GLOBAL BUSINESS SPEED OF CHANGE
ARIZONA STATE UNIVERSITY
OMT 440 - INTERNATIONAL BUSINESS
WEEK 5
1.1. Definitions:
Ball et al. (2005) provide various definitions of international business as follows:
1. International business is business whose activities cross national borders. This definition
includes not only international trade and overseas manufacturing, but also the growing
service industries in areas such as transportation, tourism, banking, advertising,
construction, retail trade, wholesale trade, and mass communications.
2. An offshore business is a business that has domestic operations outside of its home
country. The term is sometimes used interchangeably with international business by
some authors.
3. A multidomestic company (MDC) is a business organization with branches in many
countries, formulating its own business strategy based on the basic differences
understood in each destination country.
4. A global company (GC) is a business organization that seeks to homogenize and
integrate operations around the world in all functional areas.
5. International company (IC) refers to both global and multidomestic companies.
1.2. Forces of Globalization
According to Ball et al. (2005), there are five types of drivers, all based on change, that
lead international firms to globalize their operations:
1. Political
Currently, countries in the world have a tendency towards unification and socialization
of the global community. For example, countries in the North American region (the
United States, Canada and Mexico) formed a preferential trade agreement, the North
American Free Trade Agreement (NAFTA) and countries in Europe formed the
European Union. These agreements have grouped several countries into a single market
and have opened up opportunities for companies. Many companies have moved quickly
to penetrate both through exports and production in the region. This trend has also given
rise to other aspects that contribute to globalization and business operations, namely: (a)
the progressive reduction of restrictions on foreign trade and investment by most
governments, which has accelerated the opening of new markets by international
companies, both through exporting to those countries and setting up production facilities
in those countries, and (b) the privatization of many industries in former communist
countries and the opening of their economies to global competition.
2. Technology
Increasing advances in computer and communication technology have made it easier for
the flow of ideas and information to cross national boundaries. It also gives customers
the opportunity to learn about foreign goods. Global communication networks allow
manufacturing personnel to coordinate production and design functions worldwide so
that factories in many parts of the world can work on the same product. The Internet and
computerized networks allow small companies to compete globally because they allow
for the rapid flow of information without the need for intermediaries. Regardless of the
physical location of buyers and sellers. The internet makes it easier to obtain information
and conduct transactions in many companies and especially in inter-company trade more
cheaply and quickly than using fax, telephone or mail.
3. Market
When companies operate only in the domestic market, there is a possibility that the
domestic market will become saturated over time. Therefore, companies start to enter
overseas markets especially when marketers realize there is a commonality of customer
tastes and lifestyles due to the increase in tourist travel, the spread of satellite TV, and
the use of global brands.
4. Cost
The goal of corporate management is to achieve Economies of scale, which is to reduce
the cost per unit of product. Globalization of product lines is one way to reduce
production and inventory development costs. Companies can also locate production in
countries where the cost of production factors is lower.
5. Competition
The level of competition between companies is getting higher. Many new companies
have emerged from developing countries and new industries have entered the world
Environment
All the forces that surround and influence the life and development of the
company.
Forces that cannot be controlled
External forces that management does not directly control, although it can
influence them.
Controllable power
The forces that management organizes to adapt to changes in forces
that cannot be controlled.
Domestic environment
All the uncontrollable forces originating from the home country that surround
and affect the life and development of the company.
Overseas environment
All uncontrollable forces originating from outside the home country that
envelop and affect the life and development of the company.
markets in automotive and electronics. To win the competition, the tactic taken by
companies to maintain their domestic market is to enter the domestic markets of
competitors. This is the driving force of competition for globalization.
1.3. Environmental Forces
The environment in the context of business is the overall forces that envelop and
influence the life and development of the company. These forces can be classified as external
environmental forces and internal environmental forces. Company management in exercising
control over these environmental forces can be done indirectly, and can avoid influences such
as lobbying the government to change laws and promoting a product on a large scale which
requires a change in cultural attitudes (Ball et al., 2005). Ball et al. (2005) explain that
external forces are usually called uncontrollable forces and consist of the following:
1. Competitive - the type and number of competitors, their locations and their activities.
2. Distributive - national and international agents available to distribute goods and
services.
3. Economic variables (such as GNP, labor cost per unit, and personal consumption
expenditure) that affect a company's ability to do business.
4. Socioeconomics - characteristics and distribution of human populations.
5. Financial - variables such as interest rates, inflation rates, and taxation.
6. Legal, the many types of foreign and domestic laws that international companies must
comply with.
7. Physical-natural elements such as topography, climate and natural resources.
8. Political - elements of the nation's political climate such as nationalism, form of
government, and international organizations.
9. Sociocultural - cultural elements (such as attitudes, beliefs and opinions) that are
important to international business actors.
10. Labor - the composition, skills, and attitudes of workers.
11. Technology - technical skills and equipment that influence how resources are converted
into products.
Trade and Investment in International Business
There are three international business activities, namely (1) international trade, which
includes exports and imports, (2) foreign direct investment, which international companies
must make to establish and expand their overseas operations, and (3) foreign sourcing, which
is the procurement of raw materials, components and products from abroad (Ball et al.,
2005).
1.1. International Trade:
Why focus on key trading partners?
According to Ball et al. (2005), there are a number of advantages in focusing on
countries that are already major buyers and goods originating from potential exporting
countries:
1. The business climate in the importing country is relatively favorable
2. Export and import regulations
3. There will be no strong cultural resistance
4. Satisfactory transportation facilities are in place.
5. Members of the import channel (traders, banks, customs brokers) are experienced in
handling import shipments from the exporting region.
6. Foreign exchange to pay for exports is available.
7. The government of a trading partner may invoke import pressure to buy from countries
that are good customers of the country's exports.
1.2. Overseas Investment:
Overseas investment can be divided into two components: portfolio investment, which
is the purchase of stocks and bonds solely for the purpose of earning a return on invested
funds, and direct investment where investors participate in the management of the company
in addition to receiving a return on their money (Ball et al., 2005).
1.3. Portfolio Investment:
Portfolio investment is the purchase of stocks and bonds to earn a return on invested
funds. Investors who make portfolio investments do not control companies directly, but they
invest huge amounts in stocks and bonds of other countries. As more and more international
companies list their bonds and assets on foreign stock exchanges, offshore portfolio
investment is increasing in size and will continue to grow (Ball et al., 2005).
The impact of trade is to bring in foreign direct investment. Historically, foreign direct
investment (FDI) has followed foreign trade. One reason is that foreign trade has fewer costs
and risks. Also, management can expand its business little by little rather than with the much
larger amount of investment and market size required by an overseas production facility. In
general, companies will use domestic or overseas agents to export (Ball et al., 2005).
Meanwhile, managers will be watching the overall market size closely knowing their
competitors are conducting the same study. In general, since the local market will not be
large enough to support local production with all the companies exporting to it, it will be a
situation where the local market is not large enough to support local production each other to
see who will start manufacturing there first. Experienced managers know that governments
often limit the number of local firms making a particular product so that the firm starting
local operations will be assured of a profitable and sustainable business. This is especially
important for developing countries that depend on foreign investment to provide jobs and
earn taxes (Ball et al., 2005).
1.4. Direct Investment:
The purchase of sufficient shares in a company to gain significant management control
(Ball et al., 2005).
Does trade lead to FDI or vice versa?
In the previous section, we discussed international companies expanding their markets
through foreign trade. However, there has been a change in the business environment where
trade barriers imposed by the government of a country have been reduced. This has increased
competition from globalizing firms, and new production and communication technologies
have caused many international firms to spread their production system activities to locations
close to available resources. They then integrate the entire production process both regionally
and globally. Consequently, the decision of where to locate, whether an FDI decision or a
trade decision, illustrates exactly how closely intertwined FDI and trade are (Ball et al.,
2005).
Take over an existing company or build a new one?
Generally, it is more common to take over an existing company than to build a new
one. The reasons are: (1) Many management companies restructure by opening units in new
markets or even in new markets. (2) advances in the field of computers and communications
caused foreign companies to want to gain rapid access in the destination country, (3) by
taking over companies that are already running and already have well-known brand names it
will be easier to enter a large market than spending time and money to promote a new and
unknown (Ball et al., 2005).
1.5. Why Enter Foreign Markets?
Increase profits and sales:
Companies are starting to look for new markets outside their country as they face a
mature and saturated market at home. This puts managers under constant pressure to increase
sales and profits. They found that (1) rising GNI per capita and population growth signaled
potential new markets for their operations and (2) the economies of some countries where
they did not do business were growing at a faster rate than their own market economies (Ball
et al., 2005).
Protecting the domestic market
In order to prevent competitors from gaining access to customers, service firms will
generally establish their overseas operations in markets where their customers are located. A
company may also enter foreign markets to protect its home market when it faces competition
from low-priced foreign imports. By moving some or all of its production facilities to
countries where its competitors are based, it can enjoy such advantages with cheaper labor,
raw materials, and power. Management may decide to manufacture certain components
abroad and assemble them in the home country, or if the final product requires considerable
labor in final assembly, it may send the components abroad for final work. Forms of
protecting the domestic market include:
a. In-bond plant / Following industry (maquiladora)
A production facility in Mexico that temporarily imports duty-free raw materials,
components or parts to be fabricated, processed or assembled with cheaper local labor;
the final or semi-finished product is then exported.
b. Caribbean Basin Intiative/Caribbean Gulf Initiative
The benefits are the same as Mexico's bonded industries. There is a wide range of
products either grown or produced in the 24 Caribbean countries that have duty-free
entry into the United States. Although most textiles and clothing do not fall under duty-
free status, clothing assembled from materials molded and cut in the Americas can
enter the United States duty-free. The American apparel industry sends pre-cut pieces
to these countries, which are assembled and shipped back for sale in the United States.
c. Andean Trade Preference Act
It is a unilateral trade benefits program similar to the Caribbean Gulf Initiative, but
designed to boost economic development in Bolivia, Colombia, Ecuador, and Peru.
d. Growth Triangles
Transitional economic zones spread over geographically large contiguous regions,
covering three or more countries where differences in enabling factors are exploited to
increase external trade and investment.
e. Export Processing Zones
Overseas manufacturers enjoy almost complete tax and regulatory freedom regarding
materials brought into these zones for processing and subsequent re-export.
Protecting foreign markets:
According to Ball et al. (2005), changing the way of going abroad from exporting to
producing abroad is often used to protect foreign markets. The reasons why companies
produce abroad to protect their foreign markets include:
1. A shortage of foreign exchange, due to delayed payments by importers, so the company
decided to protect its market by producing locally.
2. Competitors are manufacturing overseas.
3. Opening up downstream markets
4. Protectionism practiced by local governments has encouraged companies to open up
their markets.
5. Guaranteed supply of raw materials
6. Take over technology and management know-how
7. Geographical diversification, as a means of maintaining stable sales and revenue when
the domestic market is in a slump.
8. Satisfy management's desire to expand
1.6. How to Enter the Overseas Market?
a. Exporting:
Exporting is the act of selling goods and services abroad. It requires little investment and is
relatively risk-free. The most appropriate way to get a taste of international business without
tying up a large amount of human or financial resources is exporting. There are two ways of
exporting, direct and indirect exporting. Indirect exporting is exporting goods and services
through various types of exporters based in the country. Direct exporting is exporting goods
and services by the companies that produce them, generally companies that export directly
have sales offices/companies in their foreign markets. Another form of exporting is turn key
projects, which are exports of technology, management expertise, and in some cases capital
equipment (Ball et al., 2005).
b. Overseas Manufacturing (Producing):
There are five alternatives in offshore manufacturing, namely (1) wholly-owned branches, (2)
joint ventures, (3) license agreements, (4) franchising, (5) contract manufacturing (Ball et al.,
2005).
Branches owned in total:
A company that wants to have an overseas branch can either (1) start from the ground
up to build a new factory, (2) take over an existing company, or (3) buy out its distributors,
which means acquiring a distribution network (Ball et al., 2005).
Joint venture:
A joint venture is a cooperative venture between two or more organizations that share a
common interest in a business venture or activity. A joint venture can be (1) a business entity
formed by an international company and local owners, (2) a business entity formed by two
international companies for the purpose of doing business in the current market, (3) a
business entity formed by a government agency (usually in the country where the investment
is made) and an international company or (4) cooperation between two or more companies on
a project of limited duration (Ball et al., 2005).
License agreement (licensing):
A license agreement is a contractual agreement in which a company grants access to its
patents, trade secrets or technology to another company for a fee (Ball et al., 2005).
Franchising:
Franchising is a form of licensing in which a company contracts with another company
to operate a particular type of business under a name established in accordance with certain
rules (Ball et al., 2005).
Contract manufacturing:
Contract manufacturing is an agreement in which a company contracts with another
company to manufacture products according to specifications but accepts marketing
responsibilities (Ball et al., 2005).
Practice Questions
Critical Thinking Ability Test Questions and Answer Key:
Discuss the answers to the questions below and answer briefly!
1. Explain the meaning of international trade?
2. What is the difference between foreign portfolio investment and FDI?
3. How do political factors affect foreign direct investment?
Answer Key for Chapter 2 Practice Questions:
1. International trade is trade between people from two countries. These people may be
individuals, companies, non-profit organizations, or other forms of association (Weight
30).
2. Foreign portfolio investments represent passive holdings of securities such as stocks,
bonds, or other foreign financial assets, none of which provide active management or
control over the issuer of the securities by the investor. While foreign direct investment
is the acquisition of foreign assets for the purpose of controlling them (Weight 40).
3. Political factors influence companies' trade and investment decisions, with the aim of
avoiding trade barriers. In addition, countries often provide economic development
incentives to encourage foreign direct investment, such as reduced utility rates,
employee training programs, infrastructure improvements, and tax reductions or
exemptions (Weight 30).
Economic Theories of International Business
3.1. Mercantilism:
Mercantilism, an economic philosophy refuted by Adam Smith. Adam Smith held that
it was essential for the welfare of a country to accumulate a stock of precious metals. This
was the only source of prosperity for mercantilists. Since Britain had no mines, mercantilists
tended to international trade to supply gold and silver. The government made economic
policies that promoted exports and reduced imports, resulting in a trade surplus that had to be
paid for with gold and silver. The imposition of import restrictions such as import duties
reduced imports and government subsidies to exporters increased exports. These actions
create a trade surplus (Ball et al., 2005).
Although the mercantilist era ended in the 1700s, its arguments still live on. A
"satisfactory" balance of trade still means that a country exports more goods and services
than it imports. In balance of payments accounting, exports that bring dollars into the country
are called positive, but imports that cause dollars to flow out are named negative. An example
of modern mercantilism which today is called nationalism The industrial policy based on
very strong state intervention that the socialists created for France. They nationalized key
industries and important banks in order to use the power of the state as both (1) shareholder
and financier, and (2) customer and marketer to revitalize the country's industrial base (Ball
et al., 2005).
3.2. Theory of Absolute Advantage:
Absolute Advantage
The ability of a nation to produce a good with the same amount of inputs more
than other countries.
Adam Smith said that it is market forces, not government control, that determine the
direction, volume and composition of international trade. He reasoned that in unregulated free
trade, each country would specialize in producing the goods that it could produce efficiently
(having an absolute advantage, either natural or acquired). Some of these goods would be
exported to pay for imports of goods that could be produced more efficiently elsewhere.
Smith showed by the example of absolute advantage that both countries would benefit from
trade (Ball et al., 2005).
3.3. Theory of Comparative Advantage
In 1817, David Ricardo showed that even if a nation holds an absolute advantage in the
production of two goods, the two countries can still trade with an advantage for each as long
as the less efficient nation is efficient in producing both goods (Ball et al., 2005).
3.4. Supporting Factor Theory by Heckscher-Ohlin
This theory states that international and inter-regional differences in production costs
arise due to differences in the supply of factors of production. Goods that require an
abundance of factors are cheaper to produce, allowing them to be sold more cheaply on the
international market. For example, China, which is relatively better supported by labor than
the Netherlands, should concentrate on the production of labor-intensive goods; the
Netherlands, with relatively more capital than labor, should specialize in capital-intensive
products. When these two countries trade, each will obtain goods that require a large number
of relatively scarce factors of production at a lower price, and both will benefit from the
transaction (Ball et al., 2005).
3.5. International Product Lifecycle
Comparative Advantage
A nation that has an absolute weakness in producing two goods from the point
of view of another nation has a comparative or relative advantage in producing
the goods in which its absolute weakness is less.
According to Ball et al. (2005), the international product life cycle is a theory that
explains why a product that starts out as a country's export eventually becomes its import.
The stages of the product life cycle it goes through:
1. Export
2. Overseas production starts
3. Foreign competition in the export market
4. Import competition
3.6. Trade Restrictions/Barriers
According to Ball et al. (2005), the imposition of trade restrictions or barriers is due to
several reasons, namely:
1. National defense, certain industries require protection from imports because they are
vital to national defense, and should remain in place despite comparative disadvantages
with respect to foreign competitors.
2. Protecting nascent industries, nascent industries are protected until they have a trained
workforce, master production techniques and achieve economies of scale.
3. Protect domestic employment from cheap foreign labor.
4. Scientific tariff or fair competition. Import duties that will increase the cost of imported
goods to equal the cost of domestically produced goods. By imposing such duties, it is
expected to create fair competition with domestically produced goods.
5. Countermeasures, import barriers imposed by another country because the country is
given barriers to entry into another country's market.
6. Dumping, is selling a product abroad at a price less than the cost of production, the
price in the home market or the price for third countries.
7. Subsidies, financial contributions provided directly or indirectly by the government
without profit in return. Includes grants, preferential tax treatment and government
assumptions of normal business expansion.
Types of Restriction:
According to Ball et al. (2005), import restrictions are usually classified as tariff and
non-tariff barriers.
Tariff barriers:
Tariffs or import duties are taxes imposed on imported goods primarily for the purpose
of increasing their selling price in the importing country's market to reduce competition for
domestic producers. Types of tariff barriers include:
a. Ad valorem duties: import taxes levied as a percentage of the invoice value of imported
goods.
b. Specific duty: a fixed amount levied on a physical unit of imported goods.
c. Combination tax: a combination of specific and ad valorem taxes.
d. Variable tax: an import tax determined by the difference between world market prices
and locally supported prices.
In addition, there is another type of tariff barrier: official prices. These prices are
included in the customs tariffs of some countries and are the basis for the calculation of ad
valorem taxes when the actual invoice price is lower. Official prices guarantee that a certain
minimum import tax will be paid regardless of the actual invoice price.
Non-tariff barriers:
Non-tariff barriers are all forms of discrimination against imports other than import
taxes/import duties. The following are the types of non-tariff barriers:
1. Quantitative / Quota
A quota is a form of barrier that places restrictions on the amount of certain types of
goods that a country will be allowed to import unhindered for a certain period of time.
If the quota is absolute, once a certain amount has been imported, subsequent imports
for the remainder of that time (usually one year) are prohibited. Countries also set
tariff-rate quotas that allow a set amount to enter a country duty-free or at a low tariff,
but when that amount is recorded, a much higher tax is imposed on subsequent imports.
In general, quotas are global, where the quantity is set regardless of the source.
Quotas can also be allocated, in which case the government of the importing country
approves a quantity for certain countries. Over the years there has been agreement
among countries to oppose the introduction of quotas unilateral quotas on goods
(except agricultural products). The government therefore negotiates voluntary export
restraints (VERs) with other countries. Such VERs are agreed bilaterally. For example,
to avoid the United States imposing import quotas on Japanese cars, the Japanese
government established a VER to limit the number of cars its manufacturers can export
to the United States each year.
2. Marketing order approval
Marketing order agreements are VERs that consist of agreements between the
governments of exporting and importing countries to limit international competition
and protect some national markets for local producers.
3. Non-quantitative
Many governments tend to set up nontariff barriers to obtain the protection sought
through import taxes, such as direct government participation in trade. The most
common form of direct government participation is subsidies.
4. Customs and other administrative procedures.
The government provides a wide range of policies and procedures that both
discriminate against imports and favor exports. Governments have found ways to
discriminate against service exports. Overseas US aviation faces a number of situations
where national airlines receive preferential treatment, such as the provision of airport
services, the location of airport counters and the number of landing slots.
5. Standards
The government sets standards that must be met by the exporting country.
Practice Questions
Critical Thinking Ability Test Questions and Answer Key:
Discuss the answers to the questions below and answer briefly!
1. Explain Adam Smith's theory of absolute advantage?
2. How does Ricardo's theory of comparative advantage differ from the theory of absolute
advantage?
3. There are two general classifications of trade barriers: tariff and non-tariff barriers.
a. Explain the different types of tariff barriers?
b. Name some non-tariff barriers?
Answer Key for Chapter 3 Practice Questions:
1. The theory of absolute advantage states that the ability of a nation to produce a good with the
same amount of inputs is more than other countries. (Weight 30).
2. The theory of absolute advantage states that market forces, not government control, should
determine the direction, volume and composition of international trade. Some of these goods
will be exported to pay for imports of goods that can be produced more efficiently elsewhere.
While Ricardo's theory of comparative advantage states that a nation that has an absolute
weakness in producing two goods from the point of view of another nation has a comparative
or relative advantage in producing the good in which its absolute weakness is less (Weight
30).
3. There are two general classifications of trade barriers: tariff and non-tariff barriers. Weight:
40
a. Name and explain the different types of tariff barriers? Types of tariff barriers:
1. Import duties consist of:
•
Ad valorem duties: import taxes levied as a percentage of the invoice value of imported
goods.
•
Specific duty: a fixed amount levied on a physical unit of imported goods.
•
Combination/compound duty: a combination of specific and ad valorem taxes.
•
Variable taxes: import taxes determined by the difference between world market prices
and locally supported prices
2. Official prices, these prices are included in the customs tariffs of some countries and are the
basis for the calculation of ad valorem taxes where the actual invoice price is lower. Official
prices guarantee that certain minimum import taxes will be paid regardless of the actual
invoice price.
b. Name some non-tariff barriers?
1. Quantitative / Quota
a. Tariff rate quota
b. Global
c. Discriminatory (Restrictions on export voluntary/VER; Marketing regulations)
2. Non-quantitative
3. Customs and other administrative procedures
4. Standards
Case Study
TRADE IS BLOOMING:
Nowadays, flowers are a product that is needed and traded. People's consumption
patterns are not only to fulfill basic needs but also to create a beautiful and aesthetic
environment as well as the need for mutual respect between individuals where flowers
function as greetings in various events and celebrations. Have you ever asked where the red
roses you give or receive on Valentine's Day come from? If you're North American, they
were probably grown on a mountainside in Colombia or Ecuador. If you're European, they
probably came from Ethiopia or Kenya. And, if you're Asian, they may have come from
Kunming, a city in the interior of Yunnan province, China. While most bouquet recipients
don't care where their pretty flowers were grown, they are heirs to a burgeoning international
trade in flowers and plants. Previously run by small-scale farmers focused on serving local
chapters, the globalization of the floriculture industry is now driven by technological forces,
trade liberalization, the desire to improve core competencies, and the need to respond to new
competitors. The supply chains and technologies required to bring fresh cut roses or
chrysanthemums to our loved ones are no less sophisticated than those used by high-tech
manufacturers of smartphones, personal computers and big screen TVs.
The Netherlands has long been the center of the international commercial flower
industry. Dutch farmers began using greenhouses to grow fruits, vegetables and flowers in
medieval times. Universities, farmers and research centers have been leaders for centuries in
developing new types of plants. The Netherlands is still the most important exporter of
flowers and plants, with about 65 percent of the world export market. Much of the country's
prominence relates to FroraHolland, the most important flower auction in the world in the
world that is structured as a cooperative owned by its 5000 members (mainly farmers).
FloraHolland was created in 2008 through the merger of six flower auction markets in the
country, the largest of which was Aalsmeer (near Schipol airport), followed by Naaldwijk
and Rijnsburg. In 2011, FloraHolland auctioned more than 12.5 billion plants and flowers
worth €4.2 billion. Cut flowers accounted for about 57 percent of this income. Not
surprisingly, roses are the most important flower, with auction sales valued at €761 million,
followed by chrysanthemums and tulips. Most of its cut flowers are destined for the European
Union (EU) market; potted plants and bulbs, being more resistant, have a wider market. For
example, the US market absorbs about a quarter of Dutch bulb exports.
These statistics, however, do not tell the whole story of FloraHolland's significance. Its
large trading volume has enabled it to create a futures market for tulips, roses, and other
flowers. By purchasing flower futures, large flower wholesalers can advertise and market
flowers to be delivered to their clients the following month without fear that changes in
flower prices will wipe out their profits when they actually deliver and pay for the flowers.
The availability of flower futures attracts more buyers and sellers to the FloraHolland
exchange thereby increasing their transaction volume and market liquidity.
To expand its influence beyond the regional market, the flower exchange has integrated
e-commerce into its auction system. Now buyers from Germany, France, and other European
countries can monitor auctions of tulips, roses, and chrysanthemums from their home
computers without having to travel to Aalsmeer. The auction site can also be used to place
orders by combining new technology with its traditional auction methods. FloraHolland
assures that it will still play an important role in the international flower market.
This adaptation is particularly important because Dutch farmers face high labor and
land costs that have created opportunities for farmers in other countries. Colombian farmers
have benefited from lower costs, geographical location and a more favorable climate to
become a major source of cut flowers from the North American market, which accounts for
more than half of the flowers imported by US flower wholesalers and retailers. Neighboring
Ecuador specializes in roses, which suit the country's climate. Kenya and Ethiopia are
important suppliers to the European market. China, particularly the city of Kunming in
Yunnan province, is growing to supply the Asian market. The Chinese government has
encouraged the growth of the industry through low-interest loans for greenhouses and
refrigerated trucks. Dutch, Korean and Japanese companies have begun investing in the area,
believing they can provide lower-cost sourcing for the Asian market. The domestic Chinese
market is also expanding rapidly, in line with the country's growing middle class.
The growth of international trade in flowers from plants has impacted other industries.
The airline industry has adapted quickly to the changing needs of the floriculture industry.
Flowers are perishable goods, so the reliability of scheduled air services is critical to the
needs of buyers. In addition, most passenger aircraft have unused cargo space after
accommodating passenger baggage. Flowers also have a high value-to-weight ratio and are
packed in small boxes that can easily fit into the cargo hold of modern jet aircraft. Upon
arrival at the destination airport, specialized carriers are needed to ensure that the flowers
remain refrigerated from the airport to the wholesaler or retailer, creating new opportunities
for innovative trucking companies and logistics service providers to thrive.
Dynamics of International Organizations
International organizations serve to facilitate, regulate, measure or finance international
business activities. The purpose of studying international organizations is to understand the
impact of international organizations on businesses and business people around the world and
to understand the political and legal power environment (Ball et al., 2005).
4.1. United Nations (UN):
The United Nations (UN) is an International Organization with 191 member states
dedicated to promoting peace; it also has many business-related functions. The United
Nations (UN) was formed and born amidst the idealism and hope that came with peace
following World War II (1939-1945) (Ball et al., 2005).
The tasks of the United Nations are carried out through the main organs or bodies.
General Assembly, Security Council. Social and Economic Council, International Court of
Justice, and Secretariat. Although the UN conducts its work worldwide, all major UN
organs/bodies are headquartered in New York City except the International Court of Justice
which is located in The Hague, Netherlands. The United Nations has six official languages:
Arabic, Chinese, English, Russian and Spanish (Ball et al., 2005).
All member states of the UN are members - members of the General Assembly, where
each country has one vote with the regardless of size, prosperity or power. The General
Assembly acts by adopting resolutions to express the will of member states. Decisions on
important issues, such as those concerning peace and security, admission of new member
states, budgetary matters, require a two-thirds majority, while decisions on various other
matters require a simple majority. Decisions of the General Assembly do not have the force
of law binding on governments or citizens in member states, but they carry the weight of
world opinion (Ball et al., 2005).
4.2. Multilateral Development Banks:
According to Ball et al. (2005), multilateral development banks are international
lending institutions owned by member countries and aim to promote economic and social
progress in developing member countries, by providing loans, technical assistance, capital
investment and assisting with economic development plans.
There are five multilateral development banks:
1. African Development Bank (AfDB)
2. Asian Development Bank (ADB)
3. European Bank for Reconstruction and Development (EBRD)
4. Interamerican Development Bank (IDB)
5. World Bank
World Bank:
The International Bank for Reconstruction and Development (IBRD), also known as
the World Bank, consists of the International Finance Corporation (IFC) and the
International Development Association (IDA). The World Bank provides hard loans at
prevailing market interest rates and is guaranteed only to sound borrowers for a period not
exceeding 25 years. The International Finance Corporation (IFC) assists private enterprises
in less developed countries in the form of joint ventures and sells securities to local capital
markets. International The International Development Association (IDA) provides
concessional loans or credits with a maturity period of 40 years to poor countries. IDA's
sources of capital come from contributions by developed countries and some less developed
countries (Ball et al., 2005).
4.3. Bank for International Settlements (BIS):
The BIS is a financial institution where central bankers of major industrialized
countries meet every ten years to discuss the global financial system. The BIS has four main
functions, namely (1) a forum for international monetary cooperation, (2) a research center,
(3) a banker for central banks, and (4) an agent or trustee for various international financial
agreements (Ball et al., 2005).
4.4. International Monetary Fund:
The IMF helps less developed countries with balance of payments deficits and works
with the World Bank to correct the fiscal and monetary policies of borrowers. The size of a
member country's quota is equal to the amount of contributions to the IMF. The IMF's
objectives are to assist the development of (1) orderly foreign exchange arrangements, (2)
convertible currencies, (3) shorten the period and reduce the degree of balance of payments
imbalances (Ball et al., 2005).
The IMF fulfills its safeguarding obligations in two main ways. First, the board of
governors regularly examines carefully the economic policies and performance of each
member and the interaction of those policies with economic development in other countries.
Second, the board holds regular reviews of world economic outlook and periodic discussions
on exchange rate developments in major industrialized countries (Ball et al., 2005).
4.5. World Trade Organization & General Agreement on Tariffs and Trade:
The General Agreement on Tariffs and Trade (GATT) is a set of trade rules, tariff
reductions and barriers. GATT negotiations to reduce tariffs and other trade barriers were
conducted in sessions called rounds, of which there were eight from the first in 1947 to the
Uruguay Round launched in 1986 in Punta del Este, Uruguay. The main objective of the first
seven rounds was to reduce tariffs among industrialized countries from an average of 40
percent to 5 percent (Ball et al., 2005).
The weakness of GATT is that when two or more countries dispute about this tariff
agreement, GATT is unable to resolve the problem because GATT is only a set of agreements
or trade regulations. Therefore, an institution that regulates the international trade law system
was formed, namely the World Trade Organization (WTO). The WTO allows members to
form intergovernmental agreements to establish customs unions (CUs), Free Trade Areas
(FTAs), interim agreements leading to the establishment of CUs and FTAs and Economic
Integration Agreements (EIAs) (Ball et al., 2005).
4.6. Organization of Petroleum Exporting Countries:
OPEC is an organization that aims to negotiate issues regarding production, prices and
petroleum concession rights with oil companies.
4.7. European Union (The European Union):
As a result of the Second World War, Europe was in a state of turmoil due to the
struggle and the expenditure of effort and investment on the war. To help Europe get back on
its feet and to encourage strong and friendly governments, the US secretary of state, George
C. Marshall, recommended that the United States provide financial assistance to and work
with European countries in rebuilding them. Thus was born the Marshal Plan, named in honor
of US Secretary of State George C. Marshal, which suggested the use of U.S. capital and
cooperation in rebuilding Europe after World War II, led to the creation of the European
Union. The goals of the European Union are eliminate trade barriers among member
countries and cooperate in various ways (Ball et al., 2005).
In December 1991, representatives of the various countries that later became members
of the European Union met in the Dutch city of Maastrich, where they signed a treaty bearing
the name of the city. The objectives of the Maastricht Treaty included economic and
monetary unification, with a European Central Bank to replace national central banks and a
European currency instead of various national currencies (Ball et al., 2005).
4.8. Regional Group of Nations
There are four main forms of economic integration of countries forming regional
groups of nations, namely:
1. Free Trade Area (FTA). Tariffs are eliminated among FTA members, but each
member country maintains its own external tariffs on imports from non-member
countries.
2. Customs union. In this form, member countries add a common external tariff to the
FTA form while member countries have removed tariffs among themselves.
3. Common market, a customs union plus the removal of restrictions on the mobility of
capital and labor among member countries.
4. Complete economic integration. This form involves a high degree of political
integration as member states give up important elements of their sovereignty. Central
banks are created jointly. The group of countries determines monetary and fiscal
policy as well as labor and social policy for all member countries, so that a single
currency can be created that will replace the currencies of the member countries, as in
the European Union.
Practice Questions for Chapter 4
Critical Thinking Ability Test Questions and Answer Key
Discuss the answers to the questions below and answer briefly!
1. Explain the function of international organizations in international business?
2. Explain the difference between GATT and WTO?
3. Describe four forms of economic integration of regional groups of nations?
Answer Key for Chapter 4 Practice Questions
1. The function of international organizations in international business is to facilitate,
regulate, measure or finance international business activities.
2. GATT stands for General Agreement on Tariffs and Trade is a set of trade rules, tariff
reductions and barriers. GATT is not an institution, but only a set of agreements
discussed by member countries in negotiation rounds (such as the Uruguay Round), so
that if there is a dispute between members. The GATT agreement cannot solve the
problem. While the WTO (World Trade Organization) is an institution that regulates
the international trade law system. The WTO allows members to form
intergovernmental agreements to establish customs unions (CUs), Free Trade Areas
(FTAs), interim agreements leading to the establishment of CUs and FTAs and
Economic Integration Agreements (EIAs).
3. The four forms of economic integration include:
a. Free Trade Area (FTA). Tariffs are eliminated among FTA members, but each member
country maintains its own external tariffs on imports from non-member countries.
b. Customs union. In this form, member states add a common external tariff to the FTA
form while member states have removed tariffs among themselves.
c. Common market, a customs union plus the removal of restrictions on the mobility of
capital and labor among member countries.
d. Complete economic integration. This form involves a high degree of political
integration as member states give up important elements of their sovereignty. Central
banks are created jointly. The group of countries determines monetary and fiscal policy
as well as labor and social policy for all countries members, so that a single currency
can be created that will replace the currencies of member countries, as in the European
Union.
Case Study
TRADE AND PROSPERITY: MEXICO CASE:
Mexico is one of the countries that has successfully promoted economic development
through trade. Previously, Mexico was a country that was very closed to trade. From 1971 to
1982, Mexico relied on domestic economic policies where the government set high tariffs to
reduce imports and restricted foreign direct investment (FDI) to reduce the presence of
foreigners in the Mexican economy. The government at the time controlled key industries
with a strong and conservative bureaucracy that discriminated against the private sector and
limited innovation. Although the Mexican economy grew with this policy, its performance
did not match that of export-driven economies such as Hong Kong, Taiwan, or South Korea.
Seeing this fact, the last six Mexican presidents then reversed this policy. The government
lowered tariffs, encouraged FDI, made state-owned companies private, and joined the
General Agreement on Tariffs and Trade (GATT) and the World Trade Organization (WTO).
Under their leadership, Mexico signed a series of free trade agreements with 44 countries,
including the United States and Canada, the European Union, Israel, Japan, Chile, and five
Central American neighbors.
Mexico's joining of the North American Free Trade Agreement (NAFTA) with the
United States and Canada was big news. Its implementation in 1994 opened up the US and
Canadian markets to factories located in Mexico, allowing them to take advantage of
Mexico's lower labor costs. While the majority of newspaper headlines highlighted NAFTA's
impact on major industries such as automotive or textiles, Mexican entrepreneurs were quick
to recognize new opportunities. For example, a $100 million dental-related supply business
per year, grew in Mexico due to NAFTA, producing labor-intensive products such as buccal
tubes, endodontic files, and dental wax. Mexico's service sector also benefits, as companies
locate service centers, data processing facilities, and customer support services there. Seagate
Technology's Reynosa facility, for example, provides after-sales support for customers in
North America. In 2012, the business's service exports to the United States exceeded $3.3
million. However, China's joining the WTO, along with the downturn in the US economy in
2001, dampened Mexico's export boom. Many manufacturers of low-margin and value-added
products, such as toys and clothing, and companies requiring labor-intensive assembly,
moved to China to take advantage of low labor costs.
The economic benefits of producing these goods in China have stopped in recent years.
Wages in China have been increasing annually at double digit rates for a decade. The average
hourly manufacturing wage is estimated at $3.00 in China and
$3.50 in Mexico, but labor productivity is higher in Mexico. As a result, some companies
moved manufacturing activities back to Mexico to take advantage of proximity to the US
market and integration into the supply chains of North American companies. For example,
manufacturers of high-definition flat-screen televisions, such as Samsung, Sony, and Vizio,
found convenient locations in Mexico to assemble their products for shipment to customers in
North America. Contract manufacturer Hon Hai Precision Industries now assembles custom-
ordered computers for Dell in Ciudad Juarez, while still rapidly producing standardized
models in Chinese factories. Queretaro, a colonial-era city in the middle of the Mexican
highlands, is becoming a hub for international companies. General Electric employs 1,300
engineers at its research and development (R&D) center in Queretaro who design large-
capacity jet engines for the company. Airbus and Boeing, while Bombardier's 1,600 workers
build airframes, electrical systems, and horizontal and vertical stability for the company's
latest line of jets. Mexico's automotive industry is also booming. The industry is currently the
world's fourth-largest exporter of automobiles - 2.1 million vehicles in 2012. And, the
industry's success has led auto component suppliers to invest heavily in Mexico. Pirelli
invested $400 million in its Silao tire plant to service car assembly plants in Mexico.
Similarly, Bosch of Germany, Akebono Brake Industry and Nippon Steel of Japan, and
Delphi of the United States have invested heavily to feed the country's production lines.
Of course Mexico still faces many challenges. Increased crime among drug lords has
scared off some foreign investors. For example, Elektrolux AB, a giant Swedish appliance
manufacturer, chose to locate its latest plant in Memphis, Tennessee, rather than Mexico, due
to safety concerns. Mexican exporters are vulnerable to the economic crisis in the United
States - 80 percent of Mexico's exports go to its northern neighbor. Moreover, the Mexican
government realizes that it must increase the productivity of its workforce and improve the
country's infrastructure if Mexico is to continue to compete in the global economy.
Case Question:
1. Based on the above case, how has Mexico's success affected the economies of Canada
and the United States?
2. Assuming you decide to locate your factory in China or Mexico to serve the US market,
what factors influence your location decision?
3. What is the difference between WTO and GATT?
4. What is NAFTA? What is its purpose?
