CHAPTER 1

GLOBALİZATİON TODAY

1.1 INTRODUCTION AND KEY PLAYERS

International business is rooted in the cultural political, economic and legal moorings
of nations.
The study of international business involves learning about government
policies, company activities, the work of managers, the work and social lives of
ordinary people, and a host of social issues.
People are at the center of each of these topics and are what makes
international business a dynamic and thrilling journey of discovery.

1.1.1 Key Players in International Business

1. A multinational corporation (MNC) has direct investments abroad in
multiple countries.
They generate significant jobs, investment, and tax revenue for the regions and
nations they enter.
a. Some MNCs have more employees than small nations have citizens
(e.g., Walmart has 2.3 million employees globally).
b. If Walmart were a country, it would rank one place behind
Poland in terms of economic power.
2. A born global firm is a company that has a global perspective, engages
in international business from inception, and quickly achieves a
competitive advantage.
a. They tend to have innovative cultures and knowledge-based
organizational capabilities that are difficult to imitate.
1.2 WHAT IS GLOBALIZATION?
Globalization is the trend toward greater economic, cultural, political, and
technological interdependence among national institutions and economies.
It is marked by “denationalization,” which is not “internationalization.” See
Figure 1.2 which shows the home country for each of the 500 largest companies in the
world.
You can see a rise of Chinese firms, going from having no companies in the top
500 in 1990 to having 124 in 2020. You will also see a drop in the number of US
firms, peaking from 175 top 500 firms in 2000 and 20 years later having 121.
Over the same period, Japan lost more than half of its top spots from 1990 to
220 and around half of Britain’s firms dropped off the list.
1.2.1 Evolution of Globalization
During the first age of globalization trade and capital flowed more freely than
ever before.
Trade was becoming increasingly more important. Up until around
1870 the global trade to GDP ratio never exceeded 10 percent.
This means that, on average, a country traded around 10 percent of its
total annual output. Figure 1.3 shows that the global trade to GDP ratio grew to

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 27 percent by 1970. This means countries traded 27 percent of their yearly
output, a gain of 17 percentage points in 100 years.
1. Recent Events
Throughout the 1990s and early 2000s trade has been expanding.
Membership in the European Union has been expanding, the agreement
between the United States, Mexico and Canada had been revised, and
China entered the World Trade Organization. The global trade to GDP
ratio has been growing significantly.
But a trade war between China and the United States forced
companies to re-examine their strategies of outsourcing to China and
their lengthy supply chains placed distant production and distribution
activities at risk.
Then the global pandemic arrived and the economic shutdowns
it prompted helped shrink the economy by 8 percent in 2020.

2. Measuring Globalization
Although we intuitively feel that the world is getting smaller,
researchers have measured the extent of globalization.
a. The KOF Swiss Economic Institute’s Globalization Index ranks
nations on their economic, social, and political engagement.
b. Richest nations are the most global, with many in Europe. The
United States is currently ranked 25th.
c. The least global nations are found in Africa, East Asia, South
Asia, Latin America, and the Middle East.

1.2.2 Globalization of Markets

1. Convergence in buyer preferences in markets around the world
a. Reduces marketing costs by standardizing activities
b. Creates market opportunities abroad if home is small or saturated
c. Levels uneven income streams for global seasonal products
d. Companies must not overlook local buyers’ needs
e. Need for global sustainability—development that meets the needs
of the present without compromising the ability of future
generations to meet their own needs

1.2.3 Globalization of Production

1. Dispersal of production activities to locations that help a company to
minimize costs or maximize quality
a. Access lower-cost workers to cut overall production costs
b. Access technical expertise (e.g., tech support, record keeping)
c. Access production inputs unavailable or more costly at home

1.3 DRIVERS OF GLOBALIZATION

Forces increase competition among nations by leveling the global business playing
field.
1.3.1 Falling Barriers to Trade and Investment

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 1947 General Agreement on Tariffs and Trade (GATT) promoted free trade by
reducing tariffs and nontariff barriers.
1994 GATT revision (1) reduced tariffs and lowered subsidies for
agricultural products; (2) defined and protected intellectual property rights; and
(3) created the WTO.

1. World Trade Organization

a. World Trade Organization (WTO) is the international
organization that enforces the rules of international trade.
b. WTO goals: (1) to help the free flow of trade, (2) help negotiate
the further opening of markets, and (3) settle trade disputes.
c. WTO agreements are contracts committing members to fair and
open trade policies. WTO dispute settlement system is the spine
of the global trading system.
d. Critics say the WTO is at risk of becoming irrelevant today
because it is not adequately addressing changes in the global
trading system.
2. Regional Trade Agreements
a. Groupings of nations smaller than the WTO are also integrating
their economies (e.g., USMCA, European Union, Asia-Pacific
Economic Cooperation).
b. A key advantage of regional trade agreements is that negotiating
with fewer nations can be easier than dealing with the WTO’s
many more members.
3. Other International Organizations
a. The World Bank was formed to finance European reconstruction
after the Second World War. It later shifted its focus to the
general financial needs of developing countries. Today it
finances development projects in Africa, South America, and
Southeast Asia.
b. The International Monetary Fund was created to regulate fixed
exchange rates and to enforce the rules of the international
monetary system. Among the purposes of the IMF are
promoting international monetary cooperation, facilitating the
expansion and balanced growth of international trade, avoiding
competitive exchange devaluation, and making financial
resources temporarily available to members that suffer from
severe balance of payment problems.
1.3.2 Global E-commerce
Technology accelerates globalization by making it easier, faster, and less costly
to move data, goods, and equipment around the world.
Businesses and consumers use technology to conduct transactions. E-
commerce is the use of computer networks to purchase, sell, or exchange
products; to service customers; and to collaborate with partners.
1. The Internet

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 a. Helps firms sharpen forecasting, lower inventories, improve
communication with suppliers, and communicate quickly and
cheaply with distant managers.
b. Reduces the cost of reaching an international customer base,
which is essential for the competitiveness of small firms.
c. North America comprised 12 percent of the world’s internet
users in 2011 but just 6.5 percent in 2021. Africa made up 6.2
percent of world internet users in 2011 but grew to 12.5 percent
in 2021.
d. The Internet of Things (IoT) includes all devices and equipment
that are readable, recognizable, locatable, addressable, and/or
controllable via the internet.

2. Intranets and Extranets

a. Intranets are private networks of company Web sites and other
information sources that allow employee access to information
from distant locations.
b. Extranets are computer networks that give distributors and
suppliers access to a company’s database so they can place
orders or restock inventories electronically and automatically.
1.3.3 Digital Transformation
This is fundamental change in which digital technologies penetrate all areas of
operations, strategy, and culture to produce customer-focused competitive
advantage.
Technological innovation involves the process of changing information
from analog to digital form for use by computers and other information
technologies, referred to as digitization.
This leads to efficiency gains and cost savings. Digitalization is the use
of digital data and technology to develop new business operations, strategies,
or business models.
1.3.4 Communication and Transportation
Operating across borders and time zones complicates the job of coordinating
and controlling business activities.
Technological innovation in the various methods of communication and
transportation can ease the task of international management.
1. Communication
a. Communication technology can speed the flow of information
and ease the task of coordination and control (i.e.,
videoconferencing).
2. Transportation Technologies
a. Makes global shipping more efficient and dependable (i.e.,
GPS, RFID). Outsourcing lengthens and complicates supply
chains and distribution channels. Corporate logistics

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 departments and logistic specialist firms assist international
companies in dealing with these issues.

1.4 GLOBALIZATION DEBATE

1.4.1 Globalization Harms Jobs and Wages
1. Critics say globalization eliminates manufacturing jobs in developed
nations as good-paying manufacturing jobs go abroad to developing
countries. They say lower-priced goods are not worth lost jobs.
2. They say it causes worker dislocation that gradually lowers wages
because new jobs that replace lost manufacturing jobs often pay less.
3. They say it exploits workers in lower-wage nations who work for lower
wages servicing western consumers.
1.4.2 Globalization Improves Jobs and Wages
1. Supporters say globalization increases wealth and efficiency in all
nations because trade openness raises output. Firms grow more
efficient and pass savings on to consumers.
2. They say it generates labor market flexibility in developed nations that
allows an economy to rapidly deploy labor where demand is relatively
high.
3. They say it advances the economies and living standards of developing
nations by injecting capital that creates higher-paying jobs. This helps
expand the middle class.
Summary: Although globalization eliminates jobs in some economic sectors, it
creates jobs in other sectors. The key point of difference in the debate is
whether or not overall gains in a nation’s economy is worth the lost livelihoods
that some individuals suffer.
1.4.3 Debate about Income Inequality
1. Inequality within Nations
a. Globalization critics claim that income disparity in developed
nations is increasing as firms move factory jobs to developing
and emerging nations.
b. The evidence is mixed, but people in developing nations seem
to benefit from an open economy.
2. Inequality between Nations
a. Globalization opponents say it is widening the gap in average
incomes between developed and developing nations.
b. But evidence shows that open nations are benefiting from trade
whereas closed ones are not.
1.4.4 Globalization and Culture
1. Critics say globalization homogenizes our world and lets MNCs
destroy cultural diversity.
2. Yet globalization allows nations to: (1) specialize and trade for goods
they do not produce, (2) import other peoples’ cultural goods, and (3)
still protect deeper values and cultural norms.
1.4.5 Globalization and National Sovereignty
1. Menace to Democracy?

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 a. Critics say supranational institutions with international goals
and appointed officials undermine national sovereignty and
democracy.
b. They say political authorities undercut democracy and local and
regional authority with international agreements on citizens’
behalf.
2. Guardian of Democracy?
a. Supporters say globalization has helped spread democracy
worldwide (e.g., more democratic nations than ever).
b. Some losses of sovereignty have had positive social impacts, as
in human rights, workers’ rights, and discrimination.
1.4.6 Globalization and the Environment
1. Most international firms today support reasonable environmental laws
because (if for no other reason) they want to expand future local
markets for their goods and services. They recognize that healthy future
markets require a sustainable approach to business expansion.

1.5 WORKPLACE SKILLS

International business today is rapidly changing. Driving disruption across all
industries are digitalization strategies, automation of routine physical and cognitive
tasks, implementation of artificial intelligence, and expansion of the green economy.
1.5.1 Skills for Your Career
The most competitive businesses focus on constantly upgrading their
employees’ skills to keep pace with technological advancements.
This course will assist in developing employability skills.
1. Application of knowledge refers to the ability to learn a concept and
appropriately apply that knowledge to another setting to achieve a
higher level of understanding.
2. Reflective (critical) thinking involves purposeful and goal directed
thinking used to define and solve problems, make decisions, or form
judgments related to a set of circumstances.
3. Analytical thinking involves following a fact pattern to draw a
conclusion.
4. Communication skills which involve the use of oral, written and
nonverbal language along with technology to communicate ideas
effectively and to listen effectively.
5. A keener sense of ethical understanding and social responsibility serves
as guiding principles that influence the way individuals and
organizations behave with society.
1.5.2 The Global Business Environment
What makes international business special is that it occurs within a dynamic,
integrated system that weaves together four distinct elements:
1. Global forces are transforming societies and commercial activities.
Globalization increases competition everywhere, forcing companies to
be vigilant to ethical situations, social responsibility issues, and
sustainability in all its forms.

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 2. Each national business environment consists of unique cultural,
political, legal, and economic characteristics. Companies must be
attentive to nuances and adapt products and practices as needed.
3. The international business environment influences how business is
conducted so firms must closely monitor events.
4. The context of international business management is defined by the
characteristics of the national and international business environments.
Managers must abide by the prevailing rules in each market in which it
operates.

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 CHAPTER 2
ETHİCS, SOCİAL RESPONSİBİLİTY, AND SUSTAİNABİLİTY

INTRODUCTION
Multinational companies must comply with laws and regulations both at home and in
every jurisdiction in which they operate.
They adhere to environmental regulations, antitrust laws, labor laws, securities laws,
and more.
Today, cross-cultural business brings moral issues to the fore. Although cultures differ
in their views of what defines ethical behavior in certain situations, businesses are expected to
be model citizens in every country in which they operate.
Global competition means it is critical for each firm to have a competitive advantage
—an attribute that is difficult to imitate and enables a firm to outperform its competitors in the
same industry.
Building trust and behaving ethically are essential for business because their activities
are grounded in a motivation for profit.
Operating in an ethical and socially responsible manner can bolster a firm’s brand and
competitive advantage.
There is a moral foundation for ethical behavior, corporate social responsibility, and
sustainable business practices.

2.1 ETHICS THEORIES

Ethics are the moral principles of society that govern human behavior and
decision making.
Ethical behavior is individual behavior in accordance with principles of good
conduct of morality.
An ethical dilemma arises when one’s ethics are challenged in a decision-
making situation because no available alternative presents a clear moral solution.
Ethical theories can serve as a guide for how a manager can make an ethical
decision when facing a dilemma.
2.1.1 Utilitarianism
This ethics theory advocates actions that foster happiness and oppose actions
that cause unhappiness. It says companies should behave in a way that
maximizes good outcomes and minimizes bad outcomes.
1. A utilitarian manager asks the question “What outcome should I aim
for?” and answers, “That which produces the best outcome for all
affected parties.”
2. Example: manager pays a bribe based on calculations that more people
will benefit than will be harmed by the outcome.
2.1.2 Rights Theory
This theory states that every human being has rights and all governments are
obligated to protect them. It views these rights as universal and not culture-
specific.
1. The United Nations’ Universal Declaration of Human Rights declares
every person’s fundamental right as inherent and inalienable.

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 2. Recognizes that all humans are born free and equal and in dignity and
rights regardless of nationality, residence, gender, ethnicity, race,
religion, language, or any other status.
3. Several articles in the Declaration deal explicitly with business
dealings. These include the right to own property, the right to work and
choose one’s work, the right to paid time off work for leisure, and the
right to the fruits of one’s creations.
2.1.3 Theory of Justice
Theory that describes a society of free citizens who have equal basic rights and
who cooperate within an egalitarian economic system.
1. Desires a social contract that bestows society’s rights, freedoms, and
resources equitably and fairly to all.
2. A manger following this theory would work to find solutions to ethical
dilemmas that are most equitable and fair to all parties.
2.1.4 Cultural Relativism
This theory says the morality of an act depends on how the act is perceived
within that specific culture at the time of the act. It says a company should
adopt local ethics everywhere because all belief systems are determined within
a cultural context.
1. Sees truth, itself, as relative and argues that right and wrong are
determined within a specific situation.
2. “When in Rome, do as the Romans do” captures the essence of cultural
relativism.

2.2 BUSINESS ETHICS

All company employees should sustain a high standard of ethical behavior.
This may be more challenging for companies entering cultures that have value
systems that are very different than at home.
2.2.1 Resolving Ethical Dilemmas
Executives can employ several concepts to resolve ethical dilemmas.
1. The conflict of relative development recognizes that countries and their
populations can differ in their stage of development. A manager asks if
the practice would be acceptable in the manager’s home country if it
were in a similar stage of development.
2. The conflict of cultural tradition asks if a practice would be acceptable
if (1) is it not possible to do business successfully in the country
without engaging in the practice, and (2) the practice does not violate a
core human value.
3. Managers choosing an ethical path to follow can also look for guidance
to the ethics theories presented above, including utilitarianism, rights
theory, theory of justice, and cultural relativism.
2.2.2 Codes of Ethics
A code of ethics is a formal statement that conveys ethical values and describes
baseline professional conduct expected of individuals.
1. Describes how employees are to interact ethically with co-workers,
suppliers, customers, and others. It guides employees’ attitudes,

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 demeanor, and judgments while they fulfill duties and can be consulted
when employees face ethical dilemmas.
2. Ethical imperialism is when a company attempts to export their home
country’s ethical beliefs to other countries. This rarely works because
ethics are deeply engrained in a people’s culture.
3. Companies also must be careful not to follow cultural relativism and
blindly accept local ethics in their entirety if significant differences
exist with the home country.
4. The Academy of Management identifies three general principles that
serve as a guide in determining ethical courses of action, including (1)
responsibility, (2) integrity, and (3) respect for people’s rights and
dignity.
2.2.3 Sources of Unethical Behavior
1. Two principal sources of unethical behavior are the moral integrity of
individuals and a firm’s managerial setting or policies.
2. Individuals differ in their moral integrity. Each person possesses a
unique set of values learned throughout their life.
3. It is crucial that leaders set an acceptable example. Managers should
behave ethically in official meetings as well as when the spotlight is
off.
4. Corporate compliance departments traditionally ensure that their
companies abide by the relevant laws and regulations and good
corporate practices.

2.3 CORPORATE SOCIAL RESPONSIBILITY

Conscientious business leaders know their company’s future depends on
healthy communities and environments worldwide.
Probably every international company of at least moderate size has a policy for
social responsibility.
Issues include child labor, human rights, the environment, and more.
2.3.1 Efficiency and Profits as Social Responsibility
1. Historically speaking, to be considered socially responsible a company
was to maximize profits for its owners (or shareholders) while
operating within the law, and follow basic ethical guidelines.
2. In the modern corporation, managers are hired to run a business for the
owners. These managers are legally obligated to work in the best
interests of owners (shareholders).
3. Economic theory argues that the presence of private businesses
operating in free and competitive markets maximizes economic
efficiency and society’s well-being. This is the view of Adam Smith
and Milton Friedman.
4. Utilitarianism would support this view, as would cultural relativism.
Yet from a justice perspective one might argue that a business should
do more to redistribute wealth and income to the less well-off. And
from a rights perspective one might say that firms should also defend
people’s basic rights and provide equal opportunity for all.

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 2.3.2 Business Responsibility to Society
Another perspective views a business as having social responsibilities
beyond efficiency and maximizing profits.
This view is known as corporate social responsibility (CSR)—the belief
that a company should incorporate social objectives within its goals and
policies and contribute positively to society.
1. The pyramid of corporate social responsibilities involves four areas:
a. Economic—businesses must create economic value for society.
b. Legal—businesses must follow each society’s “codified ethics.”
c. Ethical—businesses must follow the norms, values, principles,
and expectations of society.
d. Philanthropic—businesses must voluntarily give back to
society.
2. Some social responsibilities differ depending on their industry. For
example, sugary and fast-food companies versus oil and gas
companies. Other social responsibilities are common to all industries,
including respect for human rights and providing safe working
conditions.

2.3.3 Stakeholder Theory

1. Stakeholder theory is a view of capitalism that stresses the
interconnected relationships between a business and those who have an
interest or “stake” in the company.
2. These individuals are called stakeholders and include all parties who
affect, or are affected by, a company’s activities. These individuals can
be either internal or external to the organization.
3. The stakeholder view argues that the purpose of a business is to create
as much value as possible for all stakeholders, not only shareholders. It
can support development of competitive advantage.
4. Benefit Corporation
A benefit corporation is a business entity legally empowered to pursue
positive stakeholder impacts alongside profits.
a. The Certified B Corporation (B Corp) movement is a
community of mission-driven entrepreneurs that is creating
companies that balance purpose and profit to use business as a
force for good.

2.4 SUSTAINABILITY
Development that meets the needs of the present without compromising the
ability of future generations to meet their needs.
Net-zero emissions is reached when the amount of greenhouse gases released
into the atmosphere and the amount removed are equal.
Businesses are embracing the challenge to become net zero.
2.4.1 Carbon Footprints and Climate Change
1. Carbon footprint is the environmental impact of greenhouse gases
measured in units of carbon dioxide that are emitted by human activity.

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 2. A primary footprint are emissions from the burning of fossil fuels used
to produce a good or service. A secondary footprint are emissions from
the whole life cycle of products from their manufacture to eventual
breakdown.
2.4.2 A Circular Economy
1. A circular economy is an approach that designs products and
components that can be reused, disassembled, and upgraded to
minimize waste (see Figure 2.7).
2. The circular economy attempts to mimic natural systems and differs
markedly from a linear economy. It aims to produce the same or better
output with less material input and fewer emissions.
3. This resilient system is good for business, people, and the planet. The
circular economy is a systems solution framework that tackles global
challenges like climate change, biodiversity loss, waste, and pollution.
2.4.3 Greenwashing
1. Greenwashing is providing false or misleading information that
presents a business or its products as being environmentally friendly.
2. There are at least four reasons why companies engage in greenwashing.
a. Give the appearance of going green when a company is simply
complying with environmental regulations.
b. Highlight green features that a product may or may not have to
appeal to environmentally-minded consumers.
c. Internal reward system might encourage executives to
pronounce untruthfully that a business has met sustainability
targets.
d. Personal biases, preferences, or thrill-seeking behavior might
motivate individuals to try and get away with lying.
3. Environmental, Social, and Governance Funds
a. ESG funds are stock or bond investments for which
environmental, social, and governance factors are considered
during the investment process.
b. These funds are supposed to invest in companies that are good
stewards of the environment and have strong stakeholder
relationships.
c. However, some ESG funds are more genuine than others.
Companies are being forced to disclose more information on
their business activities and ESG funds are being more closely
scrutinized.

2.5 ADDITIONAL KEY GLOBAL ISSUES

This section covers additional issues that are prominent in international business.
2.5.1 Bribery and Corruption
1. Corruption can lead to the misallocation of resources, hurt economic
development, distort public policy, and damage national integrity.

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 2. The president of US-based Lockheed Martin once bribed Japanese
officials to obtain a large sales contract. Public disclosure of the
incident resulted in the passage of the Foreign Corrupt Practices Act
(FCPA), a law that forbids US companies, subsidiaries, or citizens from
bribing government officials or political candidates worldwide.
3. Enron’s failure sent a shockwave around the world. Energy trading
markets were in chaos and many lost jobs worldwide.
4. In reaction, the US Congress passed the Sarbanes-Oxley Act, which set
more stringent accounting standards and reporting practices.
2.5.2 Working Conditions and Human Rights
1. Managers must monitor their own behavior plus that of employees and
business partners.
2. Governments, labor unions, consumer groups, and human rights
activists forced apparel companies to implement codes of conduct and
the monitoring of international production.
2.5.3 Diversity, Equity, and Inclusion
1. Diversity in the workplace means that a firm’s employees represent a
limitless variety of social viewpoints, cultural perspectives,
experiences, and identities.
a. Corporations benefit when they develop a diverse, equitable and
inclusive workplace at every level of the organization.
b. Diversity includes people of different ages, ethnicities, genders,
physical abilities, religions, etc.
2. Equity in the workplace means that a company offers every employee
an equal opportunity for work and advancement.
a. Equity recognizes and eliminates barriers that reduce
opportunity for underrepresented employees.
b. An employee must know that people from their social and
cultural background will receive equal opportunity for success
in the organization.
3. Inclusion in the workplace means that a company welcomes every
employee, whatever their identity, and helps them to feel they are an
integral part of the organization.
a. Inclusion fosters acceptance of and respect for all people and is
often defined as diversity in action.
b. Employees are encouraged to be their authentic selves without
fear of recrimination.
4. DEI Efforts Within Companies
a. A DEI statement can establish a company’s commitment to
these ideals. This helps form the basis of the overall workplace
culture and guides policies with employees, suppliers,
customers, and all community stakeholders.
b. Diversity, equity, and inclusion goals are increasingly integrated
into executive and management compensation structures today.

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 c. Some firms achieve DEI goals through a practice called impact
sourcing—a practice that brings marginalized groups into the
global business service workforce.

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 CHAPTER 3
CROSS-CULTURAL BUSİNESS

INTRODUCTION
This chapter describes culture in the context of international business, explains how culture
affects international business practices and competitiveness, and presents two methods of
classifying cultures.

3.1 WHAT IS CULTURE?

Culture is the set of values, beliefs, rules, and institutions held by a specific
group of people.
Main components include: physical environment, material culture, values,
attitudes, aesthetics, manners, customs, social structure, education, religion, personal
communication.
Globalization encouraged cultures to assimilate to some extent. Yet it is
enormously unlikely that the world will ever homogenize to a culture in which all
people share similar lifestyles, values, and attitudes.

3.1.1. Cross-Cultural Literacy

1. Avoiding Ethnocentricity
a. Ethnocentricity is the belief that one’s own ethnic group or
culture is superior to that of others. It causes people to view
other culture in terms of their own and overlook beneficial
aspects of other cultures.
b. Ethnocentricity can undermine business can undermine business
projects when employees are insensitive to cultural nuances.
2. Developing Cross-Cultural Literacy
a. Managers working directly in international business should
develop cross-cultural literacy—detailed knowledge about a
culture that enables a person to work happily and effectively
within it.
b. Cross-cultural literacy brings a company closer to customer
needs and improves competitiveness.
3.1.2. National culture
1. Nation-states support and promote the concept of a national culture by
building museums and monuments to preserve the legacies of
important events and people.
2. Companies get involved in supporting culture, in part, for the public
relations benefit.
3.1.3 Subcultures
1. A subculture is a group of people who share a unique way of life within
a larger, dominant culture. It can differ from the dominant culture in
language, race, lifestyle, values, attitudes, and so on.
2. Companies must be mindful of subcultures when formulating business
strategies (e.g., China has 50 ethnic groups).

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 3. Decisions regarding product design, packaging, and advertising must
consider distinct cultures.
4. Subcultures also can extend beyond national borders.

3.1.4. Physical Environment

1. Physical environment heavily influences a culture’s development and
pace of change.
2. Topography includes all physical features that characterize the surface
of a geographic region. Cultures isolated by mountains or large bodies
of water are less exposed to the cultural traits of others and change
slowly.
3. Topography impacts product needs and personal communication (e.g.,
mountains and the Gobi Desert consume two-thirds of China).
4. Climate affects where people settle, directs systems of distribution, and
plays a large role in lifestyle, clothing, and work habits.
3.1.5 Material Culture
1. This is all technology a culture uses to manufacture goods and provide
services. It can measure a culture’s technological advancement.
2. A firm enters a market under one of two conditions: (1) demand for its
products has developed, or (2) the market can support its production
operations.
3. Changes in material culture can change other aspects of culture.
4. Many nations display uneven levels of material culture across
geography, markets, and industries.

3.2 VALUES, ATTITUDES, AND BEHAVIOR

People in different nations behave differently and that every culture has segments of
people with distinct values and behaviors.
3.2.1 Values
Values are ideas, beliefs and customs to which people are emotionally attached.
1. They affect work ethic and desire for material possession. Some
cultures value leisure while others value hard work.
3.2.2 Attitudes
Attitudes are positive or negative evaluations, feelings, and tendencies that
individuals harbor toward objects or concepts.
1. Learned from role models and formed within a cultural context. They
are more flexible over time than values.
3.2.3 Aesthetics
Aesthetics is what a culture considers to be in “good taste” in the arts, the
imagery evoked by certain expressions, and the symbolism of colors.
1. Appropriate colors for advertising, product packaging, and even work
uniforms can enhance success (e.g., Green in Islam).
2. Blunders can result from selecting inappropriate colors and symbols for
advertising, product packaging, and architecture.
3. It is also an important consideration in marketing over the internet.
3.2.4 Behaviors

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 An understanding of manners and customs can help one avoid mistakes
abroad. In depth knowledge improves the abilities of managers.
1. Manners are appropriate ways of behaving, speaking, and dressing in a
culture.
2. Customs are habits or ways of behaving in specific circumstances that
are passed down through generations in a culture. Customs define
appropriate habits or behaviors in specific situations.
a. Folk and Popular Customs
Folk customs are behaviors, dating back generations, practiced
within a homogeneous group of people. A popular custom is
behavior practiced by a heterogeneous group or by several
groups.
b. Gift-Giving Customs
Although giving token gifts to business and government
associates is customary, the proper type of gift varies. Cultures
differ in their legal and ethical rules regarding bribery. US law
prohibits companies from giving large gifts to win business
favors.

3.3 SOCIAL STRUCTURE AND EDUCATION

Social structure embodies a culture’s fundamental organization, including
groups and institutions, social positions and relationships, and resource distribution.
3.3.1 Social Group Associations
A social group is a collection of two or more people who identify and interact
with one another. Social groups contribute to identity and self-image.
1. Type of Groups
a. A primary group is a small group of people who share close
personal relationships that form early in life and endure through
time (e.g., family, close friends)
b. A secondary group is a larger, less personal, and less enduring
than a primary group. They develop later in life and are
established to achieve a specific goal (e.g., company
employees).
c. A reference group is one that people use as a standard (or
reference) for their own preferences, beliefs, attitudes or
behaviors (e.g., influencers and followers).
2. Family
a. Nuclear family consists of immediate relatives, including
parents, brothers, and sisters. Prevails in Australia, Canada,
United States, and in Europe.
b. Extended family includes grandparents, aunts and uncles,
cousins, and relatives through marriage. Mostly found in Asia,
Middle East, North Africa, and Latin America.
3. Collectivism and Individualism
a. Identifies the extent to which a culture emphasizes the
individual versus the group.

17

 b. Collectivist cultures have a tendency toward groups, including
family and work units. Goals include maintaining group
harmony and working toward collective, rather than personal,
accomplishments.
c. Individualist cultures stress individual rights, entrepreneurial
risk taking, and a focus on personal goals.
3.3.2 Social Status
Social stratification is the process of ranking people into social layers, or
classes.
1. An objective social status ranking is a direct determination of social
class based on socioeconomic variables. Such factors normally are
family heritage, income, wealth, power, behavior, and occupation.
2. A subjective social status ranking is one in which people place
themselves into various categories, relying mostly on income and to a
lesser extent, education as powerful determinants.
3. Social status rankings are fairly stable over time in a culture but they
can and do change.
3.3.3 Social Mobility
1. Social mobility is the ease with which individuals can move up or down
a culture’s “social ladder.”
2. Caste system: people are born into a social ranking, with little or no
opportunity for social mobility.
3. Class system: personal ability and actions determine social status and
mobility. Highly class-conscious cultures can offer less mobility but
experience more class conflict.
3.3.4 Education
1. Education passes on traditions, customs, and values. Cultures educate
young people through schooling, parenting, religious teachings, and
group memberships. Families and other groups provide informal
instruction about customs and how to socialize with others.
2. Excellent basic education attracts high-wage industries that invest in
training and increase productivity. A skilled and well-educated
workforce attracts high-paying jobs; a poorly educated one attracts
low-paying jobs.
3. The “Brain Drain” Phenomenon
a. Brain drain is the departure of highly educated people from one
profession, geographic region, or nation to another.
b. Reverse brain drain is when those professionals return to their
homelands.

3.4 RELIGION
Human values often originate in religious beliefs. Different religions take
different views of work, savings, and material goods.
Beliefs can influence competitiveness, economic development, and business
strategies.
3.4.1 Christianity

18

 1. Founded in Palestine 2,000 years ago among Jews who believed that
Jesus of Nazareth was their savior. With 2 billion followers, it is the
world’s single largest religion.
2. More than 300 denominations but most are Roman Catholic, Protestant,
or Eastern Orthodox.
3. Roman Catholics are to refrain from placing materialism above God
and people. Protestants believe that salvation comes from faith in God
and that hard work gives glory to God.
4. Christian organizations sometimes get involved in social causes that
affect business policy.
3.4.2 Islam
1. Founded by Muhammad in 600 A.D. in Mecca, Saudi Arabia—the holy
city of Islam. World’s second largest religion with 1.3 billion adherents.
2. Word Islam means “submission to Allah” and Muslim means “one who
submits to Allah.”
3. Religion strongly affects the goods and services acceptable to Muslim
consumers (e.g., alcohol, pork, interest on loans).
3.4.3 Hinduism
1. Founded 4,000 years ago in present-day India, where more than 90
percent of its nearly 900 million adherents live.
2. Some say it is a way of life rather than a religion. Believe in
reincarnation—rebirth of the human soul at the time of death. Do not
eat or willfully harm living creatures as they may be reincarnated
human souls.
3. Cows considered sacred animals so eating beef is not allowed (e.g.,
McDonald’s replaces beef with lamb).
3.4.4 Buddhism
1. Founded 2,600 years ago in India by a Hindu prince named Siddhartha
Gautama. About 380 million followers, mostly in Asia, including
China, Tibet, Korea, Japan, Vietnam, and Thailand.
2. Promotes a life centered on spiritual rather than worldly matters.
Buddhists seek nirvana (escape from reincarnation) through charity,
modesty, compassion for others, and general self-control.
3.4.5 Judaism
1. Founded more than 3,000 years ago and has 18 million followers. Was
the first religion to teach belief in one God. Orthodox Jews make up 12
percent of Israel and constitute an increasingly important economic
segment.
2. Important observances are Rosh Hashanah (the Jewish New Year), Yom
Kippur (the Day of Atonement), Passover (the Exodus from Egypt),
and Hanukkah (a victory over the Syrians).
3. The Sabbath lasts from sundown on Friday to sundown on Saturday so
work schedules might need adjustment.
4. Marketers must take into account foods banned among observant Jews
(e.g., pork and shellfish prohibited, meat stored and served separately
from milk) and “kosher” foods.

19

 3.4.6 Confucianism
1. Founded 2,500 years ago by exiled politician and philosopher
Confucius. Confucian thought is ingrained in the cultures of China,
Japan, South Korea, and nations with large numbers of ethnic Chinese,
including Malaysia, Singapore, Indonesia, and Thailand.
2. Some observers contend that the Confucian work ethic and a
commitment to education helped spur East Asia’s phenomenal
economic growth.
3. Others say Chinese leaders distrusted Confucian ideas for centuries
because they believed it stunted economic growth. Moreover, the
primary objective of merchants (to earn profits) goes against Confucian
beliefs.

3.5 PERSONAL COMMUNICATION

Every culture has a communication system to convey thoughts, feelings,
knowledge, and information through speech, writing, and actions.
A culture’s spoken and body language can help us understand people’s
thoughts and behaviors.

1. Spoken and Written Language

Spoken and written language is the most obvious difference we notice when
traveling in another country. Linguistically different segments of a population
are often culturally, socially, and politically distinct.
1. Implications for Managers
a. Language proficiency is crucial in production facilities where
non-native managers are supervising local employees.
b. Marketers prize insights into the interests, values, attitudes, and
habits of consumers to better target promotions.
2. Language Blunders
a. Companies have made language blunders in their international
business dealings.
b. Advertising slogans and company documents must be translated
carefully so that the messages are received precisely as
intended.
3. Lingua Franca
a. A lingua franca is a third or “link” language that is understood
by two parties who speak different languages.
b. Although only 5 percent of the world’s population speaks
English as a first language, it is the most common lingua franca

20

 used in international business, followed closely by French and
Spanish.
3.5.2 Body Language
1. Body language is communicated through unspoken cues, including
hand gestures, facial expressions, physical greetings, eye contact, and
the manipulation of personal space.
2. Communicates information and feelings and differs among cultures. It
can be quite subtle and takes time to interpret.
3. Proximity is an element of body language. Standing too close may
invade personal space and appear aggressive.
4. Physical gestures can easily cause misunderstanding between people of
different cultures because they can convey very different meanings.

3.6 CULTURE IN THE GLOBAL WORKPLACE

The workplace holds a prominent position in a culture. It provides a way to
earn a living and supplies people with an avenue to give their lives meaning, structure,
and identity.
3.6.1 Perception of Time
1. People in different culture often perceive time differently. People in
polychronic time (P-time) cultures tend to engage in less advance
planning and tend to do things according to their own schedule.
2. People in monochronic times (M-time) cultures tend to prefer well-
defined advance schedules for deadlines, meetings, and so forth.
3.6.2 View of Work
1. Some cultures have a strong work ethic, others stress a balanced pace
in work and leisure (e.g., a work to live versus a live to work
mentality).
2. Many European nations are trying to foster an entrepreneurial spirit to
achieve the job growth realized in the United States.
3.6.3 Cultural Change
Cultural trait is anything that represents a culture’s way of life including
gestures, material objects, traditions, and concepts. Cultural diffusion is the
process whereby cultural traits spread from one culture to another.
1. When Companies Change Cultures
a. Globalization and technology increased the pace of cultural
diffusion and encouraged cultural convergence in some market
segments for some products.
b. Cultural imperialism is the replacement of one culture’s
traditions, folk heroes, and artifacts with substitutes from
another.
2. When Cultures Change Companies
a. Culture can force companies to adjust business policies and
practices. Managers can encounter cultural differences that
force changes in how they motivate employees in other
countries, for example.

21

 b. Managers can use situational management to walk an employee
through every step of a task and monitor the results at each
stage. This helps employees understand the scope of their jobs
and clarifies their responsibilities.
3.6.4 Kluckhohn–Strodtbeck Framework
The Kluckhohn–Strodtbeck Framework compares cultures along six
dimensions by asking the following questions:
1. Do people believe that their environment controls them, that they
control the environment, or that they are part of nature?
2. Do people focus on past events, on the present, or on the future
implications of their actions?
3. Are people easily controlled and not to be trusted, or can they be
trusted to act freely and responsibly?
4. Do people desire accomplishments in life, carefree lives, or spiritual
and contemplative lives?
5. Do people believe that individuals or groups are responsible for each
person’s welfare?
6. Do people prefer to conduct most activities in private or in public?
a. CASE: Japanese Culture:
i. Japanese believe in a delicate balance between people
and environment that must be maintained.
ii. Japanese culture emphasizes the future.
iii. Japanese culture treats people as quite trustworthy.
iv. Japanese are accomplishment oriented – not necessarily
for themselves, but for their employers and work units.
v. Japanese culture emphasizes individual responsibility to
the group and group responsibility to the individual.
vi. The culture of Japan tends to be public.
3.6.5 Hofstede Framework
The Hofstede Framework grew from a study of more than 110,000 people
working in IBM subsidiaries in 40 countries by Dutch psychologist Geert
Hofstede. He developed five dimensions for examining cultures. Later research
included more people in additional countries, and he expanded the framework
to a total of six dimensions.
1. Individualism versus Collectivism: Identifies the extent to which a
culture emphasizes the individual versus the group.
a. Individualist cultures value hard work, entrepreneurial risk-
taking, and freedom to focus on personal goals.
b. Collectivist cultures feel a strong association to groups,
including family and work units. The goal is to maintain group
harmony and work toward collective goals.
2. Power Distance: Identifies the degree to which a culture accepts social
inequality among its people.
a. A large power distance can cause inequality between superiors
and subordinates. Organizations are hierarchical and power
flows from prestige, force, and inheritance.

22

 b. A small power distance translates to greater equality, with
prestige and rewards equally shared between superiors and
subordinates. Power derives can be seen as more legitimate.
3. Uncertainty Avoidance: Identifies the extent to which a culture avoids
uncertainty and ambiguity.
a. Cultures with large uncertainty avoidance value security, place
faith in strong systems of rules and procedures, have lower
employee turnover, have formal rules for employee behavior,
and more difficulty implementing change.
b. Low uncertainty avoidance cultures are more open to change
and new ideas.
4. Masculinity versus Femininity: Identifies the extent to which a culture
emphasizes “masculinity” versus “femininity.”
a. High “masculinity” cultures are characterized by personal
assertiveness, wealth accumulation, and entrepreneurship.
b. Low “masculinity” cultures have more relaxed lifestyles and
place a concern for others over material gains.
5. Long-Term Orientation: Indicates a society’s time perspective and an
attitude of overcoming obstacles with time.
a. This dimension attempts to capture differences between Eastern
and Western cultures.
b. Cultures scoring high (strong long-term orientation) value
respect for tradition, thrift, perseverance, and a sense of
personal shame.
c. Cultures scoring low are characterized by individual stability
and reputation, fulfilling social obligations, and reciprocation of
greetings and gifts.
6. Indulgence versus restraint: Captures the extent to which a society
allows free expression.
a. An indulgent society (one scoring high on this dimension)
allows people to rather freely satisfy human needs related to
enjoying life and having fun.
b. A restrained society uses varying degrees of social norms to
suppress the free satisfaction of such needs.

23

 CHAPTER 4
POLİTİCAL ECONOMİC AND LEGAL SYSTEMS

INTRODUCTION
This chapter considers the basic differences between political and legal systems
around the world.
Disputes grounded in political and legal matters affect business activities. Companies
should be aware of how to manage the associated risks.
Individualism is a belief that individual rights and responsibilities should be placed
above the group’s welfare.
Collectivism stresses the relative importance of a group’s welfare over that of the
individual. The legal, political, and economic systems of every nation display a unique blend
of individual and group values.

4.1 POLITICAL SYSTEMS

A political system includes the structures, processes, and activities by which a
nation governs itself.
A nation’s political system derives from its history and culture, and includes
such factors as population, age, race composition, and per capita income.
Anarchism is the belief that only individuals, and private groups should control
a nation’s political activities.
Pluralism is the belief that private and public groups belong in politics. The
political system also allows for Participation, which occurs when people voice
opinion, vote and show general approval or disapproval of the system.
4.1.1 Totalitarianism is a political system in which individuals govern regardless of
the people’s support, tightly control people’s lives, and do not tolerate
opposing viewpoints.
1. These governments share three features: imposed authority, lack of
constitutional guarantees, and restricted participation.
2. Theocratic totalitarianism is a political system under the control of
totalitarian religious leaders.
3. Secular totalitarianism is a political system in which leaders maintain
control through military and bureaucratic power. It takes three forms:
Communist, tribal and right wing.
a. Communism is a system that says social and economic equality
can only by establishing an all-powerful Communist Party,
violently gaining control over economic resources, and
eliminating political opposition.
b. Socialism is a political system in which government owns and
controls all types of economic activity to achieve social and
economic equality.
c. Tribal totalitarianism is a system in which one ethnic group
imposes its will on others with whom it shares a national
identity.
d. Right-wing totalitarianism is when government grants few (if
any) political freedoms and endorses private ownership of

24

 property and a market-based economy. Leaders strive for
economic growth and oppose left-wing totalitarianism, or
communism.

4. Doing Business in Totalitarian Countries

a. Companies need not be concerned with political opposition
outside the government. It can be risky because the law is vague
or nonexistent, and people in powerful government positions
can interpret laws at will.
4.1.2 Democracy is a political system in which government leaders are elected
directly by wide participation of the people or their representatives.
1. In representative democracies, citizens elect individuals from their
groups to represent their political views.
2. Representative democracies strive to provide freedom of expression,
periodic elections, full civil and property rights, minority rights, and
nonpolitical bureaucracies.
3. In a parliamentary democracy, the nation divides itself into geographic
districts and people in each district vote for competing parties rather
than individual candidates.
a. Absolute majority: the number of representatives the party gets
elected exceeds the number of representatives elected by all
other parties.
b. Coalition government: if the party with the largest number of
representatives lacks an absolute majority it can join with one or
more parties to share responsibilities. Examples include Italy,
Israel, the Netherlands.
4. Doing Business in Democracies
Democracies tend to maintain stable business environments through
laws protecting individual property rights. Participative democracy,
property rights, and free markets tend to encourage economic growth.

4.2 ECONOMIC SYSTEMS

An economic system is the structure and processes that a country uses to
allocate its resources and conduct its commercial activities.
No economy reflects a completely individual or group orientation but displays
a blend of individual and group values.
4.2.1 Centrally Planned Economy
Land, factories, and other economic resources are owned by the government,
which plans nearly all economic activity. Goal is to achieve political, social,
and economic objectives through complete control of production and
distribution of resources.
1. Origins of the Centrally Planned Economy
a. Based on the belief that group welfare is more important than
individual well-being, and thus strives to achieve economic and
social equality.

25

 b. Karl Marx in the 1800s argued the economy must be
overthrown and replaced with an equitable “communist”
system.
c. By the 1970s, central planning was the economic law in lands
stretching across Central and Eastern Europe, Asia, Africa, and
Latin America.
2. Decline of Central Planning
a. In the late 1980s, after the former Soviet Union implemented its
twin policies of glasnost (political openness) and perestroika
(economic reform), its totalitarian government collapsed. Other
nations began to dismantle communist central planning in favor
of market-based economies.
b. Failure to create economic value: Central planners failed to
produce quality products efficiently.
c. Failure to provide incentives: Government ownership limited
incentives to maximize benefits from resources, which lowered
economic growth and living standards.
d. Failure to achieve rapid growth: Leaders realized their nations
were falling behind other nations due to a lack of innovation.
e. Failure to satisfy consumer needs: Consumers’ basic needs were
not being met.
f. China experimented with market economics before the former
Soviet Union began its reform programs. Today, China practices
state capitalism, whereby the government is the leading
economic actor and uses markets for political gain. China
continues to experience strong economic growth.
4.2.2 Mixed Economy
Economic system in which land, factories, and other economic
resources are rather equally split between private and government ownership.
Government controls economic sectors important to national security
and long-term stability.
Generous welfare systems support the unemployed and provide health
care.
1. Origins of the Mixed Economy
A successful economy is efficient and innovative, but also protects
society. Its goals are low unemployment, low poverty, steady economic
growth, and an equitable distribution of wealth.
2. Progress of Mixed Economies
Mixed economies believe they should not dismantle their social welfare
institutions but should modernize them so they contribute to national
competitiveness.
a. Somewhat slow economic growth caused many mixed
economies to want to increase economic efficiency, boost
productivity, and raise living standards. This led nations to
pursue privatization—the sale of government-owned economic
resources to private operators.

26

 4.2.3 Market Economy
Economic system in which most land, factories, and other economic resources
are privately owned, either by individuals or businesses. Price mechanism
determines:
• Supply: Quantity of a good or service that producers are willing to provide at a
specific selling price.
• Demand: Quantity of a good or service that buyers are willing to purchase at a specific
selling price.
1. Origins of the Market Economy
It Places individual concerns above group concerns. The group benefits
when individuals receive incentives and rewards to act in certain ways.
a. Laissez-faire economics: French for “allow them to do [without
interference].” Individualism fosters democracy as well as a
market economy.
2. Features of a Market Economy
a. Free choice: Individuals have purchase options.
b. Free enterprise: Companies can decide what to produce and
which markets to compete in.
c. Price flexibility: Prices rise or fall reflecting supply and
demand.
3. Government’s Role in a Market Economy
It has little direct involvement, but plays four important roles:
a. Enforce Antitrust Laws
i. Goal of antitrust (antimonopoly) laws is to encourage
the development of industries with as many competing
businesses as the market will sustain.
ii. Encourage competition and innovation that lower prices
and increase product choices.
iii. Prevent trade-restraining monopolies from price-fixing,
sharing markets and gaining unfair advantages.
b. Preserve Property Rights
i. Encourage individuals and firms to take risks such as
technology investments, new product invention.
ii. Legally safeguard claims to assets and future incomes
they generate.
c. Provide a Stable Fiscal and Monetary Environment
i. Influence inflation and unemployment rates through
effective fiscal and monetary policies.
ii. Stability improves company forecasts and reduces risks
associated with future investments.
d. Preserve Political Stability
i. Market economy depends on a stable government.
ii. Reduces political risk for companies.
4. Economic Freedom
a. Connection between political freedom and economic growth is
uncertain.

27

 b. Greater economic freedom tends to coincide with higher living
standards. But the economic success of autocratic state
capitalism complicates this subject.

4.3 LEGAL SYSTEMS

A legal system is a country’s set of laws and regulations, including how its laws
are enacted and enforced, and how its courts hold parties accountable.
It is influenced by cultural variables, including class barriers, religious beliefs,
emphasis on individualism or conformity, and the political system.
The legal system can also be influenced by political moods and upsurge in
nationalism, the devotion of a people to their nation’s interests and advancement.
Totalitarian governments favor public ownership and enact laws limiting
entrepreneurial behavior.
Democracies encourage entrepreneurial activity and protect businesses with
property-rights laws.
4.3.1 Common Law
• Tradition: Country’s legal history
• Precedent: Past cases that have come before the courts
• Usage: How laws are applied in specific situations
1. Originated in England in the eleventh century and adopted in its
territories worldwide.
2. Business contracts tend to be lengthy because they consider many
contingencies and possible interpretations in case of dispute. Common
law systems are flexible, taking into account particular situations and
circumstances.
3. Practiced in Australia, Britain, Canada, Ireland, New Zealand, the
United States, and some nations in Asia and Africa.
4.3.2 Civil Law
1. Based on a detailed set of written rules and statutes that constitute a
legal code. Can be traced to Rome in the fifth century BCE and is the
oldest and most common legal tradition.
2. Can be less adversarial than common law because it is not interpreted
according to tradition, precedent, and usage. Because laws are codified
and concise, parties are concerned with the explicit wording of the code
—obligations, responsibilities, and privileges follow directly from the
relevant code.
3. Practiced in Cuba, Puerto Rico, Quebec, all of Central and South
America, most of Western Europe, and parts of Asia and Africa.

4.3.3 Theocratic Law

1. Legal tradition based on religious teachings (e.g., Islamic, Hindu, and
Jewish law).
2. Islamic law is the most widely practiced theocratic legal system today.
It was initially a code governing moral and ethical behavior and was
later extended to commercial transactions. It restricts investments and
sets guidelines for business conduct.

28

 3. Firms operating in countries with theocratic legal systems must
evaluate business activities, including hiring practices and investment
policies, to ensure compliance with the law, local values, and beliefs.

4.4 GLOBAL LEGAL ISSUES

Companies must adapt to dissimilar legal systems in global markets because
there is no clearly defined body of international law that all nations accept.
There is a movement toward standardizing the interpretation and application of
laws in more than one country, but this does not involve standardizing entire legal
systems.
Enduring differences, therefore, can force companies to continue the costly
practice of hiring legal experts in each country where they operate.
4.4.1 Intellectual Property
1. This results from intellectual talent and abilities such as graphic
designs, novels, computer software, machine-tool designs, and secret
formulas. The move to cloud computing and increased sales of
subscription software are lowering prices and reducing the incidence of
unlicensed software. Cloud computing is the delivery of computing
services over the internet, or the cloud.
2. Industrial Property
a. Property rights are the legal rights to resources and any income
they generate. Intellectual property can be traded, sold, and
licensed in return for fees or royalty payments.
b. Industrial property is intellectual property and often a firm’s
most valuable asset. Laws protecting industrial property reward
innovative and creative activity.
c. A patent is a right granted to the inventor of a product or
process that excludes others from making, using, or selling the
invention. The WTO grants patents for 20 years.
d. Trademarks are words or symbols that distinguish a product and
its manufacturer. Trademark protection lasts indefinitely,
provided the word or symbol continues to be distinctive (e.g.,
Apple’s logo).
3. Copyrights give creators of original works the freedom to publish or
dispose of them as they choose.
a. The holder can (1) reproduce the copyrighted work, (2) derive
new works from it, (3) sell or distribute it, (4) perform it, and
(5) display it publicly.
b. Protected under the Berne Convention and the 1954 Universal
Copyright Convention and are granted for the creator’s lifetime
plus 70 years.
4.4.2. Product Safety and Liability
1. Product liability is the responsibility of manufacturers, sellers,
individuals, and others for damage, injury, or death caused by defective
products.

29

 2. Developed nations have the toughest product liability laws compared to
developing and emerging countries.
4.4.3 Antitrust Regulations
1. Antitrust (antimonopoly) laws are designed to prevent companies from
fixing prices, sharing markets, and gaining unfair monopoly
advantages. They help ensure a variety of products at fair prices.
2. The United States and the European Union have strict antitrust
regulation and are strict enforcers.
3. In strict antitrust countries, companies are at a disadvantage if
competitors’ home countries condone market sharing, whereby
competitors agree to serve only designated market segments.
4.4.4 Taxation
1. Tax revenues needed to pay government salaries, build military
capacity, and shift earnings from people with high incomes to those
with low incomes.
2. Consumption taxes help pay for the consequences of using a particular
product and to make imports more expensive.
3. Value added tax (VAT) is levied on each party that adds value to a
product throughout its production and distribution. Supporters of the
VAT system contend that it distributes taxes on retail sales more evenly
between producers and consumers. Yet consumers ultimately pay the
tax because producers and distributors usually increase prices to
compensate for their tax burden.

30

 CHAPTER 5
ECONOMİC DEVELOPMENT OF NATİONS

I. INTRODUCTION
National culture can have a strong impact on a nation’s economic development.
In turn, the development of a country’s economy can dramatically influence many
aspects of its culture.
Economic systems in individualist cultures tend to provide incentives and
rewards for individual business initiatives.
Collectivist cultures tend to offer fewer such incentives and rewards.

5.1 ECONOMIC DEVELOPMENT

Economic development refers to an increase in the economic well-being,
quality of life, and general welfare of a nation’s people.
It reflects economic output (agricultural and industrial); infrastructure (power
and transportation facilities); physical health, safety, life expectancy, environmental
sustainability, level of education; and cultural, political, legal, and economic
differences.
5.1.1 Classifying Countries
Classifications normally based on indicators such as figures on national
production, portion of the economy devoted to agriculture, volume of exports
in the form of industrial goods, and overall economic structure.
1. Advanced Countries (also called developed countries)
a. Highly industrialized, highly efficient, and whose people enjoy
a high quality of life. People receive the finest health care and
benefit from the best educational systems in the world.
b. Examples are Australia, Canada, Japan, New Zealand, the
United States, all western European nations.
2. Emerging Markets (also called Newly industrialized countries)
a. Recently increased the portion of national production and
exports derived from industrial operations.
b. Mainly in Asia and Latin America: Hong Kong, South Korea,
Singapore, Taiwan, Brazil, China, India, Malaysia, Mexico,
South Africa, and Thailand. Depending on the classification
criteria, the group can include Argentina, Brunei, Chile, the
Czech Republic, Hungary, Indonesia, the Philippines, Poland,
Russia, Slovakia, Turkey, and Vietnam.
3. Developing Countries
a. A nation that has a low-quality infrastructure and low personal
incomes. Mainly in Africa, the Middle East, and the least
affluent nations in Eastern Europe and Asia.
b. Rely on one or a few sectors of production—agriculture,
mineral mining, or oil drilling. They may lack key resources
and skills.

31

 c. Often characterized by technological dualism—use of the latest
technologies in some sectors of the economy coupled with the
use of outdated technologies in other sectors.

5.1.2 National Production

Can classify countries by gross domestic product per capita, but there are
problems using GDP and GNP as indicators of development.
1. Uncounted Transactions
a. Volunteer work, unpaid household work, illegal activities,
shadow economy transactions, and unreported cash
transactions.
b. The shadow economy (also called the hidden, gray, cash or
informal economy) includes economic activities that have
market value but are not formally registered. The shadow
economy can be so large and prosperous that official statistics
are almost meaningless.
2. Question of Growth
a. GDP and GNP figures are a snapshot of one year’s economic
output, and do not indicate whether an economy is growing.
3. Problem of Averages
b. Per capita figures are averages. Urban areas can be more
developed than rural areas and have higher per capita income.
4. Pitfalls of Comparison
a. To compare gross product per capita, each currency must be
translated into a single currency.
b. Official exchange rates do not show what the local currency can
buy in its home country.
5.1.3 Purchasing Power Parity
1. Purchasing power is the value of goods and services that can be
purchased with one unit of a country’s currency. Purchasing power
parity is the relative ability of two countries’ currencies to buy the same
“basket” of goods in those two countries.
2. Using purchasing power parity to compare the wealth of nations, for
example, Mexico’s GDP/capita is $9,489 (in US dollars at current
exchange rates) and that of the United States is $65,134. If we adjust
Mexico’s GDP/capita for purchasing power in Mexico, we obtain a
figure of $20,944.
5.1.4 Human Development
a. Human development index (HDI) measures extent to which a
government equitably provides its people with a long and healthy life,
an education, and a decent standard of living.
b. There is often disparity between wealth and HDI.

32

 c. HDI demonstrates that high national income alone does not guarantee
human progress.

5.2 POLITICAL RISK

Political risk is the likelihood of political action that positively or negatively
affect a business. It can threaten an exporter’s market, manufacturing facilities, and the
ability to repatriate profits.
Political risk levels vary from nation to nation. Two broad categories of
political risk reflect the range of companies they affect.
Macro risk threatens the activities of all domestic and international companies
in every industry.
Micro risk threatens companies within a particular industry or even smaller
groups. The main sources of political risk include:
5.2.1 Conflict and Violence
1. Local conflict discourages investment. Violence hinders manufacturing,
obtaining materials and equipment, and recruiting talented personnel.
2. It can arise from resentment toward government, territorial disputes,
and disputes over ethnic, racial, and religious differences.
5.2.2 Property Seizure
1. Confiscation is the forced transfer of assets from a company to the
government without compensation. There is no framework for legal
appeal, and compensation tends to be far below value.
2. Expropriation is the forced transfer of assets from a company to the
government with compensation.
3. Nationalization involves government takeover of an entire industry and
is more common than confiscation and expropriation. It is used to: (1)
protect an industry for ideological reasons, (2) save local jobs in an
ailing industry, (3) control industry profits so they cannot be transferred
to low tax-rate countries, and (4) invest in industries (such as public
utilities) that private companies cannot afford.
5.2.3 Government Policies
1. Policy changes can result from newly empowered political parties,
pressure from special interests, and civil or social unrest.
2. One policy tool restricts ownership to domestic companies or limits
ownership by nondomestic firms to a minority stake.
3. Other policies relate to investments made across borders.
4. Local content requirements are laws stipulating that a specified amount
of a good or service be supplied by producers in the domestic market.
These laws can force companies to use local raw materials, procure
parts from local suppliers, or employ local workers. May force a firm to
take on poorly trained or excess workers, and local raw materials could
increase costs or reduce quality.

5.3 MANAGING POLITICAL RISK

Companies manage political risks that threaten operations and future earnings.

33

 5.3.1 Adaptation: Incorporate risk into business strategies, often with the help of
local officials.
1. Partnerships can be used to leverage expansion plans through informal
arrangements or joint ventures, strategic alliances, and cross-holdings
of company stock.
2. Localization entails modifying operations, the product mix, or other
elements to suit local tastes and culture.
3. Development assistance allows an international business to assist the
host country in developing distribution and communications networks
and improving the quality of life for locals.
4. Insurance can be used to protect companies against losses and can
provide project financing. The US International Development Finance
Corporation insures US companies that invest abroad against loss and
can provide project financing.
5.3.2 Information Gathering: Sources include employees with information and
political risk agencies.
1. Current employees with relevant information: people who worked in
the country and have valuable contacts and knowledge.
2. Agencies specializing in political-risk services: such as banks, political
consultants, news publications, and risk-assessment services.
5.3.3 Political Influence: Deal with local lawmakers and politicians directly or by
lobbying–a policy of hiring people to represent a company’s views on political
matters.
5.3.4 International Relations
Favorable political relationships foster stable business environments
and increase international cooperation.
Stable environments require a strong legal system to resolve disputes
quickly and fairly.
Multilateral agreements are treaties concluded among several nations,
each of which agrees to abide by treaty terms even if tensions develop.
5.3.5 The United Nations
1. Formed after the Second World War to provide leadership in fostering
peace and stability around the world. The UN and its many agencies
provide food, medical supplies, educational supplies and training, and
financial resources to lower-income member nations.
2. Receives funding from member contributions based on gross national
product (GNP). Entire world is involved with the UN in some manner.
3. UN system consists of six main segments: (1) General Assembly; (2)
Security Council; (3) Economic and Social Council; (4) Trusteeship
Council; (5) International Court of Justice; and (6) the Secretariat.
4. Within the UN Economic and Social Council is the United Nations
Conference on Trade and Development (UNCTAD). The organization
has a broad mandate in international trade and economic development.

5.4 ECONOMIC TRANSITION

34

 Changing a nation’s fundamental economic organization and creating new free-market
institutions. Typically involves several reforms:
• Stabilize the economy, reduce budget deficits, and expand credit availability.
• Allow prices to reflect supply and demand.
• Legalize private business, sell state-owned firms, and support property rights.
• Reduce barriers to trade and investment and allow currency convertibility.
• Encourage innovation through investment and entrepreneurship.
5.4.1 Transition Obstacles:
Transition from central planning to free market economies generates
tremendous international business opportunities. Yet difficulties arising from
decades of centrally planned economic principles can impair development
efforts. Several key obstacles for countries in transition.
1. Managerial Expertise
a. Central planners had little need for management skills in
production, distribution, pricing, or marketing strategies.
b. Some managers from former communist nations can now rival
the abilities of the best managers.
2. Shortage of Capital
Transition is expensive, requiring spending to:
a. Develop a telecommunications and infrastructure system.
b. Create financial institutions, including stock markets and a
banking system.
c. Educate people in the ways of market economics.
3. Cultural Differences
a. Transition causes cultural change and replaces dependence on
the government with greater emphasis on individuals.
b. Often cuts are made in welfare, unemployment benefits, and
guaranteed government jobs.
5.4.2 China’s Economic Transition
China’s system is “Socialism with Chinese characteristics,” and the nation has
undergone great economic reform over the past two decades.
1. Early Years
a. 1949: Communes planned all agricultural and industrial
production and schedules. Rural families owned their homes
and land and produced particular crops which could be
consumed by the family or sold for profit.
b. 1979: Government reforms allowed families to grow crops they
chose and sell produce at market prices.
c. 1984: Township and village enterprises (TVEs) obtained
materials, labor, and capital on open market and used a private
distribution system. TVEs laid the groundwork for a market
economy.
d. Mid-1980s: Foreign companies were allowed to form joint
ventures with Chinese partners. In 1988, China relaxed
government controls over private property. China began selling

35

 “land-use rights” for residential, commercial, and other uses to
raise capital.
e. 1994: China formalized the practice of “land-use rights" into
law. In a capitalist economy this would be called private land
ownership.
2. Chinese Patience and Guanxi
a. If there is one trait that all private companies need in China, it is
patience. An interesting facet of doing business there is guanxi,
the Chinese term for personal relationships.
3. China’s Challenges
a. China’s economy continues to grow following the Covid-19
pandemic.
b. Increased democratic reform is not supported by the
government and protests arise whenever citizens grow impatient
with political issues.
c. Uncertainty surrounds Taiwan’s eventual reunification with the
Chinese mainland.
5.4.3 Russia’s Economic Transition
Russia’s experience with communism began in 1917. For 75 years,
government controlled all aspects of production and distribution, including
prices of labor, capital, and products.
1. Russia’s Challenges
a. In the 1980s, Russia entered a new era of freedom of thought,
freedom of expression, and economic restructuring.
b. People could now speak freely, and vented frustration over lack
of consumer goods, poor quality products, and long lines at
banks and grocery stores.
c. Transition away from government ownership and central
planning was sudden and turbulent. Politicians and bureaucrats
looked out for themselves and most made out fine in the
transition. But most people had difficulty maintaining their
standard of living and affording many basic items.
d. Russia invaded Georgia in 2008 over two of Georgia’s restive
republics that wanted to draw closer to Russia. In 2014, Russia
annexed the Ukraine’s peninsula of Crimea and two eastern
provinces away from Ukraine. Many nations swiftly rebuked
Russia’s actions and some, including the United States, imposed
political and economic sanctions. Then, in 2022 Russia invaded
the rest of Ukraine. Western nations fled Russia, sanctioned its
politicians and oligarchs, and decoupled from its economy.

36

 CHAPTER 6
INTERNATİONAL TRADE THEORY

INTRODUCTION
This chapter explores international trade in goods and services, examining its benefits,
volume, and patterns as well as the main theories of why nations trade.
Trade theory tells us that if a refrigerator can be made more cheaply in Mexico and
exported to Canada, it should be.
The same reasoned logic tells us that if a US credit card inquiry can be equally
processed for less money in India, it should be.
In both cases, the country that imports the service benefits from a less-expensive
product, and the country that exports the service benefits from inward-flowing investment and
jobs.

6.1 THE NATURE OF INTERNATIONAL TRADE

International trade is the purchase, sale, or exchange of goods and services
across national borders.
This is in contrast to domestic trade, which occurs between different states,
regions, or cities within a country.
Differences in national culture and system of politics, economics, and law are
just some features of international trade that make it more complicated than domestic
trade.
6.1.1 Benefits of International Trade
Countries obtain three primary benefits from international trade: (1) Trade
provides people with a greater choice of goods and services, (2) International
trade is an engine for job creation, and (3) Trade allows for greater
consumption possibilities and raise people’s standard of living.
6.1.2 Economic Importance of Trade
We can measure the importance of trade to a nation by examining the value of
its trading activity relative to its gross domestic product. Trade as a share of
GDP is equal to the sum of exports and imports (for goods and services)
divided by GDP (see Map 6.1).
6.1.3 Top Trading Nations
World merchandise exports are valued at $17.6 trillion, which is more than
three times the value of service exports at $4.9 trillion. Table 6.1 shows the
world’s largest exporters of both merchandise and services. The United States
ranks first in commercial services exports and second in merchandise exports
behind China (see Table 6.1).
6.1.4 Global Trade and Output
Trade volume and world output provide insight into the international trade
environment (see Figure 6.1). Total global exports lagged global output until
2007 when they became equal. Global trade then surpassed output for the first
time in 2008, dipped below output in 2009, but then quickly rebounded and
has exceeded output in about three-fourths of the years since 2008. But the
US–China trade war starting in 2018 and the global pandemic in 2020 slowed
both global trade and output.

37

 6.1.5 Trade Interdependence
Trade between most nations is characterized by a degree of interdependency.
The level of interdependency between pairs of countries often reflects the
amount of trade that occurs between a company’s subsidiaries in the two
nations. Emerging markets that share borders with developed countries are
often dependent on their wealthier neighbors.
Trade dependency can be a blessing and benefit a nation or harm the nation if
companies suddenly pull out in difficult economic times.

6.2 MERCANTILISM
Theory that nations should accumulate financial wealth, usually in the form of
gold, by encouraging exports and discouraging imports.
Viewed other measures of a nation’s well-being, such as living standards or
human development, as irrelevant.
It was practiced from around 1500 to the late 1700s by European nations,
including Britain, France, the Netherlands, Portugal, and Spain.
6.2.1 How Mercantilism Worked
Trade was to benefit mother countries and colonies in Africa, Asia, and North,
South, and Central America were exploitable resources.
1. Trade Surpluses
Nations increased wealth through a trade surplus—the value of a
nation’s exports exceeds the value of imports. Trade deficits were to be
avoided at all costs.
2. Government Intervention
Governments intervened in international trade to maintain a trade
surplus. They banned certain imports, imposed tariffs or quotas, and
subsidized home-based industries to expand exports. Removal of gold
and silver from the nation was outlawed.
3. Colonialism
Mercantilist nations acquired colonies as sources of inexpensive raw
materials and markets for higher-priced finished goods. Trade among
mercantilist nations and their colonies expanded wealth and created
armies and navies to control colonial empires and protect shipping.
6.2.2 Flaws of Mercantilism
The main problem with mercantilism is that it viewed international
trade as a zero-sum game—a nation benefits only at the expense of other
nations.
But if all nations barricade their markets from imports and push their
exports onto others, international trade would be severely restricted.
It also kept colonial markets poor—they received little money for raw
materials but were charged high prices for finished goods. This severely
limited their purchasing power.

6.3 THEORIES OF ABSOLUTE AND COMPARATIVE ADVANTAGE

6.3.1 Absolute Advantage

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 Ability of a nation to produce a good more efficiently than any other
nation (produce a greater output using the same, or fewer, resources).
Adam Smith reasoned that international trade should not be burdened
by tariffs and quotas but should flow according to market forces.
A country should produce the goods in which it holds an absolute
advantage and trade to obtain the goods it needs but does not produce
efficiently.
1. Case: Riceland and Tealand
In a world of two countries (Riceland and Tealand) with two products
(rice and tea) where transport costs nothing, each produces and
consumes its own rice and tea. In Riceland, 1 resource unit produces a
ton of rice, but 5 units are needed to produce a ton of tea. In Tealand, 6
resource units produce a ton of rice, but 3 units are needed to produce a
ton of tea. Thus, Riceland has an absolute advantage in rice production
and Tealand has an absolute advantage in tea production.
2. Gains from Specialization and Trade
i. Although each country now specializes and world output
increases, both countries face a problem: Riceland consumes
only its rice and Tealand consumes only its tea. The problem
can be resolved through trade.
ii. Although Tealand does not gain as much as Riceland, it gets
more rice than it would without trade. Actual gains depend on
the total resources of each country and the demand for each
good in each country (Figure 6.3).
iii. The theory of absolute advantage destroys the mercantilist idea
that international trade is a zero-sum game. Because both
countries gain, international trade is a positive-sum game.
iv. The theory argues against restrictive trade policies and for
nations to instead open their doors to trade, so their people
obtain more goods more cheaply in order to raise living
standards.
6.3.2 Comparative Advantage
Inability of a nation to produce a good more efficiently than other
nations, but an ability to produce that good more efficiently than it does any
other goods. Thus, trade is still beneficial even if one country is less efficient
in the production of two goods, as long as it is less inefficient in the production
of one of the goods.
1. Gains from Specialization and Trade
a. Suppose that Riceland now holds absolute advantages in the
production of both rice and tea. In Riceland, 1 resource unit
produces a ton of rice but 2 are needed to produce a ton of tea.
In Tealand, 6 resource units still produce a ton of rice, and 3
units are still needed to produce a ton of tea. Thus, Riceland has
absolute advantages in producing both goods.

39

 b. Although Tealand has absolute disadvantages in rice and tea, it
has a comparative advantage in tea; Tealand produces tea more
efficiently than it produces rice.
c. By specializing and trading, Tealand gets double the rice than if
it produced the rice itself, and Riceland gets twice as much tea
than if it produced the tea itself (Figure 6.4).
2. Assumptions and Limitations
a. Assumes countries are only driven by the maximization of
production and consumption. Yet governments get involved in
trade for many reasons.
b. Assumes only two countries engaged in the production and
consumption of two goods. yet there currently are more than
180 countries and countless products are produced, traded, and
consumed.
c. Assumes that there are no costs for transporting traded goods
from one country to another. Yet transportation costs are a major
expense of international trade.
d. Assumes labor is the only resource for production and is mobile
within each nation but cannot be transferred. Other resources
are clearly needed in production and labor is becoming more
mobile.
e. Assumes specialization does not result in efficiency gains. In
fact, specialization results in increased knowledge of a task and
future improvements.

6.4 FACTOR PROPORTIONS THEORY

Factor proportions theory (also known as Heckscher–Ohlin theory) states that
countries produce and export goods that require resources (factors) that are abundant
and import goods that require resources that are in short supply.
Thus, the theory focuses on the productivity of the production process.
6.4.1 Labor versus Land and Capital Equipment
1. Factor proportions theory breaks resources into two categories: (1)
labor and (2) land and capital equipment. It predicts that a country will
specialize in products that require labor if labor abundant (low cost)
relative to land and capital, and vice versa.
2. Factor proportions theory is conceptually appealing. Australia has
much land relative to its population. Its exports consist of products that
require land whereas imports consist of manufactured and consumer
goods.
6.4.2 Evidence on Factor Proportions Theory: The Leontief Paradox
1. Theory not supported by studies that examine trade flows.
2. Wassily Leontief tested whether the United States, which uses an
abundance of capital equipment, exports goods requiring capital-
intensive production, and imports goods requiring labor-intensive
production. He found U.S. exports require more labor-intensive
production than its imports; called the Leontief Paradox.

40

 3. One explanation is that factor proportions theory considers a country’s
production factors to be homogeneous—particularly labor. But labor
skills vary greatly within a country.

6.5 INTERNATIONAL PRODUCT LIFE CYCLE

The international product life cycle theory states that a company begins by
exporting its product and later undertakes foreign direct investment as the product
moves through its life cycle (a country’s export eventually becomes its import).
6.5.1 Stages of the Product Life Cycle
1. In the new product stage, stage 1, high purchasing power and demand
of buyers spur a company to design and introduce a new product
concept. Although initially there is virtually no export market, exports
increase late in the new product stage.
2. In the maturing product stage, stage 2, the domestic market, and
markets abroad become fully aware of the existence of the product and
its benefits. Demand rises and is sustained over a fairly lengthy period
of time. Near the end of the maturity stage, the product generates sales
in developing nations, and perhaps manufacturing is established there.
3. In the standardized product stage, stage 3, competition from other
companies selling similar products pressures companies to lower prices
in order to maintain sales levels. An aggressive search for low-cost
production bases abroad begins and the home market may begin
importing.
6.5.2 Limitations of the Theory
1. The United States is no longer the sole innovator of products in the
world. New products spring up everywhere as the research and
development activities globalize.
2. Companies today design new products and make product modifications
at a very quick pace.
3. Companies introduce products in many markets simultaneously to
recoup a product’s research and development costs before sales decline.
4. The theory is challenged by the fact that more companies are operating
in international markets from their inception. The Internet has made
this easier particularly for small and midsize companies. Also, small
companies are more often teaming up with companies in other markets
to develop new products or production technologies.
5. Yet the theory retains explanatory power when applied to technology-
based products that are eventually mass-produced.

6.6 NEW TRADE THEORY

New trade theory argues:
(1) there are gains to be made from specialization and increasing economies of
scale;
(2) the companies first to market can create barriers to entry; and

41

 (3) government may play a role in assisting its home-based companies. It
emphasizes productivity rather than resources, and is in line with the theory of
comparative advantage but as odds with factor proportions theory.
6.6.1 First-Mover Advantage4
1. As specialization and output increase, companies realize economies of
scale, and unit production costs decline. Then companies expand, lower
prices, and force competitors to produce at a similar level of output to
be competitive.
2. A first-mover advantage is the economic and strategic advantage
gained by being the first company to enter an industry. It creates a
barrier to entry for potential rivals and may allow a country to dominate
in a product.
3. Some make a case for government assistance; by working together to
target new industries, a government and its home-based companies can
be the first mover in an industry.

6.7 NATIONAL COMPETITIVE ADVANTAGE

National competitive advantage theory states that a nation’s competitiveness in
an industry depends on the capacity of the industry to innovate and upgrade.
This theory attempts to explain why some nations are more competitive in
certain industries.
The Porter diamond (the basis of national competitiveness) consists of:
(1) factor conditions;
(2) demand conditions;
(3) related and supporting industries; and (4) firm strategy, structure, and
rivalry
6.7.1 Factor Conditions
Porter acknowledges the importance of basic factors (such as labor, natural
resources, climate, and surface features) in what a country produces and
exports but adds the significance of advanced factors.
1. Advanced factors include skill levels of the workforce and quality of
the technological infrastructure. Account for the sustained competitive
advantage that a country enjoys in a product.
6.7.2 Demand Conditions
1. Sophisticated buyers in the home market are important to national
competitive advantage in a product area. A sophisticated domestic
market drives companies to modify existing products to include new
design features and develop new products and technologies.
6.7.3 Related and Supporting Industries
1. Companies in internationally competitive industries do not exist in
isolation. Supporting industries provide inputs, forming clusters of
related activities in the same region that reinforce productivity and
competitiveness.
2. Exporting clusters are those that export products or make investments
to compete outside the local area and can lead to long-term prosperity.
6.7.4 Firm Strategy, Structure, and Rivalry

42

 a. Strategic decisions of firms have lasting effects on future
competitiveness, but equally important is industry structure and rivalry
among companies.
b. The more intense the struggle to survive among domestic companies,
the greater is their competitiveness. This heightened competitiveness
helps them to compete against imports and against companies that
might develop a production presence in the home market.
6.7.5 Government and Chance
a. Government policies toward industry and export and import regulations
can hurt or help competitiveness.
b. Chance events also can influence national competitiveness because
they can support competitiveness or threaten it.
c. Porter’s theory holds promise but has just begun to be subjected to
research using actual data on each of the factors involved and national
competitiveness.

43

 CHAPTER 7
GOVERNMENTS AND TRADE

INTRODUCTION
This chapter explores business–government trade relations, considers why nations
implement barriers to trade, and explores the cultural, political, and economic motives for
such barriers. It also examines the instruments countries use to restrict imports and exports,
and how the global trading system promotes trade.

7.1 WHY DO GOVERNMENTS INTERVENE IN TRADE?

Free trade is the pattern of imports and exports that occurs in the absence of
trade barriers.
Governments impose restrictions on free trade for political, economic, and
cultural reasons.
7.1.1 Political Motives
1. Protect Jobs
Short of an unpopular war, nothing will oust a government faster than
high unemployment. All governments become involved when trade
threatens jobs at home.
2. Preserve National Security
Industries essential to national security receive government-sponsored
protection for both imports and exports.
a. Imports
Governments restrict imports to guarantee domestic supply,
which preserves national security. Many countries fiercely
protect their agricultural sector for national security reasons
because a nation that imports its food supplies could face
starvation in times of war.
b. Exports
Governments have national security motives for banning certain
defense-related goods from export to other nations. Agencies
review requests to export technologies or products that have
dual uses—meaning they have both civilian uses and military
applications.
3. Respond to “Unfair” Trade
Many argue that it makes no sense for one nation to allow free trade if
others do not. Governments threaten to close their ports or to impose
high tariffs if another nation does not concede on a certain trade issue.
4. Gain Influence
Governments of the largest nations may become involved in trade to
gain influence over smaller nations. The United States wishes to
maintain control over Central, North, and South America and the
Caribbean basin. For example, in 1962, the United States banned all
trade and investment with Cuba in the hope of exerting political
influence against its communist leaders.
7.1.2 Economic Motives

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 1. Protect Young Industries
The infant industry argument says that emerging industries need
protection from international competition during development until
they become competitive internationally. Protection can be removed
after it gains the knowledge to become innovative, efficient, and
competitive.
a. Drawbacks
Governments may make errors in distinguishing between
industries worth protecting and those that are not. Protection
can cause domestic firms to grow complacent toward
innovation and limit their competitiveness and increase
consumer prices. Small promising ventures today can get
private funding.
2. Pursue Strategic Trade Policy
New trade theorists believe government intervention helps firms take
advantage of economies of scale and enjoy first-mover advantages.
First-mover advantages result because economies of scale limit the
number of companies in an industry. Strategic trade policy attempts to
affect the outcomes of strategic competition among companies in favor
of domestic firms.
a. Benefits
Companies earn profits if they obtain first-mover advantages
and solidified market positions. The chaebol (South Koran
family-owned conglomerates) helped companies survive poor
economic time because of the wide range of industries in which
they competed; policies had spin-off effects on industries such
as transportation.
b. Drawbacks
Government assistance to support specific industries, can be
subject to political lobbying and special-interest groups could
capture gains with no benefit for consumers.
7.1.3 Cultural Motives
Exposure to people and products of other countries slowly alters cultures.
1. Unwanted cultural influence causes great distress and can force
governments to block imports.
2. Many countries have laws that protect their media programming for
cultural imperialism.
3. The United States is seen as a threat to national cultures because of its
global strength in consumer goods, entertainment, and media.

7.2 INSTRUMENTS OF TRADE PROMOTION

A government may intervene in trade if it believes that another nation is
restricting foreign companies from entering its domestic market.
Managed trade refers to government efforts to achieve trade objectives
pertaining to market shares or quantities of specific products.
7.2.1 Subsidies

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 A subsidy is financial assistance to domestic producers in the form of cash
payments, low-interest loans, tax breaks, product price supports, or other form.
Subsidies are intended to help domestic companies fend off international
competitors.
1. Drawbacks of subsidies
Some say subsidies cover costs that competitive industries should
absorb, thus encouraging inefficiency and complacency. Because
governments pay for subsidies with tax income, they may benefit
companies but harm consumers. Although subsidies provide short-term
relief, their helpfulness in the long term is questionable.
7.2.2 Export Assistance
1. Governments promote exports by helping companies finance their
export activities through low-interest-rate-loans or loan guarantees.
2. Two agencies help U.S. companies to obtain export financing: Export-
Import Bank and the International Development Finance Corporation.
This agency insures up to $1 billion of losses due to currency
inconvertibility, government interference, and political violence
including terrorism.
3. Financing is often crucial to small businesses just beginning to export.
7.2.3 Foreign Trade Zones
1. A foreign trade zone (FTZ) is a designated geographic region in which
merchandise is allowed to pass through with lower customs duties
(taxes) or fewer customs procedures. Increased employment is often the
intended purpose of FTZs, with a by-product being increased trade.
2. Customs duties increase production costs and the time it takes to get a
product to market. Companies can reduce such costs and time by
establishing a facility inside a foreign trade zone.
3. A common purpose of such zones is final product assembly. Lower
customs duties are offset by the jobs created in the United States.
4. China established very large foreign trade zones to reap the benefits.
5. Mexico’s maquiladora zone: import materials from the United States
without duties, process them, and re-export them to the United States,
which charges duties only on the value added in Mexico.
7.2.4 Special Government Agencies
1. Governments have trade-promotion agencies responsible for promoting
exports. Such agencies organize trips for trade officials and
businesspeople to visit other countries and open trade offices in other
countries.
2. Governments not only promote exports but also may encourage imports
of product that the nation does not or cannot produce.

7.3 INSTRUMENTS OF TRADE RESTRICTION

7.3.1 Tariffs
A tariff is a government tax levied on a product as it enters or leaves a
country.

46

 An ad valorem tariff is levied as a percentage of the stated price of an
imported product.
A specific tariff is levied as a specific fee for each unit (by number or
weight) of an imported product.
A compound tariff is calculated partly as a percentage of the stated price
of an imported product, and partly as a specific fee for each unit.
1. Protect Domestic Producers
Because import tariffs raise the cost of an imported good, domestically
produced goods appear more attractive to buyers. But protection may
cause domestic producers to become lax in increasing efficiency.
2. Generate Revenue
Tariffs are a source of revenue for many developing nations. Some of
these nations have less formal economies that do not track all domestic
transactions accurately. Nations sometimes compensate for this
shortfall by raising revenue through import and export tariffs. As
countries develop, they tend to obtain revenue from taxes on income,
capital gains, and other economic activities. Tariffs exact a cost on
countries because they lessen the gains from trade.
7.3.2 Quotas
A quota is a restriction on the amount (measured in units or weight) of a
good that can enter or leave a country during a certain period of time.
Governments administer quota systems by granting quota licenses to other
nations’ companies or governments (import quotas) and domestic producers
(export quotas).
1. Import Quotas
a. Protects domestic producers by placing a limit on the amount of
goods entering the country. This helps domestic producers
maintain market shares and prices by restraining competition.
b. Domestic producers win because of market protection, but
consumers lose because of higher prices and limited selection.
Other losers include domestic producers whose production
requires the import subjected to a quota; companies relying on
imported intermediate goods find the final cost of their own
products increase.
2. Export Quotas
a. A country may wish to maintain supplies in the home market. This is
common for countries that export natural resources that are needed in
the domestic market.
b. A country may restrict supply on world markets to increase the
international price. Export quotas hurt consumers in the importing
nation because of reduced selection and higher prices. Export quotas
might retain jobs if imports threaten to put domestic producers out of
business.
3. Voluntary Export Restraints
Unique version of export quota that a nation imposes on its exports,
usually at the request of an importing nation. If domestic producers do

47

 not curtail production, consumers benefit from lower prices due to a
greater supply.
4. Tariff Quotas
A tariff quota (tariff-rate quota) is a lower tariff rate for a certain
quantity of imports and a higher rate for quantities that exceed the
quota. These are allowed by the WTO.
3. Other Nontariff Barriers
1. Embargoes
Complete ban on trade (imports and exports) in one or more products
with a particular country. It may be placed on one or a few goods or
completely ban trade in all goods. It is the most restrictive nontariff
trade barrier and often has political goals. Embargoes can be decreed
by individual nations or by supranational organizations such as the UN.
2. Local Content Requirements
Laws stipulating that a specified amount of a good or service be
supplied by domestic producers in a market. Designed to force
companies from other nations to employ local resources in their
production processes—particularly labor. May protect domestic
producers from the price advantage of companies based in lower-wage
countries. Developing countries use them to boost industrialization.
3. Administrative Delays
Administrative delays are regulatory controls or bureaucratic rules
designed to impair the rapid flow of imports into a country. Can include
government actions such as requiring international air carriers to land at
inconvenient airports, inspections that damage the product,
understaffing customs offices, and requiring special licenses that take
time to obtain.
4. Currency Controls
Currency controls are restrictions on the convertibility of a currency
into other currencies. Governments can require a license to obtain
currency, restrict who is allowed to convert the nation’s currency, and
stipulate an exchange rate that is unfavorable to potential importers.
Alternatively, a country can allow exporters to exchange home
currency for an international currency at favorable rates to encourage
exports.

7.4 GLOBAL TRADING SYSTEM

World trade volume peaked in the late 1800s. U.S. Smoot-Hawley Act in 1930
shifted nation from free trade to protectionism.
Smoot-Hawley and global trade wars crippled industrialized nations and helped
spark the Great Depression.
7.4.1 General Agreement on Tariffs and Trade (GATT)
The GATT was a 1947 treaty designed to promote free trade by reducing both
tariff and nontariff barriers to international trade. Success in GATT’s early
years began to wane in the 1980s (Table 7.3 lists the completed Rounds of
GATT).

48

 1. Uruguay Round of Negotiations
The Uruguay Round made significant progress in reducing trade
barriers by revising and updating GATT.
a. Agreement on Services
The General Agreement on Trade in Services (GATS) extended
the principle of nondiscrimination to cover trade in services.
The GATS identifies four forms of services: cross-border
supply, consumption abroad, commercial presence, and
presence of natural persons.
b. Agreement on Intellectual Property
i. Intellectual property refers to property that results from
people’s intellectual talent and abilities and is legally
protected by copyrights, patents, and trademarks.
ii. Uruguay Round created the Agreement on Trade-
Related Aspects of Intellectual Property (TRIPS) to
standardize intellectual-property rules.
c. Agreement on Agricultural Subsidies
i. Popular barriers to protect agricultural sectors include
import quotas and subsidies paid to farmers.
ii. Uruguay Round increased exposure of national
agricultural sectors to market forces and increased
predictability in international agricultural trade.
iii. Forces countries to convert nontariff barriers to tariffs
and calls for cutting of agricultural tariffs significantly
but places no requirements on least-developed
economies.
7.4.2 World Trade Organization
The World Trade Organization (WTO) is the international organization that
regulates trade among nations. The WTO replaced the institution of the GATT
but absorbed the GATT agreements (such as on services, intellectual property,
and agriculture) into its own agreements. The three main goals of the WTO are
to help free trade, negotiate opening of markets, and settle trade disputes. A
key component of the WTO is normal trade relations: WTO members must
extend the same favorable terms of trade to all members that they extend to
any single members.
1. Dispute Settlement in the WTO
a. WTO’s power to settle trade disputes set it apart from the
GATT. WTO agreements are contracts among member nations
that commit them to maintaining fair and open trade policies.
b. When a member files a complaint, the Dispute Settlement Body
of the WTO renders a decision. Offenders must realign policies
according to WTO guidelines or suffer financial penalties and
perhaps trade sanctions.
2. Recent Issues
Over the years the WTO has done a good job encouraging fair trade
among its members. Later on, powerful nations started to grow

49

 impatient with the WTO, disagreeing with its rulings and sometimes
flagrantly continuing practices that caused another nation to bring a
case to the WTO in the first place.
3. Dumping and the WTO
a. WTO gets involved in settling disputes that involve “dumping”
and the granting of subsidies. Dumping occurs when a company
exports a product at a price that is either lower than the price
normally charged in its domestic market, or lower than the cost
of production.
b. Because dumping is an act by a company, not a country, the
WTO cannot punish the country in which dumping is based.
c. The WTO allows a nation to retaliate against dumping if it
proves dumping charges, calculates the damage, and can show
the damage is significant. Nations retaliate by imposing an
antidumping duty—an additional tariff placed on an imported
product that a nation believes is being dumped on its market.
4. Subsidies and the WTO
a. Governments retaliate when the competitiveness is threatened
by a subsidy that another country pays domestic producers. A
countervailing duty is an additional tariff placed on an imported
product that a nation believes is receiving an unfair subsidy.
b. WTO regulates the actions of the government that reacts to the
subsidy and the one that imposes the subsidy.
5. WTO and the Environment
a. Rapid industrialization in many developing and emerging
economies has generated environmental concerns among
governments and special-interest groups.
b. WTO has no separate agreement for environmental issues, but
works alongside existing international agreements on the
environment.
c. But the WTO has a Committee on Trade and Environment to
study the relationship between trade and the environment and to
recommend changes in the WTO trade agreements.
d. The WTO also takes explicit positions on some environmental
issues related to trade. It states that labeling requirements or
policies cannot discriminate against the products of other WTO
members. It also supports policies of the least-developed
countries that require full disclosure of potentially hazardous
products for reasons of public health and environmental
damage.

50

 CHAPTER 8
FOREİGN DİRECT INVESTMENT

INTRODUCTION
Foreign direct investment (FDI) is the purchase of physical assets or significant stock
ownership of a company in another country to obtain management control.
It differs from portfolio investment—an investment that does not involve obtaining a
degree of control in a company.
Most governments set the threshold for an investment to be called FDI at anywhere
from 10 to 25 percent of stock ownership in a company abroad—the U.S. Commerce
Department sets it at 10 percent.

8.1 THE NATURE OF FOREIGN DIRECT INVESTMENT

Trade and foreign investment are related to one another.
Historically, to circumvent trade barriers, companies accessed promising
markets by investing directly in foreign markets.
After the Uruguay Round of negotiations of GATT, countries lowered trade
barriers.
Businesses then realized they could now establish their business in the most
efficient and productive locations almost anywhere and export to markets worldwide.
8.1.1 Forms of Foreign Direct Investment
Foreign direct investment takes two main forms:
1. Greenfield investment is the purchase of land in another country and
construction of new facilities or an entire subsidiary from the ground
up.
2. Companies may also merge with or acquire an existing company
abroad. Companies from developed countries historically were the
main participants behind cross border mergers and acquisitions.
However, firms from emerging markets are accounting for an even
greater share of the global M&A activity. Many cross-border M&A
deals are done to:
a. Get a foothold in a new geographic market
b. Increase a firm’s global competitiveness
c. Fill gaps in companies’ product lines in a global industry
d. Reduce costs in R&D, production, distribution, etc.
8.1.2 Worldwide Flows of FDI
1. FDI inflows grew around 20 percent per year in the first half of the
1990s, then around 40 percent annually in the second half of the
decade. FDI inflows measured a little more than $1.3 trillion in 2000
(see Figure 8.1), then slowed as internet-related investments suffered a
downturn, and recession ensued. FDI then benefitted from strong
global growth and high corporate profits between 2004 and 2007,
reaching a high of around $1.9 trillion.
2. The global financial crisis in 2008 resulted in a global recession and
lower FDI in 2008 and 2009. The crisis reduced FDI by one-third and

51

 flows took 2.5 years to recover. FDI then increased in 2015 and 2016
on strong economic growth. It then declined through 2020.
8.1.3 Recipients and Sources of FDI (see Figures 8.2 and 8.3)
1. Developed nations have been the biggest recipients of FDI. But since
2014 they are attracting a smaller share of the world’s total FDI flows.
2. In 2014, developing countries attracted a greater amount of FDI than
developed countries, accounting for about 55% of the total.
3. Developing nations then attracted nearly as much FDI as developed
nations did in 2018 and 2019 and attracted far more in 2020.
4. Developed nations are the historic sources of FDI but developing
countries are increasingly becoming sources of FDI. Their outflows are
rising as the strong, homegrown competitors in these nations, seek
growth and market share worldwide.
5. See Table 8.1 for a listing of the top ten countries for FDI inflows and
outflows.

8.2 THEORIES OF FOREIGN DIRECT INVESTMENT

8.2.1 International Product Life Cycle
1. States that a company begins by exporting its product and later
undertakes foreign direct investment as the product moves through its
life cycle.
2. In the new product stage, a good is produced entirely in the home
market. In the maturing product stage, a good is produced in the home
market and in markets abroad that are large enough to warrant
production facilities. In the standardized product stage, a company
builds production capacity in low-cost developing nations to serve its
markets around the world.
3. Yet the international product life cycle theory does not explain why
companies choose FDI over other forms of market entry.
8.2.2 Market Imperfections
When an imperfection in the market makes a transaction less efficient than it
could be, a company will undertake FDI to internalize the transaction and
remove the imperfection. In a perfect market, prices are as low as possible, and
goods are easily available. Flaws in the efficient operation of an industry are
market imperfections.
1. Trade Barriers
a. A trade barrier such as a tariff is a common form of market
imperfection.
b. Firms undertake FDI when market imperfections are present.
2. Specialized Knowledge
a. A unique competitive advantage may consist of specialized
knowledge, which could be technical expertise or the special
abilities of engineers or managers.
b. When a company’s specialized knowledge is embodied in its
employees, the only way to exploit an opportunity may be FDI.

52

 c. A company may undertake FDI if charging another company
for access to its knowledge might create a future competitor.
8.2.3 Eclectic Theory
1. States that firms undertake foreign direct investment when the features
of a location combine with ownership and internalization advantages to
make a location appealing for investment. When each advantage is
present, a company will undertake FDI.
2. A location advantage is the advantage of locating a particular economic
activity in a specific location because of the characteristics (natural or
acquired) of the location.
3. An ownership advantage is the advantage that a company has due to its
ownership of some special asset, such as a powerful brand, technical
knowledge, or management ability.
4. An internalization advantage is the advantage that arises from
internalizing a business activity rather than leaving it to a relatively
inefficient market.
8.2.4 Market Power
1. The market power theory states that a firm tries to establish a dominant
market presence in an industry by undertaking foreign direct
investment.
2. The benefit of market power is greater profit because the firm is better
able to dictate the cost of its inputs or the price of its output.
3. Companies can gain market power through vertical integration—the
extension of activities into production that provide a firm’s inputs
(backward integration) or that absorb its output (forward integration).

8.3 MANAGEMENT ISSUES AND FOREIGN DIRECT INVESTMENT

8.3.1 Control
Many companies invest abroad because they wish to control activities
in the local market, such as the firm’s production costs.
Other reasons are related to the market and the industry in which a firm
competes.
Examples include customer preferences or ensuring selling price
remains the same across markets. Yet complete ownership does not guarantee
control.
1. Partnership Requirements
a. Many companies have strict policies regarding how much
ownership they take in firms in other nations.
b. Yet a nation may demand shared ownership in return for market
access. Governments may use such requirements to shield
workers and industries from exploitation or domination by large
multinationals.
2. Benefits of Cooperation
a. Greater harmony exists today between governments and
international companies. Developing nations and emerging

53

 markets need investment, employment, tax revenues, training,
and technology transfers.
b. A country with a reputation for overly restricting the operations
of multinationals can see its inward investment dry up.
c. Cooperation can open communication channels to maintain
positive relationships in the host country.
8.3.2 Purchase-or-Build Decision
1. The purchase-or-build decision entails deciding whether to purchase an
existing business or build a subsidiary abroad from the ground up—
called a greenfield investment.
2. An acquiring firm may benefit from the goodwill the existing company
has built over the years and, perhaps, brand recognition of the existing
firm. The purchase of an existing business also may allow for
alternative methods of financing, such as an exchange of stock
ownership.
3. Factors that reduce the appeal of purchasing existing facilities are
obsolete equipment, poor labor relations, and an unsuitable location.
4. If adequate facilities are unavailable, a company might need to go
ahead with a greenfield investment. These can require obtaining
necessary permits and financing. Also, hiring local personnel can be
difficult in some markets.
8.3.3 Production Costs
Local labor regulations can increase the hourly cost of production and
benefits packages and training programs add to wage costs.
Although the cost of land and tax rate on profits can be lower locally,
they may not remain constant.
1. Rationalized Production
a. Production system in which each component is produced where
the cost of producing that component is lowest.
b. The components are brought together at one location for
assembly into a final product.
c. Potential problem is that a work stoppage in one country can
halt the entire production process.
2. Cost of Research and Development
a. Cost of developing new technologies has led to cross-border
alliances and acquisitions.
b. One indicator of the significance of technology in FDI is the
amount of R&D conducted by affiliates of parent companies in
other countries. FDI in R&D appears to be spurred by supply
factors such as access to high-quality scientific and technical
human capital.
8.3.4 Customer Knowledge
1. Buyer behavior is an important issue in the decision of whether to
undertake FDI. A local presence can give companies valuable
knowledge of customers that is unobtainable in the home market.

54

 2. Some countries have quality reputations in certain product categories
that make it profitable to produce there.
8.3.5 Following Clients
1. FDI can place companies near the firms they supply. Following
clients occurs in industries in which component parts are
obtained from suppliers with whom a manufacturer works
closely.
8.3.6 Following Rivals
1. FDI decisions resemble a follow-the-leader scenario in
industries with a limited number of large firms.
2. Firms may believe that not making a move parallel to that of the
first mover might result in being shut out of a lucrative market.

8.4 WHY GOVERNMENT INTERVENE IN FDI

Nations can enact laws, create regulations, or construct administrative hurdles
for foreign companies.
A bias toward protectionism or openness is rooted in a nation’s culture, history,
and politics.
But FDI tends to raise output and enhance standards of living. Besides
philosophical ideals, countries intervene in FDI for a variety of practical reasons.

8.4.1 Balance of Payments

1. National accounting system that records all receipts coming into a
nation and all payments to entities in other countries.
2. International transactions that result in outflows to entities in other
nations are reductions in the balance of payments accounts.
3. International transactions that result in inflows from other nations are
additions to the balance of payments accounts.
4. Current account
a. National account that records transactions involving the export and
import of goods and services, income receipts on assets abroad,
and income payments on foreign assets inside the country.
b. A current account surplus occurs when a country exports more
goods and services and receives more income from abroad than
it imports and pays abroad.
c. A current account deficit occurs when a country imports more
goods and services and pays more abroad than it exports and
receives from abroad.
5. Capital account
a. National account that records transactions involving the purchase or
sale of assets.
b. Financial assets such as stocks and bonds and physical assets such
as investments in plants and equipment.
8.4.2 Reasons for Intervention by the Host Country
1. Control Balance of Payments

55

 a. Many governments see intervention as the only way to keep
their balance of payments under control.
b. Host countries get a balance-of-payments boost from initial FDI
flows. Local content requirements can lower imports, providing
an added balance-of-payments boost. Exports from the FDI can
further help the balance-of-payments position.
c. When companies repatriate profits, they deplete the foreign
exchange reserves of their host countries; these capital outflows
decrease the balance of payments. Thus, a host nation may
prohibit or restrict nondomestic firms from removing profits.
d. But host countries conserve their foreign exchange reserves
when international companies reinvest their earnings in local
manufacturing facilities. This improves the competitiveness of
local producers, boosts a host nation’s exports, and improves its
balance-of-payments position.
2. Technology, Skills, and Employment
a. Nations encourage FDI in technology because it increases its
productivity and competitiveness.
b. Encouraging FDI into a country can allow talented foreign
managers to train local personnel in how to operate the local
facilities. Some of these managers will also go on to establish
their own businesses.
8.4.3 Reasons for Intervention by the Home Country
There are fewer concerns regarding the outflow of FDI among home nations
because they tend to be prosperous, industrialized nations.
1. Influence Balance of Payments
a. Investing in other nations sends resources out of the home
country and can lessen investment at home.
b. Outgoing FDI may damage a nation’s balance of payments by
reducing exports otherwise sent to international markets.
2. Protect Jobs
a. An outgoing FDI might cause job losses at home. Yet FDI
abroad might create jobs at home if they are needed to support
the operations created by the FDI.
3. Improve Competitiveness
a. Outward FDI can increase long-run competitiveness as
companies grow to become global industry leaders.
b. Nations may encourage FDI in industries that use obsolete
technology or employ low-wage workers with few skills.

8.5 GOVERNMENT POLICY INSTRUMENTS AND FDI

8.5.1 Host Countries: Promotion
1. Financial Incentives
a. Host governments commonly offer tax incentives such as lower
tax rates or offers to waive taxes on local profits for a period of
time. Or they may offer low-interest loans to attract investment.

56

 b. But incentives can create bidding wars between locations vying
for investment. The cost to taxpayers of attracting FDI can be
more than what the actual jobs pay.
2. Infrastructure Improvements
a. Lasting benefits for communities surrounding the investment
location can result from local infrastructure improvements—
better seaports for containerized shipping, improved roads and
telecommunications systems.
8.5.2 Host Countries: Restriction
1. Ownership Restrictions
a. Governments may impose ownership restrictions that prohibit
nondomestic companies from investing in certain industries or
owning certain types of business.
b. Another restriction is a requirement that nondomestic investors
hold less than a 50 percent stake in local firms.
2. Performance Demands
a. Some performance demands dictate the portion of a product’s
content that originates locally, stipulates the portion of output
that must be exported, or requires that certain technologies be
transferred to local businesses.
8.5.3 Home Countries: Promotion
1. Offer insurance to cover the risks of investments abroad.
2. Grant loans to firms wishing to increase their investments abroad.
3. Offer tax breaks on profits earned abroad or negotiate special tax
treaties.
4. Apply political pressure on other nations to get them to relax their
restrictions on inbound investments.
8.5.4 Home Countries: Restriction
1. Impose differential tax rates that charge income from earnings abroad
at a higher rate than domestic earnings.
2. Impose sanctions that prohibit domestic firms from making
investments in certain nations.

57

 CHAPTER 9
REGİONAL ECONOMİC INTEGRATİON

INTRODUCTION
This chapter focuses on regional efforts to encourage free trade and investment.
Regional integration is defined and its benefits and drawbacks are identified.
The chapter also explores several long-established trading agreements and some
agreements in the earliest stages of development.
The goal is greater cross-border trade and investment and higher living standards.
Specialization and trade allow more choice, lower prices, and increased productivity.

9.1 THE NATURE OF REGIONAL INTEGRATION EFFORTS

Regional economic integration is a process by which countries in a geographic
region cooperate to reduce or eliminate barriers to the international flow of products,
people, or capital.
A regional trading bloc is a group of nations in a geographic region undergoing
economic integration.
Regional trade agreements help nations accomplish economic growth
objectives and perhaps even eventual political union.
9.1.1 Levels of Economic Integration
There are five levels of economic integration. Free trade area is the lowest
extent of national integration, political union the greatest. Each level of
integration incorporates the properties of those levels that precede it (see
Figure 9.1).
1. Free Trade Area
a. Countries remove all barriers to trade among members, but each
country determines its own barriers against nonmembers.
b. Countries in a free trade area also may establish a process to
resolve trade disputes among members.
2. Customs Union
a. Countries remove all barriers to trade among members but erect
a common trade policy against nonmembers.
b. Countries might also negotiate as a single entity with other
supranational organizations such as the WTO.
3. Common Market
a. Countries remove all barriers to the free movement of trade,
labor, and capital among themselves but erect a common trade
policy against nonmembers.
b. Can be difficult for nations to cooperate on economic and labor
policies.
4. Economic Union
a. Countries remove barriers to the free movement of trade, labor,
and capital, erect a common trade policy against nonmembers,
and coordinate their economic policies.

58

 b. Requires members to harmonize their tax, monetary, and fiscal
policies, create a common currency. Nations thus concede some
amount of sovereignty to the supranational organization.
5. Political Union
a. Countries coordinate aspects of economic and political systems.
Members accept a common stance on economic and political
policies regarding nonmember nations.
b. Nations are allowed a degree of freedom in setting certain
political and economic policies within their territories.
9.1.2 The Case for Regional Integration
Debates continue over the effects of regional trade agreements on
people, jobs, companies, culture, and living standards.
Nations engage in specialization and trade to benefit from gains in
output and consumption.
Higher levels of trade among nations should increase specialization,
efficiency, and consumption and raise standards of living.
1. Trade Creation
a. Increase in the level of trade between nations that results from
regional economic integration.
b. Gives consumers and industrial buyers a wider selection of
goods and services than was previously available.
c. Buyers can acquire goods and services at lower prices due to
lower trade barriers such as tariffs. Lower costs can lead to
higher aggregate consumption because people have more
money after a purchase to buy other products.
2. Greater Consensus
a. Eliminating trade barriers in smaller groups of countries may
make it easier to gain consensus as opposed to working in the
far larger WTO.
3. Political Cooperation
a. A group of nations can have significantly greater political
weight than nations have individually. Integration involving
political cooperation can reduce the potential for military
conflict among members.
4. Employment Opportunities
a. Regional integration can expand employment by enabling
people to move from country to country for work, or to earn a
higher wage.
5. Corporate Savings
a. Trade agreements allow companies to alter their strategies.
Companies that do business throughout the region could save
money from the removal of tariffs and potentially from
supplying entire regions from fewer factories.
9.1.3 The Case Against Regional Integration
1. Trade Diversion

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 a. Diversion of trade away from nations not belonging to a trading
bloc and toward member nations. This can occur after formation
of a trading bloc because of the lower tariffs charged among
member nations.
b. Can result in reduced trade with a more efficient nonmember
nation in favor of trade with a less efficient member nation.
Unless there is other internal competition, buyers will pay more
due to inefficient production.
2. Shifts in Employment
a. Because trading blocs reduce or eliminate barriers to trade, the
preferred producer will be decided by relative productivity.
Industries requiring unskilled labor shift production to lower-
wage nations within a trading bloc.
b. Job dislocation allows a nation to upgrade its economy toward
higher-wage jobs and greater competitiveness from a more
educated and skilled workforce.
3. Loss of National Sovereignty
a. Successive levels of integration require nations to surrender
more sovereignty. Political union requires nations to give up a
high degree of sovereignty in foreign policy.
b. Because some members have delicate ties with nonmember
nations whereas others have strong ties, the setting of a
common foreign policy is difficult.

9.2 INTEGRATION IN EUROPE

European efforts at integration began shortly after the Second World War
among a small group of countries and involved a few select industries.
Regional integration now encompasses practically all of Western Europe and
all industries.
9.2.1 European Union
1. Early Years
a. Europe in 1945 faced two challenges: (1) rebuild itself and avoid further conflict, and
(2) increase its industrial strength to stay competitive with the United States.
b. Belgium, France, West Germany, Italy, Luxembourg, and the Netherlands signed the
Treaty of Paris in 1951, creating the European Coal and Steel Community to remove
barriers to trade in coal, iron, steel, and scrap metal.
c. Members of the European Coal and Steel Community signed the Treaty of Rome in
1957, creating the European Economic Community (EEC), which outlined a future
common market.
d. In 1967 the Community’s scope was broadened to include additional industries,
notably atomic energy, and changed its name to the European Community.
Enlargement continued and in 1994 the bloc changed its name to the European Union
(EU).
e. Today the 27-member European Union has a population of about 450 million people
and a GDP of around $16 trillion.
f. Single European ACT (SEA)

60

 This removed remaining barriers, increased harmonization, and
enhanced the competitiveness of EU companies. Mergers and
acquisitions swept Europe as large firms combined their
understanding of European needs, capabilities, and cultures
with economies of scale.
g. Maastricht Treaty
The Treaty (1) created single, common currency; (2) set
monetary and fiscal targets for countries taking part in monetary
union; and (3) proposed eventual political union, including a
common foreign and defense policy and common citizenship.
There are 19 member nations using the single currency,
comprising the “eurozone.”
h. Management Implications of the Euro
The euro reduces transaction costs by eliminating the need to
exchange currencies. It eliminates exchange-rate risk for
business deals among member nations using the euro. And
transparency in prices harmonizes prices across markets.
2. The UK Exits the EU
a. The UK became a member of the EU in 1973. Yet citizens of
the UK became unhappy with the EU because of fear of loss of
sovereignty and other reasons. The UK government held a
referendum and the voters decided to leave the EU.
b. Trade and Cooperation Agreement (TCA)
This agreement governs the UK-EU relationship going forward.
3. Future EU Enlargement
Albania, North Macedonia, Serbia, and Turkey remain official
candidates for EU membership. Potential members must show that they
meet the Copenhagen Criteria: (1) Stable institutions, (2) Has a
functioning market economy, (3) Able to assume the obligations of
membership, and (4) Ability to adopt the rules and regulations of the
community.
4. Structure of the EU
a. European Parliament
i. Members elected by popular vote within each nation
every five years.
ii. Parliament acts as a consultative rather than a legislative
body by debating and amending legislation proposed by
the European Commission.
b. European Council
i. Not to be confused with the Council of the EU, it is the
highest level of political cooperation among EU
countries.
ii. Consists of the heads of each EU country, the European
Council President, and the European Commission
President.
c. Council of the EU

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 i. The legislative body of the EU. Council members
change depending on the topic under discussion.
ii. No proposed legislation becomes EU law unless the
Council votes it into law. Some legislation today
requires only a simple majority to win approval.
d. European Commission
i. The executive body of the EU. Commissioners are
appointed by each country.
ii. Drafts legislation, manages and implements policy, and
monitors members’ compliance with EU law.
e. Court of Justice
i. Acts as the EU court of appeals. One type of case heard
is when a member nation is accused of not meeting its
treaty obligations.
ii. Justices are required to act in the interest of the EU as a
whole, not in the interest of their own countries.
f. European Central Bank (ECB)
i. The central bank of the EU eurozone. Its primary
objective is to stabilize prices and safeguard the value of
the euro, thereby supporting economic growth and job
creation.
g. Court of Auditors
i. Composed of one individual from each member nation
who are appointed for six-year terms.
ii. Audits EU accounts and implements the EU budget.
Also aims to improve EU financial management and
report to member nations’ citizens.
9.2.2 European Free Trade Association (EFTA)
1. Some nations wanted the benefits of a free-trade area but were wary of
a full common market. The European Free Trade Association (EFTA)
formed in 1960 to focus on trade in industrial goods. Today members
are Iceland, Liechtenstein, Norway, and Switzerland and has 13.6
million people and a combined GDP of $990 billion.
2. The EFTA and EU cooperate on the free movement of goods, persons,
services, and capital. They also cooperate in other areas, including the
environment, social policy, and education.

9.3 INTEGRATION IN THE AMERICAS

North America has made major progress toward economic integration. Latin
America began forming regional trading arrangements in the early 1960s and made
substantial progress in the 1980s and 1990s.
9.3.1 United States-Mexico-Canada Agreement (USMCA)
The North American Free Trade Agreement (NAFTA) sought to eliminate most
tariffs and nontariff trade barriers on most goods originating from North
America. This was later replaced by the USMCA.
1. Record of NAFTA

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 a. Liberalized rules regarding government procurement practices,
the granting of subsidies, and the imposition of countervailing
duties.
b. Other provisions dealt with trade in services, intellectual
property rights, and standards of health, safety, and the
environment.
c. Trade among Canada, Mexico, and the US grew from $297
billion in 1993 to around $1.6 trillion.
i. Mexico’s exports to the US rose to about $280 billion,
and US exports to Mexico grew to more than $226
billion.
ii. Canada’s exports to the US more than doubled to
approximately $332 billion, and US exports to Canada
grew to $300 billion.
iii. Canada’s exports to Mexico grew to $3.9 billion, and
Mexico’s exports to Canada grew from $1.5 billion to
$5.2 billion.
d. NAFTA’s effect on employment and wages is not as easy to
determine. The US Trade Representative Office and the AFL-
CIO group of unions debate NAFTA’s effect on jobs.
2. Creation of USMCA
a. Disagreement over the effects of NAFTA on each economy and
growing discontent with it enticed the parties to begin
renegotiating its terms in 2017. Mexico, Canada, and the US
created the United States-Mexico-Canada Agreement
(USMCA), which came into effect July 1, 2020.
3. Key Provisions
a. The USMCA tightened standards and rules in NAFTA by (a)
raising North American content from 62.5 percent to 75 percent
for preferential tariff treatment, (b) requiring at least 70 percent
of its steel and aluminum content to be from North America,
and (c) requiring 40 percent of a passenger car and 45 percent
of a truck to be built by workers earning at least $16 an hour.
b. Guarantees workers rights to collective bargaining and the right
to vote on their contracts. This will improve wages and working
conditions in Mexico and give US producers less reason to
move or outsource to Mexico.
c. Guarantees the free flow of data internationally and says a
company cannot be forced to keep data within the country in
which it was gathered. It also prohibits customs duties on digital
products and promotes cybersecurity cooperation.
d. Maintains the zero-tariff structure in the dairy industry and
opens markets further.
e. Commits over $600 million to environmental initiatives.

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 f. The USMCA is set to terminate 16 years after it goes into effect
unless the parties agree to extend its life following a review
period in year 6 of the agreement.
9.3.2 Central American Free Trade Agreement (CAFTA-DR)
1. Established in 2006 between the United States and Costa Rica, El
Salvador, Guatemala, Honduras, Nicaragua, and later the Dominican
Republic.
2. Average tariffs have been cut from 45 percent to around 7 percent.
3. The value of goods traded among the United States and the six other
members equals around $57 billion.
4. The CAFTA-DR aims to (1) lower tariff and nontariff barriers; (2)
ensure US companies are not disadvantaged by Central American
nations’ trade agreements with other countries; (3) require Central
American nations and Dominican Republic to encourage competition
and investment, protect intellectual property rights, and promote
transparency and the rule of law; and (4) support US national security
interests by advancing regional integration, peace, and stability.
9.3.3 Andean Community (CAN)
1. Formed in 1969 and today includes Bolivia, Colombia, Ecuador, and
Peru. It comprises a market of around 101 million consumers and a
combined GDP of about $900 billion.
2. Objectives include tariff reduction, a common external tariff, and
common policies in both transportation and certain industries.
3. But each member is given exceptions in the common tariff structure for
trade with nonmembers. Delays mean it has yet to create a customs
union.
9.3.4 Southern Common Market (MERCOSUR)
1. MERCOSUR was established in 1988 between Argentina and Brazil
but expanded to include Paraguay and Uruguay in 1991. Venezuela
joined in 2006 but was suspended in 2017.
2. Today MERCOSUR acts as customs union with a market of more than
295 million consumers (nearly half of Latin America’s total population)
and a GDP of around $4.6 trillion.
3. It is progressing on trade and investment liberalization and is emerging
as the most powerful trading block in all of Latin America.
4. Latin America’s large consumer base and its potential as a low-cost
production platform for worldwide export appeal to companies in the
European Union and the United States.
9.3.5 Central America and the Caribbean
1. Caribbean Community and Common Market (CARICOM)
a. Formed in 1973 and today has 15 members. Bahamas is a
member of the Community but does not belong to the common
market. Has a combined GDP of nearly $30 billion and a
market of almost 16 million.
b. The goal is a single market that permits the free movement of
goods services, capital, and labor. But the main difficulty

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 CARICOM continues faces is that members tend to trade more
with nonmembers than they do with each other because
members do not produce the imports others need.
2. Central American Common Market (CACM)
a. Intends a common market between Costa Rica, El Salvador,
Guatemala, Honduras, and Nicaragua. Comprises a market of
30 million and combined GDP of $200 billion.
b. Not yet a customs union and cooperation is tentative. But
officials are aiming for closer integration, political ties, and a
single currency—likely the US dollar. El Salvador adopted the
dollar as its official currency in 2000, and Guatemala already
uses the dollar alongside its own currency, the quetzal.

9.4 INTEGRATION IN ASIA AND AFRICA

9.4.1 Comprehensive and Progressive Agreement for Trans-Pacific Partnership
(CPTPP)
1. Arose after the United States pulled out of negotiations for creation of
the Trans-Pacific Partnership (TPP) in 2017.
2. The 11 remaining nations forged a revised agreement (2018) and left
the door open for the US to join. Fears of more lost manufacturing jobs
is why the US left the agreement.
3. Member nations comprise a combined GDP of $14 trillion.
4. Aims to eliminate and reduce trade barriers, create rules to allow for
freer foreign investment and digital commerce, and increase protections
for labor, intellectual property, and the environment.
9.4.2 Association of Southeast Asian Nations (ASEAN)
1. Indonesia, Malaysia, the Philippines, Singapore, and Thailand formed
the Association of Southeast Asian Nations (ASEAN) in 1967. Brunei,
Vietnam, Laos, Myanmar, and Cambodia joined later. The 10 ASEAN
countries comprise a market of nearly 670 million consumers and GDP
of nearly $ 3.4 trillion.
2. Goals: (1) promote economic, cultural, and social development; (2)
safeguard economic and political stability; and (3) serve as a forum in
which differences can be resolved fairly and peacefully.
9.4.3 Regional Comprehensive Economic Partnership (RCEP)
1. Free trade agreement launched in January 2022. Grouping includes the
ten members of ASEAN plus six additional countries: Australia, China,
India, Japan, New Zealand, and South Korea.
2. RCEP creates a market of 2.3 billion consumers with a GDP of around
$26 trillion (about 30 percent of global GDP). All 16 members will
account for around 25 percent of world trade and roughly 30 percent of
global FDI inflows.
3. RCEP aims to increase market access, strengthen economic integration,
and support free and fair trade. In addition, they expect to expand
business and employment opportunities.
9.4.4 Asian Pacific Economic Cooperation (APEC)

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 1. APEC has 21 members and comprises more than 47 percent of world
trade and 61 percent of global GDP valued at more than $53 trillion.
2. Aims to strengthen the multilateral trading system and expand the
global economy by simplifying and liberalizing trade and investment
procedures.
3. Record of APEC
a. Halved members’ tariffs from an average of 15 to 7.5 percent.
The early years saw the greatest progress.
b. Is a political body as much as it is a movement toward free
trade and thus encourages open dialogue and cooperation.
9.4.5 Africa’s Integration Efforts
1. The Economic Community of West African States (ECOWAS) intends
to form a customs union and an eventual common market and monetary
union. ECOWAS nations comprise a large portion of the economic
activity in sub-Saharan Africa.
a. Slow progress on market integration, but some progress in the
free movement of people, construction of international roads,
and development of international telecom links.
b. Improvement is needed in political stability, infrastructure, and
economic policies.
2. The African Union (AU) is a group of 55 nations joined forces in 2002
to create the African Union.
a. Goals: (1) develop and promote common policies on trade,
defense, and foreign relations; (2) promote cooperation in all
fields of human activity to raise living standards; (3) accelerate
political and socioeconomic integration of the continent; (4)
defend the sovereignty, territorial integrity, and independence of
members.
3. The African Continental Free Trade Area (AfCFTA) is the most recent
effort at economic integration.
a. Fifty-four African Union members (all except Eritrea) signed
the agreement and free trade began January 1, 2021. The
agreement establishes a single market of 1.2 billion people and
a combined GDP of $3 trillion.
b. It intends to increase intra-African trade by creating a single
market, slashing tariffs 90 percent, and reducing nontariff
barriers. It also aims to encourage industrialization across
Africa, create jobs, and boos incomes.
c. Too early to judge the success of AfCFTA. But Africa has a
young, entrepreneurial population and seems poised to be a
strong component of the global economy.

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 CHAPTER 10
INTERNATİONAL FİNANCİAL MARKETS

INTRODUCTION
This chapter explores the two interrelated systems that comprise the international
financial markets—the international capital market and the foreign exchange market.

10.1 THE INTERNATIONAL CAPITAL MARKET

A capital market is a system that allocates financial resources in the form of
debt and equity according to their most efficient uses.
Its main purpose is to provide a mechanism to borrow or invest money
efficiently.
Capital markets provide companies two primary means to obtain external
financing: debt and equity:
1. Debt
a. Loans in which borrower repays borrowed amount (the principal) plus
interest. Company debt normally takes the form of bonds—debt
instruments specifying the timing of principal and interest payments.
b. Holder of a bond (the lender) can force the borrower into bankruptcy if
payment is not made on a timely basis. Bonds to fund investments are
issued by private-sector companies and by municipal, regional, and
national governments.
2. Equity
a. Equity is part ownership of a company in which the equity holder
participates with other owners in the company’s financial gains and
losses. Equity normally takes the form of stock—shares of ownership
in a company’s assets that give shareholders a claim on the company’s
future earnings.
b. Shareholders may be rewarded with dividends or by increases in the
value of their shares. They may also suffer losses through decreases in
the value of their shares. Dividend payments are not guaranteed but
decided by the company’s board of directors and based on financial
performance.
10.1.1 Benefits of the International Capital Market
The international capital market is a network of individuals,
companies, financial institutions, and governments that invest and borrow
across national boundaries.
Large international banks gather excess cash of investors and savers
around the world and then channel it to global borrowers.
1. Expands Opportunities for Borrowers
a. Joins lenders and borrowers in different nations and expands
opportunities for borrowers. They have the option of seeking
funds outside the home nations.
b. Essential for firms in countries with small or developing capital
markets or emerging stock markets.
2. Reduces Risk for Lenders

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 a. The international capital market expands the available set of
lending opportunities. Lenders (who are essentially investors)
can reduce portfolio risk by spreading their money over many
debt and equity instruments.
b. Lenders also benefit from international securities because some
economies are growing while others are in decline.
10.1.2 International Bond Market
Consists of all bonds sold by issuing companies, governments, and
other organizations outside their own countries.
Buyers include medium- to large-size banks, pension funds, mutual
funds, and governments.
1. Types of International Bonds
a. Eurobond
Issued outside the country in whose currency it is denominated.
For example, a bond issued by an Australian company,
denominated in US dollars, and sold in Britain, France,
Germany and the Netherlands (but not available in the US or to
its residents). The Australian borrower receives its loan and
pays interest in US dollars. Eurobonds are not regulated, which
reduces the cost of issuing a bond but increases its risk.
b. Foreign Bond
Sold outside borrower’s country and denominated in currency
of country in which it is sold. An example is a yen-denominated
bond issued in Japan’s domestic bond market by a foreign
company. Foreign bonds are regulated like domestic bonds in
the country where issued.
2. Bonds and Interest Rates
a. Borrowers from newly industrialized and developing countries
borrow money from nations where interest rates are lower.
b. Lenders in developed countries buy bonds in newly
industrialized and developing nations to obtain a higher return
(yet greater risk).
c. Many emerging countries see the need to develop their own
national bond markets. Volatility in currency market hurts
projects that earn funds in those currencies and pay debts in
dollars.
10.1.3 International Equity Market
Consists of all stocks bought and sold outside the issuer’s home
country. Companies and governments issue equity.
Buyers include other companies, banks, mutual funds, pension funds,
and individuals.
1. Privatization
a. A single privatization often places billions of dollars of new
equity on stock markets.

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 b. Peru’s government raised $1.2 billion when it sold its 26
percent share of national telephone company, Telefonica del
Peru.
2. Emerging Markets
a. Growth in newly industrialized and developing countries
contributes to growth in the international equity market.
b. Companies in emerging markets require greater investment as
they succeed and expand operations.
3. Investment Banks
a. Global banks facilitate the sale of stock worldwide by bringing
together sellers and buyers.
b. Listing outside one’s home country is becoming an increasingly
common.
4. Electronic Trading
a. Proliferation of electronic trading and computer automation
encourage growth in the international equity market.
b. Technological innovations encourage global trading activities
that are conducted instantly over the internet.
10.1.4 Eurocurrency Market
All the world’s currencies banked outside their countries of origin are
Eurocurrency and trade on the Eurocurrency market (e.g., Eurodollars,
Europounds, Euroyen, etc.).
It involves large transactions by the largest companies, banks, and
governments.
Eurocurrency sources are:
(1) Governments with excess funds from prolonged trade surplus,
(2) Commercial banks with large deposits of excess currency,
(3) international companies with excess cash, and
(4) Extremely wealthy individuals.
1. Appeal of the Eurocurrency Market
a. Complete absence of regulation lowers costs.
b. Low transaction costs because transactions are large. Banks can
charge borrowers less and pay investors more but still earn
profit.
c. Interbank interest rates are those that the world’s largest banks
charge one another for loans. London Interbank Offer Rate
(LIBOR) is the interest rate charged by London banks to other
large banks borrowing Eurocurrency. London Interbank Bid
Rate (LIBID) is the interest rate offered by London banks to
large investors for Eurocurrency deposits.

10.2 THE FOREIGN EXCHANGE MARKET

Market in which currencies are bought and sold and in which currency prices
are determined.
Financial institutions convert currencies using an exchange rate. For example,
the exchange rate between the Japanese yen and the US dollar is stated as ¥110/$.

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 We read this as “110 yen are needed to buy one dollar.”
10.2.1 Functions of the Foreign Exchange Market
1. Currency Conversion
Companies use the foreign exchange market to convert one currency
into another. They must convert to local currencies when they
undertake foreign direct investment. When a firm’s international
subsidiary earns a profit and the company wants to return some of it to
the home country, it must convert the local money into the home
currency.
2. Currency Hedging
The practice of insuring against potential losses that result from adverse
changes in exchange rates. Companies use it to: (1) lessen the risk of
international transfers; and (2) reduce exposure in transactions where a
time lag exists between billing and receipt of payment.

3. Currency Arbitrage
Instantaneous purchase and sale of a currency in different markets for
profit. Common among experienced foreign exchange traders, large
investors, and firms in arbitrage business.
a. Interest arbitrage is the profit-motivated purchase and sale of
interest-paying securities denominated in different currencies.
Companies use interest arbitrage to find higher interest rates
abroad in government treasury bills, corporate and government
bonds, and even bank deposits.
4. Currency Speculation
Purchase or sale of a currency with the expectation that its value will
change and generate a profit. Riskier than arbitrage because the value,
or price, of currencies is quite volatile over time.
10.2.2 Exchange-Rate Risk
Potential for adverse changes in exchange rates that could harm a business.
1. Transaction Exposure
Risk that an exchange rate change will affect the value of a business
transaction. Usually arises when a company orders a product in
advance from a supplier in a country that uses another currency.
2. Translation Exposure
Risk that an exchange rate change will affect a company’s financial
statements. Situation arises when a company consolidates financial
statements of international subsidiaries into those of the parent
company in the home country.
3. Economic Exposure
Risk that an exchange rate change will affect a company’s long-term
earnings potential from international operations. This has to do with
exchange rate changes that can influence sales, expenses, and
investments abroad.

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 4. Managerial Implications
The exchange rate between two countries has implications for their
economies and business. For example, should the value of the euro fall
relative to the Japanese yen, a Dutch buyer will have to pay more euros
to obtain products from its Japanese supplier. The Dutch company can
raise the price of Japanese products it sells, or keep prices steady and
accept reduced profits.

10.3 CURRENCY RATES AND INSTRUMENTS

10.3.1 Spot and Forward Rates
1. Spot Rate
Exchange rate that requires delivery of a traded currency within two
business days. The spot market helps companies:
a. Convert income from sales abroad into the home currency
b. Convert funds into the currency of a supplier
c. Convert funds into a currency of a nation it will invest in
2. Forward Rates
Exchange rate at which two parties agree to exchange currencies on a
specified future date. Represents expectations of a currency’s future
spot rate. Reflects a country’s social and political situation as well as its
present and future economic conditions. Companies use forward rates
to insure against unfavorable changes in exchange rates.
10.3.2 Forward Contracts, Swaps, and Options
Three other types of currency instruments are used in the forward market.
1. Forward Contract
Requires the exchange of an agreed-on amount of a currency on an
agreed-on date at a specified exchange rate. All conditions are fixed
and not adjustable and are commonly signed for 30, 90, and 180 days
into the future.
2. Currency Swaps
The simultaneous purchase and sale of a currency for two different
dates. This allows a company to reduce exchange-rate risk and lock in a
future exchange rate.
3. Currency Options
Right, or option, to exchange a specified amount of a currency on a
specified date at a specified rate. Companies use currency options to
hedge against exchange rate risk.

10.4 MARKET STRUCTURE AND CONVERTIBILITY

The foreign exchange market is an electronic network that connects the world’s
foreign exchange traders, currency trading banks, and investment firms residing in the
major financial centers.
Single-day trading volume on the foreign exchange market (spot exchanges,
forward contracts, and currency swaps) is $6.6 trillion.
10.4.1 Financial Centers

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 Much of the global trade in currencies occurs in the European Union euro,
Japanese yen, and the US dollar. Each of these currencies is called a vehicle
currency, which is a currency is used as an intermediary to convert fuds
between two other currencies.
1. Currency Trading Centers
Four locations account for 75 percent of global foreign exchange
trading. London accounts for 43 percent while New York City,
Singapore, and Hong Kong account for 32 percent among them.
2. Offshore Financial Center
Country or territory where financial sector features few regulations and
few, if any, taxes. They (1) are economically and politically stable; (2)
are advanced in telecommunications; (3) offer large amounts of funding
in many currencies; and (4) provide a less costly source of financing.
Booking centers see relatively little financial activity and funds usually
pass through on their way to large operational centers.
10.4.2 Interbank Market
Market in which the world’s largest banks exchange currencies at spot and
forward rates. Act as agents for clients and turn to foreign exchange brokers for
seldom-traded currencies.
1. Clearing mechanisms aggregate currencies that one bank owes another
and then carry out that transaction. Today, clearing is a mostly digital,
computerized affair, whereas in the past it meant physically delivering
currencies from one bank to another.

10.4.3 Currency Convertibility

A convertible currency is one that trades freely in the foreign exchange market,
with its price determined by the forces of supply and demand. Some countries
do not permit the free convertibility of their currencies.
1. Goals of Currency Restriction
a. Preserve a nation’s hard currencies to repay debts owed to other
nations.
b. Preserve hard currencies to pay for imports and to finance trade
deficits.
c. Protect a currency from speculators.
d. Keep individuals and businesses from investing in other
nations.
2. Instruments for Restricting Convertibility
a. Demand that the nation’s central bank performs all foreign
exchange transactions.
b. Issue import deposit requirements that require a business to
deposit a portion of its foreign exchange holdings in a special
account before being granted an import license.
c. Issue quantity restrictions that limit the amount of foreign
currency that individuals can take out of the country when
traveling abroad.

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 d. Implement a system of multiple exchange rates that specifies
higher rates on imports of certain goods or on imports from
certain nations.
e. Countertrade
The practice of selling goods or services that are paid for, in
whole or part, with other goods or services. Companies can
circumvent currency convertibility restrictions and yet conduct
business. A simple form of countertrade is barter, in which
goods are exchanged for others of equal value.

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 CHAPTER 11
INTERNATİONAL MONETARY SYSTEM
INTRODUCTION
This chapter explores factors that determine exchange rates and various international
attempts to manage them.
It presents different methods of forecasting exchange rates and explores attempts to
create systems of both fixed and floating exchanges rates.
It also reviews recent financial crises and the functioning of the international monetary
system.

11.1 IMPORTANCE OF CURRENCY VALUES

Exchange rates affect demand for products. When a country’s currency is
weak, the price of its export’s declines, making the exports more appealing on world
markets. We see the opposite effects for a strong currency.
Devaluation is the intentional lowering of the value of a currency by the
nation’s government.
Gives domestic producers an edge on world markets, but also reduces
citizens’ domestic purchasing power.
Revaluation is the intentional raising of the value of a nation’s currency.
Increases the price of exports and reduces the price of imports.
Exchange rates affect profits earned abroad when repatriated by the parent
company into the home currency.
Translating subsidiary earnings from a weak host country currency into a
strong home currency reduces earnings, and vice versa.
11.1.1 Desire for Stability and Predictability
1. Unfavorable movements in currency values can be costly for business.
Stability makes for accurate financial planning and cash flow forecasts.
2. Predictability reduces odds that a company will be caught off-guard by
unexpected rate changes. Reduces the need for costly insurance
(currency hedging) against possible adverse exchange rates.
3. Figure 11.2 shows how the value of the U.S. dollar has changed over
time. The figure reveals the dollar’s periods of instability, which
challenged the financial management capabilities of international
companies. Before undertaking international business, managers try to
forecast exchange rates and the impact of currency values on earnings.
11.1.2 Efficient Versus Inefficient Market View
1. The efficient market view says prices of financial instruments reflect all
publicly available information at any given time. This says forward
exchange rates accurately forecast future rates.
2. The inefficient market view says prices of financial instruments do not
reflect all publicly available information. Proponents believe that
companies can search for information to improve forecasting.
5. The inefficient view is more compelling considering private
information. For example, a currency trader who holds privileged
information can act on this information to make a profit.

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 11.1.3 Forecasting Techniques
1. Fundamental Analysis
Fundamental analysis uses statistical models based on fundamental
economic indicators to forecast exchange rates. These variables include
inflation, interest rates, the money supply, tax rates, government
spending, and government spending.
2. Technical Analysis
Technical analysis uses charts of past trends in currency prices and
other factors to forecast exchange rates. This technique examines
conditions that prevailed during changes in exchange rates and tries to
estimate the timing, magnitude, and direction of future changes.
3. Forecasting exchange rates is not a pure science, despite sophisticated
statistical techniques. For example, people might miscalculate the
importance of certain economic events, placing too much emphasis on
some elements and ignoring others.

11.2 FACTORS THAT DETERMINE EXCHANGE RATES

The purchasing power of currencies is extremely important in international
business. A currency can gain purchasing power and lose purchasing power.
To understand what determines exchange rates, must know:
(1) the law of one price and
(2) purchasing power parity. Each tells the level at which an exchange rate
should be.
11.2.1 Law of One Price
1. Law of one price says an identical product must have an identical price
in all countries when the price is expressed in a common currency.
Product must be identical in quality and content and be entirely
produced within each country.
2. If price were not identical in each country, an arbitrage opportunity
would arise. Traders would buy in the low-priced market and sell in the
high-priced market. The act of buying in the one market (higher
demand) and selling in the other (greater supply) would cause prices to
equalize eventually.
11.2.2 Purchasing Power Parity (PPP)
1. PPP theory says that an exchange rate between two nations’ currencies
is equal to the ratio of their price levels. Economic forces will push a
market exchange rate toward that calculated by PPP or an arbitrage
opportunity arises.
2. McCurrency
The Economist magazine publishes its “Big Mac Index” using the law
of one price to determine the exchange rate between the US dollar and
other currencies. Fair predictor of the “direction” rates should move.

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 3. Exchange Rates and Inflation
Exchange rates adjust for different rates of inflation in different
countries, which is necessary to maintain purchasing power parity
between nations. For example, if inflation in Mexico is higher than in
the United States, the exchange rate adjusts to reflect that a dollar will
buy more pesos due to higher inflation in Mexico. US goods become
more expensive for Mexican firms, and Mexican goods become
cheaper for US firms.
a. Money Supply
i. Governments manage the supply of and demand for
currency with policies that influence the money supply.
ii. Monetary policy refers to activities that directly affect a
nation’s interest rates or money supply. Governments
buy or sell government securities on the open market to
influence the money supply.
iii. Fiscal policy involves using taxes and government
spending to influence the money supply indirectly.
Governments can increase or lower taxes or increase or
decrease government spending.
b. Unemployment and Interest Rates
i. Low unemployment puts upward pressure on wages. To
maintain profit margins with higher labor costs,
producers pass the cost of higher wages on to consumers
in higher prices, causing inflationary pressure.
ii. Low interest rates encourage consumers and businesses
to borrow and spend, causing inflationary pressure.
11.2.3 Evaluating Purchasing Power Parity
PPP is better at predicting long-term exchange rates than short-term rates.
Short-term forecasts, however, are most beneficial to managers.
1. Added Costs
PPP assumes no transportation costs, thus overstating the threat of
arbitrage. The presence of transportation costs can allow unequal prices
between markets to persist, causing PPP to fail.
2. Trade Barriers
PPP assumes no trade barriers. But a high tariff or outright ban on a
product can impair price leveling, causing PPP to fail to predict
exchange rates accurately.
3. Business Confidence and Psychology
PPP overlooks business confidence and human psychology. Nations try
to maintain confidence of investors, businesspeople, and consumers in
their economies and currencies.

11.3 FIXED EXCHANGE-RATE SYSTEMS

11.3.1 The Gold Standard
Gold was internationally accepted as payment for goods and services.

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 Pros: its limited supply caused high demand and it can be traded, stored, and
melted into coins or bars, making a good medium of exchange.
Cons: its weight made transport expensive and if a ship sank the gold was lost.
Gold Standard was an international monetary system in which nations linked
the value of their paper currencies to a specific value of gold. Great Britain
was the first to implement the gold standard in the early 1700s.
1. Par Value
a. The value of a currency expressed in terms of gold. All nations
fixing their currencies to gold also indirectly linked their
currencies to one another. Thus, the gold standard was a fixed
exchange rate system—one in which the exchange rate for
converting one currency into another is fixed by international
governmental agreement.
b. The US dollar was fixed at $20.67/oz of gold and the British
pound was fixed at £4.2474/oz. So, the dollar-pound exchange
rate equaled $4.87/£ ($20.67 ÷ £4.2474).
2. Advantages of the Gold Standard
a. Reduced the risk in exchange rates because it locked exchange
rates between currencies. Fixed exchange rates reduced the
risks and costs of trade and it grew as a result.
b. Imposed strict monetary policies that required nations to
convert paper currency into gold if demanded by holders of the
currency. This forced nations to keep adequate gold reserves on
hand. A nation could not let paper currency grow faster than the
value of its gold reserves, which controlled inflation.
c. Helped correct a nation’s trade imbalance. A nation that imports
more than it exports sends gold out of the country to pay for
imports. The government must decrease its paper currency in
the domestic economy because it cannot be valued in excess of
its gold reserves. As the money supply falls, so do prices of
goods and services because fewer dollars are chasing the same
supply of goods and services. Falling prices lower the price of
its exports on world markets and exports rise until the nation’s
international trade is again in balance.
3. Collapse of the Gold Standard
a. The gold standard was violated when nations financed their
efforts in the First World War by printing paper currency. This
caused rapid inflation and nations abandoned the gold standard.
b. Britain returned to the gold standard in the early 1930s at the
same par value that existed before the war. The United States
returned to the gold standard at a new, lower par value that
reflected the inflation of previous years.
c. This decision of the US to effectively devalue its currency and
Britain’s decision to not do so lowered the price of US exports
and increased the price of British goods imported. Whereas it
had previously required $4.87 to purchase one British pound, it

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 now took $8.24 ($35.00 ÷ £4.2474). This drastically increased
the price of imports from Britain (and other countries).
d. Countries retaliated against one another through “competitive
devaluations” to improve their own trade balances. Faith in the
gold standard vanished, as it was no longer an accurate
indicator of a currency’s true value.
11.3.2 Bretton Woods Agreement
1944 accord among nations to create a new international monetary system
based on the value of the U.S. dollar. Designed to balance strict discipline of
the gold standard with flexibility to manage temporary domestic monetary
difficulties.
1. Fixed Exchange Rates
a. Incorporated fixed exchange rates by tying the value of the US
dollar directly to gold, and the value of other currencies to the
value of the dollar.
b. Fixed US dollar par value at $35/oz of gold; other currencies
had par values against the US dollar, not gold.
c. Members were to keep their currencies from deviating more
than 1 percent above or below their par values. Extended the
right to exchange gold for dollars only to national governments.
2. Built-In Flexibility
a. Allowed devaluation only in extreme circumstances called
fundamental disequilibrium—when a trade deficit causes a
permanent negative shift in the balance of payments.
b. Devaluation in such situations was to reflect a permanent
economic change in a country only, and not be used for
temporary misalignments.
3. World Bank
a. Officially called the International Bank for Reconstruction and
Development (IBRD). Created to fund national economic
development.
b. Immediate purpose was to finance European reconstruction
after the Second World War. Later shifted its focus to the
general financial needs of developing countries.
c. Finances economic development projects in Africa, Asia and
South America. Offers funds to countries unable to obtain
capital for projects considered too risky. Often helps develop
transportation networks, power facilities, and agricultural and
educational programs.
4. International Monetary Fund
a. Intended to regulate fixed exchange rates and enforce the rules
of the international monetary system. Purposes of the IMF are
to: (1) Promote international monetary cooperation, (2)
Facilitate expansion and balanced growth of international trade,
(3) Promote exchange stability and avoid competitive exchange
devaluation, (4) Make resources temporarily available to

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 members, (5) Shorten the duration and lessen the degree of
disequilibrium in the international balance of payments of
member nations.
i. Special Drawing Right
IMF asset whose value is based on a weighted “basket”
of five currencies: the US dollar, EU euro, Chinese
renminbi, Japanese yen, and British pound.
5. Collapse of the Bretton Woods Agreement
Bretton Woods faltered in the 1960s because of US trade and budget
deficits. Other nations holding US dollars doubted the government had
gold reserves to redeem all of its paper currency, resulting in a global
sell-off of US dollars.
a. Smithsonian Agreement
The Smithsonian Agreement was to restructure and strengthen
the international monetary system. It (1) lowered the value of
the dollar in terms of gold to $38/oz., (2) required other
countries to increase the value of their currencies against the
dollar, and (3) increased the 1 percent floatation band to 2.25
percent.
b. Final Days
Many nations abandoned the system in 1972 and 1973, and
currency values floated freely against the US dollar.
11.4 FLOATING EXCHANGE-RATE SYSTEM
The new system of floating exchange rates was to be a temporary solution.
No new international monetary system emerged but there were several efforts
to manage exchange rates.
1. Jamaica Agreement
This 1976 accord (1) formalized the existing managed float system of
exchange rates, (2) eliminated gold as the primary reserve asset of the
IMF; and (3) expanded the IMF’s mission to act as a “lender of last
resort” for nations with balance-of-payments difficulties.
2. Later Accords
From 1980 to 1985 the US dollar rose against other currencies, pushing
up prices of US exports and adding to its trade deficit.
a. The Plaza Accord (1985) was an agreement among the largest
industrialized economies known as the G5 (Britain, France,
Germany, Japan, and the United States) to act together in
forcing down the value of the U.S. dollar.
b. The Louvre Accord (1987) was an agreement among G7 nations
(the G5 plus Italy and Canada) to affirm the dollar was
appropriately valued and that they would intervene in currency
markets to maintain its current market value.
11.4.1 Today’s Exchange-Rate Arrangements
Remains a managed float system, but some nations maintain more stable
exchange rates by tying their currencies to other currencies
1. Pegged Exchange-Rate Arrangement

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 a. Pegged exchange-rate arrangements tie a currency to a more
stable and widely used one in international trade.
b. Many small countries peg their currencies to the US dollar, the
EU euro, the special drawing right (SDR) of the IMF, or even a
basket of currencies. Countries that peg their currency to the US
dollar include The Bahamas, Belize, Eritrea, Turkmenistan, and
Saudi Arabia.
2. Currency Board
a. A monetary regime based on a commitment to exchange
domestic currency for a specified foreign currency at a fixed
exchange rate. It makes a government legally bound to hold an
amount of foreign currency equal to the amount of domestic
currency, which helps cap inflation.
b. The currency board’s survival depends on sound budget
policies.
11.4.2 Recent Financial Crises
Despite nations’ best efforts to head off financial crises within the international
monetary system, the world has seen several wrenching crises.
1. Developing Nations’ Debt Crisis
a. By the 1980s, developing countries (especially in Latin
America) had amassed huge debts with large international
commercial banks, the IMF, and the World Bank. To prevent a
meltdown of the entire financial system, international agencies
revised repayment schedules.
b. In 1989, the Brady Plan called for large-scale reduction of poor
nations’ debt, exchange of high-interest loans for low-interest
loans, and debt instruments tradable on world financial markets.
2. Mexico’s Peso Crisis
a. Political turmoil shook investors’ faith in Mexico’s financial
system in 1993–1994. Its government responded slowly to the
flight of portfolio investment capital.
b. In late 1994, the Mexican peso was devalued, forcing a loss of
purchasing power on the Mexican people. The IMF and private
commercial banks in the United States provided around $50
billion in loans to support Mexico’s economy.
c. Mexico repaid the loans ahead of schedule and once again has a
sizable reserve of foreign exchange.
3. Southeast Asia’s Currency Crisis
a. On July 11, 1997, speculators sold off Thailand’s baht on world
currency markets. The baht plunged and every other economy
in the region experienced a slump.
b. The shock waves of Asia’s crisis could be felt throughout the
global economy. Indonesia, South Korea, and Thailand needed
IMF and World Bank funding.
4. Russia’s Ruble Crisis

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 a. Russia’s problems in the 1990s: (1) spillover from the Southeast
Asia crisis, (2) depressed oil prices, (3) falling hard currency
reserves, (4) unworkable tax system, and (4) inflation.
b. In 1996 the Russian government tried to defend its ruble on
currency markets when currency traders sold it. Russia received
a $10 billion aid package from the IMF and promised to reduce
debt, collect taxes, cease printing currency, and peg its currency
to the dollar.
c. Then in 1998 the government found itself once again trying to
defend the ruble. By late 1998, the IMF had lent Russia more
than $22 billion.
5. Argentina’s Peso Crisis
a. By late 2001, Argentina had been in recession for nearly 4
years. Argentina’s exports were expensive because its currency
was linked to a strong US dollar through a currency board.
b. The country finally defaulted on its $155 billion of public debt
in early 2002, the largest default by any country ever.
c. The government scrapped its currency board and the peso
quickly lost about 70 percent of its value.
d. From 2001 through 2002, the economy shrank by 15 percent,
unemployment shot up to 21 percent, and poverty engulfed 56
percent of its citizens.
e. Argentina’s plan of boosting wages, imposing price controls,
keeping the peso low, and increasing public spending worked
for a time. But inflation soon reached double digits and cut
purchasing power, increased poverty, and shrank the economy.
The IMF loaned Argentina $50 billion. The nation was hit hard
by the pandemic in 2020. In 2021, Argentina restructured its
debt and made arrangements to repay the IMF $45 billion by
2032. In early 2022, inflation was rising 54 percent a year.
11.4.3 Future of the International Monetary System
1. Recurring crises are raising calls for a new system designed to meet the
challenges of a global economy.
2. Revision of the IMF and its policy prescriptions are likely;
transparency on the part of the IMF is being increased to instill greater
accountability. The IMF is increasing its surveillance of members’
macroeconomic policies and abilities in the area of financial sector
analysis.
3. Ways must be found to integrate international financial markets to
manage risks. The private sector must become involved in the
prevention and resolution of financial crises.

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 CHAPTER 12
INTERNATİONAL STRATEGY AND ORGANİZATİON

INTRODUCTION
Planning is the process of identifying and selecting an organization’s objectives and
deciding how the organization will achieve those objectives.
Strategy is the set of planned actions taken by managers to meet company objectives.
Developing an effective strategy requires a clear definition of objectives (or goals) and a plan
to achieve them.
An analysis of capabilities and strengths identifies what a company does better than
the competition.
Companies also must assess the competitive environment and the national and
international business environments.
A well-defined strategy coordinates divisions and departments to reach corporation-
wide goals effectively and efficiently.
A clear, appropriate strategy focuses on the activities performed best to avoid
mediocre performance or total failure.

12.1 COMPANY ANALYSIS

Firms must determine what products to produce, where to produce them, and
where and how to market them.
Whether a site for operations or potential market, each international location
has a rich mixture of cultural, political, legal, and economic traditions and processes.
All these factors add to the complexity of planning and strategy.
12.1.1 Company Mission and Goals
Mission statement is a written statement of why a company exists and what it
plans to accomplish (e.g., supply the highest level of service in a market
segment).
1. Types of Mission Statements
a. Often describe how a company’s operations affect stakeholders
—all parties (from suppliers and employees to stockholders and
consumers) who affect, or are affected by, a company’s
activities.
b. The mission statement of an international business depends on
the type of business, the domestic and international
stakeholders, and the most important aspect of the business for
achieving its goals.
c. Managers must define objectives. Objectives at the highest level
in a company tend to be stated in general terms. Those at the
level of business units are more specific, and department-level
objectives are the most specific and can carry numerical
performance targets.
12.1.2 Core Competency and Value Creation
Before formulating strategies, managers analyze the company, industry,
and national business environment(s).

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 They should examine industries and nations targeted for potential entry.
This helps managers discover its competencies and the activities that
create customer value.

1. Unique Abilities of Companies

a. Core competency is an ability of a company that competitors
find extremely difficult or impossible to equal. They are
multiple skills coordinated to form a single technological
outcome.
b. Skills are learned through on-the-job training and personal
experience, but core competencies develop over a long period
and are difficult to teach.
2. Value Chain Analysis
Process of dividing a company’s activities into primary and support
activities and identifying those that create value for customers.
a. Primary Activities
Company activities directly related to the creation of a product,
its marketing and delivery to buyers, and its after-sales support
and services. These include inbound and outbound logistics,
production (goods and services), marketing and sales, and
customer service.
b. Support Activities
Company activities that contribute to the value-creating
potential of each primary activity. These include firm
infrastructure, human resource management, technology
development, and procurement. Each is a source of strength or
weakness for a company.
12.1.3 Business Environment
1. National differences in language, religious beliefs, customs, traditions,
and climate complicate strategy formulation.
2. Manufacturing processes must sometimes be adapted to the supply of
local workers, local customs, traditions, and practices.
3. Differences in political and legal systems complicate international
strategies.
4. Different national economies complicate strategy formulation, and it
can also affect the location in which a company chooses to perform an
activity.
12.2 STRATEGY FORMULATION
A company’s strengths and capabilities as well as environmental forces
influence strategy.
12.2.1 Two International Strategies
The two strategies presented here are not for companies that export only.
Exporters do not have foreign direct investments and should instead devise an
appropriate export strategy.
1. Multinational Strategy

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 a. Adapts products and marketing strategies in each national
market to suit local preferences.
b. Benefit: monitor buyer preferences in each local market and
respond quickly and effectively to new buyer preferences.
c. Drawback: cannot exploit scale economies in product
development, manufacturing, or marketing.
d. Not suited to industries in which price competitiveness is a key
to success.

2. Global Strategy
a. Offers the same products using the same marketing strategy in
all markets.
b. Firms take advantage of scale and location economies by
producing entire inventories or components in a few optimal
locations. They perform product R&D in one or a few locations
and design promotional campaigns and advertising strategies at
headquarters.
c. Benefit: cost savings from standardized products and
marketing; lessons learned in a market are shared.
d. Drawback: may overlook differences in buyer preferences; only
simple modifications in features. Competitors can step in and
satisfy unmet needs creating a niche market.
12.2.2 Corporate-Level Strategies
Companies in more than one business must formulate a corporate-level
strategy by identifying the markets and industries in which to operate.
Overall objectives for different business units are developed and the
role of each unit in reaching those objectives is determined.
1. Growth Strategy
a. Designed to increase the scale or scope of a corporation’s
operations. Scale refers to the size of a corporation’s activities;
scope to the kinds of activities it performs.
b. Organic growth relies on internally generated growth.
c. Other methods of growth are mergers and acquisitions, joint
ventures, and strategic alliances. Partners in pursuing these
include competitors, suppliers, and buyers; firms join
competitors to reduce competition, expand product lines, or
expand geographically.
2. Retrenchment Strategy
a. Reduces the scale or scope of a corporation’s businesses.
Typical when economic conditions worsen or competition
increases. Close factories with unused capacity, lay-off
employees, sell unprofitable business units.
3. Stability Strategy
a. Guards against change, Avoids growth and retrenchment.

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 b. Corporations have met objectives, are satisfied with
accomplishments, and see no opportunities or threats.
4. Combination Strategy
a. Mixes growth, retrenchment, and stability strategies across a
corporation’s business units.
b. Common because rarely do international corporations follow
identical strategies in each business unit.
12.2.3 Business-Level Strategies
A company may need only one strategy for its one line of business
where others may need many strategies.
Key to an effective business-level strategy is a general competitive
strategy in the marketplace.
1. Low-Cost Leadership Strategy
a. Exploits economies of scale to have the lowest cost structure of
any competitor in an industry.
b. Companies have a myriad of cost including administrative costs
and the costs of its various primary activities, including
marketing, advertising, and distribution.
c. Low-cost leadership is based on efficient production in large
quantities, which guards against attack by competitors because
of the large start-up costs.
d. A negative aspect of the low-cost leadership strategy is low
customer loyalty—buyers will purchase from the low-cost
leader if everything else is equal. Works best with mass-
marketed products aimed at price-sensitive buyers.
2. Differentiation Strategy
a. Company designs products to be perceived as unique.
b. Tends to force a company into a lower-market-share
position because it involves the perception of exclusivity
or meeting the needs of a certain group.
c. Companies develop loyal customer bases to offset
smaller market shares and higher costs of producing and
marketing a unique product.
d. Products can be differentiated on the basis of quality,
brand image, and product design. Special features
differentiate goods and services in the minds of
consumers. Manufacturers combine differentiation
factors in formulating their strategies.
3. Focus Strategy
a. Company focuses on the needs of a narrowly defined market
segment by being the low-cost leader, by differentiating its
product, or both.
b. Competition forces more products to be distinguished by price,
quality, or design. Greater product range leads to refinement of
market segments.
12.2.4 Department-Level Strategies

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 Achieving corporate and business-level objectives depends on effective
departmental strategies that focus on activities that transform resources into
products.
Department-level strategies rely on capabilities—primary and support
activities that create value for customers.
1. Primary and Support Activities
Each department creates customer value through lower costs or
differentiated products.
a. For primary activities, manufacturing strategies cut production
costs and improve product quality; marketing strategies
promote differences in products; and efficient logistics result in
cost savings.
b. Support activities create customer value. For example, R&D
identifies market segments with unsatisfied needs and designs
products to meet them.

12.3 ISSUES OF ORGANIZATIONAL STRUCTURE

Organizational structure is the way in which a company divides its activities
among separate units and coordinates activities among them.
An appropriate organizational structure for a firm’s strategic plans will help it
achieve its goals.
12.3.1 Centralization versus Decentralization
Centralized decision making occurs at a high level in one location such as
headquarters. Decentralized decision making occurs at lower levels, such as in
international subsidiaries.
Managers cannot get involved in every hiring decision or task
assignment. But overall corporate strategy cannot be delegated to subsidiaries
because only top management has the appropriate perspective.
Companies rarely centralize or decentralize all decision making but
seek the approach that creates the greatest efficiency and effectiveness.
International companies may centralize decision making in certain geographic
markets but decentralize it in others.
1. When to Centralize
a. Centralization helps coordinate international subsidiaries. This
is very important when one subsidiary’s output is another’s
input.
b. Companies might maintain strong central control over financial
resources by channeling all subsidiary profits back to the parent
for redistribution to subsidiaries.
c. Other companies centrally design policies, procedures, and
standards to create a single global organizational culture.
2. When to Decentralize

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 a. Decentralization is beneficial when fast-changing business
environments require local responsiveness.
b. Subsidiary managers in close contact with local business
environment can result in products suited to the needs and
preferences of local buyers.
c. Fosters participative management practices and employee
morale is higher if subsidiary managers and subordinates are
involved in decisions.
d. Delegating decisions can increase commitment. Local managers
rewarded for their decisions often invest more in making and
executing them.
12.3.2 Coordination and Flexibility
Key questions: What is the most efficient way to link divisions? Who should
coordinate the divisions? How should the company process and deliver
information? How should it use corrective measures?
1. Structure and Coordination
a. Structure defines chains of command—lines of authority that
run from top management to each employee and specify
internal reporting relationships.
b. Companies need structures to bind areas requiring cooperation,
such as linking R&D and manufacturing to avoid product
designs that complicate manufacturing.
2. Structure and Flexibility
a. Structure is not permanent but is modified to suit changes
within a company and in its external environment.
b. Changes in strategy and the business environment can force
changes in organizational structure.

12.4. TYPES OF ORGANIZATIONAL STRUCTURE

Four organizational structures are common for most international companies.
12.4.1 International Division Structure.
1. An international division with its own manager keeps domestic and
international activities separate. A general manager for each nation in
which a company operates then controls product manufacturing and
marketing within that market.
2. Concentrates international expertise in one division where the manager
becomes a specialist in foreign exchange, exporting, etc. Firm reduces
costs, increases efficiency, and prevents international activities from
disrupting home operations.
3. Potential problems: (1) international managers must often rely on
home-country managers for financial resources and technological
know-how, (2) poor coordination between the international division
and the rest of the company can hurt performance, and (3) destructive
rivalries may arise between different country managers within the
division.
12.4.2 International Area Structure

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 1. Organizes a company’s global operations into countries or regions. The
more countries in which a company operates, the greater the likelihood
it will organize into regions, not countries.
2. Each geographic division operates as a self-contained unit, with
decision making decentralized to country or regional managers.
3. Useful structure when there are vast cultural, political, or economic
differences among nations or regions.
4. By controlling activities in their environments, general managers
become experts on the unique needs of their buyers. But because units
act independently, resources may overlap, and cross-fertilization of
knowledge across units can be limited.
12.4.3 Global Product Structure
1. Divides worldwide operations according to a company’s product areas.
Suitable when a firm has a diverse set of products.
2. Because the primary focus is on the product, domestic and international
managers for each product division must coordinate their activities so
they do not conflict.
12.4.4 Global Matrix Structure
1. Splits the chain of command between product and area divisions. Each
manager reports to two bosses—the president of the product division
and the president of the geographic area.
2. Brings together geographic area managers and product area managers
in joint decision making.
3. Bringing specialists together creates a team-type organization.
Increases local responsiveness, reduces costs, coordinates worldwide
operations, and can increase coordination while improving agility and
local responsiveness.
4. Two major shortcomings: (1) complex coordination can slow decision
making and reaction time, and (2) shared responsibility can cause a
manager to attribute poor performance to the other manager.
12.4.5 Work Teams
Work teams can be useful in improving responsiveness by cutting across
functional boundaries that can slow decision making in an organization. Work
teams coordinate their efforts to arrive at solutions and implement corrective
action.
1. Self-Managed Teams
a. Employees from a single department accept responsibilities of
former supervisors. In production settings, self-managed teams
reduce the need for direct supervisors and increase productivity,
product quality, customer satisfaction, employee morale, and
company loyalty.
b. Quality-improvement teams are the most common type of self-
managed team in many manufacturing companies because they
reduce production waste and costs.

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 c. Cultural differences can cause resistance to the concept of self-
management teams. Experts suggest that international managers
use caution when implementing them.
d. Certain cultures are less individualistic and more collectivist,
some harbor greater respect for differences in status. In cultures
in which people are hard-working, teams will be productive if
given greater autonomy.
2. Cross-Functional Teams
a. Composed of employees who work at similar levels in different
functional departments. They can improve interdepartmental
coordination and boost product quality.
b. Break down interdepartmental barriers and reorganize
operations around processes, not functional departments.
3. Global Teams
a. Group of top managers from both headquarters and subsidiaries
who meet to develop solutions to company-wide problems.
b. Large distances between team members, lengthy travel times to
meetings, and the inconvenience of working across several time
zones can hamper global teams.

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 CHAPTER 13
ANALYZİNG INTERNATİONAL OPPORTUNİTİES

INTRODUCTION
Technological advances in communication and transportation open national markets around
the globe. Managers screen and analyze locations as potential markets and as potential sites
for operations. The attraction to distant markets and the integrated nature of location decisions
demand that location decisions be made in a systematic manner.

13.1 BASIC APPEAL AND NATIONAL FACTORS

Managers try to keep search costs low yet examine every potential market or location
when screening potential markets and sites. The screening process has four steps (See
Figure 13.1).
13.1.1 Identify Basic Appeal
For a potential market this means estimating basic product demand. For a
potential site this means assessing the availability of resources required.
1. Determining Basic Demand
Must explore the suitability of a nation’s physical and cultural
environment and whether certain products are banned.
2. Determining Availability of Resources
a. Raw materials for manufacturing must be local or imports.
Imports may face tariffs, quotas, or other barriers.
b. Companies making labor-intensive products often relocate to
lower-wage countries.
c. Companies may go abroad for financing if not available at
home or when interest rates are high at home.
13.1.2 Assess the National Business Environment
Managers must understand differences in cultures, politics, laws, and
economies and incorporate that understanding into market and site selection
decisions.
1. Cultural Forces
a. Countries differ in language, attitudes toward business,
religious beliefs, traditions, and customs. Cultural elements can
influence what kinds of products are sold and how.
b. Companies sometimes locate production in the local market
when modifications must be made to a product’s physical
features for cultural reasons.
c. Local work ethic, education, and level of managerial skills
affect site-selection decisions.
2. Political and Legal Forces
a. Regulations and Bureaucracy
i. Attitudes toward trade and investment are reflected in the
quantity and types of restrictions a government places on
imports, exports, and investment in its country.
ii. Governments can create investment barriers to ensure
domestic control of a company or industry (e.g.,

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 imposing rules on domestic ownership or restricting
companies from removing profits).
iii. Lean and smoothly operating bureaucracy can encourage
investment whereas an inefficient, cumbersome, or
corrupt one can discourage it.
iv. Companies will endure an inefficient bureaucracy if the
benefits outweigh the cost of inefficiencies.
b. Political Stability
i. Companies must monitor political events and political
risk that threaten operations and earnings.
ii. Political risk increases if a company cannot estimate the
future political environment accurately.
iii. Companies can obtain political risk information from
political risk agencies, international relations scholars,
political and union leaders, bankers, etc.
3. Economic and Financial Forces
a. Poor fiscal and monetary policies can increase inflation and
budget deficits, weaken a currency, lower productivity levels,
and slow innovation. These reduce investor confidence and can
cause companies to scale back or cancel proposed investments.
b. Currency and liquidity issues: a volatile currency complicates
the prediction of future earnings in the home-country currency.
c. Managers can obtain information about economic and financial
conditions from international agencies.

13.2 MEASURE AND SELECT THE MARKET OR SITE

13.2.1 Measure Market or Site Potential
Despite local demand for a product or availability of resources, consumers
might not be ready or able to buy a product or certain sites may be unable to
supply the resources needed.
1. Measuring Market Potential
Level of economic development affects products sold, how they are
sold, and their features. Different levels of economic development can
require different approaches to researching market potential.
a. Information for estimating market potential in industrialized
nations may be more readily available than for emerging
markets.
b. Industry reports can be used to approximately estimate market
demand. These often include
• Market shares of largest competitors
• Volume of exports and imports
• Structure of wholesale and retail networks
• Population, social trends, and marketing methods
• Total expenditure on product and substitutes
• Retail sales volume and prices
• Future market outlook and potential opportunities

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 c. Income Elasticity
One way to forecast market demand is to determine a product’s
income elasticity—sensitivity of demand for a product relative
to a change in income (percent change in quantity demanded
divided by percent change in income).
i. Income-elastic products—demand increases more
relative to an increase in income. Tend to be
discretionary purchases such as jewelry or expensive
furniture.
ii. Income-inelastic—demand increases less relative to
increase in income. Tend to be essential including food,
beverages, utilities, and toiletries.
d. National Data
In some markets companies can face a lack of data to estimate
market potential. They can calculate a market-potential index
using country data and then rank locations according to their
appeal:
• Market size: Snapshot of market size
• Market intensity: Estimate wealth or buying power
• Market growth rate: See if market is expanding or not
• Market consumption capacity: Spending capacity
• Commercial infrastructure: Distribution channels and
communication assessment.
• Market receptivity: Market “openness” assessment
• Economic freedom: Extent of free-market principles
• Country risk: Political, economic, social, financial risk
4. Measuring Site Potential
a. Companies must assess the quality of resources they will
employ locally. Most important resource is often labor and
management.
b. Wages are lower if labor is abundant, relatively less skilled
(though perhaps well-educated), or both. Training can require a
substantial investment of time and money.
c. Companies must assess the productivity of local labor and
managers.
d. Company should examine local infrastructure, including roads,
bridges, airports, seaports, and telecommunications systems, for
the impact on efficiency.
13.2.2 Select the Market or Site
This involves intensive efforts to assess the remaining potential markets
and sites.
Managers visit each location to confirm earlier expectations and
perform a competitor analysis.
Managers evaluate each potential location’s contribution to cash flows
by undertaking a financial evaluation.
1. Field Trips

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 Trips to each remaining site let managers experience the culture,
observe the workforce, or make personal contact with potential new
customers and distributors.
2. Competitor Analysis
Intensely competitive markets put downward pressure on prices firms
can charge customers. Appealing sites for production and R&D
increase the costs of doing business. Competitor analysis should
address the following:
• Number of competitors (domestic and international)
• Market share of each competitor
• Competitors appeal to market segments or mass market
• Whether each competitor focuses on high quality or low price
• Whether competitors tightly control channels of distribution
• Customer loyalty commanded by competitors
• Potential threat from substitute products
• Potential entry of new competitors into the market
• Competitor control of production inputs (labor, capital, materials,
etc.)

13.3 SECONDARY MARKET RESEARCH

Secondary market research is obtaining information that already exists within the
company or that can be obtained from outside sources. It can help estimate demand for
a product or research a business environment relatively inexpensively.
13.3.1 Public Information Sources
1. Global institutions designed to promote free trade collect and
disseminate a wide range of national economic data.
2. These include the World Trade Organization, United Nations,
International Trade Center, World Bank, International Monetary Fund,
and the Asian Development Bank.
3. Commerce departments and international trade agencies of most
countries also supply import and export regulations, quality standards,
and sizes of various markets.
4. The Central Intelligence Agency’s World Factbook is useful throughout
the market- or site-screening process because of its facts on each
nation’s business environment.
5. The International Trade Administration (ITA), operated by the
Department of Commerce details product standards in other countries.
It also offers advice on opportunities for US companies in individual
markets and offers information on federal export-assistance programs.
13.3.2 Private Information Sources
1. Associations of firms within an industry or trade often publish
information to keep members abreast of market happenings and
opportunities in their particular industry.
2. They sometimes commission specialized studies of their industries and
offer them to members at subsidized prices.
13.3.3. Issues with Secondary Research

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 Unique circumstances present difficulties that force adjustments in conducting
market research in different nations.
1. Availability of Data
a. Whereas industrialized markets have secondary data on product
markets, emerging and developing countries have less. And
when available, it may not be reliable.
b. International research agencies are entering these markets and
increasing the availability of information.
2. Reliability of Data
a. Tainted information can result from improper local collection
methods and analysis techniques.
b. International research agencies are employing advanced
techniques to collect and analyze emerging and developing
markets and supplying more reliable information.
3. Comparability of Data
a. Data obtained from other countries must be interpreted with
caution. Terms such as poverty, consumption, and literacy can
differ greatly from one country to another.
b. Governments can measure data differently and affect its
comparability among nations. Care must be taken to not
misinterpret data.

13.4 PRIMARY MARKET RESEARCH

Primary market research is the process of collecting and analyzing original
data and applying results to current research needs.
Primary research helps complete the broad picture supplied by secondary data.
13.4.1 Trade Shows and Trade Missions
1. Trade show is an exhibition at which members of an industry or group
of industries showcase their latest products, study activities of rivals,
and examine recent trends and opportunities.
2. Trade mission is a government-sponsored international trip designed to
explore international business opportunities.
3. Trade missions are appealing for small- and medium-size firms because
(1) it offers added clout as they are seen with home-country
government officials, and (2) it is a cost-effective way to visit several
national markets in one trip.
13.4.2 Interviews and Focus Groups
1. These techniques can uncover potential or current buyers’ emotions,
attitudes, and general impressions of a company or its product.
Interviews must be conducted carefully in other countries if they are to
yield unbiased and reliable information.
2. A focus group is an unstructured but in-depth interview of a small
group of individuals (8 to 12 people) by a moderator. It is helpful in
learning attitudes about a company or its product. Moderators should
be natives of the countries in order to detect subtle differences in verbal
and body language.

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 3. A consumer panel is research in which people record in personal
diaries information on their attitudes, behaviors, or purchasing habits.
This can be useful if people might tend to agree with others in a group
setting—as in group-oriented cultures.
13.4.3 Surveys and Environmental Scanning
1. A survey is research in which current or potential buyers answer a
series of written or verbal questions. They are helpful in obtaining
facts, opinions, and attitudes and are capable of gathering a vast
amount of data in a single sweep.
2. Environmental scanning is an ongoing process of gathering, analyzing,
and dispensing information. This entails obtaining factual and
subjective information on business environments.
3. Contributes to well-informed decisions and effective strategies by
helping develop contingency plans in a volatile environment.
13.4.4 Issues with Primary Research
1. Unique conditions and circumstances in other countries can present
difficulties that force adjustments in the way research is performed.
2. Marketers in unfamiliar markets must pay attention to how cultural
variables can potentially pose issues while collecting primary data.
3. Translations of questions to be asked of individuals must be done
carefully so the intended meaning is not altered.
4. Written surveys are impractical in countries with low literacy rates
although verbal responses can be obtained.
5. Companies with little experience in a market can hire local agencies to
assist in the research process.

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 CHAPTER 14
SELECTİNG AND MANAGİNG ENTRY MODES

INTRODUCTION
An entry mode is the institutional arrangement by which a firm gets its products,
technologies, human skills, or other resources into a market.
Companies seek entry to new marketplaces for manufacturing or selling products.
Entry mode selection depends on market experience, level of control desired, and
market size.

14.1 EXPORTING AND COUNTERTRADE

One of the most common methods of buying and selling goods internationally is
exporting.
14.1.1 Why Companies Export
1. Expand total sales when the domestic market is saturated.
2. Diversify sales to level cash flows, making it easier to coordinate
payments to creditors with receipts from customers.
3. Owners and managers with little or no knowledge of how to conduct
business in other cultures, use exporting as a low-cost, low-risk way of
gaining valuable international experience.
14.1.2 Developing an Export Strategy: A Four-Step Model
A logical approach to exporting is to research and analyze international
opportunities and develop a coherent export strategy. A firm with such a
strategy pursues export markets rather than waiting for orders to arrive.
1. Step 1: Identify a Potential Market.
a. Perform market research to learn if demand exists in a target
market.
b. Novice exporters should focus on one or a few markets that are
culturally understood.
c. A new exporter should seek advice on regulations, general
exporting, and the target market.
2. Step 2: Match Needs to Abilities
a. Assess a company’s ability to satisfy market needs.
3. Step 3: Initiate Meetings
a. Early meetings with potential distributors, buyers, and others
should focus on building trust and cooperation.
b. Later meetings can estimate success of cooperation.
c. In the most advanced stage, negotiations take place and details
of agreements are finalized.
4. Step 4: Commit Resources
a. After agreement is reached it is time to put the company’s
human, financial, and physical resources to work.
b. The objectives of the export program must be clearly stated and
should extend out at least 3 to 5 years.
c. As company activities expand, they discover the need for an
export department or division.

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 14.1.3 Degree of Export Involvement
Some companies use intermediaries to get their products in a market abroad.
Other companies perform all of their export activities themselves, with an
infrastructure that bridges the gap between the two markets.
1. Direct Exporting
Company sells directly to buyers in a target market. Need not sell
directly to end-users; can hire local representative or distributor.
a. A sales representative represents its own company’s products,
not those of other companies. It promotes products by attending
trade fairs and making personal visits to local retailers and
wholesalers. They do not take title to the merchandise.
b. Distributors take ownership of merchandise when it enters their
country, accept risks associated with local sales, and sell to
retailers, wholesalers, or end users through their own channels
of distribution. This reduces an exporter’s risk but also reduces
its control.
2. Indirect Exporting
Company sells to intermediaries who resell to buyers in a target market.
The choice of intermediary depends on many factors, including the
importance of exports in total sales, available resources, and the growth
rate of the target market.
a. Agents
i. Individual or organization that represents one or more
indirect exporters in a target market. Compensated with
commissions on sales.
ii. Can represent several indirect exporters. Might focus
promotional efforts on products of the company paying
the highest commission.
b. Export Management Company
i. EMC exports products on behalf of indirect exporters,
operating contractually, either as an agent or as a
distributor.
ii. Additional services on retainer basis: Gather market
information, formulate promotional strategies, perform
promotional duties, research customer credit, arrange
shipping, and coordinate export documents.
iii. Advantage: deep understanding of the cultural, political,
legal, and economic conditions in target market.
Disadvantage: breadth and depth of an EMC’s service
hinders exporter’s international skills development.
iv. After the EMC contract expires, a company can go at it
alone in exporting its products.

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 c. Export Trading Company
i. ETC provides services in addition to those directly
related to indirect exporters’ activities: Export and
countertrade services, develop distribution channels,
provide storage, finance trade and investment, and even
manufacture products.
ii. Concept met limited success in the United States.
iii. Governments, financial institutions, and companies have
closer working relationships in Asia. The US regulatory
environment is wary of such arrangements, and the lines
between companies and industries are clearly drawn.
d. Freight Forwarder
i. Specialist in export related activities such as customs
clearing, tariff schedules, shipping, and insurance fees.
ii. Freight forwarders can pack shipments for export and
take responsibility for getting a shipment from the port
of export to the port of import.
14.1.4 Countertrade
Selling goods or services that are paid for, in whole or part, with other goods or
services. Developing and emerging markets often rely on countertrade to
import goods due to lack of hard currency.
1. Types of Countertrade
a. Barter: Exchange of goods or services directly for other goods
or services without the use of money.
b. Counterpurchase: Sale of goods or services to a country by a
company that promises to make a future purchase of a specific
product from that country.
c. Offset: Agreement that a company will offset a hard-currency
sale to a nation by making a future hard-currency purchase of
an unspecified product from that nation.
d. Switch trading: One company sells to another its obligation to
make a purchase in a given country.
e. Buyback: Export of industrial equipment in return for products
produced by that equipment.
2. Countertrade can provide access to markets otherwise off-limits
because of a lack of hard currency. Typically involves commodity and
agricultural products.
3. Problems arise when the price of a product declines between the barter
time and the selling time; fluctuating prices generate the same type of
risk as in currency markets. Managers might hedge this risk on
commodity futures markets as they hedge against currency fluctuations
in currency markets.

14.2 EXPORT/IMPORT FINANCING

International trade poses risks for both exporters and importers. Exporters risk not
receiving payment after delivery, whereas importers fear that delivery might not occur

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 once payment is made. There are several main export/import financing methods
(Figure 14.2):
14.2.1 Advance Payment
1. Importer pays for merchandise before it is shipped. Used when two
parties are unfamiliar with each other, the transaction is small, or the
buyer has a poor credit rating.
2. Prior payment eliminates the risk of nonpayment but creates the
complementary risk of non-shipment—importers might pay for goods
but not receive them.
14.2.2 Documentary Collection
1. Bank acts as an intermediary without accepting financial risk. Used in
ongoing business relationships between two parties. The documentary
collection process can be broken into three main stages and nine
smaller steps.
2. A draft (bill of exchange) is a document ordering an importer to pay an
exporter a specified sum of money at a specified time. A bill of lading
is a contract between an exporter and a shipper that specifies
merchandise destination and shipping costs.
3. After receiving the appropriate documents from the exporter, the
exporter’s bank sends the documents to the importer’s bank.
4. Documentary collection reduces the risk of non-shipment because the
packing list details the contents of the shipment, and the bill of lading is
proof that the merchandise was shipped. The risk of nonpayment is
increased because the importer does not pay until he receives the
necessary documents.
14.2.3 Letter of Credit
1. Importer’s bank issues a letter pledging to pay the exporter when the
exporter fulfills the terms listed in the letter.
2. Used when parties are unfamiliar with each other, an importer’s credit
rating is unknown or questionable, and when a market’s regulations
require it.
3. Banks issues the letter of credit after an importer has deposited a sum
equal to the value of the imported merchandise. The exporter then
delivers a documentary packet to its bank.
4. The exporter’s bank delivers the letter of credit and documentary
packet to the importer’s bank for review. When the importer’s bank is
satisfied that the terms of the letter have been met, it sends payment to
the exporter’s bank, which then credits the exporter’s account. The
importer pays its bank (or makes provision for future payment) and, in
return, receives the documentary packet that includes title to the
merchandise.
5. Several types of letters of credit:
a. An irrevocable letter of credit allows the bank issuing the letter to modify its terms
only after obtaining the approval of both exporter and importer.
b. A revocable letter of credit can be modified by the issuing bank without obtaining
approval from either the exporter or the importer.

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 c. A confirmed letter of credit is guaranteed by both the exporter’s bank in the country
of export and the importer’s bank in the country of import.
6. Letter of credit also reduces the risk of non-shipment over advance
payment. Risk of nonpayment is also increased over advance payment
but is lower than the letter-of-credit method because the importer’s
bank accepts the risk of nonpayment.
14.2.4 Open Account
1. Exporter ships merchandise and later bills the importer.
2. Used for sales between two subsidiaries within an international
company and when the parties are familiar with each other.
3. Reduces risk of non-shipment for importer but increases the risk of
nonpayment for exporter.

14.3 CONTRACTUAL ENTRY MODES

Some products simply cannot be traded in open markets because they are
intangible.
Companies can use a variety of contracts to market highly specialized assets
and skills in international markets.
14.3.1 Licensing
1. Contractual entry mode in which a company owning intangible
property (the licensor) grants another firm (the licensee) the right to use
that property for a limited period of time.
2. Licensors typically receive royalty payments based on a percentage of
licensee’s revenue generated by the property and may receive a one-
time fee. Commonly licensed intangible property includes patents,
copyrights, special formulas and designs, trademarks, and brand names.
3. Licensing often involves granting companies the right to use process
technologies inherent to production.
4. Cross-licensing occurs when companies employ licensing agreements
to exchange intangible property with one another.
5. Advantages of Licensing
a. Finance international expansion.
b. Low risk method of international expansion.
c. Lower likelihood of a product will be counterfeited.
d. Licensees can upgrade existing production technologies.
6. Disadvantages of Licensing
a. May restrict a licensor’s future activities.
b. May reduce global consistency in quality and marketing.
c. May lend strategically important property to competitor.
14.3.2 Franchising
1. Contractual entry mode in which one company (the franchiser)
supplies another (the franchisee) with intangible property and
assistance over an extended period. Franchisers typically receive
compensation as flat fees, royalty payments, or both.

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 2. The brand name or trademark is normally the most important item
desired by the franchisee (e.g., KFC, Starbucks).
3. Franchising differs from licensing in three ways:
a. More control over a product’s sale in a target market.
b. Licensing is fairly common in manufacturing industries and
franchising is primarily used in the service sector.
c. Licensing normally involves a one-time transfer of property and
franchising requires franchiser’s ongoing assistance.
4. Advantages of Franchising
a. Low-cost, low-risk mode of entry into new markets.
b. Allows for rapid geographic expansion.
c. Uses cultural knowledge and know-how of local managers.
5. Disadvantages of Franchising
a. May be cumbersome to manage many franchisees across
several nations.
b. Franchisees can experience a loss of organizational flexibility in
franchising agreements.

14.3.3 Management Contracts

1. One company supplies another with managerial expertise for a specific
period of time. The supplier of expertise is compensated with either a
lump-sum payment or a fee based on sales.
2. Used to transfer two types of knowledge: (1) specialized knowledge of
technical managers, and (2) business-management skills of general
managers.
3. Advantages of Management Contracts
a. Exploit an international opportunity yet risk few physical assets.
b. Nation can award contract to operate and upgrade public
utilities when a nation is short of investment financing.
c. Help nations develop skills of local workers and managers.
4. Disadvantages of Management Contracts
a. Supplier’s personnel remain exposed to political or social
turmoil in the nation.
b. Supplier of expertise may nurture a formidable new competitor
in the local market.
14.3.4. Turnkey (build-operate-transfer) Projects
1. Designing, constructing, and testing a production facility for a client.
Often large-scale and involve government agencies.
2. Transfer special process technologies or production-facility designs to a
client (e.g., power plants, telecommunications, petrochemical
facilities).
3. Advantages of Turnkey Projects
a. Firm specializes in its core competency.
b. Government obtains infrastructure from the world’s leading
companies.

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 4. Disadvantages of Turnkey Projects
a. Company may be awarded a project for political reasons rather
than for technological know-how.
b. Can create future competitors.

14.4 INVESTMENT ENTRY MODES

Investment entry modes entail the direct investment in plant and equipment in a
country coupled with ongoing involvement in the local operation.
14.4.1 Wholly Owned Subsidiaries
1. Facility entirely owned and controlled by a single parent company. Can
establish by purchasing an existing company or by forming a new
company from the ground up.
2. Whether an international subsidiary is purchased or newly created
depends on its operations: High-tech products may need new facilities
because state-of-the-art operations are hard to locate.
3. Yet a ground-up subsidiary can take time to construct new facilities,
hire and train employees, and launch production.
4. Advantages of a Wholly Owned Subsidiary
a. Managers have complete control over daily operations in the
target market and over the subsidiary’s technologies, processes,
and other intangible properties.
b. Firm can coordinate activities of all national subsidiaries.
5. Disadvantages of a Wholly Owned Subsidiary
a. Can be too expensive for small- and medium-sized firms.
b. Higher risk due to the substantial resources invested.
14.4.2 Joint Ventures
Separate company created and jointly owned by two or more independent
entities to achieve a common business objective.
1. Joint Venture Configurations
a. Forward integration joint venture
Parties invest together in activities later in value chain.
b. Backward integration joint venture
Parties invest together in activities earlier in value chain.
c. Buyback joint venture
Parties supply the venture’s inputs and absorb its output.
d. Multistage joint venture
One partner integrates backward and the other forward.
2. Advantages of Joint Ventures
a. Can reduce risk as it exposes fewer of a partner’s assets to risk
than would a wholly owned subsidiary—each partner risks only
its contribution.
b. Penetrate international markets otherwise off-limits.
c. Access another company’s global distribution network.
d. Defensive reason: Local government or government-controlled
company as a partner gives authorities a direct stake in helping
to ensure the venture’s success.

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 3. Disadvantages of Joint Ventures
a. Co-ownership can result in conflict between partners and cause
managerial paralysis.
b. Yet a loss of control over operations can result when the local
government is a partner in the joint venture.
14.4.3 Strategic Alliances
1. Two or more entities cooperate (but do not form a separate company) to
achieve the strategic goals of each.
2. Like joint ventures, can be formed for short or long periods, depending
on the goals of the participants.
3. Can be established between a company and its suppliers, its buyers, and
even competitors. Sometimes partners will purchase shares in each
other’s company.
4. Advantages of Strategic Alliances
a. Share the cost of an international investment project.
b. Tap into competitors’ specific strengths (e.g., channels of
distribution).
5. Disadvantages of Strategic Alliances
a. Can create a future competitor.
b. Conflict can arise and eventually undermine cooperation.

14.4.4 Partner Selection

1. Suitable partners must offer something valuable. Managers must
evaluate the benefits of a potential international cooperative
arrangement as they would any other investment opportunity.
2. Although the importance of locating a trustworthy partner seems
obvious, cooperation should be approached with caution.
3. Each party’s managers must be comfortable working with people of
other cultures and, perhaps, living abroad. Managers also must be
comfortable working with and within one another’s corporate culture.
4. Each partner must be firmly committed to the stated goals of the
arrangement. Detailing duties and contributions of each party through
prior negotiations helps ensure continued cooperation.

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 CHAPTER 15
DEVELOPİNG AND MARKETİNG PRODUCTS

INTRODUCTION
Globalization affects international business activities, industries, and products
differently. Some companies market an identical product worldwide, whereas others must
adjust marketing strategies across national markets.
Companies that cannot sell the same product abroad as at home must create new
products, modify promotional campaigns, or adjust their marketing strategies in some other
way.
Yet how do managers decide when their marketing strategies can remain the same or if
they need modification? This dilemma is referred to as the standardization-versus-adaptation
decision.

15.1 DEVELOPING PRODUCT STRATEGIES

15.1.1 Laws and Culture
1. Companies must adapt their products to satisfy laws and regulations in
a target market.
2. Companies sometimes must adapt their products to suit local buyers’
preferences rooted in culture.
3. Not all companies modify products but find a different cultural need
that it satisfies.
4. The fact that many developing countries have looser consumer-
protection laws can create an ethical issue if exploited.
15.1.2 Brand and Product Names
1. Brand name is the name of one or more items in a product line that
identifies the source or character of the items. Consumers assign
products a certain value based on experiences with a brand.
2. Brand names help consumers select, recommend, or reject products.
They also function as legal property that owners can protect from
competitors.
3. A consistent worldwide brand image is important as more consumers
and businesspeople travel internationally.
4. Companies must review its brand image and update it if needed.
5. Selecting International Brand and Product Names
a. Products in international markets need carefully selected names
whether standardized or localized.
b. Company and product names are made up of morphemes—
semantic elements, or language building blocks.
c. Brand names seldom offend people in international markets, but
product names can.
15.1.3 Other Product Issues
1. Counterfeit goods are imitation products passed off as legitimate
trademarks, patents, or copyrighted works. Chapter 4 presents how
companies protect intellectual property from counterfeiting.

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 2. Counterfeits can damage buyers’ images of a brand when they are of
inferior quality to the original. Buyers who purchase a brand expect a
level of craftsmanship and satisfaction, and if it fails to deliver on
expectations, the brand image is tarnished.
3. Companies traditionally extended a product’s life by introducing it into
different markets consecutively; first in industrialized nations and later
in developing markets.
4. Waterfall Strategy is the sequential introduction of a product into new
markets abroad one at a time.
5. Advanced telecommunications alert consumers around the world to the
latest product introductions; consumers in developing and emerging
markets also desire the latest products.
6. Companies now undertake new product development at a rapid pace,
which shortens product life cycles.

15.2 CREATING PROMOTIONAL STRATEGIES

Promotion mix includes activities designed to reach distribution channels and target
customers through communications such as personal selling, advertising, public
relations, and direct marketing.
15.2.1 Push and Pull Strategies
1. Pull strategy: Promotional strategy to create buyer demand that will
encourage distribution channel members to stock a company’s product.
Buyer demand is generated in order to “pull” products through
distribution channels to end-users.
2. Push strategy: Promotional strategy to pressure distribution channel
members to carry a product and to promote it to final users. Used by
producers of goods that are sold to retail outlets.
3. The strategy to use depends on several factors.
a. Distribution system: Implementing a push strategy is difficult
when channel members wield a great deal of power relative to
that of producers. It can be ineffective when distribution
channels are lengthy.
b. Access to mass media: If developing and emerging markets
have fewer forms of mass media, it can be more difficult to
increase consumer awareness and generate product demand.
Advertisers may prefer billboards and radio if consumers cannot
afford cable or satellite TV.
c. Type of product: A pull strategy is appropriate when buyers
display brand loyalty; brand-loyal buyers know what they want
before they buy it. Push strategies are appropriate for
inexpensive consumer goods among buyers who are not brand
loyal; buyers will the brand carried by the seller. A push strategy
is also suited for industrial products because potential buyers
usually need to be informed about a product’s special features
and benefits.
15.2.2 International Advertising

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 International advertising differs from domestic advertising. Cultural
similarities mean ads are only slightly modified in different nations. Cultural
differences may mean that entirely new ads must be created.
1. Standardizing or Adapting Advertisements
a. Most advertising in any one nation is produced solely for that
domestic audience. Companies that advertise in multiple
markets must determine which aspects of the advertising
campaign to standardize.
b. Companies can reach a global audience by sponsoring global
sporting events, such as the Olympics and World Cup Soccer.
c. Marketers tried to standardize advertising across Europe to
appeal to a so-called Euro-consumer. Many attempts failed for
language and cultural reasons. Successful pan-European ads are
highly visual, contain few words, and focus on the product and
consumer.
15.2.3 Communicating Promotional Messages
1. Marketing communication is the process of sending
promotional messages about products to target markets.
2. Marketing internationally often means translating promotional
messages from one language to another. Marketers must also be
knowledgeable of cultural nuances that affect how buyers
interpret a promotional message.
3. Laws that govern promotion in another country also can force
changes in marketing communication.
4. Marketing communication is typically considered a circular
process:
i. The company with an idea to communicate is the
source.
ii. The idea is encoded (translated into images, words, and
symbols) into a promotional message.
iii. The promotional message is sent to the audience
(potential buyers) through various media. The audience
receives the message, decodes the message, and
interprets its meaning.
iv. Information in the form of feedback (purchase or
nonpurchase) flows to the source of the message.
v. The decoding process can be disrupted by the presence
of noise—anything that disrupts the audience’s ability to
receive and interpret the promotional message.
Language barriers between the company and potential
buyers create noise if a company’s promotional message
is incorrectly translated into the local language.
15.2.4 Blending Product and Promotional Policies
Companies extending marketing to international markets develop
communication strategies that blend product and promotional strategies. The

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 right communication strategy considers the nature of the product and the
promotion mix. There are five product/promotional methods.
1. Product/communication extension (dual extension)
a. Extends the same home-market product and marketing
promotion into target markets. Under certain conditions, it can
be the simplest and most profitable strategy.
b. May grow more popular as technology ties the world together.
Best suited for companies selling upscale, brand-name personal
items using a global strategy.
c. Useful to low-cost leaders in their industries; one product and
one promotional message keep costs down.
2. Product extension/communication adaptation
a. Extends the same product into new target markets but alters its
promotion. Requires communications adaptation because the
product satisfies a different need, serves a different function, or
appeals to a different type of buyer.
b. The product is not altered so it contains costs; developing new
promotional campaigns is expensive.
c. Communications may need to be adapted in developing markets
because media coverage can be limited. Marketers can instead
use door-to-door personal selling and regional product shows or
fairs.
3. Product adaptation/communication extension
a. Requires a company to adapt its product to the international
market yet retain the original marketing communication.
b. Company may adapt its product for reasons such as legal
requirements in the local market. Governments can require
certain local materials, labor, or other resources in local
production process; if the same materials are not available
locally, the product may be modified.
c. Can be costly, especially if a company invests in production
facilities to remain close to buyer preferences. It can be
successful if a firm sells a differentiated product and charges a
higher price to offset production costs.
4. Product/communication adaptation (dual adaptation)
a. Adapts a product and its marketing communication to suit the
target market. The product itself is adapted to match the needs
or preferences of local buyers. The promotional message is
adapted to explain how the product meets those needs and
preferences.
b. High cost means few companies employ this strategy; it can be
implemented successfully if a large and profitable market
segment exists.
5. Product invention

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 a. Requires that an entirely new product be developed for the
target market. Product invention is necessary when many
differences exist between the domestic and target markets.
b. One reason for invention is that local buyers cannot afford a
product because of low purchasing power.
c. Product inventions can arise due to poor infrastructure.

15.3 DESIGNING DISTRIBUTION STRATEGIES

Distribution is planning, implementing, and controlling the physical flow of a
product from its point of origin to its point of consumption.
The physical path that a product follows on its way to customers is called a
distribution channel.
1. Service providers such as consulting companies, health-care organizations, and
news services need distribution channels as well as goods manufacturers.
2. Companies develop their international distribution strategies based on two
related decisions: (1) how to get the goods into a country and (2) how to
distribute goods within a country.
15.3.1 Designing Distribution Channels
When managers establish distribution policies, they consider the market
exposure needed and the cost of distribution.
1. Market Exposure
a. Exclusive channel: Manufacturer grants the right to sell its
product to only one or a limited number of resellers. Producers
have significant control over sales to wholesalers and retailers.
b. Exclusive channels create barriers for outsiders to penetrate the
channel and helps constrain distributors from selling competing
brands.
c. Intensive channel: Producer grants the right to sell its product to
many resellers. Provides convenience because of the many
outlets through which a product is sold. It does not create strong
barriers to channel entry, nor provide control over reseller
decisions such as what competing brands to sell.
d. Obstacle for small companies that choose intensive channels is
gaining shelf space. This is exacerbated by the increasing global
trend toward retailers developing their own brands.
2. Cost and Channel Length
a. Channel length refers to the number of intermediaries between
the producer and the buyer.
b. In a zero-level channel (called direct marketing) producers sell
directly to final buyers. In a one-level channel there is one
intermediary between producer and buyer, and so on.
c. Cost goes up as the number of intermediaries rises because each
one adds a fee for services.
15.3.2 Special Distribution Issues

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 1. Value density: Value of a product relative to its weight and volume; an
important variable in formulating distribution policies.
2. As a rule, the lower a product’s value density, the more localized the
distribution system. Commodities, including cement, iron ore, and
crude oil, have low value density ratios. This means that the cost to
transport these goods is high relative to their values.
3. Products with high value-density ratios include monitors,
semiconductors, and premium perfumes. Because the cost of
transporting these products is small relative to their values, they can be
processed or manufactured in optimal locations, then shipped to
markets worldwide.
4. Some companies’ products are substantially similar worldwide yet
require small manufacturing adjustments in the final production stage.
When products need to be modified for local markets, companies can
design their distribution system accordingly.
5. Each nation’s distribution system develops over time and has some
unique characteristics. A good understanding of the distribution system
can reduce uncertainty and risk.

15.4 DEVELOPING PRICING STRATEGIES

The pricing policy must match a company’s overall international strategy.
15.4.1 Worldwide Pricing
Pricing strategy in which a product has the same price in all international
markets. It can be difficult to achieve for four reasons.
1. Production costs differ from one nation to another.
2. Producing in just one location cannot guarantee the same selling price
in international markets because of the different cost of reaching
different markets.
3. Purchasing power of local buyers must be considered.
4. Fluctuating currency values can affect a product’s price abroad.
15.4.2 Dual Pricing
Pricing strategy in which a product has a different price (typically higher) in
export markets than it has in the home market.
1. Price escalation is the name for when a product has a higher selling
price in the target market than it does in the home market. This
typically results from exporting costs and currency fluctuations.
2. But a product’s export price can be lower than that in the home market.
This can occur when a company wants exports to cover only additional
costs associated with exporting (e.g., tariffs).
3. To apply dual pricing in international markets domestic and
international buyers must be kept separate. If not, buyers could
undermine the policy through arbitrage—buying products at lower
prices in one market and reselling them at higher prices in others.
15.4.3 Factors That Affect Pricing Decisions
1. Transfer Price

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 Price charged for a good or service transferred among a company’s
headquarters and its subsidiaries.
a. Companies enjoy great freedom in setting transfer prices;
subsidiaries in countries with high taxes charged other
subsidiaries low prices. This lowers the parent company’s
overall taxes by lowering profits in the high-tax country.
b. The ability to manipulate earnings using transfer prices may
change with the signing of a global tax treaty among more than
130 nations in 2021. The extent to which the practice is reduced
depends on how many nations follow through on ratifying the
treaty and if it can be enforced.
2. Arm’s Length Pricing
Free-market price that unrelated parties charge one another for a
specific product.
a. Many governments now assign arm’s length prices to clamp
down on tax avoidance. There is also pressure on companies to
be good corporate citizens in target markets.
b. Developing and emerging markets suffer from lost revenue
when international companies manipulate prices to reduce
tariffs and taxes. These nations need revenue to build schools,
hospitals, and infrastructure, which in turn, benefit companies
by improving local productivity and efficiency.
3. Price Controls
Upper or lower limits placed on the prices of products sold within a
country.
a. Upper-limit price controls provide price stability when prices
are rising. Companies that want to raise prices must apply to
government authorities.
b. Lower-limit price controls can be imposed to help local
companies compete against lower-priced imports or done to
ward off price wars.
4. Dumping
Price of a good is lower in export markets than in a company’s
domestic market.
a. Accusations of dumping are often made against foreign
competitors when inexpensive imports flood a domestic market.
b. Although charges of dumping normally result from deliberate
efforts to undercut the prices of competitors in the domestic
market, changes in exchange rates can cause unintentional
dumping.
c. Antidumping tariffs punish producers in the offending nation by
increasing the price of their products.

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 CHAPTER 16
MANAGİNG INTERNATİONAL OPERATİONS

INTRODUCTION
Essential to success in international markets are production strategies, including the
decision to centralize or decentralize production and standardize or adapt production to
national markets.

16.1 PRODUCTION STRATEGY

Careful planning of production helps companies cut costs to become low-cost
leaders and to design new products or product features necessary for a differentiation
strategy.
16.1.1 Capacity Planning
Assessing a company’s ability to produce enough output to satisfy market
demand.
1. If capacity now used is greater than the expected market demand,
production must be scaled back.
2. Yet countries have different laws regulating the ability of employers to
eliminate jobs; depending on the country, a firm may or may not need
to give advance notice of layoffs or plant closings.
3. If market demand is growing, managers must determine in which
facilities to expand production or whether additional facilities are
needed to expand capacity.
4. Capacity planning is also extremely important for service companies.
For example, a hotel needs to estimate the number of rooms to offer,
business meeting rooms, a Wi-Fi system, videoconferencing
capabilities, and so on.
16.1.2 Facilities Location Planning
Selecting a location for production facilities.
1. Factors include the cost and availability of labor and management, raw
materials, component parts, energy, political stability, extent of
regulation and bureaucracy, economic development, and local culture,
including beliefs about work and important traditions.
2. Reducing production costs through lower wages is often needed when
labor accounts for a large portion of production costs.
3. Service companies must locate near their customers and consider
customers’ needs when locating facilities.
4. Supply issues are important in location planning. Greater distances
between production facilities and target markets lengthens the time for
customers to receive shipments.
5. Maintaining larger inventories in target markets may be needed in case
of potential shipment delays. This increases the cost of storage and
insurance.
6. Shipping costs are greater when production is conducted far from target
markets. Transportation costs are a driving force behind the
globalization of the steel and potentially other industries.

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 7. Location Economies
Economic benefits derived from locating production activities in
optimal locations.
a. Companies can take advantage of location economies by
undertaking business activities there or obtain products and
services from companies located there.
b. The key point is that each production activity generates more
value in a particular location than could be generated
elsewhere. The productivity of a location is heavily influenced
by labor and capital.
8. Centralization Versus Decentralization
a. Centralized production concentrates production facilities in one
location. Decentralized production spreads facilities over
several locations—can mean a facility in each market.
b. Companies pursuing low-cost leadership often centralize
production facilities as much as possible to benefit from
economies of scale.
c. Low-cost leaders sell undifferentiated products in all markets
and do not need to be near markets to observe buyer
preferences. They can choose locations with the lowest
combined production and transportation costs.
d. Companies selling differentiated products find that
decentralized production close to customers improves
responsiveness to buyer preferences.
e. Firms must balance the cost of getting inputs into production
and getting products to market.
f. R&D and manufacturing tend to locate closer together if
cooperation is needed to achieve differentiation. Yet technology
allows for greater separation today.
16.1.3 Process Planning
Deciding the process that a company will use to create its product.
1. Low-cost strategies often require large-scale production because
producers want the cost savings from economies of scale.
2. Differentiation strategies demand extra value by offering something
unique, such as superior quality, added features, or special brand
images.
3. Availability and cost of labor is crucial. If labor in a host country is
relatively lower cost, a company may opt for less technology and more
labor-intensive production methods.
4. Standardization Versus Adaptation
a. Production processes can be standardized or adapted for
modified products in different markets.
b. Large production batches reduce the cost of producing each unit
and offset higher initial investment in automation. Costs are
further reduced as employees work and learn.

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 c. Differentiation often requires decentralized facilities to improve
local responsiveness. These facilities produce for national or
regional markets and tend to be smaller but increase per-unit
production costs. R&D costs are higher for products with
special designs, styles, and features.
16.1.4 Facilities Layout Planning
Deciding the spatial arrangement of production processes within production
facilities.
1. If an abundance of space combines with a lower cost of land,
companies can have more flexibility in designing facilities.
2. Facility layout depends on the type of production process, which
depends on a company’s business-level strategy. Just-in-time inventory
may reduce facility size due to lower inventories.

16.2 ACQUIRING PHYSICAL RESOURCES

International companies need to decide whether to acquire facilities and
production equipment or build their own.
They must decide whether to make or buy products for production processes,
and determine the sources of any required raw materials.
The make-or-buy decision refers to deciding whether to make a product or to
buy it from another company.
16.2.1 Reasons to Make
Vertical integration is the process whereby a company extends its control over
additional a stage of production that provides an input or receives an output. A
company that integrates upstream into activities that provide an input engages
in backward integration. One that integrates downstream into activities that
receive an output engages in forward integration.
1. Lower Costs
a. Companies use in-house production when it costs less than
buying on the open market.
b. Producing a product can (1) avoid potential import tariffs that
add to cost, and (2) avoid additional services provided by
intermediaries that increase costs.
c. Smaller companies may be less likely to make, unless they own
special technology or another competitive advantage.
2. Greater Control
a. Making products can give managers greater control over raw
materials, product design, and the production process itself—all
important factors in product quality.
b. In-house production can also eliminate the need for a company
to persuade a supplier to specially modify a product on its
behalf.
c. A company may also make a product when buying would
require it to provide key technology to a supplier.
16.2.2 Reasons to Buy

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 Outsourcing is buying from another company a good or service that is part of a
company’s value-added activities. By outsourcing, a company can reduce the
degree to which it is vertically integrated and lessen the overall number of
specialized skills and knowledge that it must possess.
1. Lower Risk
a. Buying a product can avoid exposing facilities, equipment, and
employees to social unrest or open conflict.
b. Reduces the need for insurance coverage needed in an unstable
country. Still, political instability can cause delays in receiving
needed parts through global value chains.
2. Greater Flexibility
a. Buying a product can reduce the need to invest in specialized
equipment and facilities that reduce flexibility.
b. Sourcing products from one or more outside suppliers retain or
gain flexibility.
c. Buying from several suppliers in different countries still allows
for outsourcing from one location if instability interrupts the
supply chain in another.
d. Buyers can react to a volatile exchange rate that increases the
cost of imported product by switching among multiple suppliers
in different countries and currencies.
e. Maintaining operational flexibility by not investing in
production facilities can allow a company to alter its product
line quickly.
f. By not locking up its capital in plant and equipment a company
maintains financial flexibility to access capital and pursue
opportunities.
3. Market Power
a. Buyers can gain a great deal of power with suppliers simply by
becoming important customers.
b. Sometimes a supplier can become bound to one particular
customer and increase a buyer’s market power.
c. This can give a buyer significant control with respect to
suppliers in dictating quality improvements, making special
modifications, and forcing cost reductions.
16.2.3 Raw Materials
1. The twin issues of quality and quantity drive many decisions about raw
material acquisition.
2. Some industries and companies rely almost exclusively on the quantity
of locally available raw materials. Adequate supply must be available
to justify investment.
3. Raw material quality has a huge influence on the quality of a
company’s end product. Certain products require a minimum quality of
an ingredient product.
16.2.4 Fixed Assets

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 1. Fixed assets are physical items that a company plans to use over the
long term to help generate income. Examples include production
facilities, inventory warehouses, retail outlets, and office equipment.
2. Companies can either (1) acquire or modify existing factories, or (2)
build new facilities—called a greenfield investment.
3. Considering either option involves many individuals, such as
production managers, site-acquisition experts, and legal staff.
4. Local infrastructure must support proposed on-site business operations.

16.3 KEY PRODUCTION CONCERNS

Company strategy and its organizational structure play a role in determining
the number and location of manufacturing facilities.
Let’s see how manufacturing companies maximize quality and minimize
shipping and inventory costs, and examine some important reinvestment-versus-
divestment decisions.

16.3.1 Quality Improvement Efforts

1. Quality improvement efforts help keep production costs low by
reducing waste in valuable inputs, reducing the cost of retrieving
defective products, and reducing the cost to dispose of defective
products.
2. Furthermore, a minimum level of acceptable quality is an aspect of
every product today. A company that combines a low-cost position with
a high-quality product can gain a competitive advantage.
3. Quality is also important for service providers, yet complex because
services are often created and consumed simultaneously. Activities
conducted prior to service delivery are also important.
4. Total Quality Management
a. TQM is a company-wide commitment to meet or exceed
customer expectations through continuous quality improvement
efforts and processes. Each individual is responsible for
focusing on the quality of their output.
b. By continuously improving quality, a company differentiates
itself from rivals and attracts loyal customers.
5. ISO 9000
a. International Standards Organization (ISO) 9000 is a series of
individual standards that a company is certified as achieving
when it meets the highest quality standards in its industry.
b. To become certified companies must demonstrate the reliability
and soundness of all business processes that affect the quality of
their products.
16.3.2 Shipping and Inventory Costs

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 1. Shipping costs can have a dramatic effect on the cost of getting
materials and components to the location of production facilities.
2. Shipping costs are affected by a nation’s business environment, such as
its level of economic development, including the condition of seaports,
airports, roads, and rail networks.
3. Because storing inventory is costly, companies might adopt just-in-time
(JIT) manufacturing—inventory is kept to a minimum and inputs arrive
to the production process exactly when they are needed.
4. JIT drastically reduces the costs of large inventories and reduces
wasteful expenses because defective materials and components are
spotted quickly during production.
5. The technique quickly spread throughout manufacturing industries
worldwide. But the global pandemic highlighted the supply chain
shortages that can result from maintaining low inventories.
16.3.3 Reinvestment versus Divestment
1. Companies tend to reinvest profits in markets that require lengthy
payback periods as long as the extended outlook is good.
2. They reinvest when a market is experiencing rapid growth. Investing in
expanding markets is attractive because potential customers may not
yet be loyal to one company or brand.
3. Companies tend to scale back or divest international operations if it is
apparent that profitability will take longer than expected.
4. Political, social, or economic problems can force companies to reduce
or eliminate operations altogether.
5. Companies invest in operations that offer the best return on investment.
This can mean reducing or divesting operations in profitable markets to
invest in more profitable opportunities elsewhere.

16.4 FINANCING BUSINESS OPERATIONS

Companies need financial resources to pay for operating expenses and to fund
new projects.
They must buy raw materials and component products for manufacturing and
assembly activities.
At times they need large sums of capital to expand production capacity or enter
new geographic markets.
They must also pay for training and development programs, compensate
employees, and advertise.
16.4.1 Borrowing
1. International companies (like domestic companies) try to get the lowest
interest rates possible on borrowed funds.
2. Difficulties include exchange-rate risk, restrictions on currency
convertibility, and restrictions on international capital flows.
3. Borrowing locally can be advantageous, especially when the value of
the local currency has fallen against that of the home country.
4. Yet companies are not always able to borrow funds locally and may be
forced to seek international sources of capital.

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 5. A back-to-back loan is one in which a parent company deposits money
with a host-country bank, which then lends the money to a subsidiary
located in the host country.
16.4.2 Issuing Equity
The international equity market consists of all stocks bought and sold outside
the home country of the issuing company. This helps firms access investors
with funds unavailable domestically. Yet getting shares listed on another
country’s stock exchange can be complex.
1. American Depository Receipts
a. To maximize international access to funds, non-US companies
list themselves on US stock exchanges by issuing American
Depository Receipts (ADRs)—certificates that trade in the
United States and that represent a specific number of shares in a
non-US company.
b. International companies may also issue Global Depository
Receipts (GDRs). These are similar to ADRs but are listed and
traded in London and Luxembourg.
c. Advantages of ADRs: (1) Buyers pay no currency-conversion
fees, (2) there are no minimum purchase requirements, and (3)
ADRs appeal to US mutual funds that are limited in how much
money they can invest in companies not registered on US
exchanges.
2. Venture Capital
a. Venture capital is financing from investors who take part
ownership in a business that is expected to experience rapid
growth.
b. Venture capitalists invest in new risky ventures because they
can generate large returns on investment.
c. The venture capital industry has become global.
3. Emerging Stock Markets
a. Emerging stock markets tend to be volatile because investments
are often hot money—portfolio investment that can be quickly
withdrawn in a crisis. By contrast, patient money is direct
investment in factories, equipment, and land that cannot be
withdrawn as easily.
b. Moreover, large and sudden selloffs of equity can occur in
emerging stock markets because of uncertainty regarding the
nation’s future economic growth.
16.4.3 Internal Funding
Ongoing international business activities and new investments can also be
financed internally with funds supplied by the parent company or its
international subsidiaries (see Figure 16.2).
1. Internal Equity, Debt, and Fees
a. Parent companies often finance the operations of new
subsidiaries until they grow financially independent.

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 b. Subsidiaries can obtain capital by issuing equity solely to the
parent, which benefits from an appreciating share price.
c. In return, subsidiaries with excess cash loan money to parent or
sister companies when they need capital.
2. Revenue from Operations
a. Revenue is money earned from the sale of goods and services. It
is the lifeblood of international companies and their
subsidiaries.
b. For long-term success, a company must generate sufficient
revenue to sustain day-to-day operations. Outside financing is
used only to expand operations or survive lean periods.
c. A transfer price is the price charged for a good or service
transferred between a company and subsidiaries. Transfer
pricing can be used if there are no national restrictions on the
use of foreign exchange or on the repatriation of profits from
host countries.
16.4.4 Capital Structure
1. A company’s capital structure is the mix of equity, debt, and internally
generated funds used to finance a company’s activities.
2. Firms try to strike the right balance among financing methods to
minimize risk and the cost of capital.
3. If a company defaults on its payments to creditors, it can be forced into
bankruptcy. The same is true for holders of preferred stock.
4. Thus, a company prefers to not carry so much debt in relation to equity
that it increases its risk of insolvency.
5. Debt appeals to companies because interest payments are deducted
from taxable earnings—lowering income tax owed.
6. National restrictions can influence an MNC’s choice of capital
structure, including limits on international capital flows, the cost of
local versus international financing, access to international financial
markets, and currency exchange controls.

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 CHAPTER 17
HİRİNG AND MANAGİNG EMPLOYEES

INTRODUCTION
Human resource management (HRM) is the process of staffing a company and
ensuring that employees are as productive as possible.
It requires managers to be effective in recruiting, selecting, training, developing,
evaluating, and compensating employees and in forming good relationships with them.
International HRM differs considerably from domestic HRM.
There is the issue of expatriates—citizens of one country who are living and working
in another. And culture is central to the discussion of HRM in international companies.

17.1 INTERNATIONAL STAFFING POLICIES

Staffing policy is the customary means by which a company staffs its offices. It
is influenced by the extent of a firm’s international involvement.
Three approaches to staffing international operations are often blended in
practice.
17.1.1 Ethnocentric Staffing
Individuals from the home country manage operations abroad.
1. Appeals to companies that want control over decision making abroad
and that formulate policies designed to work in every country. This
policy is primarily used only for top managerial posts internationally
because it can be too costly and impractical at lower levels.
2. Advantages of Ethnocentric Staffing
a. Can help overcome a competitive local labor market as foreign
and local companies compete for a limited number of talented
individuals available locally.
b. Can help recreate operations in the image of home-country
operations, which is important for companies wanting to instill
shared values across all national subsidiaries.
c. Some companies believe that managers sent from the home
country will look out for the company’s interests more than
host-country natives will. Can be important in nationalistic
markets and when concerned with industrial espionage.
3. Disadvantages of Ethnocentric Staffing
a. Expense of relocating managers and families from the home
country plus relocation bonuses can grow expensive.
b. The presence of home-country managers in the host country can
contribute to a “foreign” image of a business. This can make
lower-level employees feel that managers do not understand the
culture and their needs.
17.1.2 Polycentric Staffing
Individuals from the host country manage operations abroad.
1. Well-suited to companies that want to grant national units a significant
amount of autonomy in decision making.

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 2. Managers new to the company can visit the home office for an
extended period to learn its culture and business practices.
3. Advantages (+) and Disadvantages (−) of Polycentric Staffing
a. (+) Managers have deep understanding of the local market. The
understand the subtle cues of the culture and need not overcome
cultural barriers. They may have a better feel for the needs of
employees, customers, and suppliers.
b. (+) Eliminates the high cost of relocating expatriate managers
and families.
c. (−) A company can become a collection of national businesses
The potential lack of integration, knowledge sharing, and
common image may negatively impact performance of a
company with a global strategy.
17.1.3 Geocentric Staffing
The best-qualified individuals of any nationality manage operations abroad.
1. The local manager is from the host country, the home country, or a
third country depending on the operation’s needs. This policy is often
reserved for top-level managers.
2. Advantages (+) and Disadvantages (−) of Geocentric Staffing
a. (+) Develops global managers who can adjust easily to any
business environment and cultural differences Useful for
companies trying to break down nationalistic barriers between
subsidiaries.
b. (−) Can be costly to implement. The high demand for people
with these special skills can inflate their salaries.

17.2 RECRUITING AND SELECTING HUMAN RESOURCES

Companies try to recruit and select qualified managers and nonmanagerial workers
who are well suited to their tasks and responsibilities.
17.2.1 Human Resource Planning
Forecasting a company’s human resources needs and its supply.
1. Phase one: Take inventory of a company’s current human resources.
Data is collected on employees, including education, job skills,
previous jobs, language skills, and experience living abroad.
2. Phase two: Estimate future HR needs and whether to hire employees or
to subcontract production to other producers.
a. This decision can raise ethical questions. Subcontracting work
to lower-wage nations and allegations of workplace abuse has
encouraged many firms to establish codes of conduct and take
steps to ensure compliance.
3. Phase three: Develop a plan for recruiting and selecting people to fill
vacant and anticipated positions.
a. Companies sometimes must also make plans for reducing its
workforce—a process called decruitment—when current HR
levels are greater than anticipated.
17.2.2 Recruiting Human Resources

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 Identifying and attracting qualified applicants for vacant positions.
1. Current Employees
a. Likely candidates within the company are those managers who
were involved in previous stages of an international project.
b. These individuals may have important contacts in the host
country and have been exposed to its culture.
2. Recent College Graduates
a. Recent college graduates who have come from other countries
to attend college in the firm’s home country.
b. Common practice among US companies. New hires receive
general and specialized training and receive positions in their
native countries. They learn about the organization’s culture and
how it conducts business.
c. Familiarity with the culture of the target market, including its
customs, traditions, and language is very important.
3. Local Managerial Talent
a. Hiring local managers is common when cultural understanding
is a key job requirement.
b. Local managers with government contacts may speed the
approval process for local operations.
c. Governments may force a company to recruit local managers to
develop its own managerial talent.
d. Governments may restrict the number of international managers
that can work in the host country.
4. Nonmanagerial Workers
a. Companies recruit locally for nonmanagerial positions if there
is little need for specialized skills or training.
b. A specialist from the home country can be brought in to train
people chosen for more demanding positions.
c. Companies recruit locally when government restricts the
number of foreign workers allowed in the host country; this can
reduce local unemployment rates.
d. Some countries will allow foreign nonmanagerial workers.
17.2.3 Selecting Human Resources
Screening and hiring the best-qualified applicants with the greatest
performance potential.
1. For international assignments, it is essential to measure a person’s
ability to bridge cultural differences.
2. Expatriate managers must adapt to a new way of life in the host country
and work with others from different cultural backgrounds.
3. Culturally sensitive managers increase the likelihood that a company
will achieve its business goals.
4. Recruiters assess cultural sensitivity by asking candidates questions
about their receptiveness to new ways of doing things and can employ
global aptitude tests.

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 5. The cultural sensitivity of each family member moving to the host
country needs assessment to help avoid expatriate failure.
17.2.4 Culture Shock
Psychological process affecting people living abroad that is characterized by
homesickness, irritability, confusion, aggravation, and depression.
1. A person experiencing it has trouble adjusting to the new environment
in which they find themselves.
2. Sometimes employees return early from an international assignment
because of cultural stress.
3. Selecting managers who are comfortable living in unfamiliar cultures is
an extremely important factor when recruiting for international posts.
17.2.5. Reverse Culture Shock
Psychological process of re-adapting to one’s home culture.
1. Values and behavior that once seemed so natural can now seem strange
and unnatural.
2. Returning managers may find that either no position or a standby
position awaits them in the home office.
3. Companies sometimes do not take advantage of the cross-cultural
capabilities of managers who have spent many years abroad.
4. Expatriates who successfully adapt to new cultures sometimes leave
their companies after returning home due to difficulty blending back
into the company culture.
5. Overcoming Reverse Culture Shock
a. Spouses and children can also have difficulty leaving an
adopted culture and returning home.
b. Home-culture reorientation programs and career counseling for
returning managers and families can be effective.
c. Employers can bring the family home for a short stay prior to a
permanent return to lessen reverse culture shock.
d. Career development programs can help companies retain
valuable managers—ideally these are designed prior to an
employee going abroad.
e. A mentor can be assigned to a returning manager and be
someone with whom the manager can discuss issues related to
work, family, and readjusting to the home culture.

17.3 TRAINING AND DEVELOPMENT

After recruitment and selection, a company identifies the skills and knowledge needed
to perform duties. Employees lacking the necessary skills or knowledge go into
training or development programs. Major providers of online training include
Coursera, LinkedIn learning, Skillsoft and Udemy to name only several. Online
learning is delivering a consistent message to an infinite number of employees
worldwide.
17.3.1. Methods of Cultural Training (see Figure 17.1)

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 1. The extent of a company’s international involvement requires a
corresponding level of cultural knowledge from employees.
2. Highly international companies need employees with language fluency
and in-depth experience abroad. Small companies or those new to
global business can begin with basic cultural training.
3. The goal of cultural training is to create informed, open-minded, and
flexible managers with a level of cultural training appropriate to the
duties required of them.
4. Environmental briefing and cultural orientations
a. Environmental briefings include information on local housing,
health care, transportation, schools, and climate.
b. Cultural orientations offer insight into social, political, legal,
and economic institutions.
5. Cultural assimilation and sensitivity training
a. Cultural assimilation teaches the culture’s values, attitudes,
manners, and customs, and basic phrases in the local language.
b. This can involve role-playing whereby a trainee responds to a
situation and is evaluated by a team of judges.
c. Sensitivity training teaches people to be considerate and
understanding of other peoples’ feelings and emotions.
6. Language training
a. This gets a trainee “into the mind” of local people to learn more
about why people behave as they do.
b. This is perhaps the most critical part of cultural training for
long-term assignments.
c. Foreign-language skills among top executives may provide a
competitive edge.
d. Trainees should learn around 3,500 words—enough to be
understood in most situations.
7. Field experience
a. Field experience involves visiting the culture, mingling with the
local people, and embedding oneself in the local culture for
some time.
b. The trainee enjoys the unique cultural traits and feels the
stresses inherent in living in the culture.
17.3.2 Compiling a Cultural Profile
Cultural profiles can be helpful in deciding whether to accept an international
assignment. Sources for building a cultural profile:
1. CultureGrams: Frequent updates make this a timely source of
information. Individual sections profile each culture’s background and
its people, customs, and society. It also provides information of
required entry visas and vaccinations.
2. Bureau of Consular Affairs: This office is found within the US
Department of State and has a good deal of relevant factual information
on various countries.

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 3. Information can also be obtained by contacting the embassies of other
countries and by locating people with firsthand knowledge and specific
books and films.
17.3.3 Nonmanagerial Worker Training
1. Nonmanagerial workers also have training and development needs,
especially in developing and newly industrialized countries where
workers may lack experience in industry.
2. This need may grow as companies continue to explore opportunities in
emerging markets.
3. In many countries, national governments cooperate with business to
train nonmanagerial workers. Japan and Germany lead the world in
vocational training and apprenticeship programs for nonmanagerial
workers.

17.4 COMPENSATION, LABOR, AND MANAGEMENT

The goal is to attract and retain the best and brightest employees and reward
them for performance.
Determining compensation is complicated because a country’s compensation
practices are rooted in its culture, laws, and economic system.
17.4.1 Managerial Employees
1. Compensation packages must reflect the cost of living—the financial
cost of maintaining a certain standard of living in a specific location.
Includes factors such as the cost of groceries, dining out, clothing,
housing, schooling, heath care, transportation, and utilities.
2. The cost of living is higher in some countries than it is in others. It
usually varies between large cities to rural towns within a country.
3. Most companies add a certain amount to an expatriate manager’s pay to
cover greater cost-of-living expenses abroad. Yet managers who
relocate to lower cost-of-living countries are paid the same amount as
they were receiving at home or they would be penalized for accepting
an international job.
4. Companies also cover other costs incurred by expatriate managers such
as high-quality local education.
5. Managers recruited from within the host country generally receive the
same pay as managers who work for local companies.
6. Bonuses and Benefits
a. Companies commonly offer inducements for international
postings; the most common being a financial bonus.
b. Hardship pay is additional compensation for working in a
country with particularly difficult living conditions.
c. The US government offers citizens working abroad a “foreign-
earned income exclusion.” Citizens can exclude $112,000 (for
tax year 2022 and adjusted each year for inflation) from their
taxable income, even if it is earned in a country that does not

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 tax income. Earnings above that amount are taxed, as are non-
financial benefits received.
7. Companies should have in place policies to handle expatriates’
emergency medical expenses. Also, some benefits are mandated by the
host-country government.
17.4.2 Nonmanagerial Workers
Two main factors influence the wages of nonmanagerial workers.
1. First, their compensation is strongly influenced by increased cross-
border business investment. Workers’ wages tend to equalize across
borders when employers can relocate easily internationally. Jobs and
improvement in some workers’ lives can come at workers’ expense in
other nations.
2. Second, labor is more mobile than ever before. For example, EU
countries have abolished the requirement that workers from one EU
nation obtain visas to work in another.
17.4.3 Labor−Management Relations
Positive or negative relations between a company’s workers and its
management.
1. Companies are better able to surmount unexpected obstacles when
management and workers cooperate with each other.
2. One way to increase morale and generate commitment to improved
quality and customer service is to reward workers with a greater stake
in the company.
3. Because relations between labor and management are human relations,
they are rooted in culture and are affected by political movements.
4. Large international companies tend to make high-level labor decisions
at home and leave lower-level decisions to managers in each country.
Localizing management decisions can foster better labor–management
relations.
5. A labor union is an organization that represents workers’ interests in
negotiating with employers. Negotiations are often rooted in drives for
better wages and working conditions.
6. Under codetermination, German workers enjoy a direct say in the
strategies and policies of their employers.
7. International Labor Movements
a. Unions around the world are improving the treatment of
workers and reducing incidents of child labor.
b. Yet it can be difficult for a union in one nation to support its
counterpart abroad. Events abroad are difficult to comprehend
and workers sometimes compete for the jobs that multinational
companies offer.
c. Labor unions in one country might offer concessions to attract
the jobs created by a new production facility.
d. Some argue that this phenomenon creates downward pressure
on wages and union power worldwide.

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