research Task 186

Closing Case The Trans Pacific Partnership (TPP) 186

Appendix

International Trade and the Balance of Payments 188

Endnotes 190

C H A P T E R 7 Government Policy and International Trade 192 Opening Case Boeing and Airbus Are in a Dogfight over Illegal Subsidies 193

Introduction 194

Instruments of Trade Policy 194 Tariffs 195 Subsidies 195

Country Focus Are the Chinese Illegally Subsidizing Auto Exports? 196

Import Quotas and Voluntary Export Restraints 197 Export Tariffs and Bans 198 Local Content Requirements 198 Administrative Policies 199 Antidumping Policies 199

The Case for Government Intervention 199

Management Focus Protecting U.S. Magnesium 200

Political Arguments for Intervention 201 Economic Arguments for Intervention 203

The Revised Case for Free Trade 205 Retaliation and Trade War 205 Domestic Policies 206

Development of the World Trading System 206 From Smith to the Great Depression 207 1947–1979: GATT, Trade Liberalization, and Economic Growth 207 1980–1993: Protectionist Trends 207 The Uruguay Round and the World Trade Organization 208 WTO: Experience to Date 209

xxvi

The North American Free Trade Agreement 271 The Andean Community 273 Mercosur 274 Central American Common Market, CAFTA, and CARICOM 275

Regional Economic Integration Elsewhere 275 Association of Southeast Asian Nations 275

Map 9.3 ASEAN countries 276 Regional Trade Blocs in Africa 277 Other Trade Agreements 277

Focus on Managerial Implications: Regional Economic Integration Threats 278

Chapter Summary 280

Critical Thinking and Discussion Questions 280

Research Task 281

Closing Case The Push toward Free Trade in Africa 281

Endnotes 283

part four The Global Monetary System

C H A P T E R 1 0 The Foreign Exchange Market 286 Opening Case The Mexican Peso, the Japanese Yen, and Pokemon Go 287

Introduction 288

The Functions of the Foreign Exchange Market 289 Currency Conversion 289 Insuring against Foreign Exchange Risk 291

Management Focus Embraer and the Gyrations of the Brazilian Real 293

The Nature of the Foreign Exchange Market 293

Economic Theories of Exchange Rate Determination 294

Prices and Exchange Rates 295

Country Focus Quantitative Easing, Inflation, and the Value of the U.S. Dollar 299

Interest Rates and Exchange Rates 300 Investor Psychology and Bandwagon Effects 301 Summary of Exchange Rate Theories 301

Home-Country Costs 241 International Trade Theory and FDI 241

Government Policy Instruments and FDI 242 Home-Country Policies 242 Host-Country Policies 243 International Institutions and the Liberalization of FDI 244

Focus on Managerial Implications: FDI and Government Policy 244

Chapter Summary 247

Critical Thinking and Discussion Questions 247

Research Task 248

Closing Case Burberry Shifts Its Strategy in Japan 248

Endnotes 249

C H A P T E R 9 Regional Economic Integration 252 Opening Case Renegotiating NAFTA 253

Introduction 254

Levels of Economic Integration 255

The Case for Regional Integration 257 The Economic Case for Integration 257 The Political Case for Integration 257 Impediments to Integration 258

The Case against Regional Integration 258

Regional Economic Integration in Europe 259 Evolution of the European Union 259

Map 9.1 Member states of the European Union in 2017 260

Political Structure of the European Union 260

Management Focus The European Commission and Intel 261

The Single European Act 262 The Establishment of the Euro 263

Country Focus The Greek Sovereign Debt Crisis 266

Enlargement of the European Union 268 British Exit from the European Union (BREXIT) 269

Regional Economic Integration in the Americas 270

Map 9.2 Economic integration in the Americas 270

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Focus on Managerial Implications: Currency Management, Business Strategy, and Government Relations 333

Management Focus Airbus and the Euro 335

Chapter Summary 336

Critical Thinking and Discussion Questions 337

Research Task 337

Closing Case China’s Exchange Rate Regime 338

Endnotes 339

C H A P T E R 1 2 The Global Capital Market 340 Opening Case Saudi Aramco  341

Introduction 342

Benefits of the Global Capital Market 342 Functions of a Generic Capital Market 342 Attractions of the Global Capital Market 343

Management Focus The Industrial and Commercial Bank of China Taps the Global Capital Market 345

Growth of the Global Capital Market 347 Global Capital Market Risks 349

Country Focus Did the Global Capital Markets Fail Mexico? 350

The Eurocurrency Market 351 Genesis and Growth of the Market 351 Attractions of the Eurocurrency Market 351 Drawbacks of the Eurocurrency Market 353

The Global Bond Market 353 Attractions of the Eurobond Market 354

The Global Equity Market 354

Foreign Exchange Risk and the Cost of Capital 356

Focus on Managerial Implications: Growth of the Global Capital Market 356

Chapter Summary 357

Critical Thinking and Discussion Questions 358

Research Task 358

Closing Case Alibaba’s Record-Setting IPO 359

Endnotes 360

Exchange Rate Forecasting 302 The Efficient Market School 302 The Inefficient Market School 302 Approaches to Forecasting 302

Currency Convertibility 303

Focus on Managerial Implications: Foreign Exchange Rate Risk 304

Chapter Summary 307

Critical Thinking and Discussion Questions 308

Research Task 309

Closing Case Apple’s Earnings Hit by Strong Dollar 309

Endnotes 310

C H A P T E R 1 1 The International Monetary System 312 Opening Case Egypt and the IMF 313

Introduction 314

The Gold Standard 315 Mechanics of the Gold Standard 315 Strength of the Gold Standard 315 The Period between the Wars: 1918–1939 316

The Bretton Woods System 317 The Role of the IMF 317 The Role of the World Bank 318

The Collapse of the Fixed Exchange Rate System 319

The Floating Exchange Rate Regime 320 The Jamaica Agreement 320 Exchange Rates since 1973 320

Country Focus The U.S. Dollar, Oil Prices, and Recycling Petrodollars 323

Fixed versus Floating Exchange Rates 324 The Case for Floating Exchange Rates 324 The Case for Fixed Exchange Rates 325 Who Is Right? 326

Exchange Rate Regimes in Practice 326 Pegged Exchange Rates 327 Currency Boards 327

Crisis Management by the IMF 328 Financial Crises in the Post–Bretton Woods Era 329

Country Focus The IMF and Iceland’s Economic Recovery 330

Evaluating the IMF’s Policy Prescriptions 331

xxviii

C H A P T E R 1 4 The Organization of International Business 392 Opening Case Unilever’s Global Organization 393

Introduction 394

Organizational Architecture 395

Organizational Structure 396 Vertical Differentiation: Centralization and Decentralization 396

Management Focus Walmart International 398

Horizontal Differentiation: The Design of Structure 399 Integrating Mechanisms 405

Management Focus Dow—(Failed) Early Global Matrix Adopter 406

Control Systems and Incentives 410 Types of Control Systems 410 Incentive Systems 412 Control Systems, Incentives, and Strategy in the International Business 413

Processes 415

Organizational Culture 415 Creating and Maintaining Organizational Culture 416 Organizational Culture and Performance in the International Business 417

Management Focus Lincoln Electric and Culture 419

Synthesis: Strategy and Architecture 420 Localization Strategy 420 International Strategy 420 Global Standardization Strategy 421 Transnational Strategy 421 Environment, Strategy, Architecture, and Performance 421

Organizational Change 422 Organizational Inertia 422 Implementing Organizational Change 423

Chapter Summary 425

Critical Thinking and Discussion Questions 425

Research Task 426

Closing Case Organizational Architecture at P&G 426

Endnotes 427

part five The Strategy and Structure of International Business

C H A P T E R 1 3 The Strategy of International Business 362 Opening Case Sony’s Global Strategy 363

Introduction 364

Strategy and the Firm 364 Value Creation 365 Strategic Positioning 366 The Firm as a Value Chain 368

Global Expansion, Profitability, and Profit Growth 370

Expanding the Market: Leveraging Products and Competencies 371 Location Economies 371 Experience Effects 373 Leveraging Subsidiary Skills 375 Profitability and Profit Growth Summary 376

Management Focus Leveraging Skills Worldwide at ArcelorMittal 377

Cost Pressures and Pressures for Local Responsiveness 377

Pressures for Cost Reductions 378 Pressures for Local Responsiveness 379

Management Focus Viacom International Media Networks 380

Choosing a Strategy 382 Global Standardization Strategy 383 Localization Strategy 384 Transnational Strategy 384 International Strategy 385

Management Focus Evolution of Strategy at Procter & Gamble 386

The Evolution of Strategy 387

Chapter Summary 388

Critical Thinking and Discussion Questions 388

Research Task 388

Closing Case IKEA’s Global Strategy 389

Endnotes 390

xxix

Opening Case Tata Motors and Exporting 461

Introduction 462

The Promise and Pitfalls of Exporting 463

Management Focus Ambient Technologies and the Panama Canal 465

Improving Export Performance 466 International Comparisons 466 Information Sources 466

Management Focus Exporting with Government Assistance 468

Service Providers 468 Export Strategy 469

Management Focus 3M’s Export Strategy 470

The globalEDGETM Exporting Tool 471

Export and Import Financing 472 Lack of Trust 473 Letter of Credit 474 Draft 475 Bill of Lading 475 A Typical International Trade Transaction 476

Export Assistance 477 Export-Import Bank 477 Export Credit Insurance 478

Countertrade 478 The Popularity of Countertrade 479 Types of Countertrade 479 Pros and Cons of Countertrade 480

Chapter Summary 481

Critical Thinking and Discussion Questions 482

Research Task 482

Closing Case Embraer and Brazilian Importing 483

Endnotes 484

C H A P T E R 1 7 Global Production and Supply Chain Management 486 Opening Case Alibaba and Global Supply Chains 487

Introduction 488

Strategy, Production, and Supply Chain Management 488

Where to Produce 491 Country Factors 491

C H A P T E R 1 5 Entry Strategy and Strategic Alliances 430 Opening Case Gazprom and Global Strategic Alliances 431

Introduction 432

Basic Entry Decisions 433 Which Foreign Markets? 433

Management Focus Tesco’s International Growth Strategy 434

Timing of Entry 434 Scale of Entry and Strategic Commitments 436 Market Entry Summary 437

Management Focus The Jollibee Phenomenon 438

Entry Modes 438 Exporting 439 Turnkey Projects 439 Licensing 440 Franchising 441 Joint Ventures 442 Wholly Owned Subsidiaries 444

Selecting an Entry Mode 444 Core Competencies and Entry Mode 445 Pressures for Cost Reductions and Entry Mode 446

Greenfield Venture or Acquisition? 446 Pros and Cons of Acquisitions 447 Pros and Cons of Greenfield Ventures 449 Which Choice? 450

Strategic Alliances 450 Advantages of Strategic Alliances 450 Disadvantages of Strategic Alliances 451 Making Alliances Work 451

Chapter Summary 454

Critical Thinking and Discussion Questions 455

Research Task 455

Closing Case Starbucks’ Foreign Entry Strategy 456

Endnotes 457

part six International Business Functions

C H A P T E R 1 6 Exporting, Importing, and Countertrade 460

xxx

Communication Strategy 528 Barriers to International Communication 528 Push versus Pull Strategies 529

Management Focus Unilever among India’s Poor 530

Global Advertising 531

Pricing Strategy 533 Price Discrimination 533 Strategic Pricing 534 Regulatory Influences on Prices 535

Configuring the Marketing Mix 536

International Market Research 538

Product Development 541 The Location of R&D 542 Integrating R&D, Marketing, and Production 543 Cross-Functional Teams 544 Building Global R&D Capabilities 544

Chapter Summary 546

Critical Thinking and Discussion Questions 547

Research Task 548

Closing Case Global Branding, Marvel Studios, and Walt Disney Company 548

Endnotes 549

C H A P T E R 1 9 Global Human Resource Management 552 Opening Case Building a Global Diverse Workforce at Sodexo 553

Introduction 554

Strategic Role of Global HRM: Managing a Global Workforce 555

Staffing Policy 556 Types of Staffing Policies 556 Expatriate Managers 560

Management Focus Expatriates at Royal Dutch Shell 562

Global Mindset 563

Training and Management Development 565 Training for Expatriate Managers 565 Repatriation of Expatriates 566

Management Focus Monsanto’s Repatriation Program 567

Management Development and Strategy 567

Management Focus IKEA Production in China 492

Technological Factors 493 Production Factors 496 The Hidden Costs of Foreign Locations 499

Management Focus H&M and Its Order Timing 500

Make-or-Buy Decisions 501

Global Supply Chain Functions 504 Global Logistics 504 Global Purchasing 506

Managing a Global Supply Chain 507 Role of Just-in-Time Inventory 508 Role of Information Technology 508 Coordination in Global Supply Chains 509 Interorganizational Relationships 510

Chapter Summary 511

Critical Thinking and Discussion Questions 512

Research Task 513

Closing Case Amazon’s Global Supply Chains 513

Endnotes 514

C H A P T E R 1 8 Global Marketing and R&D 516 Opening Case ACSI and Satisfying Global Customers 517

Introduction 518

Globalization of Markets and Brands 519

Market Segmentation 521

Management Focus Marketing to Afro-Brazilians 522

Product Attributes 523 Cultural Differences 523 Economic Development 523 Product and Technical Standards 524

Distribution Strategy 524 Differences between Countries 524 Choosing a Distribution Strategy 527

xxxi

Financial Management: Global Money Management 595 Minimizing Cash Balances 596 Reducing Transaction Costs 597 Managing the Tax Burden 598 Moving Money across Borders 599

Chapter Summary 603

Critical Thinking and Discussion Questions 604

Research Task 605

Closing Case Tesla, Inc.—Subsidizing Tesla Automobiles Globally 605

Endnotes 606

part seven Integrative Cases

Global Medical Tourism 609

Venezuela under Hugo Chávez and Beyond 611

Political and Economic Reform in Myanmar 612

Will China Continue to Be a Growth Marketplace? 613

Lead in Toys and Drinking Water 614

Creating the World’s Biggest Free Trade Zone 616

Sugar Subsidies Drive Candy Makers Abroad 617

Volkswagen in Russia 618

The NAFTA Tomato Wars 619

Subaru’s Sales Boom Thanks to the Weaker Yen 620

The IMF and Ukraine’s Economic Crisis 621

The Global Financial Crisis and Its Aftermath: Declining Cross-Border Capital Flows 622

Ford’s Global Platform Strategy 624

Philips’ Global Restructuring 625

General Motors and Chinese Joint Ventures 626

Exporting Desserts by a Hispanic Entrepreneur 627

Apple: The Best Supply Chains in the World? 628

Domino’s Global Marketing 630

Siemens and Global Competitiveness 632

Microsoft and Its Foreign Cash Holdings 633

Glossary 635

Organization Index 645

Name Index 650

Subject Index 652

Performance Appraisal 568 Performance Appraisal Problems 568 Guidelines for Performance Appraisal 569

Compensation 569 National Differences in Compensation 569

Management Focus McDonald’s Global Compensation Practices 570

Expatriate Pay 570

Building a Diverse Global Workforce 572

International Labor Relations 573 The Concerns of Organized Labor 574 The Strategy of Organized Labor 574 Approaches to Labor Relations 575

Chapter Summary 576

Critical Thinking and Discussion Questions 577

Research Task 577

Closing Case AstraZeneca 578

Endnotes 579

C H A P T E R 2 0 Accounting and Finance in the International Business 582 Opening Case Shoprite—Financial Success of a Food Retailer in Africa 583

Introduction 584

National Differences in Accounting Standards 585

International Accounting Standards 586

Management Focus Chinese Accounting 587

Accounting Aspects of Control Systems 588 Exchange Rate Changes and Control Systems 589 Transfer Pricing and Control Systems 590 Separation of Subsidiary and Manager Performance 591

Financial Management: The Investment Decision 591 Capital Budgeting 592 Project and Parent Cash Flows 592

Management Focus Black Sea Oil and Gas Ltd. 593

Adjusting for Political and Economic Risk 593 Risk and Capital Budgeting 594

Financial Management: The Financing Decision 595

xxxii

ACKNOWLEDGMENTS

Numerous people deserve to be thanked for their assistance in preparing this book. First, thank you to all the people at McGraw-Hill Education who have worked with us on this project:

Bruce Gin, Content Project Manager (Assessment)

Jennifer Pickel, Senior Buyer

Egzon Shaqiri, Designer

Carrie Burger, Content Licensing Specialist

Susan Gouijnstook, Managing Director

Michael Ablassmeir, Director

Anke Braun Weekes, Executive Portfolio Manager

Katie Benson Eddy, Product Developer

Harvey Yep, Content Project Manager (Core)

Anthony C. Koh, University of Toledo

Laura Kozloski Hart, Barry University

Katarina Lagerstrom, Uppsala University

Steve Lawton, Oregon State University

Ruby Lee, Florida State University

Joseph W. Leonard, Miami University

Vishakha Maskey, West Liberty University

David N. McArthur, Utah Valley University

Shelly McCallum, Saint Mary’s University of Minnesota

Emily A. Morad, Reading Area Community College

Tim Muth, Florida Institute of Technology

Sunder Narayanan, New York University

Eydis Olsen, Drexel University

Daria Panina, Texas A&M University

Hoon Park, University of Central Florida

Dr. Mahesh Raisinghani, Texas Women’s University

Brian Satterlee, Liberty University

Dwight Shook, Catawba Valley Community College

Brenda Sternquist, Michigan State University

Michael Volpe, University of Maryland

James Whelan, Manhattan College

Man Zhang, Bowling Green State University

Yeqing Bao, University of Alabama, Huntsville

Jacobus F. Boers, Georgia State University

Peter Buckley, Leeds University

Ken Chinen, California State University, Sacramento

Macgorine A. Cassell, Fairmont State University

David Closs, Michigan State University

Ping Deng, Maryville University of St. Louis

Betty J. Diener, Barry University

Abiola O. Fanimokun, Pennsylvania State University, Fayette

John Finley, Columbus State University

Pat Fox, Marion Technical College

David Frayer, Michigan State University

Connie Golden, Lakeland Community College

Martin Grossman, Bridgewater State University

Sanjay Gupta, Michigan State University

Michael Harris, East Carolina University

Kathy Hastings, Greenville Technical College

Chip Izard, Richland College

Jan Johanson, Uppsala University

Candida Johnson, Holyoke Community College

Sara B. Kimmel, Mississippi College

Tunga Kiyak, Michigan State University

Second, our thanks go to the reviewers who provided good feedback that helped shape this book through the last few editions:

A special thanks to David Closs and David Frayer for allowing us to borrow elements of the sections titled Strategic Roles for Production Facilities; Make-or-Buy Decisions; Global Supply Chain Functions; Coordination in Global Sup- ply Chains; and Interorganizational Relationships for Chapter 17 of this text from Tomas Hult, David Closs, and David Frayer, Global Supply Chain Management, New York: McGraw Hill (2014).

International Business Competing in the Global Marketplace

Globalization L E A R N I N G O B J E C T I V E S Af ter reading this chapter, you will be able to:

LO1 -1 Understand what is meant by the term globalization.

LO1-2 Recognize the main drivers of globalization.

LO1-3 Describe the changing nature of the global economy.

LO1-4 Explain the main arguments in the debate over the impact of globalization.

LO1-5 Understand how the process of globalization is creating opportunities and challenges for management practice. 

part one Introduc tion and Over view

1

©jvdwolf/123RF

Globalization of BMW, Rolls-Royce, and the MINI

delivers the promise of effortless power, luxury, quality, and perfect sanctuary. The entry-level Rolls Royce Ghost carries a price tag around $250,000, and the models es- calate from that price point. Rolls-Royce has, from its early days of daring experimentation, created a vision for luxury that is rooted in constantly chasing perfection. This perfec- tion drives the supreme quality, exquisite hand craftsman- ship, and attention to the finest detail to maintain its global position as the pinnacle luxury automobile manufacturer in the world. Like Rolls-Royce, the MINI also traces its roots to the United Kingdom. MINI is a car brand that is owned by BMW that specializes in small cars. The full platform of MINI cars is small, with the idea of maximizing the experience and concentrating on the essential. A long-standing attention to clever solutions with distinctive designs unlocks urban driving and caters to cus- tomers’ individual needs. The most iconic is the MINI Cooper, named after British racing legend John Cooper. The MINI Cooper product line has a uniquely sporting blend of classic British mini-car heritage and appeal with precise German en- gineering and construction. According to the MINI team, they are targeting affluent urban dwellers in their 20s and 30s who enjoy the fun, freedom, and individuality that the MINI cars offer—or perhaps we should just say they target newly graduated college students living in cities! To help with its targeting of affluent urban dwellers for the MINI or the even more affluent clientele for the BMW or Rolls-Royce, the BMW Group’s leaders have studied brands outside of the automobile industry to create the company’s future retail strategy. Enter the “product ge- nius.” BMW’s product genius is a noncommissioned car expert who will spend whatever time it takes or is needed to educate customers about their car choices, options, and any issue that the customer wants to get more information on. This shifts the “performance” from closing the sale of a car to making the customer satisfied, which lessens the typical pressure most customers feel when walking in to a car dealership (and likewise lessens the pressure of the salesperson to sell a car to get commission).

Sources: Jonathan M. Gitlin, “The 2017 BMW M760i Is a Hell of a Car, but Is It an M?” ARS Technica, February 8, 2017; “BMW at 100: Bavar- ian Rhapsody,” The Economist, March 12, 2016; Carmine Gallo, “BMW Radically Rethinks the Car Buying Experience,” Forbes, April 18, 2014; “How German Cars Beat British Motors—and Kept Going,” BBC News, August 2, 2013; Hannah Elliott, “The Best Luxury Sedan Is Still a BMW,” Bloomberg BusinessWeek, June 6, 2016.

O P E N I N G C A S E Bayerische Motoren Werke, which is German for Bavarian Motor Works, is better known globally for its acronym BMW (bmwgroup.com). BMW was created as a combination of three German manufacturing companies: Rapp Motoren- werke and Bayerische Flugzeugwerke in Bavaria and Fahrzeugfabrik Eisenach in Thuringia. Aircraft engine manufacturer Rapp Motorenwerke became Bayerische Motorenwerke in 1916, and the company added motorcy- cles to its product repertoire in 1923. BMW expanded to automobiles in 1929 when it purchased Fahrzeugfabrik Eisenach, which built Austin 7 cars under a license from Dixi. Fittingly, the first BMW car was called the BMW Dixi. Globally, BMW is known for streamlined design, incred- ible luxury, and top-notch performance. The company has more than 125,000 employees, delivers about 2.4 million vehicles annually, and has a revenue of €95 billion (about $103 billion in U.S. dollars). Its leadership spans products in automobiles, motorcycles, and aircraft engines. Innovation is one of the main success factors for the BMW Group, and innovation is infused into all of BMW’s product lines. The company claims that focusing on the future is an important part of BMW’s identity, day-to-day work, and the reason for its global success. In addition to the well-known BMW brand, BMW also owns the iconic Rolls-Royce brand and the distinctive MINI automobiles. BMW and “driving pleasure” are synonymous, even by people not owning a BMW! BMW creates driving pleasure from the perfect combination of dynamic, sporty perfor- mance; ground-breaking innovations; and breath-taking design. With a range of car models, a unique feature of BMW is its “M” designation models that takes the “driving pleasure” to another level. BMW “M” (for Motorsport) was initially created to facilitate BMW’s racing program but has since become a supplement to BMW’s vehicles portfolio with specially modified higher trim features. BMW M is part of an outstanding motorsports heritage and stands for high performance out of passion, with the latest addition to the line being the BMW M760. It’s the evolutionary link that connects BMW and Rolls-Royce, bridging the gap between the 7 Series and the entry-level Rolls-Royce Ghost. Rolls-Royce is considered the most exclusive luxury au- tomobile brand in the world. This reputation is rooted in the brand’s long history and rich tradition. Rolls-Royce

3

4 Part 1 Introduction and Overview

Introduction

Over the past five decades, a fundamental shift has been occurring in the world econ- omy. We have been moving away from a world in which national economies were rela- tively self-contained entities, isolated from each other by barriers to cross-border trade and investment; by distance, time zones, and language; and by national differences in government regulation, culture, and business systems. And, as we will see later on in this chapter as well as throughout the text, international trade across country borders has become the norm, with an almost exponential increase in trade during the last decade.

We are moving toward a world in which barriers to cross-border trade and investment are declining; perceived distance is shrinking due to advances in transportation and tele- communications technology; material culture is starting to look similar the world over; and national economies are merging into an interdependent, integrated global economic system. The process by which this transformation is occurring is commonly referred to as globalization. At the same time, recent political world events (e.g., increase of terrorism, United Kingdom voting to leave the European Union, and the elections around the globe of nationalistic politicians) create tension and uncertainty regarding the future of global trade activities.

Interestingly, as the opening case outlines, BMW’s focus on the future is an impor- tant part of the company’s identity, its day-to-day work, and the reason for its global success. The futuristic perspective of BMW manifests itself in innovation, striving for improvement, positive change, and improved performance at all times to make cus- tomers satisfied and feel that they receive value for the money they spend on BMW products. Innovation is one of the main success factors for the BMW Group, and in- novation is infused into all of BMW’s product lines. Likewise, proponents of increased trade argue that cross-cultural engagement and trade across country borders is the fu- ture and that returning back to a nationalistic perspective is the past. Meanwhile, the nationalistic argument rests in citizens wanting their country to be sovereign, self- sufficient as much as possible, and basically in charge of their own economy and country environment. As with any debate, both arguments and sides have merit. We will ex- plore all aspects of today’s global marketplace in this text through 20 integrated and topical chapters.

Focusing on the increase in globalization, the rise of Uber, which we discuss in the clos- ing case in this chapter, is an illustration of the trend toward the unique opportunities that globalization can present to a company. From a standing start in 2009, Uber has built a global ride-for-hire taxi service that by 2018 could be found in more than 600 cities in more than 70 countries. Uber customers visiting London, New York, Athens, Paris, or Hong Kong can now quickly find rides by using the Uber app on their smartphone. Uber has rapidly built a global brand. Its strategy was to be “born global” virtually from day one of the company’s founding. In doing so, it is similar to many other modern technology busi- nesses such as Facebook, Google, and Amazon that have also rapidly built a global presence.

At the same time, it has not always been smooth sailing for Uber. Local authorities have banned or placed tight restrictions on Uber’s service in many cities around the world. Uber’s brash American ways have not always endeared them to local regulators, drivers, and customers. It is perhaps true, as critics have noted, that Uber might have done even better internationally if it had adapted its entry strategy to take local differences in regula- tions, culture, and political realities into account. With the rise in nationalism in many countries, companies like Uber face potential barriers to entry and operations that were hard to foresee just a few years ago.

That said, globalization now does have an impact on almost everything we do. For example, the average American—let’s call the person Isabelle—might drive to work in a car that was designed in Germany and assembled in Mexico by Ford from components made in the United States and Japan, which were fabricated from Korean steel and

Globalization Chapter 1 5

Malaysian rubber. Isabelle may have filled the car with gasoline at a Shell service sta- tion owned by a British-Dutch multinational company. The gasoline could have been made from oil pumped out of a well off the coast of Africa by a French oil company that transported it to the United States in a ship owned by a Greek shipping line. While driving to work, Isabelle might talk to her stockbroker (using a hands-free, in-car speaker) on an Apple iPhone that was designed in California and assembled in China using chip sets produced in Japan and Europe, glass made by Corning in Kentucky, and memory chips from South Korea. She could tell the stockbroker to purchase shares in Lenovo, a multinational Chinese PC manufacturer whose operational headquarters is in North Carolina and whose shares are listed on the New York Stock Exchange.

This is the world in which we live. And, interestingly, in many cases we simply do not know or perhaps even care to know where the product was deigned and where it was made. This is a change in attitude and interest. Just a couple of decades ago, “Made in the USA” or “Made in Germany” had strong meaning and referred to something (e.g., U.S. often stood for quality and Germany often stood for sophisticated engineering). The country of origin for a product has now given way to “Made by BMW,” and the company is the quality assurance platform, not the country. In many cases, it goes even beyond the company to the personal relationships a customer has developed with a rep- resentative of a company—here we focus on what has become know as CRM (customer relationship management).

Whether it is still quality associated with the country of a product’s origin or the assur- ance given by a specific company regardless of where they manufacture the product, we live in a world where the volume of goods, services, and investments crossing national borders has expanded faster than world output for more than half a century. It is a world where more than $5 trillion in foreign exchange transactions are made every day, where $19 trillion of goods and $5 trillion of services are sold across national borders every year.1 It is a world in which international institutions such as the World Trade Organiza- tion and gatherings of leaders from the world’s most powerful economies continue to work for even lower barriers to cross-border trade and investment. It is a world where the symbols of material and popular culture are increasingly global: from Coca-Cola and Starbucks to Sony PlayStations, Facebook, Netflix video streaming service, IKEA stores, and Apple iPads and iPhones. It is also a world in which vigorous and vocal groups pro- test against globalization, which they blame for a list of ills from unemployment in devel- oped nations to environmental degradation and the Westernization or Americanization of local culture. These protesters now come from environmental groups, which have been around for some time, and more recently also from nationalistic groups focused on countries being more sovereign.

For businesses, the globalization process has produced many opportunities. Firms can expand their revenues by selling around the world and/or reduce their costs by producing in nations where key inputs, including labor, are cheap. The global expansion of enter- prises has been facilitated by generally favorable political and economic trends. Since the collapse of communism over a quarter of a century ago, the pendulum of public policy in many nations has swung toward the free market end of the economic spectrum. Regula- tory and administrative barriers to doing business in foreign nations have been reduced, while those nations have often transformed their economies, privatizing state-owned enter- prises, deregulating markets, increasing competition, and welcoming investment by foreign businesses. This has allowed businesses both large and small, from both advanced nations and developing nations, to expand internationally.

As globalization unfolds, it is transforming industries and creating anxiety among those who believed their jobs were protected from foreign competition. Historically, while many workers in manufacturing industries worried about the impact foreign competition might have on their jobs, workers in service industries felt more secure. Now, this too is chang- ing. Advances in technology, lower transportation costs, and the rise of skilled workers in

6 Part 1 Introduction and Overview

developing countries imply that many services no longer need to be performed where they are delivered. Today, many individual U.S. tax returns are compiled in India. Indian ac- countants, trained in U.S. tax rules, perform work for U.S. accounting firms.2 They access individual tax returns stored on computers in the United States, perform routine calcula- tions, and save their work so that it can be inspected by a U.S. accountant, who then bills clients. As the best-selling author Thomas Friedman has argued, the world is becoming flat.3 People living in developed nations no longer have the playing field tilted in their fa- vor. Increasingly, enterprising individuals based in India, China, or Brazil have the same opportunities to better themselves as those living in western Europe, the United States, or Canada.

In this text, we will take a close look at the issues introduced here and many more. We will explore how changes in regulations governing international trade and invest- ment, when coupled with changes in political systems and technology, have dramati- cally altered the competitive playing field confronting many businesses. We will discuss the resulting opportunities and threats and review the strategies that managers can pursue to exploit the opportunities and counter the threats. We will consider whether globalization benefits or harms national economies. We will look at what economic theory has to say about the outsourcing of manufacturing and service jobs to places such as India and China and look at the benefits and costs of outsourcing, not just to business firms and their employees but also to entire economies. First, though, we need to get a better overview of the nature and process of globalization, and that is the func- tion of this first chapter.

What Is Globalization?

As used in this text, globalization refers to the shift toward a more integrated and interde- pendent world economy. Globalization has several facets, including the globalization of markets and the globalization of production.

THE GLOBALIZATION OF MARKETS

The globalization of markets refers to the merging of historically distinct and separate national markets into one huge global marketplace. Falling barriers to cross-border trade and investment have made it easier to sell internationally. It has been argued for some time that the tastes and preferences of consumers in different nations are beginning to converge on some global norm, thereby helping create a global market.4 Consumer products such as Citigroup credit cards, Coca-Cola soft drinks, video games, McDonald’s hamburgers, Starbucks coffee, IKEA furniture, and Apple iPhones are frequently held up as prototypical examples of this trend. The firms that produce these products are more than just benefactors of this trend; they are also facilitators of it. By offering the same basic product worldwide, they help create a global market.

A company does not have to be the size of these multinational giants to facilitate, and benefit from, the globalization of markets. In the United States, for example, ac- cording to the International Trade Administration, more than 300,000 small and medium-size firms with fewer than 500 employees exported in 2017, accounting for 98 percent of the companies that exported that year. More generally, exports from small and medium-sized companies accounted for 33 percent of the value of U.S. exports of manufactured goods.5 Typical of these is B&S Aircraft Alloys, a New York company whose exports account for 40 percent of its $8 million annual revenues.6 The situation is similar in several other nations. For example, in Germany, a staggering 98 percent of small and midsize companies have exposure to international markets, via either exports or international production. Since 2009, China has been the world’s largest exporter, sending more than $2 trillion worth of products and services last year from its country to the rest of the world.

LO 1 -1 Understand what is meant by the term globalization.

Globalization Chapter 1 7

Despite the global prevalence of Citigroup credit cards, McDonald’s hamburgers, Starbucks coffee, and IKEA stores, for example, it is important not to push too far the view that national markets are giving way to the global market. As we shall see in later chapters, significant differences still exist among national markets along many rele- vant dimensions, including consumer tastes and preferences, distribution channels, culturally embedded value systems, business systems, and legal regulations. Uber, for example, the fast-growing ride-for-hire service, is finding that it needs to refine its en- try strategy in many foreign cities in order to take differences in the regulatory regime into account. These differences frequently require companies to customize marketing strategies, product features, and operating practices to best match conditions in a par- ticular country.

The most global of markets are not typically markets for consumer products—where national differences in tastes and preferences can still be important enough to act as a brake on globalization—but markets for industrial goods and materials that serve universal needs the world over. These include the markets for commodities such as aluminum, oil, and wheat; for industrial products such as microprocessors, DRAMs (computer memory chips), and commercial jet aircraft; for computer software; and for financial assets from U.S. Treasury bills to Eurobonds and futures on the Nikkei index or the euro. That being said, it is increasingly evident that many newer high-technology consumer products, such as Apple’s iPhone, are being successfully sold the same way the world over.

In many global markets, the same firms frequently confront each other as competitors in nation after nation. Coca-Cola’s rivalry with PepsiCo is a global one, as are the rivalries between Ford and Toyota; Boeing and Airbus; Caterpillar and Komatsu in earthmoving equipment; General Electric and Rolls-Royce in aero engines; Sony, Nintendo, and Micro- soft in video-game consoles; and Samsung and Apple in smartphones. If a firm moves into a nation not currently served by its rivals, many of those rivals are sure to follow to prevent their competitor from gaining an advantage.7 As firms follow each other around the world, they bring with them many of the assets that served them well in other national markets— their products, operating strategies, marketing strategies, and brand names—creating some homogeneity across markets. Thus, greater uniformity replaces diversity. In an increasing number of industries, it is no longer meaningful to talk about “the German market,” “the American market,” “the Brazilian market,” or “the Japanese market”; for many firms, there is only the global market.

I N T E R N A T I O N A L B U S I N E S S R E S O U R C E S

globalEDGETM has been the world’s go-to site online for global business knowledge since 2001. Google ranks the site number 1 in the world for “international business resources.” Created by a 30-member team in the International Business Center in the Eli Broad College of Business at Michigan State University under the supervision of Dr. Tomas Hult, Dr. Tunga Kiyak, and Dr. Sarah Singer, globalEDGE is a knowledge resource that connects interna- tional business professionals worldwide to a wealth of information, insights, and learning resources on global business activities. The site offers the latest and most comprehensive international business and trade con- tent for a wide range of topics. Whether conducting extensive market research, looking to improve your international knowledge, or simply browsing, you’re sure to find what you need to sharpen your competitive edge in today’s rapidly changing global marketplace. The easy, convenient, and free globalEDGE website’s tagline is “Your Source for Global Business Knowledge.” Take a look at the site at globaledge.msu.edu. We will use globalEDGE throughout this text for exercises, information, data, and to keep every facet of the text up- to-date on a daily basis!

8 Part 1 Introduction and Overview

THE GLOBALIZATION OF PRODUCTION

The globalization of production refers to the sourcing of goods and services from loca- tions around the globe to take advantage of national differences in the cost and quality of factors of production (such as labor, energy, land, and capital). By doing this, companies hope to lower their overall cost structure or improve the quality or functionality of their product offering, thereby allowing them to compete more effectively. For example, Boeing has made extensive use of outsourcing to foreign suppliers. Consider Boeing’s 777: eight Japanese suppliers make parts for the fuselage, doors, and wings; a supplier in Singapore makes the doors for the nose landing gear; three suppliers in Italy manufacture wing flaps; and so on.8 In total, some 30 percent of the 777, by value, is built by foreign companies. And, for its most recent jet airliner, the 787, Boeing has pushed this trend even further; some 65 percent of the total value of the aircraft is outsourced to foreign companies, 35 percent of which goes to three major Japanese companies.

Part of Boeing’s rationale for outsourcing so much production to foreign suppliers is that these suppliers are the best in the world at their particular activity. A global web of suppliers yields a better final product, which enhances the chances of Boeing winning a greater share of total orders for aircraft than its global rival, Airbus. Boeing also outsources some production to foreign countries to increase the chance that it will win significant orders from airlines based in that country. For a more detailed look at the globalization of production at Boeing, see the accompanying Management Focus.

Early outsourcing efforts were primarily confined to manufacturing activities, such as those undertaken by Boeing and Apple. Increasingly, however, companies are taking ad- vantage of modern communications technology, particularly the Internet, to outsource service activities to low-cost producers in other nations. The Internet has allowed hospitals to outsource some radiology work to India, where images from MRI scans and the like are read at night while U.S. physicians sleep; the results are ready for them in the morning. Many software companies, including Microsoft, now use Indian engineers to perform test functions on software designed in the United States. The time difference allows Indian engineers to run debugging tests on software written in the United States when U.S. engi- neers sleep, transmitting the corrected code back to the United States over secure Internet connections so it is ready for U.S. engineers to work on the following day. Dispersing value-creation activities in this way can compress the time and lower the costs required to develop new software programs. Other companies, from computer makers to banks, are outsourcing customer service functions, such as customer call centers, to developing na- tions where labor is cheaper. In another example from health care, workers in the Philippines transcribe American medical files (such as audio files from doctors seeking approval from insurance companies for performing a procedure). Some estimates suggest the outsourcing of many administrative procedures in health care, such as customer service and claims processing, could reduce health care costs in America by more than $100 billion.

The economist Robert Reich has argued that as a consequence of the trend exemplified by companies such as Boeing, Apple, and Microsoft, in many cases it is becoming irrele- vant to talk about American products, Japanese products, German products, or Korean products. Increasingly, according to Reich, the outsourcing of productive activities to dif- ferent suppliers results in the creation of products that are global in nature, that is, “global products.”9 But as with the globalization of markets, companies must be careful not to push the globalization of production too far. As we will see in later chapters, substantial impediments still make it difficult for firms to achieve the optimal dispersion of their pro- ductive activities to locations around the globe. These impediments include formal and informal barriers to trade between countries, barriers to foreign direct investment, trans- portation costs, issues associated with economic and political risk, and the sheer manage- rial challenge of coordinating a globally dispersed supply chain (an issue for Boeing with the 787 Dreamliner, as discussed in the Management Focus). For example, government regulations ultimately limit the ability of hospitals to outsource the process of interpreting MRI scans to developing nations where radiologists are cheaper.

TEST PRE P Use SmartBook to help retain what you have learned. Access your instructor’s Connect course to check out SmartBook or go to learnsmartadvantage.com for help.

Did You Know? Did you know why your iPhone was assembled in China? It’s not what you might think.

Visit your instructor’s Connect® course and click on your eBook or SmartBook® to view a short video explanation from the authors.

9

M A N A G E M E N T F O C U S

Executives at the Boeing Corporation, America’s largest exporter, say that building a large commercial jet aircraft like the 787 Dreamliner involves bringing together more than a million parts in flying formation. Forty-five years ago, when the early models of Boeing’s venerable 737 and 747 jets were rolling off the company’s Seattle-area production lines, foreign suppliers accounted for only 5 percent of those parts on average. Boeing was vertically integrated and manufactured many of the major components that went into the planes. The largest parts produced by out- side suppliers were the jet engines, where two of the three suppliers were American companies. The lone foreign en- gine manufacturer was the British company Rolls-Royce. Fast-forward to the modern era, and things look very different. In the case of its latest aircraft, the super-efficient 787 Dreamliner, 50 outside suppliers spread around the world account for 65 percent of the value of the aircraft. Italian firm Alenia Aeronautica makes the center fuselage and horizontal stabilizer. Kawasaki of Japan makes part of the forward fuselage and the fixed trailing edge of the wing. French firm Messier-Dowty makes the aircraft’s land- ing gear. German firm Diehl Luftahrt Elektronik supplies the main cabin lighting. Sweden’s Saab Aerostructures makes the access doors. Japanese company Jamco makes parts for the lavatories, flight deck interiors, and galleys. Mitsubi- shi Heavy Industries of Japan makes the wings. KAA of Korea makes the wing tips. And so on. Why the change? One reason is that 80 percent of Boeing’s customers are foreign airlines, and to sell into those nations, it often helps to be giving business to those nations. The trend started in 1974 when Mitsubishi of Japan was given contracts to produce inboard wing flaps for the 747. The Japanese reciprocated by placing big orders for Boeing jets. A second rationale was to disperse compo- nent part production to those suppliers who are the best in the world at their particular activity. Over the years, for ex- ample, Mitsubishi has acquired considerable expertise in the manufacture of wings, so it was logical for Boeing to use Mitsubishi to make the wings for the 787. Similarly, the 787 is the first commercial jet aircraft to be made almost entirely out of carbon fiber, so Boeing tapped Japan’s Toray Industries, a world-class expert in sturdy but light carbon- fiber composites, to supply materials for the fuselage. A third reason for the extensive outsourcing on the 787 was that Boeing wanted to unburden itself of some of the risks and costs associated with developing production facilities for the 787. By outsourcing, it pushed some of those risks

Boeing’s Global Production System and costs onto suppliers, who had to undertake major in- vestments in capacity to ramp up to produce for the 787. So what did Boeing retain for itself? Engineering de- sign, marketing and sales, and final assembly are done at its Everett plant north of Seattle, all activities where Boeing maintains it is the best in the world. Of major component parts, Boeing made only the tail fin and wing to body fair- ing (which attaches the wings to the fuselage of the plane). Everything else was outsourced. As the 787 moved through development, it became clear that Boeing had pushed the outsourcing paradigm too far. Coordinating a globally dispersed production system this ex- tensive turned out to be very challenging. Parts turned up late, some parts didn’t “snap together” the way Boeing had envisioned, and several suppliers ran into engineering prob- lems that slowed down the entire production process. As a consequence, the date for delivery of the first jet was pushed back more than four years, and Boeing had to take millions of dollars in penalties for late deliveries. The problems at one supplier, Vought Aircraft in North Carolina, were so severe that Boeing ultimately agreed to acquire the company and bring its production in-house. Vought was co-owned by Alenia of Italy and made parts of the main fuselage. There are now signs that Boeing is rethinking some of its global outsourcing policy. For its next jet, a new version of its popular wide-bodied 777 jet, the 777X, which will use the same carbon-fiber technology as the 787, Boeing will bring wing production back in-house. Mitsubishi and Kawasaki of Japan produce much of the wing structure for the 787 and for the original version of the 777. However, recently Japan’s airlines have been placing large orders with Airbus, breaking with their traditional allegiance to Boeing. This seems to have given Boeing an opening to bring wing production back in-house. Boeing executives also note that Boeing has lost much of its expertise in wing production over the last 20 years due to outsourcing, and bringing it back in-house for new carbon-fiber wings might enable Boeing to regain these important core skills and strengthen the company’s competitive position. Sources: M. Ehrenfreund, “The Economic Reality Behind the Boeing Plane Trump Showed Off,” The Washington Post, February 17, 2017; K. Epstein and J. Crown, “Globalization Bites Boeing,” Bloomberg Businessweek, March 12, 2008; H. Mallick, “Out of Control Outsourcing Ruined Boeing’s Beautiful Dreamliner,” The Star, February 25, 2013; P. Kavilanz, “Dreamliner: Where in the World Its Parts Come From,” CNN Money, January 18, 2013; S. Dubois, “Boeing’s Dreamliner Mess: Sim- ply Inevitable?” CNN Money, January 22, 2013; A. Scott and T. Kelly, “Boeing’s Loss of a $9.5 Billion Deal Could Bring Jobs Back to the U.S.,” Business Insider, October 14, 2013.

10 Part 1 Introduction and Overview

Nevertheless, the globalization of markets and production will probably continue. Mod- ern firms are important actors in this trend, their very actions fostering increased global- ization. These firms, however, are merely responding in an efficient manner to changing conditions in their operating environment—as well they should.

The Emergence of Global Institutions

As markets globalize and an increasing proportion of business activity transcends national borders, institutions are needed to help manage, regulate, and police the global market- place and to promote the establishment of multinational treaties to govern the global busi- ness system. Over the past half century, a number of important global institutions have been created to help perform these functions, including the General Agreement on Tariffs and Trade (GATT) and its successor, the World Trade Organization; the International Monetary Fund and its sister institution, the World Bank; and the United Nations. All these institutions were created by voluntary agreement between individual nation-states, and their functions are enshrined in international treaties.

The World Trade Organization (WTO)  (like the GATT before it) is primarily respon- sible for policing the world trading system and making sure nation-states adhere to the rules laid down in trade treaties signed by WTO member states. As of 2017, 164 nations that collectively accounted for 98 percent of world trade were WTO members, thereby giving the organization enormous scope and influence. The WTO is also responsible for facilitating the establishment of additional multinational agreements among WTO member states. Over its entire history, and that of the GATT before it, the WTO has promoted the lowering of barriers to cross-border trade and investment. In doing so, the WTO has been the instrument of its member states, which have sought to create a more open global busi- ness system unencumbered by barriers to trade and investment between countries. With- out an institution such as the WTO, the globalization of markets and production is unlikely to have proceeded as far as it has. However, as we shall see in this chapter and in Chapter 7 when we look closely at the WTO, critics charge that the organization is usurping the na- tional sovereignty of individual nation-states.

The International Monetary Fund (IMF) and the World Bank were both created in 1944 by 44 nations that met at Bretton Woods, New Hampshire. The IMF was established to maintain order in the international monetary system; the World Bank was set up to promote economic development. In the more than seven decades since their creation, both institutions have emerged as significant players in the global economy. The World Bank is the less controversial of the two sister institutions. It has focused on making low-interest loans to cash-strapped governments in poor nations that wish to undertake significant in- frastructure investments (such as building dams or roads).

The IMF is often seen as the lender of last resort to nation-states whose economies are in turmoil and whose currencies are losing value against those of other nations. During the past two decades, for example, the IMF has lent money to the governments of troubled states, including Argentina, Indonesia, Mexico, Russia, South Korea, Thailand, and Turkey. More recently, the IMF took a proactive role in helping countries cope with some of the effects of the 2008–2009 global financial crisis. IMF loans come with strings attached, however; in return for loans, the IMF requires nation-states to adopt specific economic policies aimed at returning their troubled economies to stability and growth. These re- quirements have sparked controversy. Some critics charge that the IMF’s policy recom- mendations are often inappropriate; others maintain that by telling national governments what economic policies they must adopt, the IMF, like the WTO, is usurping the sover- eignty of nation-states. We will look at the debate over the role of the IMF in Chapter 11.

The United Nations (UN) was established October 24, 1945, by 51 countries commit- ted to preserving peace through international cooperation and collective security. Today, nearly every nation in the world belongs to the United Nations; membership now totals 193 countries. When states become members of the United Nations, they agree to accept

Globalization Chapter 1 11

the obligations of the UN Charter, an international treaty that establishes basic principles of international relations. According to the charter, the UN has four purposes: to maintain international peace and security, to develop friendly relations among nations, to cooperate in solving international problems and in promoting respect for human rights, and to be a center for harmonizing the actions of nations. Although the UN is perhaps best known for its peacekeeping role, one of the organization’s central mandates is the promotion of higher standards of living, full employment, and conditions of economic and social prog- ress and development—all issues that are central to the creation of a vibrant global econ- omy. As much as 70 percent of the work of the UN system is devoted to accomplishing this mandate. To do so, the UN works closely with other international institutions such as the World Bank. Guiding the work is the belief that eradicating poverty and improving the well-being of people everywhere are necessary steps in creating conditions for lasting world peace.10

Another institution in the news is the Group of Twenty (G20). Established in 1999, the G20 comprises the finance ministers and central bank governors of the 19 largest economies in the world, plus representatives from the European Union and the European Central Bank. Collectively, the G20 represents 90 percent of global GDP and 80 percent of international global trade. Originally established to formulate a coordinated policy re- sponse to financial crises in developing nations, in 2008 and 2009 it became the forum through which major nations attempted to launch a coordinated policy response to the global financial crisis that started in America and then rapidly spread around the world, ushering in the first serious global economic recession since 1981.

Drivers of Globalization

Two macro factors underlie the trend toward greater globalization.11 The first is the decline in barriers to the free flow of goods, services, and capital that has occurred in recent de- cades. The second factor is technological change, particularly the dramatic developments in communication, information processing, and transportation technologies.

DECLINING TRADE AND INVESTMENT BARRIERS

During the 1920s and 1930s, many of the world’s nation-states erected formidable barriers to international trade and foreign direct investment. International trade occurs when a firm exports goods or services to consumers in another country. Foreign direct investment (FDI) occurs when a firm invests resources in business activities outside its home country. Many of the barriers to international trade took the form of high tariffs on imports of manu- factured goods. The typical aim of such tariffs was to protect domestic industries from for- eign competition. One consequence, however, was “beggar thy neighbor” retaliatory trade policies, with countries progressively raising trade barriers against each other. Ultimately, this depressed world demand and contributed to the Great Depression of the 1930s.

Having learned from this experience, the advanced industrial nations of the West com- mitted themselves after World War II to progressively reducing barriers to the free flow of goods, services, and capital among nations.12 This goal was enshrined in the General Agreement on Tariffs and Trade. Under the umbrella of GATT, eight rounds of negotia- tions among member states worked to lower barriers to the free flow of goods and ser- vices. The first round of negotiations went into effect in 1948. The most recent negotiations to be completed, known as the Uruguay Round, were finalized in December 1993. The Uruguay Round further reduced trade barriers; extended GATT to cover services as well as manufactured goods; provided enhanced protection for patents, trademarks, and copy- rights; and established the World Trade Organization to police the international trading system.13 Table 1.1 summarizes the impact of GATT agreements on average tariff rates for manufactured goods. As can be seen, average tariff rates have fallen significantly since 1950 and now stand at about 1.6 percent. Comparable tariff rates in 2017 for China and India were 3.4 and 7.1 percent, respectively.

LO 1 -2 Recognize the main drivers of globalization.

12 Part 1 Introduction and Overview

Knowledge Society and Trade Agreements Figure 1.1 reports on the value of world trade, world production, and active regional trade agreements in the world along with the world population from 1960 to 2020 (the last four years being forecast data). Trade and production are indexed to 100 in 1960. The figure illustrates some interesting changing globalization trends. For example, according to the World Trade Organization, the value of world trade in merchandised goods has grown consistently faster than the growth rate in the world economy since 1950, and the chart shows that this growth has been markedly higher since the turn of the century.

TA B L E 1 .1

Average Tariff Rates on Manufactured Products as Percentage of Value

Sources: The 1913–1990 data are from “Who Wants to Be a Giant?” The Economist: A Survey of the Multinationals, June 24, 1995, pp. 3–4. The 2017 data are from the World Development Indicators, World Bank (between 2014 and 2017, each country in the table raised their rates by .1 percent)

1913 1950 1990 2017 France 21% 18% 5.9% 1.6%

Germany 20 26 5.9 1.6

Italy 18 25 5.9 1.6

Japan 30 — 5.3 1.4

Netherlands 5 11 5.9 1.6

Sweden 20 9 4.4 1.6

United Kingdom — 23 5.9 1.6

United States 44 14 4.8 1.6

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Globalization Chapter 1 13

As a consequence, by 2020 the value of world trade is expected to be 167 times larger than it was in 1960, whereas the world economy will be 65 times larger. This trend has continued into the modern era. Between 2000 and 2020, the value of world trade increased 3.3 times whereas the world economy has increased 2.6 times. Perhaps the most obvious difference is between world trade and world production. Trade across country borders is 2.6 times higher than world production, a figure that has gone up drastically since 2000. The forecast is also that world trade will continue to increase more rapidly than world production for the foreseeable future.

The difference in the growth rates of world production and world trade is why studying international business is so important. While we produce more goods and services today compared with before, a far greater proportion of that production is being traded across national borders than at any time in modern history. Moreover, the knowledge society that we live in has resulted in consumers knowing more than ever about goods and services be- ing produced worldwide. From a customer perspective, this is driving demand for interna- tionally traded goods. Thus, the larger the difference between the growth rates of world trade and world production, the greater the extent of globalization and the more important it becomes to understand international business.

Additionally, despite the recent wave of nationalism around the world (e.g., Brexit, 2016 U.S. presidential election), many countries have been progressively removing restrictions to foreign direct investment over the past 20 years. According to the United Nations, some 80 percent of the 1,440 changes made worldwide since 2000 in the laws governing foreign direct investment created a more favorable environment for FDI. Basically, the pressure from customers to make available any goods and services anywhere for their needs and wants has been facilitated by country governments removing restrictions on imports to their countries.

Such customer pressures and restrictions removal by countries have been driving both the globalization of markets and the globalization of production. The lowering of barriers to international trade enables firms to view the world, rather than a single country, as their market. The lowering of trade and investment barriers also allows firms to base production at the optimal location for that activity. Thus, a firm might design a product in one coun- try, produce component parts in two other countries, assemble the product in yet another country, and then export the finished product around the world.

Another important facilitator of trade across country borders is the increased number of trade agreements that have been implemented in the world. Figure 1.1 reports on re- gional trade agreements in force today (more than two countries involved), with another roughly 300 bilateral trade agreements between two countries also active worldwide. There is no doubt that trade at least between the countries in a trade agreement has been a strong reason for the increase overall in world trade. Figure 1.1 illustrates the almost 1:1 match of the trade agreement and world trade curves on the chart. That is, as regional trade agreements in force increase year-by-year, so does world trade across country borders at the same pace.

Two additional implications can be gleaned from the data in Figure 1.1 that could be- come important for the global marketplace. These are illustrated in separate charts in Figure 1.2. The first implication relates to sustainability—a topic we will cover much more in Chapter 5. In 2000, the United Nations established the Millennium Development Goals to reduce the number of people who live in extreme poverty by 2015. Subsequently, in September 2015, the United Nations and its 193 member countries ratified the Sustainable Development Goals that set targets to end poverty, protect the planet, and ensure prosper- ity for all countries by 2030 as part of a new sustainability agenda.14 The urgency of deliv- ering on UN’s Sustainable Development Goals can be traced to the difference between the world production and population data. As world production approaches the total popula- tion curve, we can infer that resource availability for all of our needs and wants in the world’s 260 countries and territories will potentially be drastically constrained.

The chart in Figure 1.1 also indicates that our needs worldwide are still rather “spiky” and not flat as Tom Friedman projected in 2004. Trading across country borders is significantly

14 Part 1 Introduction and Overview

more pronounced today than ever before, growing at a rate above the population growth of the world. These two curves are likely to not intersect any time soon, and coupled with the large difference between world trade and world production, especially in the last 20 years, we will see a world consumer market where localized needs and wants are still very much unique in a large set of industries and product categories. Overall, though, the fact that the volume of world trade has been growing faster than world GDP implies several things.

The fact that the volume of world trade has been growing faster than world GDP im- plies several things. First, more firms are doing what Boeing does with the 777 and 787: dispersing parts of their production process to different locations around the globe to drive down production costs and increase product quality. Second, the economies of the world’s nation-states are becoming ever more intertwined. As trade expands, nations are becoming increasingly dependent on each other for important goods and services. Third, the world has become significantly wealthier in the last two decades. The implication is that rising trade is the engine that has helped pull the global economy along.

Evidence also suggests that foreign direct investment is playing an increasing role in the global economy as firms increase their cross-border investments. The average yearly out- flow of FDI increased from $14 billion in 1970 to $1.45 trillion in the most recent year, 2016, audited by the United Nations Conference on Trade and Development (UNCTAD).15 As a result of the strong FDI flow, by 2016 the global stock of FDI was about $27 trillion. More than 80,000 parent companies had more than 800,000 affiliates in foreign markets that collectively employed more than 75 million people abroad and generated value accounting for about 11 percent of global GDP. The foreign affiliates of multinationals had

F I G U R E 1 . 2

Comparisons of world trade and world population; world trade and number of regional trade agreements; world population and world production; and world population and world trade (index 1960 = 100). Sources: World Bank, 2017; World Trade Organization, 2017; United Nations, 2017.

Five business executives from various parts of the world ready to board a plane. The efficiency of commercial airline travel has shrunk the world to a more manageable global marketplace. ©Glow Images

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0 1,000

2,000 3,000 4,000 5,000 6,000 7,000 8,000 9,000

10,000 11,000

12,000 13,000 14,000 15,000 16,000 17,000 18,000

0

50

100

150

200

250

300

350

World trade Regional trade agreements

0

1,000

2,000

3,000

4,000

5,000

6,000

7,000

8,000

9,000

World populationWorld production

0 1,000

2,000 3,000 4,000 5,000 6,000 7,000 8,000 9,000

10,000 11,000

12,000 13,000 14,000 15,000 16,000 17,000 18,000

World trade World population

Globalization Chapter 1 15

$36 trillion in global sales, higher than the value of global exports of goods and services, which stood at close to $23.4 trillion.16

The globalization of markets and production and the resulting growth of world trade, foreign direct investment, and imports all imply that firms are finding their home markets under attack from foreign competitors. This is true in China, where U.S. companies such as Apple, General Motors, and Starbucks are expanding their presence. It is true in the United States, where Japanese automobile firms have taken market share away from General Motors and Ford over the past three decades, and it is true in Europe, where the once- dominant Dutch company Philips has seen its market share in the consumer electronics industry taken by Japan’s Panasonic and Sony and Korea’s Samsung and LG. The growing integration of the world economy into a single, huge marketplace is increasing the inten- sity of competition in a range of manufacturing and service industries.

However, declining barriers to cross-border trade and investment cannot be taken for granted. As we shall see in subsequent chapters, demands for “protection” from foreign competitors are still often heard in countries around the world, including the United States. Although a return to the restrictive trade policies of the 1920s and 1930s is un- likely, it is not clear whether the political majority in the industrialized world favors further reductions in trade barriers. Indeed, the global financial crisis of 2008–2009 and the as- sociated drop in global output that occurred led to more calls for trade barriers to protect jobs at home. If trade barriers decline no further, this may slow the rate of globalization of both markets and production.

ROLE OF TECHNOLOGICAL CHANGE

The lowering of trade barriers made globalization of markets and production a theoretical possibility. Technological change has made it a tangible reality. Every year that goes by comes with unique and oftentimes major advances in communication, information processing, and transportation technology, including the explosive emergence of the “Internet of Things.”

Communications Perhaps the single most important innovation since World War II has been the develop- ment of the microprocessor, which enabled the explosive growth of high-power, low-cost computing, vastly increasing the amount of information that can be processed by individu- als and firms. The microprocessor also underlies many recent advances in telecommunica- tions technology. Over the past 30 years, global communications have been revolutionized by developments in satellite, optical fiber, wireless technologies, and of course the Internet. These technologies rely on the microprocessor to encode, transmit, and decode the vast amount of information that flows along these electronic highways. The cost of micropro- cessors continues to fall, while their power increases (a phenomenon known as Moore’s law, which predicts that the power of microprocessor technology doubles and its cost of production falls in half every 18 months).17

Internet of Things The explosive growth of the Internet since 1994, when the first web browser was intro- duced, is the latest expression of the development of the so-called Internet of Things. Trac- ing back about three decades to 1990, fewer than 1 million users were connected to the Internet. By 1995, the figure had risen to 50 million. By 2017, the Internet had 3.8 billion users, or 51 percent of the global population.18 As such, 2017 marked the first year that more than half of the world’s population were Internet users. It is no surprise that the Internet has developed into the information backbone of the global economy.

In North America alone, e-commerce retail sales will surpass $520 billion in 2020 (up from almost nothing in 1998), while global e-commerce sales surpassed $2 trillion for the first time in 2017.19 Viewed globally, the Internet has emerged as an equalizer. It rolls back some of the constraints of location, scale, and time zones.20 The Internet makes it much easier for buyers and sellers to find each other, wherever they may be located and whatever

16 Part 1 Introduction and Overview

their size. It allows businesses, both small and large, to expand their global presence at a lower cost than ever before. Just as important, it enables enterprises to coordinate and control a globally dispersed production system in a way that was not possible 25 years ago.

Transportation Technology In addition to developments in communications technology, several major innovations in transportation technology have occurred since the 1950s. In economic terms, the most important are probably the development of commercial jet aircraft and superfreighters and the introduction of containerization, which simplifies transshipment from one mode of transport to another. The advent of commercial jet travel, by reducing the time needed to get from one location to another, has effectively shrunk the globe. In terms of travel time, New York is now “closer” to Tokyo than it was to Philadelphia in the colonial days.

Containerization has revolutionized the transportation business, significantly lowering the costs of shipping goods over long distances. Because the international shipping indus- try is responsible for carrying about 90 percent of the volume of world trade in goods, this has been an extremely important development.21 Before the advent of containerization, moving goods from one mode of transport to another was very labor intensive, lengthy, and costly. It could take days and several hundred longshore workers to unload a ship and reload goods onto trucks and trains. With the advent of widespread containerization in the 1970s and 1980s, the whole process can now be executed by a handful of longshore work- ers in a couple of days. As a result of the efficiency gains associated with containerization, transportation costs have plummeted, making it much more economical to ship goods around the globe, thereby helping drive the globalization of markets and production. Between 1920 and 1990, the average ocean freight and port charges per ton of U.S. export and import cargo fell from $95 to $29 (in 1990 dollars).22 Today, the typical cost of trans- porting a 20-foot container from Asia to Europe carrying more than 20 tons of cargo is about the same as the economy airfare for a single passenger on the same journey.

Implications for the Globalization of Production As transportation costs associated with the globalization of production have declined, disper- sal of production to geographically separate locations has become more economical. As a result of the technological innovations discussed earlier, the real costs of information pro- cessing and communication have fallen dramatically in the past two decades. These develop- ments make it possible for a firm to create and then manage a globally dispersed production system, further facilitating the globalization of production. A worldwide communications network has become essential for many international businesses. For example, Dell uses the Internet to coordinate and control a globally dispersed production system to such an extent that it holds only three days’ worth of inventory at its assembly locations. Dell’s Internet- based system records orders for computer equipment as they are submitted by customers via the company’s website and then immediately transmits the resulting orders for components to various suppliers around the world, which have a real-time look at Dell’s order flow and can adjust their production schedules accordingly. Given the low cost of airfreight, Dell can use air transportation to speed up the delivery of critical components to meet unanticipated demand shifts without delaying the shipment of final product to consumers. Dell has also used modern communications technology to outsource its customer service operations to India. When U.S. customers call Dell with a service inquiry, they are routed to Bangalore in India, where English-speaking service personnel handle the call.

Implications for the Globalization of Markets In addition to the globalization of production, technological innovations have facilitated the globalization of markets. Low-cost global communications networks, including those built on top of the Internet, are helping create electronic global marketplaces. As noted earlier, low-cost transportation has made it more economical to ship products around the world, thereby helping create global markets. In addition, low-cost jet travel has resulted in

Globalization Chapter 1 17

the mass movement of people between countries. This has reduced the cultural distance between countries and is bringing about some convergence of consumer tastes and prefer- ences. At the same time, global communications networks and global media are creating a worldwide culture. U.S. television networks such as CNN and HBO are now received in many countries, Hollywood films are shown the world over, while non-U.S. news networks such as the BBC and Al Jazeera also have a global footprint. In any society, the media are primary conveyors of culture; as global media develop, we must expect the evolution of something akin to a global culture. A logical result of this evolution is the emergence of global markets for consumer products. Clear signs of this are apparent. It is now as easy to find a McDonald’s restaurant in Tokyo as it is in New York, to buy an iPad in Rio as it is in Berlin, and to buy Gap jeans in Paris as it is in San Francisco.

Despite these trends, we must be careful not to overemphasize their importance. While modern communications and transportation technologies are ushering in the “global vil- lage,” significant national differences remain in culture, consumer preferences, and busi- ness practices. A firm that ignores differences among countries does so at its peril. We shall stress this point repeatedly throughout this text and elaborate on it in later chapters.

The Changing Demographics of the Global Economy

Hand in hand with the trend toward globalization has been a fairly dramatic change in the demographics of the global economy over the past 30 years. As late as the 1960s, four styl- ized facts described the demographics of the global economy. The first was U.S. domi- nance in the world economy and world trade picture. The second was U.S. dominance in world foreign direct investment. Related to this, the third fact was the dominance of large, multinational U.S. firms on the international business scene. The fourth was that roughly half the globe—the centrally planned economies of the communist world—was off-limits to Western international businesses. All four of these facts have changed rapidly.

THE CHANGING WORLD OUTPUT AND WORLD TRADE PICTURE

In the early 1960s, the United States was still by far the world’s dominant industrial power. In 1960, the United States accounted for 38.3 percent of world output, measured by gross do- mestic product (GDP). By 2018, the United States accounted for 15.8 percent of world out- put, with China now at 17.1 percent of world output and the global leader in this category (see Table 1.2). The United States was not the only developed nation to see its relative stand- ing slip. The same occurred to Germany, France, Italy, the United Kingdom, and Canada—as just a few examples. These were all nations that were among the first to industrialize globally.

Of course, the change in the U.S. position was not an absolute decline because the U.S. economy grew significantly between 1960 and 2018 (the economies of Germany, France, Italy, the United Kingdom, and Canada also grew during this time). Rather, it was a relative decline, reflecting the faster economic growth of several other economies, particularly China as well as several other nations in Asia. For example, as can be seen from Table 1.2, from 1960 to today, China’s share of world output increased from a trivial amount to 17.1 percent, making it the world’s largest economy in terms of its share in world output (the U.S. is still the largest economy overall). Other countries that markedly increased their share of world output included Japan, Thailand, Malaysia, Taiwan, Brazil, and South Korea.

By the end of the 1980s, the U.S. position as the world’s leading trading nation was be- ing challenged. Over the past 30 years, U.S. dominance in export markets has waned as Japan, Germany, and a number of newly industrialized countries such as South Korea and China have taken a larger share of world exports. During the 1960s, the United States routinely accounted for 20 percent of world exports of manufactured goods. But as Table 1.2 shows, the U.S. share of world exports of goods and services had slipped to 8.2 percent by 2017, significantly behind that of China.

As emerging economies such as Brazil, Russia, India, and China—coined the BRIC countries—continue to grow, a further relative decline in the share of world output and

TEST PRE P Use SmartBook to help retain what you have learned. Access your instructor’s Connect course to check out SmartBook or go to learnsmartadvantage.com for help.

LO 1 -3 Describe the changing nature of the global economy.

18 Part 1 Introduction and Overview

world exports accounted for by the United States and other long-established developed nations seems likely. By itself, this is not bad. The relative decline of the United States re- flects the growing economic development and industrialization of the world economy, as opposed to any absolute decline in the health of the U.S. economy.

Most forecasts now predict a continued rise in the share of world output accounted for by developing nations such as China, India, Russia, Indonesia, Thailand, South Korea, Mexico, and Brazil and a commensurate decline in the share enjoyed by rich industrialized countries such as the United Kingdom, Germany, Japan, and the United States. The United Kingdom, in particular, presents an interesting case study with Britain’s exit from the European Union (Brexit) looming. Perhaps more importantly, if current trends continue, the Chinese econ- omy could ultimately be larger than that of the United States on a purchasing power parity basis as well, while the economy of India will become the third largest by 2030.23

Overall, the World Bank has estimated that today’s developing nations may account for more than 60 percent of world economic activity by 2025, while today’s rich nations, which currently account for more than 55 percent of world economic activity, may account for only about 38 percent. Forecasts are not always correct, but these suggest that a shift in the economic geography of the world is now under way, although the magnitude of that shift is not totally evident. For international businesses, the implications of this changing economic geography are clear: Many of tomorrow’s economic opportunities may be found in the de- veloping nations of the world, and many of tomorrow’s most capable competitors will prob- ably also emerge from these regions. A case in point has been the dramatic expansion of India’s software sector, which is profiled in the accompanying Country Focus.

THE CHANGING FOREIGN DIRECT INVESTMENT PICTURE

Reflecting the dominance of the United States in the global economy, U.S. firms ac- counted for 66.3 percent of worldwide foreign direct investment flows in the 1960s. British firms were second, accounting for 10.5 percent, while Japanese firms were a distant eighth, with only 2 percent. The dominance of U.S. firms was so great that books were written about the economic threat posed to Europe by U.S. corporations.24 Several European gov- ernments, most notably France, talked of limiting inward investment by U.S. firms.

However, as the barriers to the free flow of goods, services, and capital fell, and as other countries increased their shares of world output, non-U.S. firms increasingly began to in- vest across national borders. The motivation for much of this foreign direct investment by non-U.S. firms was the desire to disperse production activities to optimal locations and to build a direct presence in major foreign markets. Thus, beginning in the 1970s, European and Japanese firms began to shift labor-intensive manufacturing operations from their home markets to developing nations where labor costs were lower. In addition, many

Share of Share of Share of World Output World Output World Exports Country in 1960 (%) Today (%) Today (%) United States 38.3%  15.8%    8.2%

Germany 8.7  3.4   7.1

France 4.6  2.3   2.8

Italy  3.0  1.9   2.4

United Kingdom  5.3  2.4   2.3

Canada  3.0  1.4   2.2

Japan  3.3  4.3   3.6

China   NA 17.1  11.1

TA B L E 1 . 2

Changing Demographics of World Output and World Exports

Sources: Output data from World Bank database, 2017. Trade data from WTO Statistical Database, 2017.

C O U N T R Y F O C U S

Some 30 years ago, a number of small software enterprises were established in Bangalore, India. Typical of these enter- prises was Infosys Technologies, which was started by seven Indian entrepreneurs with about $1,000 among them. Infosys now has annual revenues of $10.2 billion and some 200,000 employees, but it is just one of more than 100 software com- panies clustered around Bangalore, which has become the epicenter of India’s fast-growing information technology sec- tor. From a standing start in the mid-1980s, this sector is now generating export sales of more than $100 billion. The growth of the Indian software sector has been based on four factors. First, the country has an abundant supply of engineering talent. Every year, Indian universi- ties graduate some 400,000 engineers. Second, labor costs in the Indian software sector have historically been low. As recently as 2008, the cost to hire an Indian gradu- ate was roughly 12 percent of the cost of hiring an Ameri- can graduate (however, this gap is narrowing fast with pay in the sector now only 30–40 percent less than in the United States). Third, many Indians are fluent in English, which makes coordination between Western firms and India easier. Fourth, due to time differences, Indians can work while Americans sleep, creating unique time effi- ciencies and an around-the-clock work environment. Initially, Indian software enterprises focused on the low end of the software industry, supplying basic software

development and testing services to Western firms. But as the industry has grown in size and sophistication, Indian firms have moved up the market. Today, the leading Indian companies compete directly with the likes of IBM and EDS for large software development projects, busi- ness process outsourcing contracts, and information technology consulting services. Over the past 15 years, these markets have boomed, with Indian enterprises cap- turing a large slice of the pie. One response of Western firms to this emerging competitive threat has been to in- vest in India to garner the same kind of economic advan- tages that Indian firms enjoy. IBM, for example, has invested $2 billion in its Indian operations and now has 150,000 employees located there, more than in any other country. Microsoft, too, has made major investments in India, including a research and development (R&D) cen- ter in Hyderabad that employs 4,000 people and was lo- cated there specifically to tap into talented Indian engineers who did not want to move to the United States.

Sources:  “Ameerpet, India’s Unofficial IT Training Hub,” The Econo- mist, March 30, 2017; “America’s Pain, India’s Gain: Outsourcing,” The Economist, January 11, 2003, p. 59; “The World Is Our Oyster,” The Economist, October 7, 2006, pp. 9–10; “IBM and Globalization: Hungry Tiger, Dancing Elephant,” The Economist, April 7, 2007, pp. 67–69; P. Mishra, “New Billing Model May Hit India’s Software Exports,” Live Mint, February 14, 2013; “India’s Outsourcing Business: On the Turn,” The Economist, January 19, 2013.

India’s Software Sector

19

Japanese firms invested in North America and Europe—often as a hedge against unfavor- able currency movements and the possible imposition of trade barriers. For example, Toyota, the Japanese automobile company, rapidly increased its investment in automobile production facilities in the United States and Europe during the late 1980s and 1990s. Toyota executives believed that an increasingly strong Japanese yen would price Japanese automobile exports out of foreign markets; therefore, production in the most important foreign markets, as opposed to exports from Japan, made sense. Toyota also undertook these investments to head off growing political pressures in the United States and Europe to restrict Japanese automobile exports into those markets.

One consequence of these developments is illustrated in Figure 1.3, which shows how the stock of foreign direct investment by the United States, China, Japan, United Kingdom, Euro- pean Union countries, Developed Economies, and the World changed between 1995 and to- day. (The stock of foreign direct investment (FDI) refers to the total cumulative value of foreign investments as a percentage of the country’s GDP.) As expected, in all cases in Figure 1.2, we invest more today outside of our own country than we did in 1995. For example, U.S. firms invested 17.8 percent of the nation’s GDP outside the country in 1995 and now that figure is 34.4 percent. Collectively, the 196 countries in the world today invest 34.6 percent of their GDP outside its country borders, an increase from 12.8 percent in 1995. Bottom line, the world is becoming more globalized in investment mentality and opportunities are no lon- ger as restricted to the home country of a firm as they used to be even as recent as in 1995.

20 Part 1 Introduction and Overview

Figure 1.4 illustrates two other important trends—the sustained growth in cross-border flows of foreign direct investment that has occurred since 1990 and the increasing impor- tance of developing nations as the destination of foreign direct investment. Throughout the 1990s, the amount of investment directed at both developed and developing nations in- creased dramatically, a trend that reflects the increasing internationalization of business corporations. A surge in foreign direct investment from 1998 to 2000 was followed by a slump from 2001 to 2004, associated with a slowdown in global economic activity after the collapse of the financial bubble of the late 1990s and 2000. The growth of foreign direct investment resumed at “normal” levels for that time in 2005 and continued upwards through 2007, when it hit record levels, only to slow again in 2008 and 2009 as the global financial crisis took hold. However, throughout this time period, the growth of foreign direct invest- ment into developing nations remained robust. Among developing nations, the largest re- cipient has been China, which in 2016 received a record $249.8 billion in inflows. As we shall see later in this text, the sustained flow of foreign investment into developing nations is an important stimulus for economic growth in those countries, which bodes well for the future of countries such as China, Mexico, and Brazil—all leading beneficiaries of this trend.

THE CHANGING NATURE OF THE MULTINATIONAL ENTERPRISE

A multinational enterprise (MNE) is any business that has productive activities in two or more countries. In the last half a century, two notable trends in the demographics of the multinational enterprise have been (1) the rise of non-U.S. multinationals and (2) the growth of mini-multinationals.

F I G U R E 1 . 3

Share of FDI stock outward as a percentage of GDP. Sources: OECD data 2017, FDI stocks.

Today1995

45 50

40 35 30 25 20 15 10 5 0

United States

China Japan United Kingdom

European Union

Developed Economies

World

F I G U R E 1 . 4

FDI inflows (in millions of dollars). Source: United Nations Conference on Trade and Development, World Investment Report 2017. (Data for 2018–2020 are forecast.)

2,500,000

2,000,000

1,500,000

1,000,000

500,000

0

19 9

0

2 0

2 0

Developed Countries Developing Countries

19 9

2

19 9

4

19 9

6

19 9

8

2 0

0 0

2 0

0 2

2 0

0 4

2 0

0 6

2 0

0 8

2 0

10

2 0

12

2 0

16

2 0

14

2 0

18

Globalization Chapter 1 21

Non-U.S. Multinationals In the 1960s, global business activity was dominated by large U.S. multinational corpora- tions. With U.S. firms accounting for about two-thirds of foreign direct investment during the 1960s, one would expect most multinationals to be U.S. enterprises. According to the data summarized in Figure 1.5, in 2003 when Forbes started compiling its ranking of the top 2000 multinational corporations, 38.8 percent of the world’s 2000 largest multinationals were U.S. firms (776 of the 2000 on the list). The second-largest source country was Japan with 16.6 percent of the largest multinationals. The United Kingdom accounted for 6.6 percent of the world’s largest multinationals at the time. The large number of U.S. multinationals has long reflected U.S. economic dominance in the half a century after World War II, while the large number of British multinationals reflected that country’s industrial dominance in the early decades of the twentieth century, which has carried on to some degree until today.

By 2017, things had shifted. Some 27 percent, or 540 firms, of the top 2000 global firms are now U.S. multinationals, a drop of 236 firms among the top 2000 global firms in only about a decade and a half. Japan and the United Kingdom also saw drops in their firms’ inclusion among the top 2000 firms in the world.

These shifts in powerful multinational corporations and their home bases can be ex- pected to continue. Specifically, we expect that firms from developing nations will emerge as even important competitors in global markets, further shifting the axis of the world economy away from North America and western Europe and challenging the long domi- nance of companies from the so-called developed world. One such rising competitor, the Dalian Wanda Group, is profiled in the Management Focus.

The Rise of Mini-Multinationals Another trend in international business has been the growth of small and medium-sized multinationals (mini-multinationals).25 When people think of international businesses, they tend to think of firms such as ExxonMobil, General Motors, Ford, Panasonic, Procter & Gamble, Sony, and Unilever—large, complex multinational corporations with operations that span the globe. Although most international trade and investment are still conducted by large firms, many medium-size and small businesses are becoming increasingly involved in international trade and investment. The rise of the Internet is lowering the barriers that small firms face in building international sales.

Consider Lubricating Systems Inc. of Kent, Washington. Lubricating Systems, which manufactures lubricating fluids for machine tools, employs 25 people, and generates sales of $6.5 million. It’s hardly a large, complex multinational, yet more than $2 million of the company’s sales are generated by exports to a score of countries, including Japan, Israel, and the United Arab Emirates. Lubricating Systems has also set up a joint venture with a German company to serve the European market.26

F I G U R E 1 . 5

National share of largest multinational corporations. Source: Forbes Global 2000 in 2003 and 2017.

100

80

60

40

20

0 United States

Japan United Kingdom

Other

2003 Today

M A N A G E M E N T F O C U S

22

In 2015, Wanda followed its AMC acquisition with the purchase of Hoyts Group, an Australian cinema operator with more than 150 cinemas. By combining AMC’s movie theaters with Hoyts and its already extensive movie prop- erties in China, Dalian Wanda has become the largest cin- ema operator in the world with more than 500 cinemas. This puts Wanda in a strong position when negotiating dis- tribution terms with movie studios. Wanda is also expanding its international real estate op- erations. In 2014, it announced that it won a bid for a prime plot of land in Beverly Hills, Los Angeles. Wanda plans to invest $1.2 billion to construct a mixed-use development. The company also has a sizable project in Chicago, where it is investing $900 million to build the third-tallest building in the city. In addition, Wanda has real estate projects in Spain, Australia, and London. Today, the Wanda Group is already among the top 400 companies in the world with some 130,000 employees, $90 billion in assets, and about $45 billion in revenue.

Sources: Keith Weir, “China’s Dalian Wanda to Acquire Australia’s Hoyts for $365.7 Million,” Reuters, June 24, 2015; Zachary Mider, “Chi- na’s Wanda to Buy AMC Cinema Chain for $2.6 Billion,” Bloomberg Businessweek, May 21, 2012; Wanda Group Corporate,  http://www. wanda-group.com/

Wanda Group The Dalian Wanda Group is perhaps the world’s largest real estate company, although as yet it is little known out- side of China. Established in 1988, Dalian Wanda Group is the largest owner of five-star hotels in the world. The com- pany’s real estate portfolio includes 133 Wanda shopping malls and 84 hotels. It also has extensive activities in the film business, sports holdings, tourism, and children’s en- tertainment. The stated ambition of Dalian Wanda is to become a world-class multinational by 2020 with assets of $200 billion, revenue of $100 billion, and net profits of $10 billion.  In 2012, Dalian Wanda made a significant step in this direction when it acquired the U.S. cinema chain AMC Entertainment Holdings for $2.6 billion. At the time, the acquisition was the largest ever of a U.S. company by a Chinese enterprise, surpassing the $1.8 billion takeover of IBM’s PC business by Lenovo in 2005. AMC is the second-largest cinema operator in North America, where moviegoers spend more than $10 billion a year on tickets. After the acquisition was completed, the headquarters of AMC remained in Kansas City. Dalian, however, indicated that it would inject capital into AMC to upgrade is theaters to show more IMAX and 3D movies. 

Consider also Lixi Inc., a small U.S. manufacturer of industrial X-ray equipment; 70 percent of Lixi’s $4.5 million in revenues comes from exports to Japan.27 Or take G. W. Barth, a manufacturer of cocoa-bean roasting machinery based in Ludwigsburg, Germany. Employing just 65 people, this small company has captured 70 percent of the global mar- ket for cocoa-bean roasting machines.28 International business is conducted not just by large firms but also by medium-size and small enterprises.

THE CHANGING WORLD ORDER

Between 1989 and 1991, a series of democratic revolutions swept the communist world. For reasons that are explored in more detail in Chapter 3, in country after country through- out eastern Europe and eventually in the Soviet Union itself, Communist Party govern- ments collapsed. The Soviet Union receded into history, having been replaced by 15 independent republics. Czechoslovakia divided itself into two states, while Yugoslavia dis- solved into a bloody civil war, now thankfully over, among its five successor states.

Many of the former communist nations of Europe and Asia seem to share a commitment to democratic politics and free market economics. For half a century, these countries were essentially closed to Western international businesses. Now, they present a host of export and investment opportunities. Two decades later, the economies of many of the former com- munist states are still relatively undeveloped, and their continued commitment to democracy and market-based economic systems cannot be taken for granted. Disturbing signs of grow- ing unrest and totalitarian tendencies continue to be seen in several eastern European and central Asian states, including Russia, which has shown signs of shifting back toward greater

Globalization Chapter 1 23

state involvement in economic activity and authoritarian government.29 Thus, the risks in- volved in doing business in such countries are high, but so may be the returns.

In addition to these changes, quieter revolutions have been occurring in China, other states in Southeast Asia, and Latin America. Their implications for international businesses may be just as profound as the collapse of communism in eastern Europe. China suppressed its pro- democracy movement in the bloody Tiananmen Square massacre of 1989. Despite this, China continues to move progressively toward greater free market reforms. If what is occurring in China continues for two more decades, China may move from third world to industrial super- power status even more rapidly than Japan did. If China’s GDP per capita grows by an aver- age of 6 to 7 percent, which is slower than the 8 to 10 percent growth rate achieved during the past decade, then by 2030 this nation of 1.4 billion people could boast an average GDP per capita of about $23,000, roughly the same as that of Chile or Poland today.

The potential consequences for international business are enormous. On the one hand, China represents a huge and largely untapped market. Reflecting this, between 1983 and 2017, annual foreign direct investment in China increased from less than $2 billion to $249.8 billion annually. On the other hand, China’s new firms are proving to be very capa- ble competitors, and they could take global market share away from Western and Japanese enterprises (e.g., see the Management Focus on the Wanda Group). Thus, the changes in China are creating both opportunities and threats for established international businesses.

As for Latin America, both democracy and free market reforms have been evident there too. For decades, most Latin American countries were ruled by dictators, many of whom seemed to view Western international businesses as instruments of imperialist domination. Accordingly, they restricted direct investment by foreign firms. In addition, the poorly managed economies of Latin America were characterized by low growth, high debt, and hyperinflation—all of which discouraged investment by international businesses. In the past two decades, much of this has changed. Throughout most of Latin America, debt and inflation are down, governments have sold state-owned enterprises to private investors, foreign investment is welcomed, and the region’s economies have expanded. Brazil, Mex- ico, and Chile have led the way. These changes have increased the attractiveness of Latin America, both as a market for exports and as a site for foreign direct investment. At the same time, given the long history of economic mismanagement in Latin America, there is no guarantee that these favorable trends will continue. Indeed, Bolivia, Ecuador, and most notably Venezuela have seen shifts back toward greater state involvement in industry in the past few years, and foreign investment is now less welcome than it was during the 1990s. In these nations, the government has seized control of oil and gas fields from foreign inves- tors and has limited the rights of foreign energy companies to extract oil and gas from their nations. Thus, as in the case of eastern Europe, substantial opportunities are accompanied by substantial risks.

GLOBAL ECONOMY OF THE TWENTY-FIRST CENTURY

The past quarter century has seen rapid changes in the global economy. Barriers to the free flow of goods, services, and capital have been coming down. As their economies advance, more nations are joining the ranks of the developed world. A generation ago, South Korea and Taiwan were viewed as second-tier developing nations. Now they boast large economies, and firms based there are major players in many global industries, from shipbuilding and steel to electronics and chemicals. The move toward a global economy has been further strengthened by the widespread adoption of liberal economic policies by countries that had firmly opposed them for two generations or more. In short, current trends indicate the world is moving toward an economic system that is more favorable for international business.

But it is always hazardous to use established trends to predict the future. The world may be moving toward a more global economic system, but globalization is not inevitable. Countries may pull back from the recent commitment to liberal economic ideology if their experiences do not match their expectations. There are clear signs, for example, of a re- treat from liberal economic ideology in Russia. If Russia’s hesitation were to become more permanent and widespread, the liberal vision of a more prosperous global economy based

24 Part 1 Introduction and Overview

on free market principles might not occur as quickly as many hope. Clearly, this would be a tougher world for international businesses.

Also, greater globalization brings with it risks of its own. This was starkly demonstrated in 1997 and 1998, when a financial crisis in Thailand spread first to other East Asian nations and then to Russia and Brazil. Ultimately, the crisis threatened to plunge the economies of the developed world, including the United States, into a recession. We explore the causes and consequences of this and other similar global financial crises in Chapter 11. Even from a purely economic perspective, globalization is not all good. The opportunities for doing busi- ness in a global economy may be significantly enhanced, but as we saw in 1997–1998, the risks associated with global financial contagion are also greater. Indeed, during 2008–2009, a crisis that started in the financial sector of America, where banks had been too liberal in their lending policies to homeowners, swept around the world and plunged the global economy into its deepest recession since the early 1980s, illustrating once more that in an interconnected world a severe crisis in one region can affect the entire globe. Still, as explained later in this text, firms can exploit the opportunities associated with globalization while reducing the risks through appropriate hedging strategies. These hedging strategies may also become more and more important as the world balances globalization efforts with a potential increase in nation- alistic tendencies by some countries (e.g., United States, United Kingdom).

The Globalization Debate

Is the shift toward a more integrated and interdependent global economy a good thing? Many influential economists, politicians, and business leaders seem to think so.30 They argue that falling barriers to international trade and investment are the twin engines driving the global economy toward greater prosperity. They say increased international trade and cross- border investment will result in lower prices for goods and services. They believe that global- ization stimulates economic growth, raises the incomes of consumers, and helps create jobs in all countries that participate in the global trading system. The arguments of those who support globalization are covered in detail in Chapters 6, 7, and 8. As we shall see, there are good theoretical reasons for believing that declining barriers to international trade and in- vestment do stimulate economic growth, create jobs, and raise income levels. Moreover, as described in Chapters 6, 7, and 8, empirical evidence lends support to the predictions of this theory. However, despite the existence of a compelling body of theory and evidence, global- ization has its critics.31 Some of these critics are vocal and active, taking to the streets to demonstrate their opposition to globalization. Here, we look at the nature of protests against globalization and briefly review the main themes of the debate concerning the merits of globalization. In later chapters, we elaborate on many of these points.

ANTIGLOBALIZATION PROTESTS

Popular demonstrations against globalization date back to December 1999, when more than 40,000 protesters blocked the streets of Seattle in an attempt to shut down a World Trade Organization meeting being held in the city. The demonstrators were protesting against a wide range of issues, including job losses in industries under attack from foreign competitors, downward pressure on the wage rates of unskilled workers, environmental degradation, and the cultural imperialism of global media and multinational enterprises, which was seen as being dominated by what some protesters called the “culturally impov- erished” interests and values of the United States. All of these ills, the demonstrators claimed, could be laid at the feet of globalization. The World Trade Organization was meeting to try to launch a new round of talks to cut barriers to cross-border trade and in- vestment. As such, it was seen as a promoter of globalization and a target for the protest- ers. The protests turned violent, transforming the normally placid streets of Seattle into a running battle between “anarchists” and Seattle’s bemused and poorly prepared police department. Pictures of brick-throwing protesters and armored police wielding their ba- tons were duly recorded by the global media, which then circulated the images around the world. Meanwhile, the WTO meeting failed to reach an agreement, and although the

LO 1 - 4 Explain the main arguments in the debate over the impact of globalization.

TEST PRE P Use SmartBook to help retain what you have learned. Access your instructor’s Connect course to check out SmartBook or go to learnsmartadvantage.com for help.

Globalization Chapter 1 25

protests outside the meeting halls had little to do with that failure, the impression took hold that the demonstrators had succeeded in derailing the meetings.

Emboldened by the experience in Seattle, antiglobalization protesters have made a habit of turning up at major meetings of global institutions. Smaller-scale protests have periodically occurred in several countries, such as France, where antiglobalization activists destroyed a McDonald’s restaurant in 1999 to protest the impoverishment of French culture by American imperialism (see the accompanying Country Focus for details). While violent protests may give the antiglobalization effort a bad name, it is clear from the scale of the demonstrations that support for the cause goes beyond a core of anarchists. Large segments of the population in many countries believe that globalization has detrimental effects on living standards, wage rates, and the environment. Indeed, the strong support for President Donald Trump in the 2016 U.S. election was primarily based on his repeated assertions that trade deals had exported U.S. jobs overseas and created unemployment and low wages in America.

Both theory and evidence suggest that many of these fears are exaggerated; both politicians and businesspeople need to do more to counter these fears. Many protests against globaliza- tion are tapping into a general sense of loss at the passing of a world in which barriers of time and distance, and significant differences in economic institutions, political institutions, and the level of development of different nations produced a world rich in the diversity of human cultures. However, while the rich citizens of the developed world may have the luxury of mourning the fact that they can now see McDonald’s restaurants and Starbucks coffeehouses on their vacations to exotic locations such as Thailand, fewer complaints are heard from the citizens of those countries, who welcome the higher living standards that progress brings.

GLOBALIZATION, JOBS, AND INCOME

One concern frequently voiced by globalization opponents is that falling barriers to inter- national trade destroy manufacturing jobs in wealthy advanced economies such as the United States and western Europe. Critics argue that falling trade barriers allow firms to move manufacturing activities to countries where wage rates are much lower.32 Indeed, due to the entry of China, India, and states from eastern Europe into the global trading system, along with global population growth, the pool of global labor has increased more than fivefold between 1990 and today. Other things being equal, we might conclude that this enormous expansion in the global labor force, when coupled with expanding international trade, would have depressed wages in developed nations.

This fear is often supported by anecdotes. For example, D. L. Bartlett and J. B. Steele, two journalists for the Philadelphia Inquirer who gained notoriety for their attacks on free trade, cite the case of Harwood Industries, a U.S. clothing manufacturer that closed its U.S. operations, where it paid workers $9 per hour, and shifted manufacturing to Honduras, where textile work- ers received 48 cents per hour.33 Because of moves such as this, argue Bartlett and Steele, the wage rates of poorer Americans have fallen significantly over the past quarter of a century.

In the past few years, the same fears have been applied to services, which have increasingly been outsourced to nations with lower labor costs. The popular feeling is that when corporations such as Dell, IBM, or Citigroup outsource service activities to lower-cost foreign suppliers—as all three have done—they are “exporting jobs” to low-wage nations and contributing to higher unemployment and lower living standards in their home nations (in this case, the United States). Some U.S. lawmakers have responded by calling for legal barriers to job outsourcing.

Supporters of globalization reply that critics of these trends miss the essential point about free trade agreements—the benefits outweigh the costs.34 They argue that free trade will result in countries specializing in the production of those goods and services that they can produce most efficiently, while importing goods and services that they cannot produce as efficiently. When a country embraces free trade, there is always some dislocation—lost textile jobs at Har- wood Industries or lost call-center jobs at Dell—but the whole economy is better off as a result. According to this view, it makes little sense for the United States to produce textiles at home when they can be produced at a lower cost in Honduras or China. Importing textiles from China leads to lower prices for clothes in the United States, which enables consumers to spend more of their money on other items. At the same time, the increased income generated in China from textile exports increases income levels in that country, which helps the Chinese

C O U N T R Y F O C U S

26

opponents, and the protests started. In May 2001, the so- cialist mayor who had approved the project was defeated in local elections in which the Mondavi project had become the major issue. He was replaced by a communist, Manuel Diaz, who denounced the project as a capitalist plot de- signed to enrich wealthy U.S. shareholders at the cost of his villagers and the environment. Following Diaz’s victory, Mondavi announced he would pull out of the project. A spokesperson noted, “It’s a huge waste, but there are clearly personal and political interests at play here that go way beyond us.” So, are the French opposed to foreign investment? The experience of McDonald’s and Mondavi seems to suggest so, as does the associated news coverage, but look closer and a different reality seems to emerge. Today, McDonald’s has more than 1,200 restaurants in France. McDonald’s em- ploys 69,000 workers in the country. France is the most profitable market for McDonald’s after the United States. In short, 20 years after the protests, France is a major success story for McDonald’s. Moreover, France has long been one of the most favored locations for inward foreign direct in- vestment, receiving more than $700 billion of foreign invest- ment between 2000 and 2017, which makes it one of the top destinations for foreign investment in Europe. American companies have always accounted for a significant percent- age of this investment. French enterprises have also been significant foreign investors; some 1,100 French multination- als have about $1.1 trillion of assets in other nations. For all of the populist opposition to globalization, French corporations and consumers appear to be embracing it.

Sources: “Behind the Bluster,” The Economist, May 26, 2001; “The French Farmers’ Anti-Global Hero,” The Economist, July 8, 2000; C. Trueheart, “France’s Golden Arch Enemy?” Toronto Star, July 1, 2000; J. Henley, “Grapes of Wrath Scare Off U.S. Firm,” The Economist, May 18, 2001, p. 11; United Nations, World Investment Report, 2014 (New York & Geneva: United Nations, 2011); Rob Wile, “The True Story of How McDonald’s Conquered France,” Business Insider, August 22, 2014.

It all started one night in August 1999, but it might as well have been today. Back to 1999, 10 men under the leadership of local sheep farmer and rural activist José Bové crept into the town of Millau in central France and vandalized a Mc- Donald’s restaurant under construction, causing an esti- mated $150,000 in damage. These were no ordinary vandals, however, at least according to their supporters, for the “symbolic dismantling” of the McDonald’s outlet had no- ble aims, or so it was claimed. The attack was initially pre- sented as a protest against unfair American trade policies. The European Union (EU) had banned imports of hormone- treated beef from the United States, primarily because of fears that it might lead to health problems (although EU sci- entists had concluded there was no evidence of this). After a careful review, the World Trade Organization stated the EU ban was not allowed under trading rules that the EU and United States were party to and that the EU would have to lift it or face retaliation. The EU refused to comply, so the U.S. government imposed a 100 percent tariff on imports of cer- tain EU products, including French staples such as foie gras, mustard, and Roquefort cheese. On farms near Millau, Bové and others raised sheep whose milk was used to make Roquefort. They felt incensed by the American tariff and de- cided to vent their frustrations on McDonald’s. Bové and his compatriots were arrested and charged. About the same time in the Languedoc region of France, California winemaker Robert Mondavi had reached agree- ment with the mayor and council of the village of Aniane and regional authorities to turn 125 acres of wooded hill- side belonging to the village into a vineyard. Mondavi planned to invest $7 million in the project and hoped to produce top-quality wine that would sell in Europe and the United States for $60 a bottle. However, local environmen- talists objected to the plan, which they claimed would de- stroy the area’s unique ecological heritage. José Bové, basking in sudden fame, offered his support to the

Protesting Globalization in France

purchase more products produced in the United States, such as pharmaceuticals from Amgen, Boeing jets, microprocessors made by Intel, Microsoft software, and Cisco routers.

The same argument can be made to support the outsourcing of services to low-wage coun- tries. By outsourcing its customer service call centers to India, Dell can reduce its cost struc- ture and thereby its prices for computers. U.S. consumers benefit from this development. As prices for computers fall, Americans can spend more of their money on other goods and ser- vices. Moreover, the increase in income levels in India allows Indians to purchase more U.S. goods and services, which helps create jobs in the United States. In this manner, supporters of globalization argue that free trade benefits all countries that adhere to a free trade regime.

Globalization Chapter 1 27

If the critics of globalization are correct, three things must be shown. First, the share of national income received by labor, as opposed to the share received by the owners of capi- tal (e.g., stockholders and bondholders), should have declined in advanced nations as a result of downward pressure on wage rates. Second, even though labor’s share of the eco- nomic pie may have declined, this does not mean lower living standards if the size of the total pie has increased sufficiently to offset the decline in labor’s share—in other words, if economic growth and rising living standards in advanced economies have offset declines in labor’s share (this is the position argued by supporters of globalization). Third, the de- cline in labor’s share of national income must be due to moving production to low-wage countries, as opposed to improvement in production technology and productivity.

Several studies shed light on these issues.35 First, the data suggest that over the past two decades, the share of labor in national income has declined. However, detailed analysis suggests the share of national income enjoyed by skilled labor has actually increased, sug- gesting that the fall in labor’s share has been due to a fall in the share taken by unskilled labor. A study by the IMF suggested the earnings gap between workers in skilled and un- skilled sectors has widened by 25 percent over the past two decades.36 Another study that focused on U.S. data found that exposure to competition from imports led to a decline in real wages for workers who performed unskilled tasks, while having no discernible impact on wages in skilled occupations. The same study found that skilled and unskilled workers in sectors where exports grew saw an increase in their real wages.37 These figures suggest that unskilled labor in sectors that have been exposed to more efficient foreign competition probably has seen its share of national income decline over the past three decades.

However, this does not mean that the living standards of unskilled workers in developed nations have declined. It is possible that economic growth in developed nations has offset the fall in the share of national income enjoyed by unskilled workers, raising their living standards. Evidence suggests that real labor compensation has expanded in most devel- oped nations since the 1980s, including the United States. Several studies by the Organisa- tion for Economic Co-operation and Development (OECD), whose members include the 34 richest economies in the world, conclude that while the gap between the poorest and richest segments of society in OECD countries has widened, in most countries real income levels have increased for all, including the poorest segment. In one study, the OECD found that real household income (adjusted for inflation) increased by 1.7 percent annually among its member states. The real income level of the poorest 10 percent of the popula- tion increased at 1.4 percent on average, while that of the richest 10 percent increased by 2 percent annually (i.e., while everyone got richer, the gap between the most affluent and the poorest sectors of society widened). The differential in growth rates was more extreme in the United States than most other countries. The study found that the real income of the poorest 10 percent of the population grew by just 0.5 percent a year in the United States, while that of the richest 10 percent grew by 1.9 percent annually.38

As noted earlier, globalization critics argue that the decline in unskilled wage rates is due to the migration of low-wage manufacturing jobs offshore and a corresponding reduction in de- mand for unskilled workers. However, supporters of globalization see a more complex picture. They maintain that the weak growth rate in real wage rates for unskilled workers owes far more to a technology-induced shift within advanced economies away from jobs where the only qualification was a willingness to turn up for work every day and toward jobs that require sig- nificant education and skills. They point out that many advanced economies report a shortage of highly skilled workers and an excess supply of unskilled workers. Thus, growing income inequality is a result of the wages for skilled workers being bid up by the labor market and the wages for unskilled workers being discounted. In fact, evidence suggests that technological change has had a bigger impact than globalization on the declining share of national income enjoyed by labor.39 This suggests that a solution to the problem of slow real income growth among the unskilled is to be found not in limiting free trade and globalization but in increas- ing society’s investment in education to reduce the supply of unskilled workers.40

Finally, it is worth noting that the wage gap between developing and developed nations is closing as developing nations experience rapid economic growth. For example, one

28 Part 1 Introduction and Overview

estimate suggests that wages in China will approach Western levels in two decades.41 To the extent that this is the case, any migration of unskilled jobs to low-wage countries is a temporary phenomenon representing a structural adjustment on the way to a more tightly integrated global economy.

GLOBALIZATION, LABOR POLICIES, AND THE ENVIRONMENT

A second source of concern is that free trade encourages firms from advanced nations to move manufacturing facilities to less developed countries that lack adequate regulations to protect labor and the environment from abuse by the unscrupulous.42 Globalization critics often argue that adhering to labor and environmental regulations significantly increases the costs of manufacturing enterprises and puts them at a competitive disadvantage in the global marketplace vis-à-vis firms based in developing nations that do not have to comply with such regulations. Firms deal with this cost disadvantage, the theory goes, by moving their production facilities to nations that do not have such burdensome regulations or that fail to enforce the regulations they have.

If this were the case, we might expect free trade to lead to an increase in pollution and result in firms from advanced nations exploiting the labor of less developed nations.43 This argument was used repeatedly by those who opposed the 1994 formation of the North American Free Trade Agreement (NAFTA) among Canada, Mexico, and the United States. They painted a picture of U.S. manufacturing firms moving to Mexico in droves so that they would be free to pollute the environment, employ child labor, and ignore work- place safety and health issues, all in the name of higher profits.44

Supporters of free trade and greater globalization express doubts about this scenario. They argue that tougher environmental regulations and stricter labor standards go hand in hand with economic progress.45 In general, as countries get richer, they enact tougher en- vironmental and labor regulations.46 Because free trade enables developing countries to increase their economic growth rates and become richer, this should lead to tougher envi- ronmental and labor laws. In this view, the critics of free trade have got it backward: Free trade does not lead to more pollution and labor exploitation; it leads to less. By creating wealth and incentives for enterprises to produce technological innovations, the free market system and free trade could make it easier for the world to cope with pollution and popula- tion growth. Indeed, while pollution levels are rising in the world’s poorer countries, they have been falling in developed nations. In the United States, for example, the concentra- tion of carbon monoxide and sulfur dioxide pollutants in the atmosphere decreased by 60 percent since 1978, while lead concentrations decreased by 98 percent—and these re- ductions have occurred against a background of sustained economic expansion.47

A number of econometric studies have found consistent evidence of a hump-shaped relationship between income levels and pollution levels (see Figure 1.6.).48 As an economy grows and income levels rise, initially pollution levels also rise. However, past some point, rising income levels lead to demands for greater environmental protection, and pollution levels then fall. A seminal study by Grossman and Krueger found that the turning point generally occurred before per capita income levels reached $8,000.49

While the hump-shaped relationship depicted in Figure 1.6 seems to hold across a wide range of pollutants—from sulfur dioxide to lead concentrations and water quality—carbon dioxide emissions are an important exception, rising steadily with higher-income levels. Given that carbon dioxide is a heat-trapping gas and given that there is good evidence that increased atmospheric carbon dioxide concentrations are a cause of global warming, this should be of serious concern. The solution to the problem, however, is probably not to roll back the trade liberalization efforts that have fostered economic growth and globalization but to get the nations of the world to agree to policies designed to limit carbon emissions. In the view of most economists, the most effective way to do this would be to put a price on carbon-intensive energy generation through a carbon tax. To ensure that this tax does not harm economic growth, economists argue that it should be revenue neutral, with in- creases in carbon taxes offset by reductions in income or consumption taxes.50

Although UN-sponsored talks have had reduction in carbon dioxide emissions as a cen- tral aim since the 1992 Earth Summit in Rio de Janeiro, until recently there has been little

Globalization Chapter 1 29

success in moving toward the ambitious goals for reducing carbon emissions laid down in the Earth Summit and subsequent talks in Kyoto, Japan, in 1997 and in Copenhagen in 2009. In part, this is because the largest emitters of carbon dioxide, the United States and China, failed to reach agreements about how to proceed. China, a country whose carbon emissions are increasing at a rapid rate, has until recently shown little appetite for tighter pollution controls. As for the United States, political divisions in Congress and a culture of denial have made it difficult for the country to even acknowledge, never mind move forward with, legislation designed to tackle climate change. However, in late 2014 America and China struck a historic deal under which both countries agreed to potentially significant reductions in carbon emissions. This was followed by a broadly based multilateral agree- ment reached in Paris in 2015 that has committed the nations of the world to carbon reduc- tion targets. If these agreements hold, progress may be made on this important issue.

Notwithstanding this, supporters of free trade point out that it is possible to tie free trade agreements to the implementation of tougher environmental and labor laws in less developed countries. NAFTA, for example, was passed only after side agreements had been negotiated that committed Mexico to tougher enforcement of environmental protec- tion regulations. Thus, supporters of free trade argue that factories based in Mexico are now cleaner than they would have been without the passage of NAFTA.51

They also argue that business firms are not the amoral organizations that critics sug- gest. While there may be some rotten apples, most business enterprises are staffed by managers who are committed to behave in an ethical manner and would be unlikely to move production offshore just so they could pump more pollution into the atmosphere or exploit labor. Furthermore, the relationship between pollution, labor exploitation, and pro- duction costs may not be that suggested by critics. In general, a well-treated labor force is productive, and it is productivity rather than base wage rates that often has the greatest influence on costs. The vision of greedy managers who shift production to low-wage coun- tries to exploit their labor force may be misplaced.

GLOBALIZATION AND NATIONAL SOVEREIGNTY

Another concern voiced by critics of globalization is that today’s increasingly interdepen- dent global economy shifts economic power away from national governments and toward supranational organizations such as the World Trade Organization, the European Union, and the United Nations. As perceived by critics, unelected bureaucrats now impose poli- cies on the democratically elected governments of nation-states, thereby undermining the sovereignty of those states and limiting the nation’s ability to control its own destiny.52

The World Trade Organization is a favorite target of those who attack the headlong rush toward a global economy. As noted earlier, the WTO was founded in 1995 to police the world trading system established by the General Agreement on Tariffs and Trade. The WTO arbitrates

F I G U R E 1 . 6

Income levels and environmental pollution. Source: C. W. L. Hill and G. T. M. Hult, Global Business Today (New York: McGraw-Hill Education, 2018).

P o

llu ti

o n

L ev

el s

$8,000 Income per Capita

Other Pollutants

Carbon Dioxide Emissions

30 Part 1 Introduction and Overview

trade disputes between its 162 member states. The arbitration panel can issue a ruling instruct- ing a member state to change trade policies that violate GATT regulations. If the violator re- fuses to comply with the ruling, the WTO allows other states to impose appropriate trade sanctions on the transgressor. As a result, according to one prominent critic, U.S. environmen- talist, consumer rights advocate, and sometime presidential candidate Ralph Nader:

Under the new system, many decisions that affect billions of people are no longer made by local or national governments but instead, if challenged by any WTO member nation, would be deferred to a group of unelected bureaucrats sitting behind closed doors in Geneva (which is where the headquarters of the WTO are located). The bureaucrats can decide whether or not people in California can prevent the destruction of the last virgin forests or determine if carcinogenic pesticides can be banned from their foods; or whether European countries have the right to ban dangerous biotech hormones in meat . . . . At risk is the very basis of democracy and accountable decision making.53

In contrast to Nader, many economists and politicians maintain that the power of supranational organizations such as the WTO is limited to what nation-states collectively agree to grant. They argue that bodies such as the United Nations and the WTO exist to serve the collective interests of member states, not to subvert those interests. Supporters of supranational organizations point out that the power of these bodies rests largely on their ability to persuade member states to follow a certain action. If these bodies fail to serve the collective interests of member states, those states will withdraw their support and the su- pranational organization will quickly collapse. In this view, real power still resides with individual nation-states, not supranational organizations.

GLOBALIZATION AND THE WORLD’S POOR

Critics of globalization argue that despite the supposed benefits associated with free trade and investment, over the past 100 years or so the gap between the rich and poor nations of the world has gotten wider. In 1870, the average income per capita in the world’s 17 richest nations was 2.4 times that of all other countries. In 1990, the same group was 4.5 times as rich as the rest. In 2017, the 34 member states of the Organisation for Economic Co- operation and Development (OECD), which includes most of the world’s rich economies, had an av- erage gross national income (GNI) per person of more than $40,000, whereas the world’s 40 least developed countries had a GNI of under $1,000 per capita—implying that income per capita in the world’s 34 richest nations was 40 times that in the world’s 40 poorest.54

While recent history has shown that some of the world’s poorer nations are capable of rapid periods of economic growth—witness the transformation that has occurred in some Southeast Asian nations such as South Korea, Thailand, and Malaysia—there appear to be strong forces for stagnation among the world’s poorest nations. A quarter of the countries with a GDP per capita of less than $1,000 in 1960 had growth rates of less than zero, and a third had growth rates of less than 0.05 percent.55 Critics argue that if globalization is such a positive development, this divergence between the rich and poor should not have occurred.

Although the reasons for economic stagnation vary, several factors stand out, none of which has anything to do with free trade or globalization.56 Many of the world’s poorest countries have suffered from totalitarian governments, economic policies that destroyed wealth rather than facilitated its creation, endemic corruption, scant protection for property rights, and pro- longed civil war. A combination of such factors helps explain why countries such as Afghani- stan, Cuba, Haiti, Iraq, Libya, Nigeria, Sudan, Syria, North Korea, and Zimbabwe have failed to improve the economic lot of their citizens during recent decades. A complicating factor is the rapidly expanding populations in many of these countries. Without a major change in gov- ernment, population growth may exacerbate their problems. Promoters of free trade argue that the best way for these countries to improve their lot is to lower their barriers to free trade and investment and to implement economic policies based on free market economics.57

Many of the world’s poorer nations are being held back by large debt burdens. Of particular concern are the 40 or so “highly indebted poorer countries” (HIPCs), which are home to some 700 million people. Among these countries, the average government debt burden has been as

Globalization Chapter 1 31

high as 85 percent of the value of the economy, as measured by gross domestic product, and the annual costs of serving government debt consumed 15 percent of the country’s export earn- ings.58 Servicing such a heavy debt load leaves the governments of these countries with little left to invest in important public infrastructure projects, such as education, health care, roads, and power. The result is the HIPCs are trapped in a cycle of poverty and debt that inhibits eco- nomic development. Free trade alone, some argue, is a necessary but not sufficient prerequisite to help these countries bootstrap themselves out of poverty. Instead, large-scale debt relief is needed for the world’s poorest nations to give them the opportunity to restructure their econo- mies and start the long climb toward prosperity. Supporters of debt relief also argue that new democratic governments in poor nations should not be forced to honor debts that were incurred and mismanaged long ago by their corrupt and dictatorial predecessors.

In the late 1990s, a debt relief movement began to gain ground among the political es- tablishment in the world’s richer nations.59 Fueled by high-profile endorsements from Irish rock star Bono (who has been a tireless and increasingly effective advocate for debt relief), the Dalai Lama, and influential Harvard economist Jeffrey Sachs, the debt relief move- ment was instrumental in persuading the United States to enact legislation in 2000 that provided $435 million in debt relief for HIPCs. More important perhaps, the United States also backed an IMF plan to sell some of its gold reserves and use the proceeds to help with debt relief. The IMF and World Bank have now picked up the banner and have embarked on a systematic debt relief program.

For such a program to have a lasting effect, however, debt relief must be matched by wise investment in public projects that boost economic growth (such as education) and by the adoption of economic policies that facilitate investment and trade. Consistent with this, in June 2005, the finance ministers from several of the world’s richest economies (including the United States) agreed to provide enough funds to the World Bank and IMF to allow them to cancel a further $55 billion in debt owed by the HIPCs. The goal was to enable the HIPCs to redirect resources from debt payments to health and education pro- grams, and for alleviating poverty.

The richest nations of the world also can help by reducing barriers to the importation of products from the world’s poorest nations, particularly tariffs on imports of agricultural products and textiles. High-tariff barriers and other impediments to trade make it difficult for poor countries to export more of their agricultural production. The World Trade Organiza- tion has estimated that if the developed nations of the world eradicated subsidies to their agricultural producers and removed tariff barriers to trade in agriculture, this would raise global economic welfare by $128 billion, with $30 billion of that going to poor nations, many of which are highly indebted. The faster growth associated with expanded trade in agriculture could significantly reduce the number of people living in poverty according to the WTO.60

Despite the large gap between the rich and poor nations, there is some evidence that progress is being made. In 2015, the United Nations adopted what were known as the Sus- tainable Development Goals. These were 17 economic and human development goals for the world. We address these goals more in Chapter 5. Overall, it is hard to escape the con- clusion that globalization and lower barriers to cross-border trade and investment were major factors behind this remarkable achievement.

Managing in the Global Marketplace

Much of this text is concerned with the challenges of managing in an international busi- ness. An international business is any firm that engages in international trade or invest- ment. A firm does not have to become a multinational enterprise, investing directly in operations in other countries, to engage in international business, although multinational enterprises are international businesses. All a firm has to do is export or import products from other countries. As the world shifts toward a truly integrated global economy, more firms—both large and small—are becoming international businesses. What does this shift toward a global economy mean for managers within an international business?

LO 1 -5 Understand how the process of globalization is creating opportunities and challenges for management practice.

TEST PRE P Use SmartBook to help retain what you have learned. Access your instructor’s Connect course to check out SmartBook or go to learnsmartadvantage.com for help.

32 Part 1 Introduction and Overview

As their organizations increasingly engage in cross-border trade and investment, manag- ers need to recognize that the task of managing an international business differs from that of managing a purely domestic business in many ways. At the most fundamental level, the differences arise from the simple fact that countries are different. Countries differ in their cultures, political systems, economic systems, legal systems, and levels of economic devel- opment. Despite all the talk about the emerging global village and despite the trend toward globalization of markets and production, as we shall see in this text, many of these differ- ences are very profound and enduring.

Differences among countries require that an international business vary its practices country by country. Marketing a product in Brazil may require a different approach from marketing the product in Germany; managing U.S. workers might require different skills from managing Japanese workers; maintaining close relations with a particular level of gov- ernment may be very important in Mexico and irrelevant in Great Britain; the business strategy pursued in Canada might not work in South Korea; and so on. Managers in an inter- national business must not only be sensitive to these differences but also adopt the appropri- ate policies and strategies for coping with them. Much of this text is devoted to explaining the sources of these differences and the methods for successfully coping with them.

A further way in which international business differs from domestic business is the greater complexity of managing an international business. In addition to the problems that arise from the differences between countries, a manager in an international business is confronted with a range of other issues that the manager in a domestic business never confronts. The managers of an international business must decide where in the world to site production ac- tivities to minimize costs and maximize value added. They must decide whether it is ethical to adhere to the lower labor and environmental standards found in many less developed na- tions. Then they must decide how best to coordinate and control globally dispersed produc- tion activities (which, as we shall see later in the text, is not a trivial problem). The managers in an international business also must decide which foreign markets to enter and which to avoid. They must choose the appropriate mode for entering a particular foreign country. Is it best to export its product to the foreign country? Should the firm allow a local company to produce its product under license in that country? Should the firm enter into a joint venture with a local firm to produce its product in that country? Or should the firm set up a wholly owned subsidiary to serve the market in that country? As we shall see, the choice of entry mode is critical because it has major implications for the long-term health of the firm.

Conducting business transactions across national borders requires understanding the rules governing the international trading and investment system. Managers in an interna- tional business must also deal with government restrictions on international trade and in- vestment. They must find ways to work within the limits imposed by specific governmental interventions. As this text explains, even though many governments are nominally commit- ted to free trade, they often intervene to regulate cross-border trade and investment. Man- agers within international businesses must develop strategies and policies for dealing with such interventions.

Cross-border transactions also require that money be converted from the firm’s home currency into a foreign currency and vice versa. Because currency exchange rates vary in response to changing economic conditions, managers in an international business must develop policies for dealing with exchange rate movements. A firm that adopts the wrong policy can lose large amounts of money, whereas one that adopts the right policy can increase the profitability of its international transactions.

In sum, managing an international business is different from managing a purely domes- tic business for at least four reasons: (1) countries are different, (2) the range of problems confronted by a manager in an international business is wider and the problems them- selves more complex than those confronted by a manager in a domestic business, (3) an international business must find ways to work within the limits imposed by government intervention in the international trade and investment system, and (4) international trans- actions involve converting money into different currencies.

In this text, we examine all these issues in depth, paying close attention to the different strategies and policies that managers pursue to deal with the various challenges created

Globalization Chapter 1 33

when a firm becomes an international business. Chapters 2, 3, and 4 explore how coun- tries differ from each other with regard to their political, economic, legal, and cultural in- stitutions. Chapter 5 takes a detailed look at the ethical issues, corporate social responsibility, and sustainability issues that arise in international business. Chapters 6, 7, 8, and 9 look at the global trade and investment environment within which international businesses must operate. Chapters 10, 11, and 12 review the global monetary system. These chapters focus on the nature of the foreign exchange market and the emerging global monetary system. Chapters 12, 13, and 14 explore the strategy, organization, and market entry choices of an international business. Chapters 15, 16, 17, 18, 19, and 20 look at the management of various functional operations within an international business, including exporting, importing, countertrade, production, supply chain management, marketing, R&D, and human resources. By the time you complete this text, you should have a good grasp of the issues that managers working in international business have to grapple with on a daily basis, and you should be familiar with the range of strategies and operating policies available to compete more effectively in today’s rapidly emerging global economy.

TEST PRE P Use SmartBook to help retain what you have learned. Access your instructor’s Connect course to check out SmartBook or go to learnsmartadvantage.com for help.

globalization, p. 6 globalization of markets, p. 6 globalization of production, p. 8 factors of production, p. 8 General Agreement on Tariffs and

Trade (GATT), p. 10 World Trade Organization

(WTO), p. 10

International Monetary Fund (IMF), p. 10

World Bank, p. 10 United Nations (UN), p. 10 Group of Twenty (G20), p. 11 international trade, p. 11 foreign direct investment

(FDI), p. 11

Moore’s law, p. 15 stock of foreign direct

investment (FDI), p. 19 multinational enterprise

(MNE), p. 20 international business, p. 31

Key Terms

C H A P T E R S U M M A R Y

This chapter has shown how the world economy is becom- ing more global and reviewed the main drivers of global- ization, arguing that they seem to be thrusting nation-states toward a more tightly integrated global economy. It looked at how the nature of international business is changing in response to the changing global economy, discussed con- cerns raised by rapid globalization, and reviewed implica- tions of rapid globalization for individual managers. The chapter made the following points:

 1. Over the past three decades, we have witnessed the globalization of markets and production.

 2. The globalization of markets implies that na- tional markets are merging into one huge market- place. However, it is important not to push this view too far.

 3. The globalization of production implies that firms are basing individual productive activities at the optimal world locations for the particular activities. As a consequence, it is increasingly irrelevant to talk about American products, Japanese products, or German products because these are being replaced by “global” products.

 4. Two factors seem to underlie the trend toward globalization: declining trade barriers and changes in communication, information, and transportation technologies.

 5. Since the end of World War II, barriers to the free flow of goods, services, and capital have been lowered significantly. More than anything else, this has facilitated the trend toward the glo- balization of production and has enabled firms to view the world as a single market.

 6. As a consequence of the globalization of produc- tion and markets, in the last decade, world trade has grown faster than world output, foreign direct investment has surged, imports have penetrated more deeply into the world’s industrial nations, and competitive pressures have increased in in- dustry after industry.

 7. The development of the microprocessor and related developments in communication and information processing technology have helped firms link their worldwide operations into so- phisticated information networks. Jet air travel,

34 Part 1 Introduction and Overview

by shrinking travel time, has also helped link the worldwide operations of international businesses. These changes have enabled firms to achieve tight coordination of their worldwide operations and to view the world as a single market.

 8. In the 1960s, the U.S. economy was dominant in the world, U.S. firms accounted for most of the foreign direct investment in the world economy, U.S. firms dominated the list of large multina- tionals, and roughly half the world—the centrally planned economies of the communist world—was closed to Western businesses.

 9. By the 2000s, the U.S. share of world output had been cut in half, with major shares now being ac- counted for by western European and Southeast Asian economies. The U.S. share of worldwide foreign direct investment had also fallen by about two-thirds. U.S. multinationals were now facing competition from a large number of Japanese and European multinationals. In addition, the emergence of mini-multinationals was noted.

10. One of the most dramatic developments of the past 30 years has been the collapse of communism in eastern Europe, which has created enormous op-

portunities for international businesses. In addition, the move toward free market economies in China and Latin America is creating opportunities (and threats) for Western international businesses.

11. The benefits and costs of the emerging global economy are being hotly debated among busi- nesspeople, economists, and politicians. The debate focuses on the impact of globalization on jobs, wages, the environment, working conditions, national sovereignty, and extreme poverty in the world’s poorest nations.

12. Managing an international business is different from managing a domestic business for at least four reasons: (a) countries are different, (b) the range of problems confronted by a manager in an international business is wider and the problems themselves more complex than those confronted by a manager in a domestic business, (c) managers in an international business must find ways to work within the limits imposed by governments’ intervention in the international trade and invest- ment system, and (d) international transactions in- volve converting money into different currencies.

C r i t i c a l T h i n k i n g a n d D i s c u s s i o n Q u e s t i o n s

 1. Describe the shifts in the world economy over the past 30 years. What are the implications of these shifts for international businesses based in Great Britain? North America? Hong Kong?

 2. “The study of international business is fine if you are going to work in a large multinational enterprise, but it has no relevance for individu- als who are going to work in small firms.” Evaluate this statement.

 3. How have changes in technology contributed to the globalization of markets and production? Would the globalization of production and mar- kets have been possible without these technolog- ical changes?

 4. “Ultimately, the study of international business is no different from the study of domestic business. Thus, there is no point in having a separate course on international business.” Evaluate this statement.

 5. How does the Internet affect international busi- ness activity and the globalization of the world economy?

 6. If current trends continue, China may be the world’s largest economy by 2030. Discuss the possible implications of such a development for a. the world trading system b. the world monetary system

c. the business strategy of today’s European and U.S.-based global corporations

d. global commodity prices  7. Reread the Management Focus on Boeing and

answer the following questions: a. What are the benefits to Boeing of out-

sourcing manufacturing of components of the Boeing 787 to firms based in other countries?

b. What are the potential costs and risks to Boeing of outsourcing?

c. In addition to foreign subcontractors and Boeing, who else benefits from Boeing’s de- cision to outsource component part manu- facturing assembly to other nations? Who are the potential losers?

d. If Boeing’s management decided to keep all production in America, what do you think the effect would be on the company, its em- ployees, and the communities that depend on it?

e. On balance, do you think that the kind of outsourcing undertaken by Boeing is a good thing or a bad thing for the American economy? Explain your reasoning.

Globalization Chapter 1 35

r e s e a r c h t a s k g l o b a l e d g e . m s u . e d u

Use the globalEDGETM website (globaledge.msu.edu) to complete the following exercises:

1. As the drivers of globalization continue to pres- sure both the globalization of markets and the globalization of production, we continue to see the impact of greater globalization on worldwide trade patterns. HSBC, a large global bank, ana- lyzes these pressures and trends to identify op- portunities across markets and sectors through its trade forecasts. Visit the HSBC Global Con- nections site and use the trade forecast tool to identify which export routes are forecasted to see the greatest growth over the next 15 to 20 years. What patterns do you see? What types of coun- tries dominate these routes?

2. You are working for a company that is consider- ing investing in a foreign country. Investing in countries with different traditions is an impor- tant element of your company’s long-term strate- gic goals. As such, management has requested a report regarding the attractiveness of alternative countries based on the potential return of FDI. Accordingly, the ranking of the top 25 countries in terms of FDI attractiveness is a crucial ingre- dient for your report. A colleague mentioned a potentially useful tool called the Foreign Direct Investment (FDI) Confidence Index. The FDI Confidence Index is a regular survey of global executives conducted by A.T. Kearney. Find this index and provide additional information regard- ing how the index is constructed.

Uber, the controversial San Francisco–based ride-for-hire service, has made a virtue out of disrupting the estab- lished taxi business. From a standing start in 2009, the company has spread across the globe like wildfire. Uber’s strategy has been to focus on major metropolitan areas around the world. This strategy has so far taken Uber into about 600 cities in more than 80 countries. The privately held company is rumored to be generating annual reve- nues of around $10 billion. At the core of Uber’s business is a smartphone app that allows customers to hail a ride from the comfort of their own home, a restaurant, or a bar stool. The app shows cars in the area, notifies the rider when a car is on the way, and tracks the progress of the car on screen using GPS map- ping technology. The rider pays via the app using a credit card, so no cash changes hands. The driver takes 80 per- cent of the fee and Uber 20 percent. The price for the ride is determined by Uber using an algorithm that sets prices in order to match the demand for rides with the supply of cars on the road. Thus, if demand exceeds supply, the price for a ride will rise, inducing drivers to get on the road. Uber does not own any cars. Its drivers are independent contrac- tors with their own vehicles. The company is, in effect, a twenty-first-century version of an old-style radio taxi dis- patch company. Interestingly, Uber’s founders got their idea for the app-based service one snowy night in Paris when they were unable to find a taxi.

Historically, taxi markets around the globe have been tightly regulated by metropolitan authorities. The stated purpose of these regulations has often included (1) limit- ing the supply of taxis in order to boost demand for other forms of public transportation, (2) limiting the supply of taxis in order to reduce traffic congestion, (3) ensuring the safety of riders by only allowing licensed taxis to offer rides, (4) ensuring that the prices charged are “fair,” and (5) guaranteeing a reasonable rate of return to the owners of taxi licenses. In practice, widespread restrictions on the supply of taxi licenses have created shortages in many cities, making it dif- ficult to find a taxi, particularly at busy periods. In New York, the number of licenses barely increased from 11,787 in 1945 to 13,587 in 2017, even though the population ex- panded significantly. In Paris, the number of licenses was 14,000 in 1937 and had only increased to 17,137 by 2017, even though both the population and the number of visitors to the city had surged. The number of taxis in Milan was frozen between 1974 and 2014, despite Milan having a ratio of taxis to inhabitants that was one of the lowest for any major city. Whenever metropolitan authorities have tried to increase the number of taxis in a city, they have often been meet by strong resistance from established taxi companies. When the French tried to increase the number of taxis in Paris in 2007, a strike among transportation workers shut down the city and forced the government to back off.

C L O S I N G C A S E

Uber: Going Global from Day One

36 Part 1 Introduction and Overview

Uber’s strategy has been to break these regulations, estab- lishing its service first and then fighting attempts by regula- tors to shut the service down. In pursuing this strategy, Uber has often used social networks to enlist the support of its riders, getting them to pressure local governments to change their regulations and allow Uber to continue offering its ser- vice. In many cities, the strategy has worked, even in the face of protests from established taxi companies and their driv- ers. In London, for example, when taxi drivers went on strike to pressure the government to restrict Uber, Uber reported a surge in downloads for its app and thousands of new riders. However, this confrontational strategy has not always worked well. The government of Vancouver, Canada, re- acted to the unauthorized entry of Uber by banning it out- right. So did the local authorities in Brussels in Belgium, Delhi in India, and a host of other cities around the globe. In Paris, the government has tried to limit Uber by impos- ing several restrictions that make it harder for Uber to do business there. To complicate matters, Uber drivers in Paris have unionized—something that they cannot do in the United States due to their status as independent con- tractors. They went on strike when Uber tried to lower fares. Similar protests by Uber drivers have occurred in other cities. Overall, there is a sense that Uber’s abrasive strategy has not always worked well, particularly outside of the United States where locals see Uber as a brash American startup that pays scant attention to local laws, customs, and culture. Uber is also witnessing the emergence of local rivals in some countries, such as India and China, where startups using a smartphone app and a business model similar to Uber are gaining traction. In China, local rival Didi Kuaidi has raised $4 billion in venture capital and claims that soon it will be operating in more than 400 cities in China. Didi

already has a 90 percent market share in Beijing, where the company fields more than 1 million daily ride requests.

Sources: Brad Stone, “The $99 Billion Idea: How Uber and Airbnb Fought City Hall, Won Over the People, Outlasted Rivals, and Figured Out the Shar- ing Economy,” Bloomberg BusinessWeek, January 26, 2017; Adi Gaskell, “Study Explores the Impact of Uber on the Taxi Industry,” Forbes, January 26, 2017; Alyson Shontel, “Uber Is Generating a Staggering Amount of Reve- nue,” Business Insider, November 15, 2014; Carmel DeAmicic, “Leaked Doc: Uber Nears $2 Billion in Revenue,” Recode, August 21, 2015; Kara Swisher, “Uber and Uber Man,” Vanity Fair, December 2014; Nitish Kulkarni, “Uber Hits Roadblock in India after Being Denied Permission to Operate in Delhi,” Tech Crunch, September 16, 2015; Brian Solomon, “Uber Seems to Be Getting Its Butt Kicked in China,” Forbes, December 1, 2015.

C a s e D i s c u s s i o n Q u e s t i o n s 1. Companies like Uber, Lyft (one of Uber’s main com-

petitors), and Airbnb (an online marketplace that enables people to lease or rent short-term lodging) are innovating in fields that traditionally have been very complex and regulated. Can Uber’s business model be applied in other industries globally?

2. Are cities around the world doing a disservice to their citizens or their visitors, or both, by banning Uber outright from operating in their community?

3. Uber’s strategy has been to break these regula- tions, establishing its service first, and then fight- ing attempts by regulators to shut the service down. This goes along with the old saying that “do first, ask questions later.” Is this business approach viable globally in the long run?

Design Elements: Implications (idea): ©ARTQU/Getty Images; Problem (jigsaw): ©ALMAGAMI/Shutterstock; All Others: ©McGraw-Hill Education.

E n d n o t e s

 1. Figures from World Trade Organization, Statistics Database, 2015.

 2. Thomas L. Friedman, The World Is Flat (New York: Farrar, Straus and Giroux, 2005).

 3. Ibid.

 4. T. Levitt, “The Globalization of Markets,” Harvard Business Review, May–June 1983, pp. 92–102.

 5. U.S. Department of Commerce, Internal Trade Administration, “Profile of U.S. Exporting and Importing Companies, 2012–2013,” April 2015.

 6. C. M. Draffen, “Going Global: Export Market Proves Profitable for Region’s Small Businesses,” Newsday, March 19, 2001, p. C18.

 7. See F. T. Knickerbocker, Oligopolistic Reaction and Multinational Enterprise (Boston: Harvard Business School Press, 1973); R. E. Caves, “Japanese Investment in the U.S.: Lessons for the

Economic Analysis of Foreign Investment,” The World Economy 16 (1993), pp. 279–300.

 8. I. Metthee, “Playing a Large Part,” Seattle Post-Intelligencer, April 9, 1994, p. 13.

 9. R. B. Reich, The Work of Nations (New York: Knopf, 1991).

10. United Nations, “About the United Nations,” http://www.un. org/en/about-un/

11. J. A. Frankel, “Globalization of the Economy,” National Bureau of Economic Research, working paper no. 7858, 2000.

12. J. Bhagwati, Protectionism (Cambridge, MA: MIT Press, 1989).

13. F. Williams, “Trade Round Like This May Never Be Seen Again,” Financial Times, April 15, 1994, p. 8.

14. United Nations Sustainable Development Goals, 2015. http://www. un.org/sustainabledevelopment/sustainable-development-goals/

Globalization Chapter 1 37

15. United Nations Conference on Trade and Investment, June 22, 2017.

16. United Nations, World Investment Report, 2015.

17. Moore’s law is named after Intel founder Gordon Moore.

18. Data compiled from various sources and listed at www.internetworldstats.com/stats.htm.

19. From www.census.gov/mrts/www/ecomm.html. See also S. Fiegerman, “Ecommerce Is Now a Trillion Dollar Industry,” Mashable Business, February 5, 2013.

20. For a counterpoint, see “Geography and the Net: Putting It in Its Place,” The Economist, August 11, 2001, pp. 18–20.

21. International Chamber of Shipping, Key Facts, www.ics-shipping.org/shipping-facts/key-facts.

22. Frankel, “Globalization of the Economy.”

23. Raj Kumar Ray, “India’s Economy to Become 3rd Largest, Sur- pass Japan, Germany by 2030,” Hindustan Times, April 28, 2017.

24. N. Hood and J. Young, The Economics of the Multinational Enterprise (New York: Longman, 1973).

25. S. Chetty, “Explosive International Growth and Problems of Success Among Small and Medium Sized Firms,” International Small Business Journal, February 2003, pp. 5–28.

26. R. A. Mosbacher, “Opening Up Export Doors for Smaller Firms,” Seattle Times, July 24, 1991, p. A7.

27. “Small Companies Learn How to Sell to the Japanese,” Seattle Times, March 19, 1992.

28. W. J. Holstein, “Why Johann Can Export, but Johnny Can’t,” BusinessWeek, November 3, 1991. Archived at http://www.businessweek.com/stories/1991-11-03/why-johann- can-export-but-johnny-cant.

29. N. Buckley and A. Ostrovsky, “Back to Business—How Putin’s Allies Are Turning Russia into a Corporate State,” Financial Times, June 19, 2006, p. 11.

30. J. E. Stiglitz, Globalization and Its Discontents (New York: W. W. Norton, 2003); J. Bhagwati, In Defense of Globalization (New York: Oxford University Press, 2004); Friedman, The World Is Flat.

31. See, for example, Ravi Batra, The Myth of Free Trade (New York: Touchstone Books, 1993); William Greider, One World, Ready or Not: The Manic Logic of Global Capitalism (New York: Simon & Schuster, 1997); D. Radrik, Has Globalization Gone Too Far? (Washington, DC: Institution for International Economics, 1997).

32. E. Goldsmith, “The Winners and the Losers,” in The Case Against the Global Economy, ed. J. Mander and E. Goldsmith (San Francisco: Sierra Club, 1996); Lou Dobbs, Exporting America (New York: Time Warner Books, 2004).

33. D. L. Bartlett and J. B. Steele, “America: Who Stole the Dream,” Philadelphia Inquirer, September 9, 1996.

34. For example, see Paul Krugman, Pop Internationalism (Cambridge, MA: MIT Press, 1996).

35. For example, see B. Milanovic and L. Squire, “Does Tariff Liber- alization Increase Wage Inequality?” National Bureau of Eco- nomic Research, working paper no. 11046, January 2005; B. Milanovic, “Can We Discern the Effect of Globalization on Income Distribution?” World Bank Economic Review 19 (2005), pp. 21–44. Also see the summary in Thomas Piketty, “The Globalization of Labor,” in Capital in the Twenty First Century (Cambridge, MA: Harvard University Press, 2014).

36. See Piketty, “The Globalization of Labor.”

37. A. Ebenstein, A. Harrison, M. McMillam, and S. Phillips, “Estimating the Impact of Trade and Offshoring on American

Workers Using the Current Population Survey,” Review of Economics and Statistics 67 (October 2014), pp. 581–95.

38. M. Forster and M. Pearson, “Income Distribution and Poverty in the OECD Area,” OECD Economic Studies 34 (2002); OECD, “Growing Income Inequality in OECD Countries,” OECD Forum, May 2, 2011.

39. See Piketty, “The Globalization of Labor.”

40. See Krugman, Pop Internationalism; D. Belman and T. M. Lee, “International Trade and the Performance of U.S. Labor Mar- kets,” in U.S. Trade Policy and Global Growth, ed. R. A. Blecker (New York: Economic Policy Institute, 1996).

41. R. B. Freeman (2006), “Labor Market Imbalances: Shortages, Surpluses, or What?” Volume 51, Conference Series, Federal Reserve Bank of Boston.

42. E. Goldsmith, “Global Trade and the Environment,” in The Case Against the Global Economy, eds. J. Mander and E. Goldsmith (San Francisco: Sierra Club, 1996).

43. P. Choate, Jobs at Risk: Vulnerable U.S. Industries and Jobs Under NAFTA (Washington, DC: Manufacturing Policy Project, 1993).

44. Ibid.

45. B. Lomborg, The Skeptical Environmentalist (Cambridge, UK: Cambridge University Press, 2001).

46. H. Nordstrom and S. Vaughan, Trade and the Environment, World Trade Organization Special Studies No. 4 (Geneva: WTO, 1999).

47. Figures are from “Freedom’s Journey: A Survey of the 20th Century. Our Durable Planet,” The Economist, September 11, 1999, p. 30.

48. For an exhaustive review of the empirical literature, see B. R. Copeland and M. Scott Taylor, “Trade, Growth and the Envi- ronment,” Journal of Economic Literature, March 2004, pp. 7–77.

49. G. M. Grossman and A. B. Krueger, “Economic Growth and the Environment,” Quarterly Journal of Economics 110 (1995), pp. 353–78.

50. For an economic perspective on climate change, see William Nordhouse, The Climate Casino (Princeton, NJ: Yale University Press, 2013).

51. Krugman, Pop Internationalism.

52. R. Kuttner, “Managed Trade and Economic Sovereignty,” in U.S. Trade Policy and Global Growth, ed. R. A. Blecker (New York: Economic Policy Institute, 1996).

53. Ralph Nader and Lori Wallach, “GATT, NAFTA, and the Subversion of the Democratic Process,” U.S. Trade Policy and Global Growth, ed. R. A. Blecker (New York: Economic Policy Institute, 1996), pp. 93–94.

54. Lant Pritchett, “Divergence, Big Time,” Journal of Economic Perspectives 11, no. 3 (Summer 1997), pp. 3–18. The data are from the World Bank’s World Development Indicators, 2015.

55. Ibid.

56. W. Easterly, “How Did Heavily Indebted Poor Countries Become Heavily Indebted?” World Development, October 2002, pp. 1677–96; J. Sachs, The End of Poverty (New York: Penguin Books, 2006).

57. See D. Ben-David, H. Nordstrom, and L. A. Winters, Trade, Income Disparity and Poverty. World Trade Organization Special Studies No. 5 (Geneva: WTO, 1999).

58. William Easterly, “Debt Relief,” Foreign Policy, November– December 2001, pp. 20–26.

59. Jeffrey Sachs, “Sachs on Development: Helping the World’s Poorest,” The Economist, August 14, 1999, pp. 17–20.

60. World Trade Organization, Annual Report 2003 (Geneva: WTO, 2004).

National Differences in Political, Economic, and Legal Systems L E A R N I N G O B J E C T I V E S Af ter reading this chapter, you will be able to:

LO2-1 Understand how the political systems of countries differ.

LO2-2 Understand how the economic systems of countries differ.

LO2-3 Understand how the legal systems of countries differ.

LO2-4 Explain the implications for management practice of national differences in political economy.

part two National Dif ferences

2

©Philimon Bulawayo/Reuters

The Decline of Zimbabwe

agricultural sector. The land was given to members of the ZANU-PF party and other supporters of Mugabe, who lacked experience with modern agricultural practices or had never farmed at all. In the wake of the land reform program, agricultural productivity slumped, and the coun- try is now a net importer of food.  The country’s mining sector remains potentially lucra- tive, with large platinum and diamond deposits mined by private enterprises, but almost all of the licensing revenues due to the state have reportedly disappeared into the hands of army officers and ZANU-PF politicians. Taxes and tariffs are high for private enterprises, which discourages private business formation, while state-owned enterprises are strongly subsidized. Tourism, once a big revenue earner, has declined as Zimbabwe’s wildlife has been dec- imated by poaching and deforestation. As economic activ- ity slumped, the country’s formal unemployment rate reached a staggering 80 percent.  To complicate matters, Zimbabwe was devastated by the AIDS epidemic, with HIV infection rates hitting a high of 40 percent of the population in 1998. Due to AIDS and other public health problems, life expectancy fell to just 43.1 years in 2003, down from 61.6 years in 1986. By 2014, with HIV prevalence down to 15 percent, life expectancy had risen back to 54 years. With tax revenues collapsing, Mugabe funded gov- ernment programs by printing money. Inflation quickly spiraled out of control, reaching 231,000,000 percent in 2008 and requiring the Central Bank to introduce a 100  trillion Zimbabwe dollar note! In April 2009, the Zimbabwe dollar was suspended (at the time the trillion dollar note was worth around $0.40 USD). Zimbabwe allowed trade to be conducted using other currencies, particularly the U.S. dollar, the South Africa rand, the euro, and the British pound. Despite the country’s economic implosion, the World Bank still believes that Zimbabwe has enormous potential for sustained economic growth given its generous endow- ment of natural resources, its existing stock of public infra- structure, and its comparatively skilled human resources. However, attaining that potential will require a change in leadership and policies. Mugabe showed no signs of giv- ing up the reins of power. However, in late 2017 he was forced to resign after a military coup.

Sources: “How Robert Mugabe Ruined Zimbabwe,” The Economist, February 26, 2017; Irwin Chifera, “What Happened to Zimbabwe, Once Known as the Jewel of Africa?” VoaZimbabwe, April 17, 2015; “The Real Balancing Rocks on Every Zimbabwe Dollar,” Slate, January 23, 2017; “Diamonds in the Rough,” Human Rights Watch Report, June 26, 2009; “Zimbabwe,” The World Bank, http://www.worldbank.org/en/ country/zimbabwe/overview.

O P E N I N G C A S E In 1980, the southern African state of Zimbabwe gained independence from its colonial master, Great Britain. Speaking at the time, the late Tanzanian president, Julius Nyerere, described Zimbabwe as “the jewel of Africa.” It was a country that boasted a strong economy, abundant natural resources, and a vibrant agricultural sector. As part of the independence process, the British bequeathed Zimbabwe with democratic political institutions. Zimbabwe’s birth as an independent nation was a diffi- cult one. In 1965, the minority white rulers of what was then known as Rhodesia unilaterally declared independence from Britain, setting up an apartheid state where blacks were excluded from power. The British government wanted majority rule, stated that the declaration of inde- pendence was an illegal rebellion, and imposed sanctions on Rhodesia. Other nations that followed suit included the United States. An armed conflict followed with two guerrilla movements waging war against Rhodesia’s white govern- ment. One of those guerrilla movements, the Zimbabwe African National Union (ZANU), was headed by Robert Mugabe, who aligned himself and his movement with the Maoist version of communism. A combination of interna- tional sanctions and guerrilla activity eventually forced the white minority rulers of Rhodesia to end their rebellion. In 1979, Rhodesia reverted to British colonial status.  The following year, Zimbabwe gained legal indepen- dence. Robert Mugabe was elected as the country’s first prime minister. For most of 2017 Mugabe was still in power, then as president. His ZANU-PF party won every election since independence. Once a largely ceremonial position, Mugabe systematically consolidated power in the presidency and restricted his political opponents. He was reelected as president in 2013 in a general election that, like many in the Mugabe era, was widely seen as rigged. The country is also beset by endemic corruption. Corruption watchdog Transparency International recently ranked Zimbabwe as one of the most corrupt nations in the world.  Zimbabwe’s economic performance in recent years ranks among the worst in the world. Although the econ- omy maintained a positive economic growth rate through the 1980s and 1990s, things have deteriorated rapidly since 2000. Between 1999 and 2009, Zimbabwe saw the lowest economic growth rate ever recorded, with an annual decline of 6.1 percent per annum in GDP. The de- cline occurred after Mugabe launched a “fast-track” land reform program that encouraged the seizure without com- pensation of land owned by white farmers. At the time, white farmers were the backbone of the country’s strong

39

40 Part 2 National Differences

Introduction

International business is much more complicated than domestic business because coun- tries differ in many ways. Countries have different political, economic, and legal systems. They vary significantly in their level of economic development and future economic growth trajectory. Cultural practices can vary dramatically, as can the education and skill levels of the population. All these differences can and do have major implications for the practice of international business. They have a profound impact on the benefits, costs, and risks associated with doing business in different countries; the way in which operations in different countries should be managed; and the strategy international firms should pursue in different countries. The main function of this chapter and the next two is to develop an awareness of and appreciation for the significance of country differences in political systems, economic systems, legal systems, economic development, and societal culture. Another function of the three chapters is to describe how the political, economic, legal, and cultural systems of many of the world’s nation-states are evolving and to draw out the implications of these changes for the practice of international business.

This chapter focuses on how the political, economic, and legal systems of countries dif- fer. Collectively, we refer to these systems as constituting the political economy of a coun- try. We use the term political economy to stress that the political, economic, and legal systems of a country are interdependent; they interact with and influence each other, and in doing so, they affect the level of economic well-being. In Chapter 3, we build on the concepts discussed here to explore in detail how differences in political, economic, and legal systems influence the economic development of a nation-state and its likely future growth trajectory. In Chapter 4, we look at differences in societal culture and at how these differences influence the practice of international business. Moreover, as we will see in Chapter 4, societal culture has an influence on the political, economic, and legal systems in a nation and thus its level of economic well-being. We also discuss how the converse may occur: how political, economic, and legal systems may also shape societal culture.

The opening case illustrates some of the issues discussed in this chapter. Zimbabwe gained its independence from the British in 1980. Although the British left the country with democratic institutions, the country has effectively become a one-party state with limited political freedom and was led by one man, Robert Mugabe, for 37 years. Under Mugabe’s economic mismanagement, the once-thriving economy has collapsed. Property rights have been violated; corruption has become endemic; private enterprise has been discouraged by regulations, taxes, and corruption; inflation surged out of control; more than 80 percent of the population is now unemployed; and life expectancy has declined. Poor economic policies have effectively transformed an economy that once held out great promise into one that cur- rently offers few opportunities for international businesses. In many respects, Zimbabwe is a case study in how not to run a country. That being said, a change in economic policies could still unlock the substantial potential over the country.

G E T I N S I G H T S B Y C O U N T R Y

The “Get Insights by Country” section of globalEDGETM (globaledge.msu.edu/global- insights/by/country) is your source for information and statistical data for nearly every coun- try around the world (more than 200 countries). As related to Chapter 2 of the text, glo- balEDGETM has a wealth of information and data on national differences in political economy. These differences are available across a dozen menu categories in the country sections (e.g., economy, history, government, culture, risk). The “Executive Memos” on each country page are also great for abbreviated fingertip access to current information. At a minimum, we suggest that you take a look at the country pages of the United Kingdom and Sweden because the authors of this text are from those countries—have you figured out who is from the UK and who is from Sweden yet?

National Differences in Political, Economic, and Legal Systems Chapter 2 41

Political Systems

The political system of a country shapes its economic and legal systems.1 As such, we need to understand the nature of different political systems before discussing economic and le- gal systems. By political system, we mean the system of government in a nation. Political systems can be assessed according to two dimensions. The first is the degree to which they emphasize collectivism as opposed to individualism. The second is the degree to which they are democratic or totalitarian. These dimensions are interrelated; systems that empha- size collectivism tend to lean toward totalitarianism, whereas those that place a high value on individualism tend to be democratic. However, a large gray area exists in the middle. It is possible to have democratic societies that emphasize a mix of collectivism and individu- alism. Similarly, it is possible to have totalitarian societies that are not collectivist.

COLLECTIVISM AND INDIVIDUALISM

Collectivism refers to a political system that stresses the primacy of collective goals over individual goals.2 When collectivism is emphasized, the needs of society as a whole are generally viewed as being more important than individual freedoms. In such circum- stances, an individual’s right to do something may be restricted on the grounds that it runs counter to “the good of society” or to “the common good.” Advocacy of collectivism can be traced to the ancient Greek philosopher Plato (427–347 b.c.), who, in The Republic, argued that individual rights should be sacrificed for the good of the majority and that property should be owned in common. Plato did not equate collectivism with equality; he believed that society should be stratified into classes, with those best suited to rule (which for Plato, naturally, were philosophers and soldiers) administering society for the benefit of all. In modern times, the collectivist mantle has been picked up by socialists.

Socialism Modern socialists trace their intellectual roots to Karl Marx (1818–1883), although so- cialist thought clearly predates Marx (elements of it can be traced to Plato). Marx argued that the few benefit at the expense of the many in a capitalist society where individual freedoms are not restricted. While successful capitalists accumulate considerable wealth, Marx postulated that the wages earned by the majority of workers in a capitalist society would be forced down to subsistence levels. He argued that capitalists expropriate for their own use the value created by workers, while paying workers only subsistence wages in re- turn. According to Marx, the pay of workers does not reflect the full value of their labor. To correct this perceived wrong, Marx advocated state ownership of the basic means of production, distribution, and exchange (i.e., businesses). His logic was that if the state owned the means of production, the state could ensure that workers were fully compen- sated for their labor. Thus, the idea is to manage state-owned enterprise to benefit society as a whole, rather than individual capitalists.3

In the early twentieth century, the socialist ideology split into two broad camps. The communists believed that socialism could be achieved only through violent revolution and totalitarian dictatorship, whereas the social democrats committed themselves to achieving socialism by democratic means, turning their backs on violent revolution and dictatorship. Both versions of socialism waxed and waned during the twentieth century.

The communist version of socialism reached its high point in the late 1970s, when the majority of the world’s population lived in communist states. The countries under Communist Party rule at that time included the former Soviet Union; its eastern European client nations (e.g., Poland, Czechoslovakia, Hungary); China; the Southeast Asian nations of Cambodia, Laos, and Vietnam; various African nations (e.g., Angola and Mozambique); and the Latin American nations of Cuba and Nicaragua. By the mid-1990s, however, communism was in retreat worldwide. The Soviet Union had collapsed and had been replaced by a collection of 15 republics, many of which were at least nominally structured as democracies. Communism was swept out of eastern Europe by the largely

LO 2-1 Understand how the political systems of countries differ.

42 Part 2 National Differences

bloodless revolutions of 1989. Although China is still nominally a communist state with substantial limits to individual political freedom, in the economic sphere, the country has moved sharply away from strict adherence to communist ideology. Old-style communism, with state control over all economic activity, hangs on in only a handful of small fringe states, most notably North Korea.

Social democracy also seems to have passed a high-water mark, although the ideology may prove to be more enduring than communism. Social democracy has had perhaps its greatest inf luence in a number of democratic Western nations, including Australia, Denmark, Finland, France, Germany, Great Britain, Norway, Spain, and Sweden, where social democratic parties have often held political power. Other countries where social democracy has had an important influence include India and Brazil. Consistent with their Marxist roots, after World War II social democratic government in some nations national- ized some private companies, transforming them into state-owned enterprises to be run for the “public good rather than private profit.” This trend was most marked in Great Britain where by the end of the 1970s state-owned companies had a monopoly in the telecommu- nications, electricity, gas, coal, railway, and shipbuilding industries, as well as substantial interests in the oil, airline, auto, and steel industries.

However, experience demonstrated that state ownership of the means of production ran counter to the public interest. In many countries, state-owned companies performed poorly. Protected from competition by their monopoly position and guaranteed govern- ment financial support, many became increasingly inefficient. Individuals paid for the luxury of state ownership through higher prices and higher taxes. As a consequence, a number of Western democracies voted many social democratic parties out of office in the late 1970s and early 1980s. They were succeeded by political parties, such as Britain’s Conservative Party and Germany’s Christian Democratic Party, that were more commit- ted to free market economics. These parties sold state-owned enterprises to private inves- tors (a process referred to as privatization). Even where social democratic parties regained the levers of power, as in Great Britain in 1997 when the left-leaning Labor Party won control of the government, they too were now committed to continued private ownership.

Individualism The opposite of collectivism, individualism refers to a philosophy that an individual should have freedom in his or her economic and political pursuits. In contrast to collectiv- ism, individualism stresses that the interests of the individual should take precedence over the interests of the state. Like collectivism, individualism can be traced to an ancient Greek philosopher, in this case Plato’s disciple Aristotle (384–322 b.c.). In contrast to Plato, Aristotle argued that individual diversity and private ownership are desirable. In a passage that might have been taken from a speech by contemporary politicians who adhere to a free market ideology, he argued that private property is more highly productive than communal property and will thus stimulate progress. According to Aristotle, communal property receives little care, whereas property that is owned by an individual will receive the greatest care and therefore be most productive.

Individualism was reborn as an influential political philosophy in the Protestant trading nations of England and the Netherlands during the sixteenth century. The philosophy was refined in the work of a number of British philosophers, including David Hume (1711–1776), Adam Smith (1723–1790), and John Stuart Mill (1806–1873). Individualism exercised a profound influence on those in the American colonies that sought indepen- dence from Great Britain. Indeed, the concept underlies the ideas expressed in the Declaration of Independence. In the twentieth century, several Nobel Prize–winning economists—including Milton Friedman, Friedrich von Hayek, and James Buchanan— championed the philosophy.

Individualism is built on two central tenets. The first is an emphasis on the importance of guaranteeing individual freedom and self-expression. The second tenet of individualism is that the welfare of society is best served by letting people pursue their own economic self-interest, as opposed to some collective body (such as government) dictating what is in

National Differences in Political, Economic, and Legal Systems Chapter 2 43

society’s best interest. Or, as Adam Smith put it in a famous passage from The Wealth of Nations, “an individual who intends his own gain is led by an invisible hand to promote an end that was no part of his intention. Nor is it always worse for the society that it was no part of it. By pursuing his own interest, he frequently promotes that of the society more effectually than when he really intends to promote it. This author has never known much good done by those who effect to trade for the public good.”4

The central message of individualism, therefore, is that individual economic and politi- cal freedoms are the ground rules on which a society should be based. This puts individual- ism in conflict with collectivism. Collectivism asserts the primacy of the collective over the individual; individualism asserts the opposite. This underlying ideological conflict shaped much of the recent history of the world. The Cold War, for example, was in many respects a war between collectivism, championed by the former Soviet Union, and indi- vidualism, championed by the United States. From the late 1980s until about 2005, the waning of collectivism was matched by the ascendancy of individualism. Democratic ide- als and market economics replaced socialism and communism in many states. Since 2005, there have been some signs of a small swing back toward left-leaning socialist ideas in sev- eral countries, including several Latin America nations such as Venezuela, Bolivia, and Paraguay, along with Russia (see the Country Focus for details). Also, the global financial crisis of 2008–2009 caused some reevaluation of the trends towards individualism, and it remains possible that the pendulum might tilt back the other way.

DEMOCRACY AND TOTALITARIANISM

Democracy and totalitarianism are at different ends of a political dimension. Democracy refers to a political system in which government is by the people, exercised either directly or through elected representatives. Totalitarianism is a form of government in which one person or political party exercises absolute control over all spheres of human life and pro- hibits opposing political parties. The democratic–totalitarian dimension is not indepen- dent of the individualism–collectivism dimension. Democracy and individualism go hand in hand, as do the communist version of collectivism and totalitarianism. However, gray areas exist; it is possible to have a democratic state in which collective values predominate, and it is possible to have a totalitarian state that is hostile to collectivism and in which some degree of individualism—particularly in the economic sphere—is encouraged. For example, China and Vietnam have seen a move toward greater individual freedom in the economic sphere, but those countries are stilled ruled by parties that have a monopoly on political power and constrain political freedom.

Democracy The pure form of democracy, as originally practiced by several city-states in ancient Greece, is based on a belief that citizens should be directly involved in decision making. In complex, advanced societies with populations in the tens or hundreds of millions, this is impractical. Most modern democratic states practice representative democracy. The United States, for example, is a constitutional republic that operates as a representative democracy. In a representative democracy, citizens periodically elect individuals to represent them. These elected representatives then form a government whose function is to make decisions on behalf of the electorate. In a representative democracy, elected representatives who fail to perform this job adequately will be voted out of office at the next election. To guarantee that elected representatives can be held accountable for their actions by the electorate, an ideal representative democracy has a number of safeguards that are typi- cally enshrined in constitutional law. These include (1) an individual’s right to freedom of expression, opinion, and organization; (2) a free media; (3) regular elections in which all eligible citizens are allowed to vote; (4) universal adult suffrage; (5) limited terms for elected representatives; (6) a fair court system that is independent from the political system; (7) a nonpolitical state bureaucracy; (8) a nonpolitical police force and armed service; and (9) relatively free access to state information.5

C O U N T R Y F O C U S

44

Putin’s Russia The modern Russian state was born in 1991 after the dra- matic collapse of the Soviet Union. Early in the post-Soviet era, Russia embraced ambitious policies designed to transform a communist dictatorship with a centrally planned economy into a democratic state with a market- based economic system. The policies, however, were im- perfectly implemented. Political reform left Russia with a strong presidency that—in hindsight—had the ability to subvert the democratic process. On the economic front, the privatization of many state-owned enterprises was done in such a way as to leave large shareholdings in the hands of the politically connected, many of whom were party officials and factory managers under the old Soviet system. Corruption was also endemic, and organized crime was able to seize control of some newly privatized enterprises. In 1998, the poorly managed Russian econ- omy went through a financial crisis that nearly bought the country to its knees. Fast-forward to 2017, and Russia still has a long way to go before it resembles a modern democracy with a func- tioning free market–based economic system. On the posi- tive side, the economy grew at a healthy clip during most of the 2000s, helped in large part by high prices for oil and gas, Russia’s largest exports (in 2013 oil and gas ac- counted for 75 percent of all Russian exports). Between 2000 and 2013, Russia’s gross domestic product (GDP) per capita more than doubled when measured by pur- chasing power parity. The country now boasts the world’s

12th-largest economy. Thanks to government oil revenues, public debt is also low by international standards—at just 12 percent of GDP in 2016 (in the United States, by com- parison, public debt amounts to 70 percent of GDP). In- deed, Russia has run a healthy trade surplus on the back of strong oil and gas exports for the last decade. On the other hand, the economy is overly dependent on commodities, particularly oil and gas. This was exposed in mid-2014 when the price of oil started to tumble as a result of rapidly increasing supply from the United States. Between mid-2014 and early 2016, the price of oil fell from $110 a barrel to a low of around around $27 before rebounding to $50. This drove a freight train through Russia’s public finances. Much of Russia’s oil and gas pro- duction remains in the hands of enterprises in which the state still has a significant ownership stake. The govern- ment has a controlling ownership position in Gazprom and Rosneft, two of the country’s largest oil and gas compa- nies. The government used the rise in oil and gas reve- nues between 2004 and 2014 to increase public spending through state-led investment projects and increases in wages and pensions for government workers. While this boosted private consumption, there has been a dearth of private investment, and productivity growth remains low. This is particularly true among many state-owned enter- prises that collectively still account for about half of the Russian economy. Now with lower oil prices, Russia is hav- ing to issue more debt to finance public spending. 

Totalitarianism In a totalitarian country, all the constitutional guarantees on which representative democ- racies are built—an individual’s right to freedom of expression and organization, a free media, and regular elections—are denied to the citizens. In most totalitarian states, politi- cal repression is widespread, free and fair elections are lacking, media are heavily cen- sored, basic civil liberties are denied, and those who question the right of the rulers to rule find themselves imprisoned or worse.

Four major forms of totalitarianism exist in the world today. Until recently, the most widespread was communist totalitarianism. Communism, however, is in decline world- wide, and most of the Communist Party dictatorships have collapsed since 1989. Excep- tions to this trend (so far) are China, Vietnam, Laos, North Korea, and Cuba, although most of these states exhibit clear signs that the Communist Party’s monopoly on political power is eroding. In many respects, the governments of China, Vietnam, and Laos are communist in name only because those nations have adopted wide-ranging, market-based economic reforms. They remain, however, totalitarian states that deny many basic civil liberties to their populations. On the other hand, there are signs of a swing back toward communist totalitarian ideas in some states, such as Venezuela, where the government of

Russian private enterprises are also hamstrung by bu- reaucratic red tape and endemic corruption. The World Bank ranks Russia 92nd in the world in terms of the ease of doing business and 88th when it comes to starting a business (for comparison, the United States is ranked 4th and 20th, respectively). Transparency International, which ranks countries by the extent of corruption, ranked Russia 131 out of 176 nations in 2016. The state and state-owned enterprises are famous for pushing work to private enter- prises that are owned by political allies, which further sub- verts market-based processes. On the political front, Russia is becoming less demo- cratic with every passing year. Since 1999, Vladimir Putin has exerted increasingly tight control over Russian politics, either as president or as prime minister. Under Putin, potential opponents have been sidelined, civil liberties have been progressively reduced, and the freedom of the press has been diminished. For example, in response to opposition protests in 2011 and 2012, the Russian govern- ment passed laws increasing its control over the Internet, dramatically raising fines for participating in “unsanctioned” street protests, and expanded the definition of treason to further limit opposition activities. Vocal opponents of the régime—from business executives who do not tow the state line to protest groups such as the punk rock protest band Pussy Riot—have found themselves jailed on dubi- ous charges. To make matters worse, Putin has recently been tightening his grip on the legal system. In late 2013, Russia’s parliament, which is dominated by Putin support- ers, gave the president more power to appoint and fire prosecutors, thereby diminishing the independence of the legal system.

Freedom House, which produces an annual ranking tracking freedom in the world, classifies Russia as “not free” and gives it low scores for political and civil liberties. Freedom House notes that in the March 2012 presidential elections, Putin benefited from preferential treatment by state-owned media, numerous abuses of incumbency, and procedural “irregularities” during the vote count. Putin won 63.6 percent of the vote against a field of weak, hand- chosen opponents, led by Communist Party leader Gen- nadiy Zyuganove, with 17.2 percent of the vote. Under a Putin-inspired 2008 constitutional amendment, the term of the presidency was expanded from four years to six. Putin will be eligible for another six-year term in 2018. In 2014, Putin burnished his growing reputation for authori- tarianism when he took advantage of unrest in the neighbor- ing country of Ukraine to annex the Crimea region and to support armed revolt by Russian-speaking separatists in east- ern Ukraine. Western powers responded to this aggression by imposing economic sanctions on Russia. Taken together with the rapid fall in oil prices, this pushed the once-booming Russian economy into a recession. In 2014, the economy grew by just 0.6 percent, while the Russian ruble tumbled, losing half of its value against other major currencies. The economy contracted by 3.7 percent in 2015 and another 0.6 percent in 2016. Despite economic weaknesses, however, there is no sign that Putin’s hold on power has been dimin- ished; in fact, quite the opposite seems to have occurred.

Sources: “Putin’s Russia: Sochi or Bust,” The Economist, February 1, 2014; “Russia’s Economy: The S Word,” The Economist, November 9, 2013; Freedom House, Freedom in the World 2015: Russia, www.freedomhouse.org; K. Hille, “Putin Tightens Grip on Legal Sys- tem,” Financial Times, November 27, 2013.

45

the late Hugo Chávez displayed totalitarian tendencies. The same is true in Russia, where the government of Vladimir Putin has become increasingly totalitarian over time (see the Country Focus).

A second form of totalitarianism might be labeled theocratic totalitarianism. Theo- cratic totalitarianism is found in states where political power is monopolized by a party, group, or individual that governs according to religious principles. The most common form of theocratic totalitarianism is based on Islam and is exemplified by states such as Iran and Saudi Arabia. These states limit freedom of political and religious expression with laws based on Islamic principles.

A third form of totalitarianism might be referred to as tribal totalitarianism. Tribal to- talitarianism has arisen from time to time in African countries such as Zimbabwe, Tanzania, Uganda, and Kenya. The borders of most African states reflect the administrative boundar- ies drawn by the old European colonial powers rather than tribal realities. Consequently, the typical African country contains a number of tribes (e.g., in Kenya there are more than 40 tribes). Tribal totalitarianism occurs when a political party that represents the interests of a particular tribe (and not always the majority tribe) monopolizes power. In Kenya, for example, politicians from the Kikuyu tribe long dominated the political system.

46 Part 2 National Differences

A fourth major form of totalitarianism might be described as right-wing totalitarianism. Right-wing totalitarianism generally permits some individual economic freedom but re- stricts individual political freedom, frequently on the grounds that it would lead to the rise of communism. A common feature of many right-wing dictatorships is an overt hostility to socialist or communist ideas. Many right-wing totalitarian governments are backed by the military, and in some cases, the government may be made up of military officers. The fas- cist regimes that ruled Germany and Italy in the 1930s and 1940s were right-wing totalitar- ian states. Until the early 1980s, right-wing dictatorships, many of which were military dictatorships, were common throughout Latin America (e.g., Brazil was ruled by a mili- tary dictatorship between 1964 and 1985). They were also found in several Asian coun- tries, particularly South Korea, Taiwan, Singapore, Indonesia, and the Philippines. Since the early 1980s, however, this form of government has been in retreat. Most Latin American countries are now genuine multiparty democracies. Similarly, South Korea, Taiwan, and the Philippines have all become functioning democracies, as has Indonesia.

Pseudo-Democracies Many of the world’s nations are neither pure democracies nor iron-clad totalitarian states. Rather they lie between pure democracies and complete totalitarian systems of government. They might be described as imperfect or pseudo-democracies, where authoritarian elements have captured some or much of the machinery of state and use this in an attempt to deny basic political and civil liberties. In the Russia of Vladimir Putin, for example, elections are still held, people compete through the ballot box for political office, and the independent press does not always tow the official line. However, Putin has used his position to system- atically limit the political and civil liberties of opposition groups. His control is not yet perfect, though. Voices opposing Putin are still heard in Russia, and in theory, elections are still contested. But in practice, it is becoming increasingly difficult to challenge a man and régime that has systematically extended its political, legal, and economic power over the past 15 years (see the Country Focus). Zimbabwe too, is nominally a democratic state, but democratic institutions have been subverted by Robert Mugabe and his ZANU-PF party, which has had a near monopoly on political power since 1980 (see the opening case).

Economic Systems

It should be clear from the previous section that political ideology and economic systems are connected. In countries where individual goals are given primacy over collective goals, we are more likely to find market-based economic systems. In contrast, in countries where collective goals are given preeminence, the state may have taken control over many enter- prises; markets in such countries are likely to be restricted rather than free. We can iden- tify three broad types of economic systems: a market economy, a command economy, and a mixed economy.

MARKET ECONOMY

In the archetypal pure market economy, all productive activities are privately owned, as opposed to being owned by the state. The goods and services that a country produces are not planned by anyone. Production is determined by the interaction of supply and demand and signaled to producers through the price system. If demand for a product exceeds sup- ply, prices will rise, signaling producers to produce more. If supply exceeds demand, prices will fall, signaling producers to produce less. In this system, consumers are sovereign. The purchasing patterns of consumers, as signaled to producers through the mechanism of the price system, determine what is produced and in what quantity.

For a market to work in this manner, supply must not be restricted. A supply restriction occurs when a single firm monopolizes a market. In such circumstances, rather than in- crease output in response to increased demand, a monopolist might restrict output and let prices rise. This allows the monopolist to take a greater profit margin on each unit it sells.

TEST PREP Use SmartBook to help retain what you have learned. Access your instructor’s Connect course to check out SmartBook or go to learnsmartadvantage.com for help.

LO 2-2 Understand how the economic systems of countries differ.

National Differences in Political, Economic, and Legal Systems Chapter 2 47

Although this is good for the monopolist, it is bad for the consumer, who has to pay higher prices. It also is probably bad for the welfare of society. Because a monopolist has no com- petitors, it has no incentive to search for ways to lower production costs. Rather, it can simply pass on cost increases to consumers in the form of higher prices. The net result is that the monopolist is likely to become increasingly inefficient, producing high-priced, low-quality goods, and society suffers as a consequence.

Given the dangers inherent in monopoly, one role of government in a market economy is to encourage vigorous free and fair competition between private producers. Govern- ments do this by banning restrictive business practices designed to monopolize a market (antitrust laws serve this function in the United States and European Union). Private own- ership also encourages vigorous competition and economic efficiency. Private ownership ensures that entrepreneurs have a right to the profits generated by their own efforts. This gives entrepreneurs an incentive to search for better ways of serving consumer needs. That may be through introducing new products, by developing more efficient production pro- cesses, by pursuing better marketing and after-sale service, or simply through managing their businesses more efficiently than their competitors. In turn, the constant improve- ment in product and process that results from such an incentive has been argued to have a major positive impact on economic growth and development.6

COMMAND ECONOMY

In a pure command economy, the government plans the goods and services that a coun- try produces, the quantity in which they are produced, and the prices at which they are sold. Consistent with the collectivist ideology, the objective of a command economy is for government to allocate resources for “the good of society.” In addition, in a pure command economy, all businesses are state owned, the rationale being that the government can then direct them to make investments that are in the best interests of the nation as a whole rather than in the interests of private individuals. Historically, command economies were found in communist countries where collectivist goals were given priority over individual goals. Since the demise of communism in the late 1980s, the number of command

North Korean leader Kim Jong-un visiting a factory. ©AFP/Getty Images

48 Part 2 National Differences

economies has fallen dramatically. Some elements of a command economy were also evi- dent in a number of democratic nations led by socialist-inclined governments. France and India both experimented with extensive government planning and state ownership, although government planning has fallen into disfavor in both countries.

While the objective of a command economy is to mobilize economic resources for the public good, the opposite often seems to have occurred. In a command economy, state- owned enterprises have little incentive to control costs and be efficient because they cannot go out of business. Also, the abolition of private ownership means there is no in- centive for individuals to look for better ways to serve consumer needs; hence, dynamism and innovation are absent from command economies. Instead of growing and becoming more prosperous, such economies tend to stagnate.

MIXED ECONOMY

Mixed economies can be found between market and command economies. In a mixed economy, certain sectors of the economy are left to private ownership and free market mechanisms, while other sectors have significant state ownership and government plan- ning. Mixed economies were once common throughout much of the developed world, al- though they are becoming less so. Until the 1980s, Great Britain, France, and Sweden were mixed economies, but extensive privatization has reduced state ownership of busi- nesses in all three nations. A similar trend occurred in many other countries where there was once a large state-owned sector, such as Brazil, Italy, and India (although there are still state-owned enterprises in all of these nations). As a counterpoint, the involvement of the state in economic activity has been on the rise again in countries such as Russia and Venezuela, where authoritarian regimes have seized control of the political structure, typi- cally by first winning power through democratic means and then subverting those same structures to maintain their grip on power.

In mixed economies, governments also tend to take into state ownership troubled firms whose continued operation is thought to be vital to national interests. For example, in 2008 the U.S. government took an 80 percent stake in AIG to stop that financial institu- tion from collapsing, the theory being that if AIG did collapse, it would have very serious consequences for the entire financial system. The U.S. government usually prefers market- oriented solutions to economic problems, and in the AIG case, the intention was to sell the institution back to private investors as soon as possible. The United States also took similar action with respect to a number of other troubled private enterprises, including Citigroup and General Motors. In all these cases, the government stake was seen as noth- ing more than a short-term action designed to stave off economic collapse by injecting capital into troubled enterprises in highly unusually circumstances. As soon as it was able to, the government sold these stakes. In early 2010, for example, the U.S. government sold its stake in Citigroup. The government stake in AIG was sold off in 2012, and by 2014, it had also disposed of its stake in GM.

Legal Systems

The legal system of a country refers to the rules, or laws, that regulate behavior along with the processes by which the laws are enforced and through which redress for griev- ances is obtained. The legal system of a country is of immense importance to international business. A country’s laws regulate business practice, define the manner in which business transactions are to be executed, and set down the rights and obligations of those involved in business transactions. The legal environments of countries differ in significant ways. As we shall see, differences in legal systems can affect the attractiveness of a country as an investment site or market.

Like the economic system of a country, the legal system is influenced by the prevailing political system (although it is also strongly influenced by historical tradition). The gov- ernment of a country defines the legal framework within which firms do business, and

TEST PREP Use SmartBook to help retain what you have learned. Access your instructor’s Connect course to check out SmartBook or go to learnsmartadvantage.com for help.

LO 2-3 Understand how the legal systems of countries differ.

National Differences in Political, Economic, and Legal Systems Chapter 2 49

often the laws that regulate business reflect the rulers’ dominant political ideology. For example, collectivist-inclined totalitarian states tend to enact laws that severely restrict private enterprise, whereas the laws enacted by governments in democratic states where individualism is the dominant political philosophy tend to be pro-private enterprise and pro-consumer.

Here, we focus on several issues that illustrate how legal systems can vary—and how such variations can affect international business. First, we look at some basic differences in legal systems. Next we look at contract law. Third, we look at the laws governing prop- erty rights with particular reference to patents, copyrights, and trademarks. Then we dis- cuss protection of intellectual property. Finally, we look at laws covering product safety and product liability.

DIFFERENT LEGAL SYSTEMS

There are three main types of legal systems—or legal traditions—in use around the world: common law, civil law, and theocratic law.

Common Law The common law system evolved in England over hundreds of years. It is now found in most of Great Britain’s former colonies, including the United States. Common law is based on tradition, precedent, and custom. Tradition refers to a country’s legal history, precedent to cases that have come before the courts in the past, and custom to the ways in which laws are applied in specific situations. When law courts interpret common law, they do so with regard to these characteristics. This gives a common law system a degree of flexibility that other systems lack. Judges in a common law system have the power to inter- pret the law so that it applies to the unique circumstances of an individual case. In turn, each new interpretation sets a precedent that may be followed in future cases. As new precedents arise, laws may be altered, clarified, or amended to deal with new situations.

Civil Law A civil law system is based on a detailed set of laws organized into codes. When law courts interpret civil law, they do so with regard to these codes. More than 80 countries— including Germany, France, Japan, and Russia—operate with a civil law system. A civil law system tends to be less adversarial than a common law system because the judges rely on detailed legal codes rather than interpreting tradition, precedent, and custom. Judges un- der a civil law system have less flexibility than those under a common law system. Judges in a common law system have the power to interpret the law, whereas judges in a civil law system have the power only to apply the law.

Theocratic Law A theocratic law system is one in which the law is based on religious teachings. Islamic law is the most widely practiced theocratic legal system in the modern world, although us- age of both Hindu and Jewish law persisted into the twentieth century. Islamic law is pri- marily a moral rather than a commercial law and is intended to govern all aspects of life.7 The foundation for Islamic law is the holy book of Islam, the Koran, along with the Sun- nah, or decisions and sayings of the Prophet Muhammad, and the writings of Islamic scholars who have derived rules by analogy from the principles established in the Koran and the Sunnah. Because the Koran and Sunnah are holy documents, the basic founda- tions of Islamic law cannot be changed. However, in practice, Islamic jurists and scholars are constantly debating the application of Islamic law to the modern world. In reality, many Muslim countries have legal systems that are a blend of Islamic law and a common or civil law system.

Although Islamic law is primarily concerned with moral behavior, it has been extended to cover certain commercial activities. An example is the payment or receipt of interest, which is considered usury and outlawed by the Koran. To the devout Muslim, acceptance

50 Part 2 National Differences

of interest payments is seen as a grave sin; the giver and the taker are equally damned. This is not just a matter of theology; in several Islamic states, it has also become a matter of law. In the 1990s, for example, Pakistan’s Federal Shariat Court, the highest Islamic lawmaking body in the country, pronounced interest to be un-Islamic and therefore illegal and de- manded that the government amend all financial laws accordingly. In 1999, Pakistan’s Supreme Court ruled that Islamic banking methods should be used in the country after July 1, 2001.8 By the late 2000s, there were some 500 Islamic financial institutions in the world, and as of 2014, they collectively managed more than $1 trillion in assets. In addi- tion to Pakistan, Islamic financial institutions are found in many of the Gulf states, Egypt, Malaysia, and Iran.9

DIFFERENCES IN CONTRACT LAW

The difference between common law and civil law systems can be illustrated by the ap- proach of each to contract law (remember, most theocratic legal systems also have ele- ments of common or civil law). A contract is a document that specifies the conditions under which an exchange is to occur and details the rights and obligations of the parties involved. Some form of contract regulates many business transactions. Contract law is the body of law that governs contract enforcement. The parties to an agreement normally re- sort to contract law when one party feels the other has violated either the letter or the spirit of an agreement.

Because common law tends to be relatively ill specified, contracts drafted under a com- mon law framework tend to be very detailed with all contingencies spelled out. In civil law systems, however, contracts tend to be much shorter and less specific because many of the issues are already covered in a civil code. Thus, it is more expensive to draw up contracts in a common law jurisdiction, and resolving contract disputes can be very adversarial in com- mon law systems. But common law systems have the advantage of greater flexibility and allow judges to interpret a contract dispute in light of the prevailing situation. International businesses need to be sensitive to these differences; approaching a contract dispute in a state with a civil law system as if it had a common law system may backfire, and vice versa.

When contract disputes arise in international trade, there is always the question of which country’s laws to apply. To resolve this issue, a number of countries, including the United States, have ratified the United Nations Convention on Contracts for the Inter- national Sale of Goods (CISG). The CISG establishes a uniform set of rules governing certain aspects of the making and performance of everyday commercial contracts between sellers and buyers who have their places of business in different nations. By adopting the CISG, a nation signals to other adopters that it will treat the convention’s rules as part of its law. The CISG applies automatically to all contracts for the sale of goods between dif- ferent firms based in countries that have ratified the convention, unless the parties to the contract explicitly opt out. One problem with the CISG, however, is that as of 2016, only 83 nations had ratified the convention (the CISG went into effect in 1988).10 Some of the world’s important trading nations, including India and the United Kingdom, have not rati- fied the CISG.

When firms do not wish to accept the CISG, they often opt for arbitration by a recog- nized arbitration court to settle contract disputes. The most well known of these courts is the International Court of Arbitration of the International Chamber of Commerce in Paris, which handles more than 500 requests per year from more than 100 countries.11

PROPERTY RIGHTS AND CORRUPTION

In a legal sense, the term property refers to a resource over which an individual or business holds a legal title, that is, a resource that it owns. Resources include land, buildings, equip- ment, capital, mineral rights, businesses, and intellectual property (ideas, which are pro- tected by patents, copyrights, and trademarks). Property rights refer to the legal rights over the use to which a resource is put and over the use made of any income that may be derived from that resource.12 Countries differ in the extent to which their legal systems

National Differences in Political, Economic, and Legal Systems Chapter 2 51

define and protect property rights. Almost all countries now have laws on their books that protect property rights. Even China, still nominally a communist state despite its booming market economy, finally enacted a law to protect the rights of private property holders in 2007 (the law gives individuals the same legal protection for their property as the state has).13 However, in many countries these laws are not enforced by the authorities, and property rights are violated. Property rights can be violated in two ways: through private action and through public action.

Private Action In terms of violating property rights, private action refers to theft, piracy, blackmail, and the like by private individuals or groups. Although theft occurs in all countries, a weak le- gal system allows a much higher level of criminal action. For example, in the chaotic pe- riod following the collapse of communism in Russia, an outdated legal system, coupled with a weak police force and judicial system, offered both domestic and foreign businesses scant protection from blackmail by the “Russian Mafia.” Successful business owners in Russia often had to pay “protection money” to the Mafia or face violent retribution, in- cluding bombings and assassinations (about 500 contract killings of businessmen occurred per year in the 1990s).14

Russia is not alone in having organized crime problems (and the situation in Russia has improved since the 1990s). The Mafia has a long history in the United States (Chicago in the 1930s was similar to Moscow in the 1990s). In Japan, the local version of the Mafia, known as the yakuza, runs protection rackets, particularly in the food and entertainment industries.15 However, there was a big difference between the magnitude of such activity in Russia in the 1990s and its limited impact in Japan and the United States. The difference arose because the legal enforcement apparatus, such as the police and court system, was weak in Russia following the collapse of communism. Many other countries from time to time have had problems similar to or even greater than those experienced by Russia.

Public Action and Corruption Public action to violate property rights occurs when public officials, such as politicians and government bureaucrats, extort income, resources, or the property itself from prop- erty holders. This can be done through legal mechanisms such as levying excessive taxa- tion, requiring expensive licenses or permits from property holders, taking assets into state ownership without compensating the owners, or redistributing assets without compensat- ing the prior owners. It can also be done through illegal means, or corruption, by demand- ing bribes from businesses in return for the rights to operate in a country, industry, or location.16

Corruption has been well documented in every society, from the banks of the Congo River to the palace of the Dutch royal family, from Japanese politicians to Brazilian bank- ers, and from government officials in Zimbabwe to the New York City Police Department. The government of the late Ferdinand Marcos in the Philippines was famous for demand- ing bribes from foreign businesses wishing to set up operations in that country. The same was true of government officials in Indonesia under the rule of former President Suharto. No society is immune to corruption. However, there are systematic differences in the ex- tent of corruption. In some countries, the rule of law minimizes corruption. Corruption is seen and treated as illegal, and when discovered, violators are punished by the full force of the law. In other countries, the rule of law is weak and corruption by bureaucrats and poli- ticians is rife. Corruption is so endemic in some countries that politicians and bureaucrats regard it as a perk of office and openly flout laws against corruption. This seems to have been the case in Brazil until recently; the situation there may be evolving in a more positive direction.

According to Transparency International, an independent nonprofit organization dedi- cated to exposing and fighting corruption, businesses and individuals spend some $400 billion a year worldwide on bribes related to government procurement contracts alone.17

52 Part 2 National Differences

Transparency International has also measured the level of corruption among public offi- cials in different countries.18 As can be seen in Figure 2.1, the organization rated countries such as Denmark and Sweden as clean; it rated others, such as Russia, India, Zimbabwe and Venezuela, as corrupt. Somalia ranked last out of all 176 countries in the survey (the country is often described as a “failed state”).

Economic evidence suggests that high levels of corruption significantly reduce the for- eign direct investment, level of international trade, and economic growth rate in a coun- try.19 By siphoning off profits, corrupt politicians and bureaucrats reduce the returns to business investment and, hence, reduce the incentive of both domestic and foreign busi- nesses to invest in that country. The lower level of investment that results hurts economic growth. Thus, we would expect countries with high levels of corruption such as Indonesia, Nigeria, and Russia to have a lower rate of economic growth than might otherwise have been the case. A detailed example of the negative effect that corruption can have on eco- nomic development is given in the accompanying Country Focus, which looks at the im- pact of corruption on economic growth in Brazil.

Foreign Corrupt Practices Act In the 1970s, the United States passed the Foreign Corrupt Practices Act (FCPA) follow- ing revelations that U.S. companies had bribed government officials in foreign countries in an attempt to win lucrative contracts. This law makes it illegal to bribe a foreign govern- ment official to obtain or maintain business over which that foreign official has authority, and it requires all publicly traded companies (whether or not they are involved in

F I G U R E 2 .1

Rankings of corruption by country, 2016. Source: Constructed by the author from raw data from Transparency International, Corruption Perceptions Index 2016.

0 10 20

Corruption Index (100 = clean; 0 = totally corrupt) 30 40 50 60 70 80 90 100

Venezuela

Vietnam

Nigeria

Russia

China

Colombia

India

Brazil

South Korea

Poland

Italy

South Africa

Turkey

France

United States

United Kingdom

Germany

Canada

Sweden

Denmark

Somalia

C O U N T R Y F O C U S

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Corruption in Brazil Brazil is the seventh-largest economy in the world with a gross domestic product of $2 trillion. The country has a democratic government and an economy characterized by moderately free markets, although the country’s larg- est oil producer (Petrobras) and one of its top banks (Banco do Brazil) are both state owned. Many econo- mists, however, have long felt that the country has never quite lived up to its considerable economic potential. A major reason for this has been an endemically high level of corruption that favors those with political con- nections and discourages investment by more ethical businesses.  Transparency International, a nongovernmental organi- zation that evaluates countries based on perceptions of how corrupt they are, ranked Brazil 79th out of the 176 countries it looked at in its 2016 report. The problems it identifies in Brazil include public officials who demand bribes in return for awarding government contracts and “influence peddling,” in which elected officials use their position in government to obtain favors or preferential treatment. Consistent with this, according to a study by the World Economic Forum, Brazil ranks 135th out of 144 coun- tries in the proper use of public funds. Over the last decade, several corruption scandals have come to light that serve to emphasize Brazil’s cor- ruption problem. In 2005, a scandal known as the mensalao (the monthly payoff scandal) broke. The scan- dal started when a midlevel postal official was caught on film pocketing a modest bribe in exchange for promises to favor certain businesses in landing government con- tracts. Further investigation uncovered a web of influence peddling in which fat monthly payments were given to lawmakers willing to back government initiatives in National Congress. After a lengthy investigation, in late 2012 some 25 politicians and business executives were found guilty of crimes that included bribery, money laun- dering, and corruption. The public uproar surrounding the mensalao scandal was just starting to die down when in March 2014 an- other corruption scandal captured the attention of Brazil- ians. This time it involved the state-owned oil company, Petrobras. Under a scheme that seems to have been operating since 1997, construction firms wanting to do

business with Petrobras agreed to pay bribes to the company’s executives. Many of these executives were themselves political appointees. The executives would inflate the value of contracts they awarded, adding a 3 percent “fee,” which was effectively a kickback. The 3 percent fee was shared among Petrobras executives, construction industry executives, and politicians. The construction companies established shell companies to make payments and launder the money. According to prosecutors investigating the case, the total value of bribes may have exceeded $3.7 billion. Four former Petrobras officials and at least 23 con- struction company executives have been charged with crimes that include corruption and money laundering. In addition, Brazil’s Supreme Court has given prosecutors the go-ahead to investigate 48 current or former mem- bers of Congress, including the former Brazilian Presi- dent Fernando Collor de Mello. The Brazilian president, Dilma Rousseff, was also tainted by the scandal. In June 2016, she was suspended from the presidency pending an impeachment trial. She was chair of Petrobras during the time this was occurring. She is also a member of the governing Workers’ Party, several members of which seem to have been among the major beneficiaries of the kickback scandal. Although there is no evidence that Rousseff knew of the bribes or profited from them, her ability to govern effectively has been severely damaged by association. The scandal has so rocked Brazil that it has pushed the country close to a recession. In August 2016, Rousseff was impeached and removed from the presidency. If there is a bright spot in all of this, it is that the scandals are coming to light. Backed by Supreme Court rulings and public outrage, corrupted politicians, government officials, and business executives are being prosecuted. In the past, that was far less likely to occur. 

Sources: Will Conners and Luciana Magalhaes, “Brazil Cracks Open Vast Bribery Scandal,” The Wall Street Journal, April 7, 2015; Marc Margolis, “In Brazil’s Trial of the Century, Lula’s Reputation Is at Stake,” Newsweek, July 27, 2012; “The Big Oily,” The Economist, January 3, 2015; Donna Bowater, “Brazil’s Continuing Corruption Problem,” BBC News, September 18, 2015; Romero, “Dilma Rousseff Is Ousted as Brazil’s President in Impeachment Vote,” The New York Times, August 31, 2016.

M A N A G E M E N T F O C U S

In the early 2000s, Walmart wanted to build a new store in San Juan Teotihuacan, Mexico, barely a mile from ancient pyramids that drew tourists from around the world. The owner of the land was happy to sell to Walmart, but one thing stood in the way of a deal: the city’s new zoning laws. These prohibited commercial development in the historic area. Not to be denied, executives at the headquarters of Walmart de Mexico found a way around the problem: They paid a $52,000 bribe to a local official to redraw the zon- ing area so that the property Walmart wanted to purchase was placed outside the commercial-free zone. Walmart then went ahead and built the store, despite vigorous local opposition, opening it in late 2004. A former lawyer for Walmart de Mexico subsequently contacted Walmart executives at the company’s corporate headquarters in Bentonville, Arkansas. He told them that Walmart de Mexico routinely resorted to bribery, citing the altered zoning map as just one example. Alarmed, execu- tives at Walmart started their own investigation. Faced with growing evidence of corruption in Mexico, top Walmart executives decided to engage in damage control, rather than coming clean. Walmart’s top lawyer shipped the case files back to Mexico and handed over responsibility for the investigation to the general council of Walmart de Mexico. This was an interesting choice as the very same general council was alleged to have authorized bribes. The gen- eral council quickly exonerated fellow Mexican executives, and the internal investigation was closed in 2006. For several years nothing more happened; then, in April 2012, The New York Times published an article detailing bribery by Walmart. The Times cited the changed zoning map and several other examples of bribery by Walmart: for example, eight bribes totaling $341,000 enabled Walmart to build a Sam’s Club in one of Mexico City’s most densely

Did Walmart Violate the Foreign Corrupt Practices Act? populated neighborhoods without a construction license, an environmental permit, an urban impact assessment, or even a traffic permit. Similarly, thanks to nine bribe pay- ments totaling $765,000, Walmart built a vast refrigerated distribution center in an environmentally fragile flood basin north of Mexico City, in an area where electricity was so scarce that many smaller developers were turned away. Walmart responded to The New York Times article by ramping up a second internal investigation into bribery that it had initiated in 2011. By mid-2015, there were reportedly more than 300 outside lawyers working on the investiga- tion, and it had cost more than $612 million in fees. In addi- tion, the U.S. Department of Justice and the Securities and Exchange Commission both announced that they had started investigations into Walmart’s practices. In Novem- ber 2012, Walmart reported that its own investigation into violations had extended beyond Mexico to include China and India. Among other things, it was looking into the alle- gations by the Times that top executives at Walmart, includ- ing former CEO Lee Scott Jr., had deliberately squashed earlier investigations. While the investigations are still on- going, in late 2016 people familiar with the matter stated that the federal investigation had not uncovered evidence of widespread bribery. Nevertheless, the company was ap- parently negotiating a settlement with the U.S. government that was estimated to be at least $600 million.

Sources: David Barstow, “Vast Mexican Bribery Case Hushed Up by Wal-Mart after Top Level Struggle,” The New York Times, April 21, 2012; Stephanie Clifford and David Barstow, “Wal-Mart Inquiry Reflects Alarm on Corruption,” The New York Times, November 15, 2012; Nathan Vardi, “Why Justice Department Could Hit Wal-Mart Hard over Mexican Bribery Allegations,” Forbes, April 22, 2012; Phil Wahba,”Walmart Bribery Probe by Feds Finds No Major Misconduct in Mexico,” Fortune, October 18, 2015; T. Schoenberg and M. Robinson, “Wal-Mart Balks at Paying $600 Million in Bribery Case,” Bloomberg, October 6, 2016.

international trade) to keep detailed records that would reveal whether a violation of the act has occurred. In 2012, evidence emerged that in its eagerness to expand in Mexico, Walmart may have run afoul of the FCPA (for details, see the Management Focus feature).

In 1997, trade and finance ministers from the member states of the Organisation for Economic Co-operation and Development (OECD), an association of 34 major econo- mies including most Western economies (but not Russia, India or China), adopted the Convention on Combating Bribery of Foreign Public Officials in International Business Transactions.20 The convention obliges member states to make the bribery of foreign pub- lic officials a criminal offense.

Both the U.S. law and OECD convention include language that allows exceptions known as facilitating or expediting payments (also called grease payments or speed money),

54

National Differences in Political, Economic, and Legal Systems Chapter 2 55

the purpose of which is to expedite or to secure the performance of a routine governmen- tal action.21 For example, they allow small payments made to speed up the issuance of permits or licenses, process paperwork, or just get vegetables off the dock and on their way to market. The explanation for this exception to general antibribery provisions is that while grease payments are, technically, bribes, they are distinguishable from (and, apparently, less offensive than) bribes used to obtain or maintain business because they merely facili- tate performance of duties that the recipients are already obligated to perform.

THE PROTECTION OF INTELLECTUAL PROPERTY

Intellectual property refers to property that is the product of intellectual activity, such as computer software, a screenplay, a music score, or the chemical formula for a new drug. Patents, copyrights, and trademarks establish ownership rights over intellectual property. A patent grants the inventor of a new product or process exclusive rights for a defined period to the manufacture, use, or sale of that invention. Copyrights are the exclusive le- gal rights of authors, composers, playwrights, artists, and publishers to publish and dis- perse their work as they see fit. Trademarks are designs and names, officially registered, by which merchants or manufacturers designate and differentiate their products (e.g., Christian Dior clothes). In the high-technology “knowledge” economy of the twenty-first century, intellectual property has become an increasingly important source of economic value for businesses. Protecting intellectual property has also become increasingly prob- lematic, particularly if it can be rendered in a digital form and then copied and distributed at very low cost via pirated DVDs or over the Internet (e.g., computer software, music, and video recordings).22

The philosophy behind intellectual property laws is to reward the originator of a new invention, book, musical record, clothes design, restaurant chain, and the like for his or her idea and effort. Such laws stimulate innovation and creative work. They provide an in- centive for people to search for novel ways of doing things, and they reward creativity. For example, consider innovation in the pharmaceutical industry. A patent will grant the in- ventor of a new drug a 20-year monopoly in production of that drug. This gives pharma- ceutical firms an incentive to undertake the expensive, difficult, and time-consuming basic research required to generate new drugs (it can cost $1 billion in R&D and take 12 years to get a new drug on the market). Without the guarantees provided by patents, companies would be unlikely to commit themselves to extensive basic research.23

The protection of intellectual property rights differs greatly from country to country. Although many countries have stringent intellectual property regulations on their books, the enforcement of these regulations has often been lax. This has been the case even among many of the 185 countries that are now members of the World Intellectual Prop- erty Organization, all of which have signed international treaties designed to protect in- tellectual property, including the oldest such treaty, the Paris Convention for the Protection of Industrial Property, which dates to 1883 and has been signed by more than 170 nations. Weak enforcement encourages the piracy (theft) of intellectual property. China and Thailand have often been among the worst offenders in Asia. Pirated computer software is widely available in China. Similarly, the streets of Bangkok, Thailand’s capital, are lined with stands selling pirated copies of Rolex watches, Levi’s jeans, DVDs, and com- puter software.

The computer software industry is an example of an industry that suffers from lax enforce- ment of intellectual property rights. Estimates suggest that violations of intellectual property rights cost personal computer software firms revenues equal to $63 billion in 2011.24 According to the Business Software Alliance, a software industry association, in 2011 some 42 percent of all software applications used in the world were pirated. One of the worst large countries was China, where the piracy rate in 2011 ran at 77 percent and cost the industry more than $9.8 billion in lost sales, up from $444 million in 1995. The piracy rate in the United States was much lower at 19 percent; however, the value of sales lost was significant because of the size of the U.S. market, reaching an estimated $9.8 billion in 2011.25

Did You Know? Did you know that it’s illegal for Americans to bribe public officials to gain business in a foreign country, even if bribery is commonplace in that nation?

Visit your instructor’s Connect® course and click on your eBook or SmartBook® to view a short video explanation from the authors.

M A N A G E M E N T F O C U S

Starbucks Wins Key Trademark Case in China Starbucks has big plans for China. It believes the fast- growing nation will become the company’s second- largest market after the United States. Starbucks entered the country in 1999, and by the end of 2016 it had opened more than 1,300 stores. But in China, copycats of well-established Western brands are common. Starbucks faced competition from a look-alike, Shanghai Xing Ba Ke Coffee Shop, whose stores closely matched the Starbucks format, right down to a green-and-white Xing Ba Ke circular logo that mimics Starbucks’ ubiqui- tous logo. The name also mimics the standard Chinese translation for Starbucks. Xing means “star,” and Ba Ke sounds like “bucks.” In 2003, Starbucks decided to sue Xing Ba Ke in Chinese court for trademark violations. Xing Ba Ke’s general manager responded by claiming it was just an accident that the logo and name were so similar to that of Starbucks. He claimed the right to use the logo and name because Xing Ba Ke had registered as a company in Shanghai in 1999, before Starbucks entered the city. “I hadn’t heard of Starbucks at the time,” claimed

the manager, “so how could I imitate its brand and logo?” However, in January 2006, a Shanghai court ruled that Starbucks had precedence, in part because it had regis- tered its Chinese name in 1998. The court stated that Xing Ba Ke’s use of the name and similar logo was “clearly mali- cious” and constituted improper competition. The court ordered Xing Ba Ke to stop using the name and to pay Starbucks $62,000 in compensation. While the money in- volved here may be small, the precedent is not. In a coun- try where violation of trademarks has been common, the courts seem to be signaling a shift toward greater protec- tion of intellectual property rights. This is perhaps not sur- prising because foreign governments and the World Trade Organization have been pushing China hard recently to start respecting intellectual property rights.

Sources: M. Dickie, “Starbucks Wins Case against Chinese Copycat,” Financial Times, January 3, 2006, p. 1; “Starbucks: Chinese Court Backs Company over Trademark Infringement,” The Wall Street Jour- nal, January 2, 2006, p. A11; “Starbucks Calls China Its Top Growth Focus,” The Wall Street Journal, February 14, 2006, p. 1.

56

International businesses have a number of possible responses to violations of their intel- lectual property. They can lobby their respective governments to push for international agreements to ensure that intellectual property rights are protected and that the law is en- forced. Partly as a result of such actions, international laws are being strengthened. As we shall see in Chapter 7, the most recent world trade agreement, signed in 1994, for the first time extends the scope of the General Agreement on Tariffs and Trade to cover intellec- tual property. Under the new agreement, known as the Trade-Related Aspects of Intellec- tual Property Rights (TRIPS), as of 1995 a council of the World Trade Organization is overseeing enforcement of much stricter intellectual property regulations. These regula- tions oblige WTO members to grant and enforce patents lasting at least 20 years and copy- rights lasting 50 years after the death of the author. Rich countries had to comply with the rules within a year. Poor countries, in which such protection generally was much weaker, had five years of grace, and the very poorest have 10 years.26 (For further details of the TRIPS agreement, see Chapter 7.)

In addition to lobbying governments, firms can file lawsuits on their own behalf. For example, Starbucks won a landmark trademark copyright case in China against a copy- cat that signaled a change in the approach in China (see the accompanying Manage- ment Focus for details). Firms may also choose to stay out of countries where intellectual property laws are lax, rather than risk having their ideas stolen by local en- trepreneurs. Firms also need to be on the alert to ensure that pirated copies of their products produced in countries with weak intellectual property laws don’t turn up in their home market or in third countries. U.S. computer software giant Microsoft, for example, discovered that pirated Microsoft software, produced illegally in Thailand, was being sold worldwide as the real thing.

National Differences in Political, Economic, and Legal Systems Chapter 2 57

PRODUCT SAFETY AND PRODUCT LIABILITY

Product safety laws set certain safety standards to which a product must adhere. Prod- uct liability involves holding a firm and its officers responsible when a product causes in- jury, death, or damage. Product liability can be much greater if a product does not conform to required safety standards. Both civil and criminal product liability laws exist. Civil laws call for payment and monetary damages. Criminal liability laws result in fines or imprison- ment. Both civil and criminal liability laws are probably more extensive in the United States than in any other country, although many other Western nations also have compre- hensive liability laws. Liability laws are typically the least extensive in less developed na- tions. A boom in product liability suits and awards in the United States resulted in a dramatic increase in the cost of liability insurance. Many business executives argue that the high costs of liability insurance make American businesses less competitive in the global marketplace.

In addition to the competitiveness issue, country differences in product safety and lia- bility laws raise an important ethical issue for firms doing business abroad. When product safety laws are tougher in a firm’s home country than in a foreign country or when liability laws are more lax, should a firm doing business in that foreign country follow the more relaxed local standards or should it adhere to the standards of its home country? While the ethical thing to do is undoubtedly to adhere to home-country standards, firms have been known to take advantage of lax safety and liability laws to do business in a manner that would not be allowed at home.

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F O C U S O N M A N A G E R I A L I M P L I C AT I O N S

THE MACRO ENVIRONMENT INFLUENCES MARKET ATTRACTIVENESS

The material discussed in this chapter has two broad implications for international business. First, the political, economic, and legal systems of a country raise impor- tant ethical issues that have implications for the practice of international business. For example, what ethical implications are associated with doing business in

totalitarian countries where citizens are denied basic human rights, corruption is rampant, and bribes are necessary to gain permission to do business? Is it right to oper-

ate in such a setting? A full discussion of the ethical implications of country differences in political economy is reserved for Chapter 5, where we explore ethics in international business in much greater depth. Second, the political, economic, and legal environments of a country clearly influence the attractiveness of that country as a market or investment site. The benefits, costs, and risks associated with doing business in a country are a function of that country’s political, eco- nomic, and legal systems. The overall attractiveness of a country as a market or investment site depends on balancing the likely long-term benefits of doing business in that country against the likely costs and risks. Because this chapter is the first of two dealing with issues of political economy, we will delay a detailed discussion of how political economy impacts the benefits, costs, and risks of doing business in different nation-states until the end of the next chapter, when we have a full grasp of all the relevant variables that are important for assessing benefits, costs, and risks. For now, other things being equal, a nation with democratic political institutions, a market- based economic system, and strong legal system that protects property rights and limits corruption is clearly more attractive as a place in which to do business than a nation that lacks democratic institutions, where economic activity is heavily regulated by the state, and where corruption is rampant and the rule of law is not respected. On this basis, for example,

LO 2- 4 Explain the implications for management practice of national differences in political economy.

58 Part 2 National Differences

a country like Canada is a better place in which to do business than the Russia of Vladimir Putin (see the Country Focus: Putin’s Russia). That being said, the reality is often more nu- anced and complex. For example, China lacks democratic institutions; corruption is wide- spread; property rights are not always respected; and even though the country has embraced many market-based economic reforms, there are still large numbers of state- owned enterprises—yet many Western businesses feel that they must invest in China. They do so despite the risks because the market is large, the nation is moving toward a market- based system, economic growth has been strong (although it faltered in 2015–2016), legal protection of property rights has been improving, and China is already the second largest economy in the world and could ultimately replace the United States as the world’s largest. Thus, China is becoming increasingly attractive as a place in which to do business, and given the future growth trajectory, significant opportunities may be lost by not investing in the country. We will explore how changes in political economy affect the attractiveness of a nation as a place in which to do business in Chapter 3.

political economy, p. 40 political system, p. 41 collectivism, p. 41 socialists, p. 41 communists, p. 41 social democrats, p. 41 privatization, p. 42 individualism, p. 42 democracy, p. 43 totalitarianism, p. 43 representative democracy, p. 43 communist totalitarianism, p. 44 theocratic totalitarianism, p. 45 tribal totalitarianism, p. 45

right-wing totalitarianism, p. 46 market economy, p. 46 command economy, p. 47 legal system, p. 48 common law, p. 48 civil law system, p. 49 theocratic law system, p. 49 contract, p. 50 contract law, p. 50 United Nations Convention on

Contracts for the International Sale of Goods (CISG), p. 50

property rights, p. 50 private action, p. 51

public action, p. 51 Foreign Corrupt Practices

Act (FCPA), p. 52 intellectual property, p. 55 patent, p. 55 copyrights, p. 55 trademarks, p. 55 World Intellectual Property

Organization, p. 55 Paris Convention for the Protection

of Industrial Property, p. 55 product safety laws, p. 57 product liability, p. 57

Key Terms

C H A P T E R S U M M A R Y

This chapter has reviewed how the political, economic, and legal systems of countries vary. The potential bene- fits, costs, and risks of do