CHAPTER 1: Globalization and International Business

What is International Business?

Any commercial transaction between two or more countries is known as International
Business. The parties of the transaction could be either companies or Governments.
What is the need of International Business?
IB is needed because:
1) Raw materials are required from abroad
2) Processes are acquired from abroad. E.g.- Wal Mart
3) Advanced technologies are required from abroad
4) Competition: There will always be competition. Even if the company does not enter
into foreign territory, foreign companies will enter into the host country.
So baring some very local businesses, it is not possible to stay insulated from international
business because of the above mentioned reasons.
What are the features of International Business?
(DIFFERENCE BETWEEN IB AND DOMESTIC BUSINESS)
1) The world is the market
2) It involves a global scale of operations
3) Ample number of opportunities
4) World class products/services
5) International level of productivity
6) Efficient/Productive value chain
International Business by its very nature is a primary determinant of International Trade. One
of the reasons of the increasing success of international business ventures is globalization.
What are the competitions arising due to global opportunities?
There are four levels of competitions due to global opportunities:
1) From host country suppliers: If a company from India wants to manufacture or
export its products to the US then the existing US suppliers will have an advantage
over the Indian company in terms of zero customs tax, minimum transportation cost
and a popular brand name.
2) From domestic players of home countries: In home country, multiple companies
with similar products having the same pricing start competing.
3) Free trade agreements/ trade blocks: The advantage of manufacturers belonging to
a trade block is that they don't have to pay any custom duty. The only cost incurred by
them is the transportation cost. E.g. NAFTA.
4) International Players - Apart from the company from home country, a number of
other companies across the world would also like to sell their product in a particular
host country. So there exists competition from international players.
Why do companies engage in International Business?
The following are the factors for companies engaging in International Business:
1) To increase sales i.e. Sales Expansion:
a) Larger canvas along with the convention of Scale Economy in which the unit cost
comes down
b) Companies leverage IPLC (International Product Life Cycle). It involves 4 stages:
i)
Induction: Company cashes in on the unmet market needs
ii)
Growth
iii)
Maturity

iv)
Decline
As the stage in the PLC changes, the place of production/manufacture changes around
the world. IPLC stages followed by a product are different in different countries. These
differences provide different market opportunities in different countries. Innovation first
spreads into developed countries, due to their high purchasing power. The critical success
factor is cost. So, developing countries become the manufacturing hub. So, they become the
main exporter and the developed country where the innovation began along with the other
developed countries becomes the main importer.
c) Following the Customer to other countries: Every company has some core
customers. Companies follow their core customers where ever they go in the
international arena. However Govt. forces the MNC to have local suppliers. E.g. In
the case of GE, the GE or home suppliers come along with GE to the host country
where GE is operating. The main threat is when GE finds the local suppliers to be
more cost effective than the home country suppliers and prefers working with the
former.
d) Lead Market: Companies want to be leaders in some market and just want to be
present in some other lead markets. Lead markets tell the future of the industry. If a
company wants to be global, then it needs to have a presence in the lead market to
know the product trend. A company might not make profit and lose, but will learn or
find a probable alliance, so it goes to the lead market. E.g. Perfume and fashion
market in France, car market in Japan or Germany
2)
a)
b)
c)
d)

To acquire resources:
Better quality or competitive resources
Resources available at lower cost
Resources (Technology, HR) might be scarce in the host country
Global Sourcing: Companies prefer not to depend on a few countries. They want to
spread the risk in acquiring resources.
E.g. BOSCO comes to India for Iron Ore

3) Reducing Risk: Companies try to reduce risk by spreading operations around the
world.
a) Business Cycles: There are ups and downs in the economy, but all countries are not
equally affected. If there is more spread it can average out returns.
b) Overdependence on a particular country for market and resources can be a problem,
especially during sensitive situations like war times. E.g. Gulf War. Thus for a country
it was better during that period to have other sources of oil.
c) Cross patrolling: Divert the competition posed by a company by trying to compete
with them in their home country. It is an offensive but very effective, as sometimes
offense is the best form of defense. If you follow your competitors, you may get the
second mover advantage. E.g. Caterpillar of USA expanded to UK first and then tried
to enter Japan. COMADSO of Japan was giving stiff competition. Then COMADSO
attacked Caterpillar in USA, thereby diverting Caterpillar from the Japanese market to
its home country.
d) Defensive reason: Companies want to counter advantages gained by competitors in
foreign markets that might hurt them elsewhere.
What is Globalisation?

It is the transformation of national and regional market into one common world/global market
for free flow of goods, services, capital, people and technology across nations.
What are the Drivers of Globalisation?
1) Progress i.e. increase in and expansion of technology. (Advances in communication
and transportation)
2) Liberalization of cross border trade (exports/imports), investment (FDI) policy by the
government and resource movements
3) Development of IB related services
4) Increasing consumer pressure
5) Increased global competitors and competition
6) Improving political relations among countries
7) Increased cross border cooperation. E.g. Copenhagen Summit
8) Increased availability of capital worldwide seeking optimal long term returns.
What are the disadvantages of Globalization?
1) Growing Income inequality/ Economical inequality: Small local players suffer.
Larger companies and consumers get benefitted by Globalization. The rich get richer
and the poor get poorer.
2) Threat to national and economical sovereignty: More dependence on external
inputs. (Question of local objectives and policies, local overdependence and cultural
homogeneity)
3) Faster ecological degradation: As high competition due to globalization spurs
industrialization which hampers the environment.
What are the modes of International Business?
There are basically three aspects of international business:
1) Manufacturing in home country
2) Manufacturing in host country
3) Project/Services in host country
1) Manufacturing in home country: In this case the products are manufactured in
home country and then exported to host country. E.g. GE manufactures in USA and
exports in the host country. It is feasible when:
a) Excess capacity in home country
b) Quality allowed by host country
c) The labor costs are low in home country
d) Transportation costs are not high
e) No tariff barriers to exports.
The advantage of this method is scale economy and excess capacity utilization.
# Exports can be Direct or Indirect.
Direct Exports involves independent distributors where company is in direct touch with the
customers. Distributors buy the goods from the manufacturer in large quantities. They sell the
product, know the country market well. A partnership happens between client and customer.
Sales people are trained and sent for missionary distribution. It also involves investing in
your ace staff to help with the sales of the product. Feedback is possible in this.
Indirect Exports is through agents in the home country and trading houses in other countries.
Agents do not have ownership, but act on behalf of the client. They generally have a good
track record of sales. The cost incurred by agents in sales is not reimbursed by the company,

but it is contained in the commission they get. In the case of non-exclusive agencies, the
agents can work for other manufacturers as well. Agents get paid only when the contract is
bagged. Thus it leads to economies of scale and scope. However the disadvantage is that here
feedback is not available, since no interaction with the customer and it is meant for short term
gains. This poses a sustainability issue for the manufacturer as it might be dumped as soon as
a cheaper manufacturer is found. Thus companies find it convenient to sell through trading
houses and one stop shops, as it helps in entering different markets and risk is not present.
E.g. Mitsubishi sells through one stop shops. #
#Piggy Back: When other companies use the distribution of a particular company. E.g.
Voltas. It has an excellent distribution network in India. Other companies approach Voltas for
distribution. They are non-competing products. Voltas gets paid for it. Foreign companies pay
Voltas for distribution. E.g. Fiat is using Tatas distribution now. Tata uses Fiats engine. They
are mutually helping each other. #
2) Manufacturing in host country: The manufacturing in the host country can be done
either by contract manufacturing or by licensing.
a) Contract Manufacturing: In contract manufacturing the company gives a contract to
local manufacturers to manufacture the product instead of setting up a factory. E.g.
Nike has done contract manufacturing with Chinese manufacturers for 1 year. As
knowhow would be shared, only strong brands like Nike can do it.
The advantages are:
i)
The companies will have a low level of involvement and in turn get a taste of
the market first.
ii)
No labour issues
iii)
Control of the market as it is the company that sells and interacts with the
customer.
iv)
Low risk option as company can terminate the contract and switch.
The disadvantages are:
i)
Dependency
ii)
Sharing of profits thus lesser margins
iii)
No control over quality, manufacturer may not be loyal
iv)
It makes the local manufacturers strong and they can turn into competitors as
they know the technique, style and design and take over the market.
b) Licensing: In licensing the licensor permits the use of technology for a certain period
of time to the licensee for the manufacturing of licensed products and sale of the
licensed products in the licensed territories. Here the licensor owns the technology.
The licensee is permitted to use the technology. For this the licensee pays downpayment as well as royalty to the licensor.
Royalty is always on sales and not on production. Host country Govt. sets the
guidelines and rules.
Companies get into licensing as there is a pressure to shorten the PLC.
Once the license is over, the licensee can use the technology, but it is not possible for
licensor to enter into the market.
Licensing is good when the political risk is high. Licensor can use the royalty on R &
D and create next generation product in accordance with the market need.

Licensee is using depreciated assets, but licensor works with todays costs, i.e. cost
factor is higher for the licensor. No customer relations exist so licensor starts from the
beginning. Thus there is higher risk in licensing than contract manufacturing.
The advantages are:
i)
Recovery of R & D investment as fast as possible
ii)
Lesser capital investment
iii)
Brand value is known
iv)
No labour issues
The disadvantages are:
i)
Creating a competition, as the licensee is in touch with the customer.
3) Projects/services in host Country:
a) BOT (Build, own and transfer)
b) BOOT (Build, own , operate & transfer)
c) Turnkey Project (Build and transfer): Client in host country. Entire responsibility
from concept to commission is given to the expert company, including design, global
procurement, testing stage up to product being switched on. Global bidding takes
place. E.g. Bechtel is a leading US based company in the infrastructure construction
sector, which designs and executes projects in Machine technology. It sources funds
from World Bank and Asian Bank, and is actively involved in the planning of where
the plant should be located and what its capacity should be. It acts as a consultant and
takes commission. The client of Bechtel only turns the key i.e. starts using it. Hence
they are called turnkey projects or turnkey contracts.
The advantages are:
i) It gets references for other projects in host country and in countries around it.
ii) Increases the domain knowledge
iii) It gets fees and part of profit. Payment is received in installments at different
milestones. It is called progress payment
d) Management Contract: Unlike the turnkey contract, management contract has the
asset. But here the company is not confident to run the plant alone (market/operation).
One company provides personnel to perform general or specialized management
functions for another. It is recurring. The company gets profit, increases its captive
capacity. E.g. Wholecem was paid money by local Dubai Cement Company for
management contract. Wholecem increases capacity in terms of infrastructure and
technology transfer and marketing strategies. So, after few years it can become
independent. They can expand to the international market. They can understand
market demand and competition to be faced.
The money received / paid in management contract is:
i)

Base Fee + certain no. of expatriates

ii)

If capacity of production/sales is higher than that agreed, pay more, and if

lower than agreed, penalty is charged.

What are the various Foreign Country Entry Strategies?

NON FDI BASED:
1) Exports
2) Contract Manufacturing
These also include turnkey projects, management contracts and R & D
# R & D: Critical part of R & D at home. No technology diffusion. Stand alone modules are a
part of R & D contract. Country should be compliant with IPR#
FDI BASED:
1) Licensing
2) Assembly
3) Joint Venture
4) Wholly owned subsidiary
5) Acquisition/ Merger
They are named in increasing order of risk.
1) Exports:
The Company goes for exports because it has higher competitive advantage. The
transportation costs are low. The tariff rates are also low.
2) Contract Manufacturing:
In contract manufacturing the parent/hiring company approaches a firm known as
contract manufacturer with a design/formula. Once the contract is finalized then the
contract manufacturer manufactures the components/products for the hiring company.
Freedom from managing the labour, tech/design diffusion will occur but only for
manufacturing part. There is no FDI and there is flexibility of switching.
3) Licensing:
In licensing, first the licensor searches for a potential licensee. Then the licensor
permits the use of technology for manufacturing a component/product to the licensee
for a definite period at a certain location. The role of the licensee is to both
manufacture and market.
A contract manufacturer only produces products where as a licensee produces as
well as sells for the licensor.
Boundary conditions of licensing:
a) It applies to a particular territory. E.g. big country like Brazil sells and manufactures
only in that territory. Economically small country like Bangladesh, Sri Lanka,
manufactures at home, sells to neighbouring countries.
b) License product: License need not cover all products. A particular product or a group
of products are licensed.
c) Period of license: Normally 5 years. Can be varied or extended.
d) Expenditure for licensee:

i)

Royalty set by the host country based on the percentage of sales. Royalty is
always on sales and not on production.

ii)

Lump sum payment for documentation, process manuals and opportunity

costs. It is negotiable.

iii)

Training purposes

Lump sum payment up to 8 % of projected sales is easily accepted by the Indian Govt. It is
paid only once. R & D cost has to be recovered in 3 years on an average.
The advantages are:
a) Lesser capital investment
b) Good income and faster R & D recovery which can be invested to come up with
newer versions
c) Right capacity to license
d) Licensor gets tie ups with best distributors, knows local market and has cost
advantage
e) Licensor can cover many countries in the world at faster speed.
f) Brand value of licensor increases.
g) No labour laws issues.
If licensor is ready with the new version, and the host country is also ready for it, then
licensing is profitable, else it is not.
The disadvantages are:
a) Diffusion of technology
b) Losing the market to licensee, as customer contact is lost.
c) Increase in competition, as at the expiry of the licensing agreement the licensee will
become the competitor to the licensor. So the market presence increases with
licensing.
While licensing deals with products, franchising refers to services. E.g. Mc Donalds.
It involves not the use of technology but the trade mark or brand name. The territory will not
cover countries. Royalty is lower compared to licensing. Customization/Adaptation is
required for each country.
4) Assembly:
In case of assembly, different parts of the product are manufactured in different countries.
The assembly of the parts takes place in the host country. Over a period of time the
product becomes local to the host country. It involves local labour.
The advantages are:
a) Host country likes it, as it creates employment, causes technology upgradation, and
causes increase in indirect and corporate tax collection resulting from profits.
b) Scale economies as there is no transportation cost.
c) Customization is easier and can be done as per host country rules
d) Employment generation
e) Government will ask manufacturers to manufacture parts in host country. Tax benefits
can be demanded for backward integration in this case.
f) Local procurement: Host country suppliers get better prices.
The disadvantages are:

a)
b)
c)
d)
e)

Huge investment
Irreversible process. Exit is difficult as Govt. will not allow you to exit.
Hassles with labour laws
Difficulty in understanding companies dynamics, such as languages, culture etc.
Risk increases because of political situations.

5) Joint Venture:
In a Joint Venture, both the parties contribute a certain amount of equity and form a
new company. It involves sharing risk and cost with local partner. E.g. Tata and
Honeywell
The advantages are:
a) Local market familiarity i.e. suppliers, distributors, employers and established channel
partners etc can be known through the local company
b) Labor management
c) Host country relation / relation with banks
d) Reduces risk as sharing risk and cost in unknown market
e) Cultural bridge
f) Local JV company having good political contacts can be leveraged upon
g) Synergy
h) Liability in host country is responsibility of JV. So parent company is insulated. E.g.
Union Carbide- Bhopal Gas Tragedy
The disadvantages are:
a) Cross-cultural differences/ Cultural mismatch due to environmental changes, guard
technology
b) Change in company strategies may lead to Divergence E.g. Tata decided it does not
want to explore instrumentation. Honeywell offered to buy Tatas share without legal
hassles.
c) No intended technology transfer but technology gets diffused.
d) Synergy issues
e) Loss of interest by one party.
f) Due to high profits, the company wants to become independent and leave the sleeping
partner.
# When one partner is government, it is called Mixed Venture #
The reasons for engaging in Joint Venture are:
a) To enter into a foreign country
b) Suppliers, Distributors and established channel partners
c) Good brand name and relations
d) Sharing risks as well as costs
e) Cultural Bridge
f) Only way to get 100% FDI otherwise not possible due to government restrictions
g) Joint ventures are a necessity by government
h) Profit sharing/market sharing
The reasons for the failure of Joint Venture are:
a) Change in external environment
b) Conflict of vision/interest
c) Both parties not contributing equally
d) Sharing of market leading to market contraction

e) Global competitiveness requires control, which is not entirely present with either
party.
f) JV might be due to govt. regulations so might be a compulsion.
# In UAE, local partnership is 51% except in Jabel Ali Free Zone: 100% free zone in Dubai
1) Connectivity advantage as it is the gateway to Europe, Africa, South-East Asia and
West Asia
2) Volatile, politically unsafe (frequent way)
3) Distance from equator #
6) Wholly Owned Subsidiary:
A wholly owned subsidiary is a subsidiary whose parent company owns 100 percent
of its common stock and there are no minority owners. There is 100% control, no
local partners. Risk involved as there are no local partners and political risk is high.
Features MNEs should have to be WOS:
a) Global Brand
b) Innovative product
c) Access to distribution channels
d) Host country government wants the company in the country
e) Effective customer reach, good CRM
f) Product knowledge, core competency, retailer is ready to fill his shelf with the product
g) Good adaptable workforce
h) Adaptable market (market ready for product or market can be created)
The advantages are:
1) Freedom in designing the plant
2) No dilution of brand image
3) No dilution of profits
4) Total control over operations in the host country
5) No dilution of system processes
6) Processes are standardized
7) If govt. likes the company, it will have concession in most of the agenda points.
8) Whole operation can be integrated with global operations
The disadvantages are:
1) Total risk ownership. No risk sharing
2) Less knowledge of the market
3) Degree of competition increases
7) Acquisition:
Acquisition may be defined as a corporate action in which a company buys most, if
not all, of the target companys ownership stakes in order to assume the control of the
target firm.
The advantages are:
1) Acquiring the entire target company
2) Saves time as it is quick to reach the market
3) Ease of access in the market, due to well established distribution and sales channel
4) The competition in the market remains unchanged
5) Company has a good domain knowledge and benefits from local technology

The disadvantages are:

1) Getting obsolete technology in parts
2) Resources might not be best in class
3) Processes and practices might not be world class
4) Cultural mismatch
5) Parent company has to take over the liabilities of the acquired company.
6) Actual worth of the company can only be known after acquiring it.
# In case of acquisition or merger, as in Tata and Corus, the capacity of Tata + Corus remains
unchanged, rivalry remains same. In wholly owned subsidiary, new capacity is created,
rivalry increases #
# In JV, companies choose location, in merger companies choose only the time of it. #
# Expropriation vs. Nationalisation:
If the government of any country takes over any foreign company, then it is known as
expropriation whereas if the government takes over any localised company, then it is known
as Nationalisation. Wholly owned subsidiaries are exposed to expropriation where as joint
venture agreements protect firms from expropriation. #
What distinguishes International Business from Domestic Business?
The following factors distinguish International business from domestic business:
1) World market
2) Political environment
3) Legal system
4) Cultural difference
5) Communication
6) Distance are higher
7) Diversity
8) Uncertainty-Political, economical and currency risks
9) Uncontrollability-The degree of Uncontrollability is higher in host countries
10) Competitions
11) Competence-people in different countries are at different levels of competence.
Why is IB complex?
1) Distances are large, which increases risk

2) Diversity of host nations (political, social, environmental and economical systems of

nations are diverse)
3) Uncertainty of political situation in the host country
4) Uncontrollable conditions in the host country. At home, the industrial policies are
clear. The company can influence Govt. policy through lobbying. It is not possible in
host country.
What is a Multinational Enterprise (MNE)?
Multinational Enterprise is a firm that has engaged in foreign direct investment (FDI).
Equivalently, an MNE is a company that owns (a significant part of) and operates facilities in
nations other than the one in which it is based.
CHAPTER 2: The Cultural Environments facing Business
What is Culture?
Culture refers to the shared behaviour patterns based on attitudes, values and beliefs of a
group of people.
Culture comprises of:
1) Countrys / National culture
(Each country, each state might have a different culture)
2) Work-related / Organizational culture
(GE: Innovation driven, Toyota: Quality, Lean Management driven, Tata: Ethics
driven)
3) Professional culture
(E.g. teacher is associated with fairness, excellence and integrity)
Why learn culture?
1) Customer, supplier or employees are all people. Home country culture is very
important
2) Strategies to be used in host country depends on their culture
3) Consumer behaviour depends on culture
What are the elements / determinants of culture?
The following are the determinants of culture
1) Education level
2) Religion
3) Language
4) Aesthetics
5) Attitudes, values and beliefs
6) Technology and material culture
7) Social Unit (family/tribe)
8) Opinion Leaders
1) Education:
The education level of a country is an important determinant of its culture. The more the
education level of a country, the more it is adaptable to change. Education broadens the mind
and thus broadens perspective. From the business point of view it shapes the kind of market
we are operating in and the kind and type of products/services the country is offering, as there
is more demand of new products and improvement of skills required by other countries. The

governance of a country becomes simple with education. In India, education is being given
the paramount importance.
2) Religion:
Religion is a major aspect of consumer behaviour. It is a strong shaper of values. Within
religion there are many factions whose specific beliefs may affect business. Religion also has
influence on practices. From business perspective, products/services have to be in sync with
religion. The religion with the largest presence is Christianity.
3) Language:
Language is a factor that greatly affects cultural stability. It includes spoken, written as well
as body language. When people from different areas speak the same language, culture spreads
more easily. Business can be done more easily with other nations that share the same
language. Because countries see language as an integral part of their cultures, they sometimes
regulate their languages. For advertising the language has a greater impact e.g. Mandarin in
China
4) Aesthetics:
As far as aesthetics is concerned, sensory perceptions play a major role. Here, consumer
behaviour is very important. There are many aspects from business point of view:
a) Design: How you make your product.
b) Colour: Packaging
c) Music: Advertising
d) Product Policy
e) Consumer preferences.
f) Brand Name Customization
5) Attitudes, values and beliefs:
Attitudes are inherent in us. They are deep seated and cannot be seen. Behaviour is the
manifestation of attitude. Changing behaviour is easier but changing attitude is difficult.
Values are derived from the people around us like parents, teachers and the society. From
company perspective understanding belief is very important. Beliefs are derived from values
and history. Beliefs are related to education also. From company perspective predispositions
i.e. risk taking ability, creativity, demands compliance etc. are important.
6) Technology and Material Culture:
It determines how much the culture has adopted technology. E.g. Robotics is being used in
US for certain kind of jobs. However countries differ in their degree of materialism.
7) Social Unit:
In some societies the family is the most important group membership. However some
societies are different. E.g. African tribes are big social units, where the chieftain makes all
the decisions. In Japanese/ American societies, individuals leave the family by the time they
come to college. In societies in which there is low trust outside the family, small family run
companies are quite successful. But these companies have difficulty in growing because of
their reluctance to share responsibility with professional managers.
8) Opinion Leaders:
People respect the opinions of these leaders. Opinion Leaders help in speeding up the
acceptance of change. By discovering the local channels of influence an international
company may locate opinion leaders. Opinion leaders may emerge in unexpected places.
Characteristics of opinion leaders vary from country to country. These are believed to be
impartial in their region. If an MNE can convince opinion leaders, then MNEs can easily
succeed.
What are the parameters of culture used to distinguish countries?
The parameters are as follows:

1) Low context and High context

2) Monochromic and Polychronic cultures
3) Ascribed and Acquired membership
1) Low context Vs High context:
In low context cultures people consider only the first-hand information that helps them
directly in decision making only, as relevant. On the other hand, in high context cultures,
people consider peripheral information as well to be valuable in decision making and infer
meaning from things said indirectly. E.g. parameters for choosing a distributor in a low
context culture like USA and Europe include:
a) Infrastructure
b) Location
c) Financial strength
d) After sales service, good quality staff
e) Current business and hence customer base
f) Good relations with host country Govt.
g) Business must be significant proportion of the market
h) High profitability
In high context cultures like Saudi Arabia and most Asian countries, the following peripheral
information like:
a) Family Background
b) Friends and connections
c) Community, are also considered while choosing the distributor.
When managers from both types of cultures deal with each other, low context individuals
believe that the high context individuals are inefficient and waste much time where as the
high context individuals believe that low context individuals are too aggressive to be trusted.
2) Monochronic Vs Polychronic:
In monochronic cultures people are used to perform tasks sequentially where as in
Polychronic culture people are comfortable doing the tasks simultaneously. Some cultures
tend to focus first on the whole and then on the parts where as others do the opposite.
Cultures such as those in Northern Europe are monochronic where as cultures in Southern
Europe are Polychronic. Monochronic cultures are comfortable with rules like the queue
system unlike Polychronic behaviour.
3) Ascribed Vs Acquired group affiliations:
Affiliations which are inherited or determined by birth are known as ascribed group
affiliations where as affiliations not determined by birth, are known as acquired group
affiliations. Ascribed group affiliations include gender, family, age, caste, ethnic, racial and
national origin. Acquired group affiliations include religion, political and professional
associations. A person's importance/ranking depends upon both kinds of affiliations.
Countries like India give a lot of importance to ascribed affiliations while the USA gives
importance to acquired affiliations.
What are the other issues in Social Stratification that affect IB?
1) Role of ladies in society and respect for elders:
There are strong country specific differences in attitudes toward males and females. In
workplaces males are generally preferred. However barriers to employment based on gender
are easing substantially in many parts of the world. In certain countries ladies are not allowed

to choose their profession. For employee engagement we need to know the family values and
the priority of work-life balance. There is tremendous respect for elders in certain countries,
not only in the family but in work place also. But age does not matter in some other countries.
They go by meritocracy.
What are the Relationship Preferences that affect IB?
There are basically three aspects:
1) Power distance
2) Individualism Vs Collectivism
3) Authoritative Vs Participative
1) Power Distance:
Power distance is a term describing the relationship between superiors and subordinates.
Employee preferences in how to interact with their bosses, subordinates and peers varies
substantially internationally. Where power distance is high, people prefer little consultation
between superiors and subordinates. Similarly where power distance is low, people prefer and
usually have consultative styles.
2) Individualism Vs Collectivism:
Some societies are individualistic (American society) where the effort is single handed and
group effort is to the extent necessary, where as in collective societies (Japanese society)
people prefer to work in teams but take a longer time to come up with a consensus. Attributes
of individualism are low dependence on the organization and a desire for personal time,
freedom and challenge. The attributes of collectivism are dependence on the organization,
desire for training, good physical conditions and benefits.
3) Authoritative Vs Participative:
In authoritative societies people prefer being instructed. They like authoritative decisions,
where as in participative societies people work in consent with each other. In certain
countries people like to take decisions where as it is exactly opposite in some other countries.
How Maslows hierarchy of needs varies across countries?
According to this theory there are five levels of needs, the needs from lowest to highest level
being physiological, security, affiliation, esteem and self actualization. People try to fulfill
lower level needs sufficiently before moving on to higher ones. But different countries have
different levels of needs. So this theory is helpful for differentiating the reward preferences of
employees in different countries.
What are the risk taking behaviours, which affect IB?
Risk taking behaviours are basically categorized into four categories
1) Uncertainty avoidance
2) Trust
3) Future Orientation
4) Fatalism
1) Uncertainty Avoidance:
In countries with high uncertainty avoidance, employees prefer set rules that are not to be
broken even if it is for company's best interest. In these countries people prioritize job
security and spend a longer time in a particular company. On the other hand, in countries with

low uncertainty avoidance people are adaptable to change easily. They like to try new
products/services.
2) Trust:
The level of trust among people varies across countries. In countries with high trust level like
the USA and Norway the cost of doing business is low because costs incurred in supervision
and contingency can be lowered. Companies have to be more cautious in doing business in
low trust level countries like Brazil and India. Low degree of trust implies less assumptions
and comprehensive agreement documents.
3) Future Orientation:
Countries differ in the extent to which individuals live for present rather than for future. In
countries with high future orientation like India and Japan, companies motivate workers
through delayed compensation like retirement programs, pension, gratuity, savings, provident
fund, superannuation fund (tax-free till withdrawal) where as it is exactly opposite in
countries with low future orientation. Lower degree of future orientation implies that savings
bank schemes will have difficulty.
4) Fatalism:
In countries with high degree of fatalism, people plan less for contingencies. They believe
that unfortunate events are acts of god. People are reluctant to take insurance schemes. High
fatalistic people are less swayed by bosses persuasive logic. Higher degree of fatalism
implies lesser motivation. Insurance sector would face difficulty in such cultures.
What are the information and task processing issues that affect IB?
1) Idealism Vs Pragmatism:
Idealist cultures first determine principle before resolving small issues where as pragmatist
cultures focus more on details of the issue rather than on principles for resolution.
What are the issues faced while dealing with cultural differences?
1) Culture Shock Vs Reverse Culture Shock:
Culture shock is the frustration that results when a person moves to another country and has
to learn and cope with a vast array of cultural cues and expectations. Some people also
encounter culture shock while returning to the home country because they have learned a
different culture abroad. This is known as reverse culture shock.
2) Accommodation of foreigners:
Every country does accommodate foreigners. The principal reason is business and FDI, in
return of which the country will emerge in the world map. However the local citizens treat
local people and foreigners differently. In many countries foreign women are easily accepted
as managers as compared to local women.
What should one do to institute cultural change within the company?
Cultural change or diffusion is a slow process. It involves:
1) Induction: Choose the sequence of change correctly
2) Create respect for the new culture by having role models in different places. This
can be done by sending expatriates to the home country.
3) Include employees in cross-functional teams
What are the various aspects of implementation of cultural change in an MNE?
The culture of a country cannot be changed. The various aspects of implementation of
cultural change in an MNE are as follows:
1) Value Systems: The more something counters our value system, the more difficult it
becomes to accept.

2) Cost benefit analysis of change: Some changes to foreign culture increase the
productivity and sales greatly where as some other changes to foreign culture increase
the productivity marginally. So we have to consider the cost due to such changes to
foreign culture and the benefits associated with those changes.
3) Too much change too soon: People are generally reluctant to accept too many
changes too soon. So the changes in products/services have to be made in a phased
manner.
4) Reward sharing: Sometimes a proposed change may have no foreseeable benefit to
the people who must support it. In this scenario the profits generated due to the
proposed change has to be shared among the people who must support it.
5) Participation in change decision: To avoid problems arising from a proposed
change, all the stakeholders are made to participate in change decisions. By this
method the company may learn how strong the resistance will be if changes are made.
6) Opinion leaders: Sometimes opinion leaders greatly help to speed up the acceptance
of change. By discovering the local channels of influence, a company might locate an
opinion leader.
7) Timing: Many good business decisions fall flat because they are ill timed. So changes
should be implemented at the right time so that it can be easily accepted.
8) Learning Abroad: Company gains more experience in overseas operations. They
may learn as well as impart valuable knowledge that proves as useful in the home
country as in the host country.
What are the various types of Company and Management Orientations?
The adaptation of a foreign culture by a company not only depends upon the conditions of the
foreign culture but also depends upon the attitudes of managers of the company. So
accordingly the attitudes or orientations can be broadly classified into three categories:
1) Polycentrism
2) Ethnocentrism
3) Geocentrism
1) Polycentrism:
A polycentric organization customizes business practices/ management processes for different
countries. The organization believes that business units in different countries should act very
much like local companies. It gives a better foothold in the market but the downside is that
the company has to give up its core business practices or core competence. Excessive
polycentrism may lead to such extensive imitation of proven host-country practices that the
company loses its innovative superiority.
2) Ethnocentrism:
In ethnocentrism the company believes that the world is the same, so what worked well in the
home country will work well in the host country. It might be business practices, management
systems or retention of employees. Since cultures and people are different, ethnocentrism
does not necessarily work. In ethnocentrism managers overlook important cultural factors
abroad because they have become accustomed to certain cause and effect relationships in the
home country. Here the management recognizes the environmental differences but still
focuses on achieving home country objectives.
3) Geocentrism:
Geocentrism is a judicial process. Here a model is being created taking into consideration the
host country needs and own company practices. Geocentrism exists when a company bases

its operations on an informed knowledge of its organization culture along with in-depth
understanding of home and host country markets, needs, capabilities and constraints.

CHAPTER 3: The Political and Legal Environments Facing Business

What is Political Risk?
It is the risk or uncertainty that certain political decisions or government actions/events in a
country could negatively affect the profitability or sustainability of an investment. Political
risk is the chance that political decisions, events or conditions in a country will affect the
business environment in ways that may adversely affect the operations of MNEs in the host
country.
1) Political risk matters the most to any MNE in the world.
2) When companies choose among the 200 countries, they consider political risk to be
very important.
3) The lower the political risk, the better the business opportunity and in turn higher the
country attractiveness.
What is Political Ideology?
It is the governments thinking about what it wants to achieve and how.
What are the causes of Political Risk?
1) Govt. Actions
2) Civil Strife/Unrest/Disorder.
3) International War.
4) Harmful actions against people.
5) Change in political ideology
1) Govt. Actions: Govt. action can change the country's attractiveness. Governments can
put restrictions to the sectors in which business can be done. Govt. puts many acts to
impose restrictions on the sectors like FERA and MRTP Act.
a) FERA Act (Foreign Exchange Regulation Act, 1973): An act to consolidate and
amend the law regulating certain payments, dealings in foreign exchange and
securities, transactions indirectly affecting foreign exchange and the import and
export of currency, for the conservation of the foreign exchange resources of the
country and the proper utilisation in the interests of the economic development of the
country.
b) MRTP (Monopolistic and Restrictive Trade Practices Act, 1969): MRTP was
enacted
i)
To ensure that the operation of the economic system does not result in the
concentration of economic power in hands of few.
ii)
To provide for the control of monopolies.
iii)
To prohibit monopolistic and restrictive trade.
# Individualistic Orientation vs. Collectivist Orientation:
In an Individualistic Orientation, the government gives a free hand and the focus is on
political environment. In a free market economy like the USA, the government doesnt

intervene much. In a Collectivist Orientation, the government intervenes in economic policies

E.g. Japan, South Korea. #
2) Civil Strife/Unrest/Disorder:
a) It could be due to economic unrest.
b) People unrest can also happen because people are unhappy with the present govt.
c) It affects companys operations and profits.
d) It can lead to damage of companys property.
E.g. French Revolution
3) International War:
a) Damages or destroys the companys local assets. E.g. When Iraq invaded Kuwait,
there were many MNEs by virtue of management contracts. Many Indian companies
were also operating.
b) MNEs are bound to leave the country during war.
4) Harmful actions against people:
a) Injurious actions that target the local staff of the company - often involves
kidnapping, extortion and terrorism.
b) Generally seen in lesser developed countries.
5)
a)
b)
c)

Change in Political Ideology (Types of Govt.):

Political ideology can change with the change in political government.
Every government has a different perception about the MNEs.
In case of Monarchy, like Saudi Arabia, when a new prince comes in, chances are that
there will be changes in political environment.

What are the types of Government?

There are 2 basic types of Government:
1) Totalitarian System
2) Democracy
1) Totalitarian System:
a) Communist: China
b) Monarchy: Nepal
c) Military Rule: Myanmar
d) Dictatorship: Pakistan
e) Fascism: Pre-WW2 Italy
f) Secular: Vietnam, Singapore
g) Theocratic: Iran, Afghanistan
h) Authoritarianism: Cuba
2) Democracy: India (Mixed Economy = Public + Private + Cooperative Sector). It has a
Planning Commission which ensures a planned economy. Indias role model in the
past was Russia (Planned Economy), now it is the US (Mixed Economy).
What are the impacts of Political Risk?
1) Expropriation or Nationalization.

2)
3)
4)
5)
6)

Disruption of property.
Unilateral breach of contract.
Restrictions on repatriation of profit.
Differing points of view.
Discriminatory taxation policies.

1) Expropriation or Nationalization:
a) A govt. or political faction unilaterally takes ownership of the companys local assets.
This is because the host countries felt that MNEs are exploiting resources in the host
country and there is no impact on the economy of the country. Compensation to the
company, if at all forthcoming is generally a trivial percent of the assets value. This
event was common in the 1960s and 1970, but is rare today. However in any event the
losses are immense.
b) Sometimes the companys assets are taken over by the host country with or without
adequate compensation. It is generally a hostile takeover, a mandate and not a choice
which is given to the company. It generally happens in developing countries for
natural resources like oil, diamond when the host country feels that there is no value
addition. E.g. Cuba, Chile, Venezuela, Uganda, Zambia, Ethiopia, Iran
2) Disruption of property:
a) Kidnapping, thefts occur.
b) Strikes happen resulting in loss of profit (opportunity loss) in addition to property
getting damaged.
3) Unilateral breach of contract:
a) Decision of a government to repudiate the original contract that it had negotiated with
the foreign company. The revision penalizes the firm and rewards the nation by
reallocating the profits of the local operations.
b) In addition this extends to government approval of a local companys choice to breach
its contracts with its foreign partner.
c) In some countries the new govt. might not honour the previous management
contracts / leases.
4) Restrictions on repatriation of profit:
The govt. arbitrarily sets limits on the gross amount of profits a foreign company can remit
from its local operation.
5) Differing points of view:
Differing interpretation of labour rights and environmental obligations create backlash
problems in the foreign companys home market.
6) Discriminatory taxation policies:
A foreign company bears a higher tax burden than the local firm, or in some cases, the more
favoured foreign company, due to its nationality.
How to access political risk?
Managers use 3 approaches to predict political risk:
1) Analyzing past trends.
2) Taking expert opinion.

3) Examining the social and economic conditions that might lead to such political risk.
(Semi-Analytical approach)
4)
1) Analyzing past trends:
Companies cannot help but get influenced by past patterns of political risk. Management can
make predictions based on past patterns. Predicting risk using past trends holds many
dangers. However political situations may change rapidly for better or worse as far as foreign
companies are concerned.
E.g.:
a) China Govt. control: More subsidies to SEZs but no transparency (Govt. controls the
judiciary). Compliance for intellectual property rights is very low. China has high
political risk.
b) Dubai: It is volatile geographically. High political risk.
c) FDI into US fell sharply after 2001 terrorist attack in NY because foreign firms saw
the US as less safe than before.
d) Expropriation of property occurred frequently in the 1970s and early 1980s, but it has
been less important in recent years.
e) In Pakistan, initially democracy ruled and then dictatorship where as in India it has
always been democratic in spite of change in governments.
2) Expert Opinions:
Companies may rely on experts opinion about a countrys political situation, with the
purpose of ascertaining how influential people may sway future political events affecting
business. 360 degree feedback is important.
Companies read the statements made by political leaders both in and out of office to
determine their philosophies on business in general, foreign input to business, the means of
affecting economic changes and their feelings toward given foreign countries. Managers visit
the country and listen to a cross section of opinions. Embassy officials and foreign and local
business people are useful sources of opinions about the probability and direction of change.
Journalists, academicians, middle level local govt. authorities and labor leaders usually reveal
their own attitudes, which often reflect changing political conditions that may affect the
business sector. Companies may determine opinions more systematically by relying on
analysts with experience in a country. These analysts might rate a country on specific political
conditions that could lead to problems for foreign businesses. A company also may rely on
commercial risk assessment services, such as those published by Business International,
Economist Intelligence Unit, and Euro Money etc.
In this method companies should examine views of govt. decision makers and then get a
cross-section of opinions and use expert analysts.
3) Economic and Social Perspective (Semantic Technique/ Semi-Analytical
Approach):
There are two economic parameters i.e. aspiration level and achievement level. Aspiration
level of people spreads with education, TV, Internet where as the achievement level increases
with income level. Differences in aspiration level and achievement level leads to frustration.
If disparity between the two is very high year after year, then the frustration level increases.
Higher the frustration level, higher the political risk in terms of unrest. Companies may
examine countrys social and economic conditions that could lead to the peoples level of
aspirations and the countrys level of welfare and expectations. If there is a great deal of

frustration in a country, groups may disrupt business by calling general strikes and destroying
property and supply lines.
E.g. Export Credit Guarantee Corp: gives ratings for the countrys risk.
What are the types of legal systems?
The legal system addresses all the disputes.
1) Common Law: Based on equity. It is the oldest system originated from the UK, then
spread through the commonwealth countries. It is based on jurisprudence. 30
countries follow common law system. Less written report, more importance on
interpretation. To have a full detailed agreement is better, since there is no confusion.
E.g. India
2) Civil Law: Judges apply the law more than interpretation.
3) Code Law: Started in Roman Empire, and then spread to European countries.
Agreements refer to code laws. E.g. Japan, China, South Korea
4) Theocratic Law: Based on religious concepts. Prevalent mostly in Islamic countries.
Evolves from the teachings of religious leaders. E.g., Interest, insurance is not
allowed.
5) Mixed: Combination of these laws. E.g. some states within US follow code, some
follow common law.
What are the types of Political Risk?
There are four types of political risk:
1) Systemic.
2) Procedural
3) Distributive
4) Catastrophic
1) Systemic Political Risk:
This risk arises when there is a change in the political ideology or government of a country.
These kinds of risks are inherent in the system. Domestic and International companies face
political risks created by shifts in public policy or change in political ideology. These
regulations alter the business system for all companies, so not necessarily meant for only
foreign companies. Then again, a government may target its public policy initiatives toward a
specific economic sector that it believes foreign companies unduly dominate. Systemic
changes do not necessarily create political risks that reduce potential profits.
E.g. In 1990, the newly elected Argentina govt. began a radical program of deregulation and
privatization of the state centered economy.
2) Procedural political risk:
Companies procure from best sources from different countries to have comparative
advantage. Globally competent supply chain is required from most competitive/best sources.
The three main objectives of supply chain are:
a) Lowest cost.
b) Shortest time.

c) Quality and reliability.

Operations in a host country require permission and a proper procedure is to be followed for
that. There can be certain delays in obtaining those permissions and hence MNEs have to be
ready to take the delays in their stride or should know how to deal with it. Normally supply
chain is never short term until there is a war situation. As we get raw materials from across
the world, it has to cross borders, so the company faces different levels of risk. Some
countries are more corrupt and the company faces many hurdles. The risks are higher in less
developed countries. Every day people, products and funds move to different locations in the
global market. Each move creates a procedural transaction between units, whether within a
company or country. Political actions sometimes create frictions that interfere with these
transactions. Government corruption, labour disputes and a partisan judicial system can
significantly raise the cost of getting things done. Corruption among custom officials can
push a foreign firm to agree to pay for special assistance, if it wants to clear goods through
customs.
3) Distributive Political Risk:
MNE and host country cannot do without each other. While the MNE controls the country
operations and aims for maximum profitability, the country receives technology, employment
and earns taxes. But if the host country feels that the MNE is capable of doing much more
than at present and mostly much of it is going currently to other countries rather than to the
host country then host country wants to have a larger share from the MNEs economic gain for
its own people and their economic growth. Thus taxation changes can come in. Many
countries see foreign investors as agents of prosperity. As foreign investors achieve greater
success, some countries question the distributive justice of the rewards, wondering whether
they are getting their fair share. Countries then aim to claim a greater share of rewards but in
ways that do not provoke the company to leave. They do so by revising their tax codes,
regulatory structure and monetary policy to capture greater benefits from foreign companies.
MNE should help the host country government by giving more tax, so that their debt reduces
and investment in infrastructure increases.
E.g. US holds the highest degree of political risk in the world for cigarette companies on
matters of taxation, regulation, business practice and liability.
4) Catastrophic Political Risk:
These types of risks arise from flash points like ethnic discord, civil disorder or war. Those
random political developments adversely affect the operations of all companies in a country.
While uncommon, their impact disrupts the business environment for all firms.
What is privatization?
Govt. starts certain industries for economic growth. After infrastructure is established, the
govt. need not be in the sector. It can reduce its stake in these sectors and give it to private
players. Foreign companies are allowed to increase exports, improve quality etc. Since Govt.
is keen, it may allow foreign countries to enter the sector. This capital reduces the debt of the
govt., employment increases, technology advances. MNEs get entry, competition remains
unchanged. On privatization, some employees lose jobs, but companies become vibrant due
to increased exports and technology. However the selling stake in PSUs has been opposed by
communists, because it will lead to loss of jobs.
What is the role of the Government?
1) Maintain the countrys sovereignty and unity

2) Maintain the countrys security (No aggression from neighbours, keeping the integrity
of borders)
3) Law and Order (No discrimination, economic safety, independent judiciary)
4) Economic development (Infrastructure, Education)
5) Business Friendly policies (No discriminatory taxes- foreign companies should not be
made to pay more taxes, open sectors, allowing new companies to start businesses,
IPR, tax concessions)
A countrys political environment has enormous implications to managers and companies. A
political system is the complete set of institutions, political organizations, interest groups, the
relationships between those institutions and the political norms and rules that govern their
functions. The purpose of a political system must agree, is that it integrates different groups
into a functioning, self sustaining and self governing society. Ultimate test of a political
system is its ability to unite a society in the face of divisive pressures of competing ideas and
outlooks.
What are the various Groups of countries?
1) EU (27 including Romania)
2) MERCUSOR (4 including Brazil, Uruguay, Argentina, Paraguay. Venezuela still
trying)
3) ASEAN (Singapore economically mightiest, Indonesia, Malaysia, Thailand,
Philippines, Myanmar, Vietnam, Cambodia, Brunei, Laos)
4) GCC (6 including Saudi Arabia, Oman, Dubai, Sharjah, Abu Dhabi, Bahrain, Kuwait)
5) SAARC (India, Sri Lanka, Pakistan, Bangladesh. Afghanistan trying to enter)
6) NAFTA (3 including Canada, US, Mexico)
Russia, Japan, South Korea, Australia, New Zealand, China dont come under any of the
above.
What are the aspects of International Arbitration?
If you have a dispute then it is better not to go to court as it increases expenses and create
bitterness between the two parties. One can go for arbitration through out-of-court settlement.
The aspects are:
a) An arbitrator is appointed by both parties
b) Arbitration is governed by law. There are a set of procedures present. Neither
countrys rules apply. International arbitration laws are to be followed.
c) Venue of arbitration should be neutral ground and pre-decided.
d) There is no escalation. The decision of the arbitrator is final.
Indian Arbitration Act of 1940 has all the details.
Distinguish between Rule of Law and Rule of Man.
In rule of law it is democracy, larger number of people in decision making, less risk, follows
rules of book. There is transparency. E.g. India
In rule of man it can be communist, monarchy or dictatorship. It is unpredictable, can
suddenly change, high political risk. E.g. China, ruled by agency CPC
What is IPR?
It is regarding patents, copyrights. The PLC is changing, as well as the business cycles. The
only way to get competitive advantage is through innovation, thus IPR is becoming
important. China does not believe in IPR. Innovation belongs to the state according to them
and this is against MNEs. But MNEs are attracted to China because of the huge market of

1.4 billion people (23% of World population), low labour cost and the business-friendliness
of the Govt. IPR compliance is under WTO.
Contract R & D
MNEs thrive on innovation and normally it takes place in the home country. US, Japan etc
are quite expensive for R& D but at the same time, lot of R & D is to be done. Companies
need to take the critical decision as to where to do their R & D. The relatively lesser
important R & D things can be outsourced. When the standalone things are outsourced, it is
known as modular outsourcing. Thus the features are:
1) They should outsource it to important markets (where demand is high and they can
customize and give the product)
2) The country to which outsourcing is done should have a good IPR rating
3) Good infrastructure should be present.
The advantages are:
1) By outsourcing you can understand that market well.
2) It is less expensive
3) It helps to build relationships with the host country
4) Low cost of manpower
5) The ease of segmenting the outsourcing into critical and non-critical.
The disadvantage is that technology diffusion takes place.
What are the strategic aspects relating to a countries political and legal environment?
1) Marketing related laws:
a) Advertising (not using children in ads)
b) No comparative ads
c) Ads of tobacco are banned
2) Marketing behavior:
a) Product liability: Huge penalty if your product fails. E.g. Brake fail in a car, toxins
in a toy
b) Local content: How much will be allowed to manufacture. Govt. pushing for
backward integration.

CHAPTER 4: The Economic Environments facing Businesses

What is Industry?
The industry is a group of players competing for the same buyers with similar products /
services.
What are the key macro-economic parameters?
The following are some of the key macro-economic parameters:
1) GDP, GDP growth rate, sectoral break-up of GDP
2) GDP per capita (Absolute and at PPP)
3) Population (urban/rural, age-distribution, health, education)
4) Unemployment and Income Distribution

5) Inflation
6) Interest Rates
7) Exchange Rate fluctuations
8) Trade Gap Surplus/Deficit
9) Sectoral Break-up of Exports/Imports
10) FDI - Inbound/Outbound
11) Balance of Payments
12) Deficit
13) Debt and Debt servicing
14) HDI
1) GDP, GDP growth rate, sectoral break-up of GDP:
GDP is the total market value of all goods and services produced within a nations borders
over one year, no matter whether domestic or foreign owned companies make the product.
For countrys attractiveness GDP is a more important factor. It is independent of country size.
In addition to the GDP, the sectored break up and growth rate also needs to be known for a
country.
Every country goes through an economic cycle:
a) Primary:
i)
Agriculture (Edible/Non-edible)
ii)
Prospecting (Natural Resources)
b) Secondary: Manufacturing
c) Services: Higher added value
The three major sectors of India are agriculture, manufacturing and services. Services sector
is the major sector.
If we take the growth rate, then developed countries have a stable growth rate but are not
growing rapidly where as the developing countries are growing at a rapid rate although their
economic base is smaller. From an organization point of view, the growth rate of the relevant
markets sector needs to be considered. Also the growth rate of the sector from where the
resources are obtained is to be considered. This is because more percentage of GDP needs to
go into a particular sector which requires more development and infrastructure. MNEs will
invest in that sector, leading to more demand and skilled labour availability (factor
conditions). It is beneficial to operate from that country. So compared to absolute growth rate,
sectoral break up is more important.
Classification based on GDP
1) LDC (least developed country): Africa. It has an untapped market, low income levels,
undergoing infrastructure development by World Bank.
2) Developing: China- 10%, India- 8%, most developing countries have risk.
3) Developed: US, Japan- Highest GDP. Japan has no natural resources, still developed
based on technology and infrastructure.
2) GDP Per Capita (Absolute and at PPP):
Absolute GDP is obtained by managers by dividing the GDP by the population of a country.
This ratio leads to a per capita estimator that measures the relative performance of a countrys
economy. It signifies the average income level of the country. It determines which kinds of
products will be bought by the people of that country. It is a good indicator for consumer

goods where as for industrial goods sectoral break up is a good indicator. In India, the GDP
per capita is below 1000.
However, absolute GDP/population cannot be used to compare 2 countries, and does not
properly reflect buying power. For this we have PPP.
The Purchasing power parity is the number of units of a countrys currency required to buy
the same amounts of goods and services in the domestic market that one unit of income
would buy in the other country. It is useful to compare the purchasing power of different
countries. The most common PPP exchange rate comes from comparing a basket of goods
and services in a country with an equivalent basket in the United States. In other words it is
the number of monetary units that will buy in India the same goods and services that $1 will
buy in the US. Ability to buy can be determined by PPP. This is important for MNEs.
3) Population (urban/rural, age-distribution, health, education):
There are a total of 6 billion people in the world. India and China are countries with 1 billion
plus population where as the average population of a country is 10 million. Together they
constitute 40% of the total population. The population tells us about the market size (market
potential). A higher population means low labour cost countries.
There are several parameters like age, gender, level of education, health and urban/rural
distribution.
a) Age Distribution: India has an advantage, as it has more youth population, a larger
available workforce which is employable and trainable. Japan has a disadvantage as it
has an ageing workforce and the number of dependents is high. They become
economic liabilities. Chinas disadvantage is the 1-child policy and a consequent less
youth population.
b) Gender: Certain professions are restricted to gents only. E.g.: Saudi Arabia
c) Education: The reach of advertisements will be determined by the literacy and
education level of the country. Also internet based products require different
education level, different demand and internet connectivity etc.
d) Health: If health is a concern, there occurs the problem of getting a proper workforce.
E.g. South Africa which is heavily affected by AIDS.
e) Urban/Rural Population: The nature of market is different whether it is urban
populated or rural populated. If there is more of a rural population then you cannot
reach those market areas and their needs/demands are less, since they have a different
standard of living. Hence that market cannot be counted.
4) Unemployment and Income Distribution:
The number of people eligible and willing to work but do not have work are termed
unemployed. The number of unemployed people divided by the total workforce gives the
unemployment rate. The proportion of unemployed workers in a country shows how well a
nations human resources are used and serves as a measure of economic activity.
High unemployment leads to:
a) Political risk/ riots/ loss of life/ increase in crime rate
b) Demand/Supply, less demand and more supply, thus low labour costs
c) If unemployment is high then companies have a better chance of getting more labour
as people do not have an option.
d) Low buying power.
As education level increases, the youth prefer not to work in certain sectors. Perception about
certain sectors has changed due to education/internet. MNEs look for those sectors where
employment is possible.

Managers access the situation of a country by checking the misery Index. Misery Index is the
sum of countrys inflation and unemployment rates. The higher the misery, the lower are the
chances that foreign companies will invest in the country.
The top 20% of the world population account for the 86% of the income where as the bottom
20% account for only 1%. In India 80% of the population earn less than $2 a day and 40% of
the population earn $1 a day. Therefore managers look for the economic potential of a
country by adjusting their analyses to reflect the actual distribution of income. The skewness
of the income distribution is very high in India as well as Asian countries.
Larger proportion of the middle class is considered healthy, as:
a) They tend to save more money and
b) They tend to educate their children
Thus they lead to healthier economic development.
If income distribution is unequal, then it will lead to poverty. So only a part of the population
will be relevant. Poverty impacts the economic environment and analyses to a huge extent.
International companies facing such situations must deal with their implications to virtually
every feature of the economic environment. In countries with high poverty levels customary
market systems may not exist, national infrastructure may not work, criminal behaviours may
be pervasive, and MNEs have to deal with these issues.
5) Inflation:
Inflation is the pervasive and sustained rise in the aggregate level of prices measured by an
index of the cost of various goods and services. Inflation results when aggregate demand
grows faster than aggregate supply and causes an increase in cost of living. From MNEs
perspective it determines the pricing and long term strategy. It is a large measure of MNEs
confidence. A moderate rate of inflation brings stability which is attractive to the MNEs. It is
a measure of the governments success in the economy. Inflation also puts great pressure on
governments to control it. Often governments try to reduce inflation by raising interest rates
and imposing protectionist trade policies and currency controls. Inflation should essentially
be low; around 3-4%. India last year had an inflation rate of 12%.
6) Interest Rates:
Interest rate is the indicator of cost of raising capital. Ideally interest rates should be low and
stable. Countries try to have interest rates which are close to LIBOR (London Inter Bank
Offer Rates). For a country, stability in inflation, interest rate and exchange rate are the
factors which attract other companies to invest in the country. The stability in these rates
helps in predicting the uncertainty in the business. Both interest rates and inflation move in
the same direction. When inflation goes up, the interest rates also go up to adjust the return
for the lender. Developed countries will have low interest rates as they have more money
supply i.e. cost of capital is low as there is high availability of capital. Developing countries
like India have abundant supply of labour but high interest rates due to low capital, which
might be due to low levels of industrialization. Low interest rates add to the countrys
attractiveness for investing as far as the MNE is concerned.
7) Exchange Rate Fluctuations:
Exchange rates between two currencies specify how much one currency is worth as compared
to the other. The foreign exchange market is one of the largest markets of the world. The
daily transaction in foreign exchange market is about $3.2 trillion dollars. When inflation is
high, export competitiveness go down and exchange rates also go down. Exchange rate
should be stable to avoid exchange gain/exchange loss.

8) Trade Gap Surplus/Deficit:

The difference between the exports and imports of a country is known as trade gap. If exports
are greater than imports then the country is said to have a trade surplus e.g. Japan and
Sweden whereas if the imports are greater than exports then the country is said to have trade
deficit e.g. India. If imports are high in a country it indicates that the domestic market is not
enough to meet the demands in that country. If exports are high it indicates that factor
conditions are competitive and hence they make it a manufacturing hub, thus producing in
excess and then exporting it. In other words, companies opt for exports when the cost of
labour in the home country is low, transportation costs and tariff barriers are also low and
when the home country has comparative advantage compared to the host country.
9) Sectoral Break-up of Exports/Imports:
If exports are high it means there is more available output or factor conditions are
competitive. Good technology, low factors of production and reach to markets provide the
scope to export as demand in the country is met internally. Scaled economies come into play
for exports. Exports tell in which sector the country is competitive, has access to raw
materials, skilled labour etc. E.g. in India, the sectors so identified are software, spices, tea,
diamonds and cotton, as India has maximum exports in these sectors. It is a good indicator for
MNEs, as they can have technological alliances with those countries in which exports are
more, e.g. Japan which exports electronics.
If imports are high, it means there is unmet demand in the country.
10) FDI - Inbound/Outbound:
Companies adopt the FDI route in order to get a controlling stake in a host country for a long
term purpose. It might not only be for manufacturing, but also be a part of the overall supply
chain. FDI helps the home country to a great extent in terms of controlling other markets.
a) Inward FDI: FDI that comes to the home country is known as inward FDI. Inward
FDI indicates how the country is being perceived by other countries and MNEs and
also tells about the competitive sectors of the country. IF a country attracts FDI, it
indicates that it is a safe and attractive market, ROI is more and political risk is low,
i.e. it is conducive for business. Thus it is a good indicator of the peoples perception
and the investors confidence in a country. E.g. China and India. The inward FDI for
India is 15 billion US Dollars.
b) Outward FDI: FDI that goes out of the home country is known as outward FDI.
Outward FDI indicates that the country has a strong capital base, good brand, good
distribution network and good technology and skills in certain sectors for which they
are venturing outside. It shows the capability of the country to capture foreign markets
and their potential to expand there, as well as their confidence to take up the world. It
indicates the economic development of the host country. Countries go for outward
FDI, when there is a market opportunity or a need to stay close to the customer as
required by the customer. For outward FDI, the country should have economic
strength as well as domain knowledge and capabilities.
11) Balance of Payments:
It is a record of the international transactions, both inflows and outflows that take place
between companies, governments or individuals for a period of 1 year. It is an indicator of the
health of a country. The BOP reports the total of all the money that comes into a country from
abroad less all the money going out of the country to any other country during the same
period. BOP is also officially known as the Statement of International Transactions. The BOP
has two main accounts namely current account (revenue account) and capital account.

a)

Current Account: It tracks all trade activity in merchandise. The components of

Current account are:
i)
Value of exports and imports of physical goods, i.e. the trade gap, which
can be deficit or surplus.
ii)
Receipts and payments for services and intangible goods.
iii)
Unilateral Transfers, i.e. one way transactions, which can be:
Private transfers such as money sent home by expatriate workers.
Official transfers such as aid from a country for help during natural
calamities.
iv)
FDI, as it is a one-time inflow for the host country, and consists of interest
and dividends earned.
b)
Capital Account: It tracks both loans given to foreigners and loans received by
citizens. The components of capital account are:
i)
Long term capital flows.
ii)
Short term capital flows.
Current accounts indicate trade balance, dividends, interests for investments, unilateral
transfers where as Capital accounts indicate FII, investments, loans and repayments.
BOP is an important measure for long term stability of a country. Ideally, the BOP should be
0, but should be kept moderate.
12) Deficit:
Deficit is the difference between the income and expenditure of a country. The expenditure
consists of both planned expenditure of a country which includes expenditure made for
infrastructure, defence, space research and health care, as well as unplanned expenditure. The
govt. Income includes taxes, dividends and interests. Dividends from government owned
companies also included in govt. Income. Generally developing countries have deficit.
Ideally deficit should be less than 5% of the GDP. EU has stringent policies about its
members should achieve a deficit of less than 3 % of the GDP.
13) Debt and Debt servicing:
It is the sum total of the governments financial obligations. It measures the states borrowing
from its population, foreign organizations, foreign governments and international institutions.
Larger the total debt, greater the instability of the countrys economy. A countrys debt has
two parts: Internal and External debt.
a) Internal Debt: Internal debt results when the government spends more than it collects
in revenues. Internal deficit occurs due to imperfect taxing system, and deficits run by
state owned enterprises. Bonds and Govt. Bonds are instruments of internal debt.
b) External Debt: External debt results when a government borrows money from
foreign lenders like World Bank. Foreign investors monitor debt levels to gauge debt
pressures on the government to revise its economic policies. The source of paying
external loans is through exports.
In this respect debt servicing is important as the country will not get loan if they cannot
service the debt.
i)
Interest should be paid.
ii)
After moratorium period loan should be paid in phases.
iii)
There should be an upper limit on debt. E.g. EU has a limit for debt and
maintains that its members should not have a debt exceeding 60% of the GDP.
14) HDI:

Human Developement Index is a futuristic parameter, which indicates the future potential
of a country. It serves as a lead indicator, which deals with the future deciding factors like
business growth and innovation and creation of the people of a country. The real
performance of the country can be gauged through HDI, which involves a combination of
social and economic parameters. HDI measures the average achievements in a country on
the following dimensions:
a) Longevity and health: Life expectancy increases if there are better medical facilities.
The more the life expectancy the better, as MNEs can count on better workforce
consisting of healthy people. E.g. Japan
b) Knowledge and Education level: As measured by the adult literacy rate and the
combined primary, secondary and tertiary gross enrolment ratio. More the education
level, better the growth and development and better the economic level.
c) Standard of living: As measured by GDP/capita or GNI per capita expressed in PPP
for US dollars.
United Nations refined the HDI by adding two more dimensions:
d) Gender equality: A gender related development index that adjusts for gender
inequalities. It measures the extent to which women are liberalized.
e) Poverty: A measure of poverty to adjust for human deprivations and the denial of
choices and opportunities. The World Bank has stated that the minimum rate of
earning per person per day should be $2.
HDI aims to capture long-term progress in human development rather than short term
changes. HDI is scaled in between 0 and 1. Countries scoring less than 0.5 are having low
HDI. From 0.5 to 0.8 are having moderate and from 0.8 to 1 have high HDI. HDI
measures both economic and social parameters to estimate its current and future
economic activity. It indicates a countrys long term potential.
What are the types of Economic Systems?
An economic system is the set of structures and processes that guides the allocation of
resources and shapes the conduct of business activities. On one end there is capitalism and on
the other hand there is communism. Capitalism is a free market system built on private
ownership and control. Communism is a centrally planned system built on state ownership of
all economic factors of production and control of economic activity. Basically there are three
types of economic systems:
1) Market Economy
2) Command Economy
3) Mixed Economy
1) Market Economy:
It is basically a capitalist economy. In market economy individuals, rather than government,
make the majority of economic decisions. The theoretical principles that define free-market
economies are based on the principle of laissez-faire (non-intervention by government in
economic matters). This principle is credited to Adam Smith and his proposition that a market
economy has two general features:
a) Producers efficiently make products that consumers want in a profit making motive.
b) Consumers determine the relationships among price, quantity, supply and demand so
that capital and labour are allocated productively.
So the consumer sovereignty, where by consumers influence the allocation of resources
through their demand of products is the essence of market economy. A market is very less
dependent upon government rules and restrictions. However for some public goods like
traffic systems or national defence, government intervenes to enforce contracts, property
rights to ensure fair and free competition and to regulate certain economic activities and

provide general security.

E.g. Hong Kong, Great Britain, Canada, United States are major market economies.
2) Command Economy:
It is also known as centrally planned economy. It is the exact opposite of market economy.
Here the government owns and controls all the resources. Here the government decides the
type, quantity, price, production and distribution of goods. In a centrally planned economy,
the government owns the means of production i.e. land, farms, factories, banks, stores and are
managed by the employees of the state. Here the price of the goods and services usually
remains constant. However the quality deteriorates over a time period because:
a) Whatever product is made is usually in short supply.
b) Consumers typically have few to no other choices.
c) There is not much incentive for companies to innovate and little profits to invest.
Command economies are traditionally found in communist countries. In communist
countries, the state economic planners give highest priority to industrial investments and
military spending where as consumer goods and food products are given little or no priority.
However centrally planned economies sometimes allowed free market forces to play in the
informal gray markets where scarce consumer goods are exchanged at market determined
rates. Command economies can perform well in terms of growth rates for short periods of
time by mobilizing unemployed or underemployed resources to generate growth. However
the products produced are not competitive with global standards, often achieved marginal
rates of efficiency while making acceptable products. Currently very fewer countries are
practicing command economies like North Korea and Cuba. Many Countries are transiting
from command economies to market economies, thereby creating business opportunities.
3) Mixed Economy:
Most of the economies are neither purely market nor command economies. Most of them fall
in the midway of the capitalism-communism spectrum. In a mixed economy the public sector,
private sector and private sector co-exist simultaneously. A mixed economy is a system where
economic decisions are largely market driven and ownership is largely private, but the
government intervenes in many private economic decisions. Here the government owns key
factors of production, yet consumers and private producers still influence price and quantity.
The proponents of mixed economies concede that an economic system should aspire to
achieve the efficiencies endemic to free markets. But an economic system must also protect
the society from the excesses of individualism and greed and ideally apply policies needed to
achieve low employment, low poverty, steady economic growth and an equitable distribution
of wealth.
Operationally government intervention in the economy takes various forms:
a) Central, regional, local governments may actually own some means of production.
b) The government can influence private production or consumption decisions.
c) The government can redistribute income and wealth in pursuit of some equity
objective.
The extent and nature of government intervention varies from country to country and changes
over time based on a countrys political, social, cultural and institutional traditions and trends.
Explain the process of transition to a market economy.
Since the market economies outperformed command and mixed economies, therefore it is
apparent that government ownership and control of the factors of production constrained
growth and prosperity due to operational inefficiency and strategic ineffectiveness. Also due
to globalization, there is free flow of products, people and ideas among nations. Together
these developments aggravate a fundamental limitation of mixed and command economies.
Market economies create powerful individual incentives that stimulate innovation, whereas

mixed and command economies seemed to create weak or no incentives.

The process of transition to a market economy varies from country to country. It largely
depends on how well the countrys government can dismantle its central planning system and
consumer sovereignty in its economic environment. The success of transition appears to be
intricately linked to how well the government deals with privatizing the means of production,
deregulating the economy, protecting property rights, reforming fiscal and monetary policies
and applying antitrust regulation. The 5 approaches are:
1) Privatization:
It is the process of transfer of a certain percentage of ownership and control of factors of
production from government to private owners, i.e. the govt. gets a certain percentage of
ownership funds liquidated by giving it to private/foreign companies. Government had started
those industries because initially there were not many private players and they do not have so
much capital. Hence the government starts the industry, operates it, generates employment
and then sells it. MNEs find it as an entry point.
Privatization has the following features:
a) It will lead to a certain level of unemployment
b) It improves general market efficiency and shapes the relationship between supply and
demand
c) It reduces govt debt by eliminating the need to subsidize typically inefficient, money
loosing state owned enterprises
d) It leads to up gradation of technologies, improvisation of business practices and
creation of innovations.
2) Deregulation/Liberalization:
Deregulation involves:
a) Relaxing or removing restrictions on the free operation of markets and business
practices, trade barriers, FDI etc.
b) Making laws more foreign business policy oriented.
c) Liberalization as there is a need for foreign exchange.
The country, by deregulating, makes it more attractive for MNEs. The result will be employee
generation, exports, infrastructure development, knowledge growth, sectoral growth. The
govt gains taxes in the form of (income taxes, company taxes, and indirect taxes). It increases
the productivity due to less regulation compliance. Therefore the resulting freedom and
savings encourage managers to make the investments into the innovations that then lead to
economic growth. The disadvantage in deregulation is that the control remains elsewhere
instead of the host country.
3) Property Rights:
Protection of property rights means that entrepreneurs who come up with an innovation can
legally claim the present and future rewards of their idea, effort and risk. It covers both
physical property as in land, as well as intellectual property like copyright, trademark, patents
etc. The protection also supports a competitive economic environment by assuring investors
and entrepreneurs that they will prosper from their hard work.
4) Fiscal and Monetary Reform:
Adopting free market principles requires a government to rely on market-oriented
instruments for macroeconomic stabilization, set strict budget limits, and use market based
policies to manage the supply. Using the market to enforce fiscal and monetary discipline
leads to stable economic environments that attract the investors, companies and capital
needed to start and finance growth.
5) Antitrust Laws:
By enforcing antitrust laws, governments can prevent monopolies from exploiting consumers
and restraining market growth. In a bid to liberalize its economic system, the government

must frame antitrust laws that encourage the development of industries with as many
competing businesses as the market will sustain. In such industries, prices are kept low by the
forces of competition. In India, the MRTP Act was implemented in 1973. Later it was
replaced by the Competition policy, which ensured that consumers get the right things at the
right prices. In US, the government has implemented the Shermans Act.
#FPI:
Foreign portfolio investments are meant for only short term purpose. Here the main motive is
to get a good return at a moderate risk with high liquidity. Countries cant get any controlling
stake by investing through FPI.
Forex Reserves:
It indicates the economic health and sustainability of the country. Forex reserves are required
for payment of interests, debts for imports. The Forex reserve of a country should be high.
Economic Risks:
Inflation, Interest Rate, Foreign Exchange. #

CHApter 5-6
Globalization: Globalization is the process of
international integration arising from the interchange of
world views, products, ideas, and other aspects of culture
Foreign Direct Investment: Foreign direct investment
(FDI) is a direct investment into production or business in
a country by an individual or company of another country,
either by buying a company in the target country or by
expanding operations of an existing business in that
country. Foreign direct investment is in contrast to
portfolio investment which is a passive investment in the
securities of another country such as stocks and bonds.
Wholly-Owned Subsidiary: Wholly owned subsidiary is a
company that is completely owned by another company
called the parent company or holding company.

 72. Joint Venture: A commercial enterprise undertaken

jointly by two or more parties which otherwise retain their
distinct identities.
73. Stakeholders: A person with an interest or concern in
something, especially a business
74. Corporate Social Responsibility: the voluntary
activities undertaken by a company to operate in an
economic, social and environmentally sustainable manner.
75. Balance of Payments: The difference in total value
between payments into and out of a country over a period.
76. Import Substitution: A trade and economic policy
that advocates replacing foreign imports with domestic
production
77. Marginal Propensity to Import: The amount
imports increase or decrease with each unit rise or decline
in disposable income. The marginal propensity to import is
thus the change in imports induced by a change in
income.
78. Net Export Effect: A change in aggregate
expenditures on real production, especially net exports
through the foreign sector, that results because a change
in the price level alters the relative prices of exports and
imports.
79. Net Capital Flows: The movement of money for the
purpose of investment, trade or business production.
80. Relativism: The doctrine that knowledge, truth, and
morality exist in relation to culture, society, or historical
context, and are not absolute

 81. Nongovernmental Organizations: A nongovernmental organization (NGO) is any non-profit,

voluntary citizens' group which is organized on a local,
national or international level.
82. Extraterritoriality: The state of being exempted from
the jurisdiction of local law, usually as the result of
diplomatic negotiations.
83. Externalities: A consequence of an industrial or
commercial activity which affects other parties without
this being reflected in market prices, such as the
pollination of surrounding crops by bees kept for honey.
84. International Chamber of Commerce: The largest,
most representative business organization in the world.
85. Corruption Perceptions Index: A ranking of
countries according to the extent to which corruption is
believed to exist
86. Sustainability: How biological systems remain
diverse and productive. Long-lived and healthy wetlands
and forests are examples of sustainable biological
systems. In more general terms, sustainability is the
endurance of systems and processes.
87. Kyoto Protocol: The Kyoto Protocol is an international
agreement linked to the United Nations Framework
Convention on Climate Change, which commits its Parties
by setting internationally binding emission reduction
targets
88. Tiered Pricing: Tier Pricing is a way to encourage
shoppers to buy larger quantities of a product by applying
discounts based on the quantity ordered.

 89. Generic Products: When patent protection expires on

a drug, a bioequivalent version may be sold as a "generic"
version of the brand name drug, typically at a significant
discount below the brand name.
90. Strategic Trade Policy: Strategic trade policy is
defined as trade policy that conditions or alters a strategic
relationship between firms, implying that strategic trade
policy focuses primarily on trade policy in the presence of
oligopoly
91. Interventionist Trade Theories: The use of
government power to control or influence domestic
Economic activity.
92. Mercantilism: Belief in the benefits of profitable
trading.
93. Neomercantilism: A policy regime that encourages
exports, discourages imports, controls capital movement,
and centralizes currency decisions in the hands of a
central government.
94. Free Trade: International trade left to its natural
course without tariffs, quotas, or other restrictions
95. Invisible Hand: the self-regulating nature of the
marketplace in determining how resources are allocated
based on individuals acting in their own self-interest.
96. Absolute Advantage: the ability of an individual or
group to carry out a particular economic activity more
efficiently than another individual or group
97. Natural Advantage: The ability for an economic
actor to produce a good or service because the resources
to do so are Physically available

 98. Acquired Advantage: Competitive advantage a

country or firm gains through accumulated knowledge,
instead of from natural resources.

99. Production Possibilities Curve: A curve depicting

all maximum output possibilities for two or more goods
given a set of inputs (resources, labor, etc.). The PPF
assumes that all inputs are used efficiently.
100. Comparative Advantage: The ability of an
individual or group to carry out a particular economic
activity (such as making a specific product) more
efficiently than another activity
101. Complementarity: A relationship or situation in
which two or more different things improve or emphasize
each other's qualities
102. Statics: the branch of mechanics concerned with
bodies at rest and forces in equilibrium.
103. Dynamics: The forces or properties which stimulate
growth, development, or change within a system or
process.
104. Nontradable Products: A good that is not tradable
is called non-tradable. Different goods have differing
levels of tradability: the higher the cost of transportation
and the shorter the shelf life, the less tradable a good is.
105. Theory of country size: Small countries which are
little in area and having small population tend to export
more because of lack of natural resources, lack of local
market and have access to sea.

 106. Factor Proportions Theory: The theory that

international trade is largely driven by differences in
countries' endowments of resources.
107. Country Similarity Theory: The idea that countries
with similar qualities are most likely to trade with each
other.
108. Product Life Cycle Theory: The product life-cycle
theory is an economic theory that was developed by
Raymond Vernon in response to the failure of the
Heckscher-Ohlin model to explain the observed pattern of
international trade

109. Porter Diamond: The Porter Diamond is a model

that helps analyze and improve a nation's role in a globally
competitive field.
110. Brain Drain: The emigration of highly trained or
qualified people from a particular country
111. Protectionism: The theory or practice of shielding a
country's domestic industries from foreign competition by
taxing imports.
112. Retaliation: The action of harming someone
because they have harmed oneself
CHAPTER 7: Governmental Influence on Trade
What is Protectionism? Why do governments of countries intervene in trade?
The governmental framework of restrictions and incentives to trade is known as
protectionism. Governments want to protect their own industries and get them ready to
compete with the world. Governments also want to promote exports at the same time. After
70s, India changed from an import-oriented economy to an export-oriented economy.
Governmental measures may limit your ability to sell abroad, such as by prohibiting the
export of certain products to certain countries, or by making it difficult for you to buy what
you need from foreign suppliers. Governments routinely influence the flow of imports and

exports, and put a cap on FDI, otherwise the country will not produce anything. Also
governments directly or indirectly subsidize domestic industries to help them engage foreign
producers at home or challenge them abroad.
All nations interfere with international trade to varying degrees. Governments intervene in
trade to attain economic, social or political objectives. Governments pursue political
rationality when trying to regulate trade. Governmental officials apply trade policies that they
reason have the best chance to benefit the nation and its citizen and in some case their
personal political longevity.
What is the role of the government as far as trade protectionism is concerned?
The role of the government is as follows:
1) Interest articulation: since different interest groups co-exist, so different interests need
to be put forward.
2) Interest aggregation: take all stakeholders view into account
3) Policy making
4) Implementation and adjudication
What are the economic rationales for governmental intervention?
The economic rationales are as follows:
1) Unemployment:
One of the social objectives of government is to prevent unemployment. The government can
do that through import restriction. One difficulty with restricting imports to create jobs is that
other countries normally retaliate with their own restrictions. In the long run, exports might
also reduce which might lead to further employment.
Two factors can ease the effects of retaliation:
a) Small trading countries are less important in the retaliation process.
b) Retaliation that decreases employment in a capital-intensive industry may not affect
employment as much as the value of the trade loss would imply.
If import restrictions do increase domestic employment, then fellow citizens will have to bear
the cost of higher prices or higher taxes. Government officials should compare the costs of
higher prices with the costs of unemployment and displaced production that would result
from freer trade. In addition, they must consider the costs of policies to ease the plight of
displaced employees, such as for unemployment benefits or retraining. The employment issue
can slow trade liberalization because displaced workers are often the ones who are least able
to find alternative work at a comparable salary. So, persistent unemployment pushes many
groups to call for protectionism. However, evidence suggests that efforts to reduce
unemployment through import restrictions are usually ineffective. Unemployment, in and of
itself, is better dealt with through fiscal and monetary policies.
2) Infant industry protection:
In 1792, Alexander Hamilton presented infant industry argument. This theory holds that a
government should shield an emerging industry from foreign competition by guaranteeing it a
large share of the domestic market until it is able to compete on its own. Government protects
these industries through subsidies, and in time, due to the learning curve, productivity
improves and the industries become competitive. The govt protects those infant industries for
which the country has either comparative or competitive advantage based on country
attractiveness factors. So the companies of those industries will become major exporters.
They become strong in the home market also.
Govt needs to protect its potential stars as well as sunrise industries, which are industries that
are coming up worldwide, which does not exist as of present. Govt needs to invest in sunrise
industries as they are the future. The infant industry argument presumes that the initial output

costs for a small scale industry in given country may be so high as to make its output non
competitive in world markets. Once the infant industry becomes globally competitive, the
government can then recoup the costs of trade protection through benefits like higher
domestic employment, lower social costs and higher tax revenues.
It is reasonable to expect production costs to decrease over time, but they may never fall
enough to create internationally competitive products. So there are two risks for protecting an
infant industry:
a) Governments must identify those industries that have a high probability of success.
b) Even if policy makers can determine those infant industries likely to succeed, it does
not necessarily follow that companies in those industries should receive governmental
assistance.
Infant industry protection requires some segment of the economy to incur the higher cost of
inefficient local production. Typically either consumers or tax payers take the burden.
Ultimately the validity of the infant industry argument rests on the expectation that the future
benefits of an internationally competitive industry will exceed the costs of the associated
protectionism.
3) Promote Industrialization:
Countries with a large manufacturing base generally have higher per capita incomes than
those that do not. Hence many emerging economies try to develop an industrial base by
largely regulating imports from foreign producers using trade protection to spur local
industrialization. As development increases, services increase. Productivity and man-power
play a greater role in services compared to the manufacturing and agriculture sector. Ideally a
larger share of the GDP should be from the manufacturing and services sector as the price
fluctuations are not much. There should be control on imports so that there is an impetus to
manufacture within the country.
The following are the effects of promoting industrialization:
a) Use of surplus workers.
b) Promoting investment inflows.
c) Diversification
d) Greater growth for manufactured products
e) Import substitution versus export promotion
f) Nation building
a) Use of surplus workers:
Surplus workers can more easily increase manufacturing output than agricultural output.
Since agricultural output per person is low, so many people can migrate from agricultural
sectors to industrial sectors and in turn increase industrial output. The industrialization
argument presumes that the unregulated importation of lower priced products prevents the
development of a domestic industry. However the industrialization rationale asserts that the
industrial output will increase, even if the prices are not globally competitive, because local
consumers must buy local goods from local producers.
b) Promoting investment inflows:
Inflows of foreign investment in the industrial area promote sustainable growth. Import
restrictions, applied to spur industrialization, may also increase foreign direct investment.
Foreign investment inflows may also add to local employment, which is attractive to
policymakers.
c) Diversification:
Prices and sales of agricultural products and raw materials fluctuate very much, which is a
detriment to economies that depend on few of them. Price variations due to uncontrollable
factors, such as weather affecting supply or business cycles abroad affecting demand, can

wreak havoc on economies that depend on the export of primary products. A greater
dependence on manufacturing does not either guarantee diversification of export earnings.
d) Greater growth of manufactured products:
Markets for industrial products grow faster than markets for agricultural products. The terms
of trade are the quantity of imports that a given quantity of a countrys exports can buy. The
prices of raw materials and agricultural commodities do not rise as fast as the prices of
finished products. Hence, overtime it takes more low priced primary products to buy the same
amount of high priced manufactured goods. So, emerging nations that depend on primary
products have become increasingly poorer relative to industrial countries. As an economy
progresses from agricultural to manufacture-oriented to service oriented, the negotiability
improves, and the country can earn more. The country needs to decide the quantity of exports
it wants. When quantity of exports required is less than the relative quantity of imports it
buys, the terms of trade is more favourable.
e) Import substitution versus export promotion:
Traditionally emerging economies promoted industrialization by restricting imports in order
to boost local production for local consumption. Some countries have achieved rapid
economic growth by promoting the development of industries that export their output. This
approach is known as export led development. Industrialization may result initially in import
substitution, yet export development of the same products may be feasible later.
f) Nation Building:
Industrial activity helps the nation building process. The performance of free markets
suggests a strong relationship between industrialization and aspects of the nation building
process. Industrialization helps countries to build infrastructure, advance rural development,
enhance rural peoples social life and boost the skills of the workforce.
4) Increasing countrys economic power or improving countrys competitive
positioning relative to other countries:
Countries monitor their absolute economic welfare as well as track how their performance
compares to other countries. Governments impose trade restrictions to improve their relative
trade positions. They also try to charge higher export and lower import prices. To remain
competitive and perform better economically, the countries adopt the following five methods.
a) Improving Balance of payments (BOP) through Balance of Trade
b) Restrictions as a Negotiating tool
c) Price control on exports
d) Fair access/Reciprocity
e) Dumping
f) Optimal tariff theory
a) Improving Balance of payments through BOT:
Governments can improve BOP by improving their balance of trade. If BOP difficulties arise
and persist, a government may restrict imports or encourage exports to balance its trade
account. One way to do this is to devalue the currency of the country, which makes all the
products cheaper in relation to foreign products.
b) Restrictions as a Negotiating tool:
The imposition of import restriction may be used as a means to persuade other countries to
lower their import barriers. To successfully use restriction as a bargaining tool required
careful consideration of what products to target. Basically the restrictions need to be
believable and important to the influential parties in the other country. Believable implies that
there are either alternative sources to buy the same product or that consumers are willing to
do without it.
c) Price control on exports:

Countries sometimes withhold goods from international markets in an effort to raise prices
abroad. This policy may also encourage other countries to develop technology that will
provide either substitute products or different ways of producing the same product. A country
may limit exports of a product that is in short supply worldwide in order to favour domestic
consumers. Companies sometimes export below cost or below their home country price, a
practice called dumping. Companies do dumping to build a market abroad.
d) Fair access/Reciprocity:
Companies and industries often argue that they are entitled to the same access to foreign
markets as foreign industries and companies have to their markets. Economic theory supports
this idea, reasoning that producers operating in industries where increased production leads to
steep cost decreases, but which lack equal access to a competitors market will struggle to
gain enough sales to be cost competitive.
e) Dumping:
Dumping is the selling of goods below the cost at which they are sold in the home country.
Companies resort to dumping, due to the following reasons:
i)
Excess production.
ii)
Companies using scale economies, enter a market at a low price, capture the
market and wipe out the local competitors at short term loss. As soon as
competition is wiped out, they start earning profits.
The WTO acts against dumping. The affected company must first make a representation to its
home country, and take permission from it. The commerce ministry of the country would then
forward the grievance to the WTO, which then gives the home country government the lead
to levy anti-dumping duty.
f) Optimal tariff theory:
Import or export duties are classified under tariffs. This theory states that a foreign producer
will lower its prices if the importing country places a tax or duty on its products. If this
occurs, benefits shift to the importing country because the foreign producer lowers its profits
on the export sales. A company having comparative advantage to produce a particular product
at a lower cost and good quality, will price it goods on the lower side. To reduce the disparity
between the price of these good and local goods, the country increases import duty so that
those cheap goods become little expensive. They attempt to make the imported goods
equally, if not less attractive, compared to local goods.
What are the noneconomic rationales for government intervention?
Governments are involved in the following noneconomic rationales:
1) Maintenance of essential industries
2) Prevention of shipment to unfriendly countries
3) Maintenance or extension of spheres of influence
4) Protecting activities that help preserve the national identity
1) Maintenance of essential industries:
The essential industries include defence, space research, media, education etc. Some of these
industries need to be controlled through government. Governments apply trade restriction to
protect essential domestic industries during peacetime so that a country is not dependent on
foreign sources of supply during war. This is called the essential industry argument. Because
of the high cost of protecting an inefficient industry or a higher cost domestic substitute, the
essential industry argument should not be accepted without a careful evaluation of costs, real
needs and alternatives. Once an industry receives protection, it is difficult to remove the
protection.
2) Prevention of shipment to unfriendly countries:

Here the government issues embargo or trade sanctions against rival countries i.e. companies
are not allowed to export goods to those countries. Countries achieve these political goals
using economic means i.e. trade controls. Countries also start blacklisting other countries
who supply to their rival countries. Countries concerned about security often use national
defence arguments to prevent the export, even to friendly countries, of strategic goods that
might fall into the hands of potential enemies or that might be in short supply domestically.
Export constraints may be valid if the exporting country assumes there will be no retaliation
that prevents it from securing even more essential goods from the potential importing
country. Trade controls on nondefense goods also may be used as a weapon of foreign policy
to try to prevent another country from meeting its political objectives. E.g. US does not
export to North Korea.
3) Maintenance or extension of spheres of influence:
It deals with the principle of neo-mercantilism. Governments give aid and credits to, and
encourage imports from countries that join a political alliance or vote a preferred way within
international bodies like the UN mainly to gain advantage or membership. Thus they increase
dependence of other countries on them and increase their sphere of influence. It is about
exporting to another country and in turn generating employment and BOP. A countrys trade
restrictions may coerce governments to follow certain political actions or punish companies
whose governments do not.
4) Protecting activities that help preserve the national identity:
Government's role is not only to govern the country but also to protect the country and put it
together. For this the country requires national identity and a sense of belongingness.
Countries are held together partially through a unifying sense of identity that sets their
citizens apart from those in other nations. Unity is required to collectively fight the
aggression of other countries. To sustain this collective identity, countries limit foreign
products and services in certain sectors. Our national flag, culture, films, sports etc are
manifestations of our patriotism, which preserves the distinct identity of the country.
What are the instruments of Trade Control?
The following are some of the instruments of trade control:
1) Tariff Barriers: A tariff (duty) is the most common type of trade control and is a tax
that governments levy on a good shipped internationally. Governments charge a tariff
when a good crosses its official boundary. Trade blocks also charge common tariff
rates to non member countries.
a) Export Tariff: Tariffs collected by the exporting country are called export tariffs.
Export tariffs are imposed because these items going out would affect local
industries. Export tariffs are put on essential items useful locally.
b) Transit Tariff: Tariffs collected by a country through which the goods have
passed are called a transit tariff.
c) Import Tariff: Tariffs collected by an importing country are called import tariff.
Import tariffs are imposed to make local production more attractive and
competitive.
Import tariffs raise the price of imported goods, thereby giving domestically produced goods
a relative price advantage. Tariffs also serve as a source of governmental revenue. Although,
revenue tariffs are most commonly collected on imports, many countries that export raw
materials charge export tariffs. WTO has a ruling to reduce customs duty gradually. Tariffs
can be specific duty, ad valorem duty and compound duty.
a) Specific (per unit, e.g. 5% per unit): where per unit basis duty is charged

b) Ad Valorem (E.g. 10% of value):

i)
Just Manufactured: Ex Works
ii)
Bought till port (local transportation): Free on Board (FOB)
iii)
Bought till destination port (ocean freight and transit insurance):
Cost, Insurance and Freight (CIF)
iv)
Downloaded at port (customs duty): Landed cost
v)
Delivered to shop/customer (Inland transport): Price for customer
Here,
CIF = Ex Works + FOB + Ocean Freight + Transit Insurance
Ad Valorem is applied on CIF
CIF Value + Duty = Landed cost
Landed Cost + Inland Transport = Price for Customer
c) Compound (combination of specific and ad valorem)
Levying duties is one way through which government regulates trade and tries to
make imports unattractive.
2) Non-Tariff Barriers (NTB): They are as follows:
a) Subsidies
b) Quota
c) Tied Aid to countries
d) Buy local legislation
e) Consular Fees
f) Customs procedures
g) Standards and Labels
h) Special Permission (Import license)
i) Foreign exchange controls
j) Administrative delays
k) Counter-Trade/ Reciprocity
l) Restrictions on services
a) Subsidies:
Host country government provides subsidies for a certain period in various ways to infant
industries and local players as they need time to achieve scale economies and also learning
curve. This is done in order to make them competitive globally and to increase their
productivity and gradually make them exporters. Governments sometimes also provide other
types of assistance like business development services (market information, trade expositions
and foreign contacts) to make it cheaper or more profitable to sell overseas. However trade
frictions result from disagreement on the definition of a subsidy. Subsidies make local players
compete domestically as well as in foreign markets. Ultimately the public pays for these
subsidies in terms of taxes. US, EU and other developed nations provide farm subsidies
because they want to make other genuine competitors non-competitive and loose competitive
edge, as developing countries cant give much subsidies.
b) Quota:
The quota is the most common type of quantitative import or export restriction. By
implementing quotas the countries increase BOP and BOT by decreasing imports and
increasing exports. An import quota prohibits or limits the quantity of a product that can be
imported in a given year. Quotas usually increase the consumer price because there is little
incentive to use price competition to increase sales. Tariffs generate revenue for the
government. However quotas generate revenues for the companies that are able to obtain and
sell the intentionally limited supply. It basically gives local players a chance to compete by
reducing the quantity of imports. No duties are levied, and no transactions take place. There
are different variations of quotas. Voluntary export restraint (VER) is one such type. Here

the government of country A asks the government of country B to reduce its companies
exports to country A voluntarily. Here either country B volunteers to reduce its exports or
country A may impose tougher trade regulations. E.g. US and Japan. The advantages of VER
are:
i) VER is much easier to switch off than an import quota.
ii) The appearance of voluntary choice by a country, does not damage the political
relations between those countries as much as an import quota does.
A country may establish export quotas to assure domestic consumers of a sufficient supply
of goods at a low price to attempt to raise export prices by restricting supply in foreign
markets. The typical goal of an export quota is to raise prices to importing countries.
Embargo is a specific type of quota that prohibits all forms of trade between the countries.
Countries or group of countries may place embargoes on either imports or exports, on whole
categories of products or specific products with specific countries. Governments impose
embargoes in the effort to use economic means to achieve political goals.
c) Tied Aid to countries:
It is given externally and is based on neo-mercantilism. When governments give aid and
loans to other countries with precondition that the recipient is required to spend the funds in
the donor country, then it is known as tied aid or tied loan. Tied aid helps win large contracts
for infrastructure, such as telecommunications, electric power projects etc. Tied aid can slow
the development of local suppliers in developing countries and shield suppliers in the donor
countries from competition. E.g. EXIM Bank helps Malaysia to enable imports from India.
d) Buy local legislation:
Sometimes governments specify a domestic content restriction i.e. a certain percentage of the
product must be of local origin. Govt has the option of buying locally as well as
internationally. So by buying locally for certain industries like infrastructure and
pharmaceuticals, the govt gives protection to the local players. Sometimes they favour
domestic producers through price mechanisms. Many nations prescribe a minimum
percentage of domestic content that a given product must have for it to be sold legally in their
country. By doing this the local market develops and technology up gradation happens in the
local market. Exports also happen on the component parts and FDI improves.
e) Consular Fees:
Some countries require consular fees. It is required because:
i)
Documentation is necessary for authentication.
ii)
Some countries do not consider the documents genuine until it is stamped and
verified from their country embassy in their country. It is a very high amount
and delays the proceedings.
iii)
It is done with the aim of restricting imports as the increase in exports
procedure costs makes the import to the country less attractive.
f) Customs valuation and procedures:
While imposing tariffs on exports or imports, custom officials first use the declared invoice
price. If officials doubt the authenticity, then they impose tariff on the basis of the value of
identical goods. If not possible, then officials may compute a value based on final sales value
or on reasonable cost. Sometimes officials use their discretionary power to assess the value
too high, thereby preventing the importation of foreign made products. Sometimes import
clearances are slow in countries like US & Japan to discourage imports.
g) Standards and Labels:
Countries devise classification, labelling and testing standards to allow the sale of domestic
products but obstruct that of foreign made ones. In case of labels, the companies have to
indicate on a product the details, manufacturing/expiry dates content, cost etc in the countrys
official language. Labels provide information to consumers who may prefer to buy products

from certain nations. The purpose of standards is to protect the safety or health of the
domestic population. However some foreign companies argue that standards are just another
means to protect domestic producers as it requires customization and adds to manufacturing
cost.
h) Specific permission (Import licenses):
Some countries require that potential importers or exporters secure permission from
governmental authorities before conducting trade transactions. This requirement is known as
import license. This procedure can restrict imports or exports directly by denying permission
or indirectly because of the cost, time and uncertainty involved in the process. E.g. in India,
45 days are required for initial clearance of goods.
i) Foreign Exchange controls:
A foreign exchange control is a similar type of control. If there is no foreign exchange, the
country cannot import. Some countries have it only for national priority e.g. Food etc.
j) Administrative delays:
International administrative delays create uncertainty and raise the cost of carrying inventory.
Competitive pressure, however, moves countries to improve their administrative systems.
k) Counter Trade/Reciprocity:
Governments sometimes require that exporters take merchandise in lieu of money or they
promise to buy merchandise or services, in place of cash payment, in the country to which
they export. These sorts of barter transactions are called countertrade or offsets. More
frequently, however, reciprocal requirements are made between countries with ample access
to foreign currency that want to secure jobs or technology as part of the transaction or with
countries which do not have much foreign exchange. IF the government is involved in the
transaction it is called offset.
E.g. Columbia has coffee. Boeing sells planes. They have a counter-trade. Boeing agrees to
sell coffee where it will get best price. Boeing converts the aircraft prices to coffee (tonnes).
The transaction is done at the future price of coffee instead of the present. Boeing takes into
account the marketing and distribution cost of coffee also. The Govt of Columbia got planes.
Boeing took the risk of selling coffee, but got a market for spare parts and pilot training in
Columbia as well as good relations with it.
Buyback policy is followed when machinery cannot be afforded, due to non-availability of
required currency, so pay-back is done in the material produced. E.g. A chemical equipment
manufacturer approaches a potential client, who does not have foreign exchange. The
manufacturer agrees and makes an agreement with the client that whatever they manufacture
with their machinery should be sent back to them and they would then sell it.
This principle is called reciprocity. Around 15% of the global trade is through counter-trade.
It helps companies to have transactions which were otherwise not possible.
l) Restrictions on services:
Services are the fastest growing sector in international trade. Countries restrict trade in
services for 4 reasons:
i)
Essentiality:
Countries sometimes prohibit private companies, foreign or domestic, in some sectors
because they feel the services are essential, e.g. transportation which connects the masses
ii)
Not for profit services:
Certain services should not be sold for profit. In other cases government sets price controls
for private competitors or subsidize government owned service organizations, creating
disincentives for foreign private participation. Mail, education, hospital, media, insurance etc
are often not for profit sectors.
iii)
Standards:

Governments limit foreign entry into many service professions to ensure practice by qualified
and experienced personnel. Government has standards in terms of qualifications for rendering
services. E.g. a certain period of internship for doctors in India, CA in India and CPA in USA
for accounts personnel.
iv)
Immigration:
Governmental regulations often require that an organization, domestic or foreign, search
extensively for qualified personnel locally before it can even apply for work permits for
personnel it would like to bring in from abroad. Even if no one is available, hiring a foreigner
is still difficult. These are done to protect employment.
What are the implications of Government influences on trade for MNEs?
The implications are as follows:
1) Look at a countrys attractiveness and select the best country for operations.
2) Look at the countrys future in the next 3-4 years and likely changes which might
come.
3) Scan the environment correctly
4) Manufacture certain goods more attractively
If the tariff barriers are too high, then:
1) FDI is possible as MNE can enter the country easily through JV, wholly owned
subsidiary etc.
2) Transportation cost is high sometimes, so FDI is a good option.