1. Business in a Global Economy4
Business in a Global Economy
Better Business
4th Edition
Solomon · Poatsy · Martin
chapter
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Learning Objectives
1. What are the implications of the globalization of markets and the globalization of production? 2. Why has globalization accelerated so rapidly? 3. What are the costs and benefits of international trade? 4. What are the different types of trade barriers? 5. What are the three basic strategies of international business? 6. How can international firms successfully enter foreign markets? 7. What are exchange rates and how do they affect international business? 8. What economic factors and challenges play a role in conducting business on a global scale? 9. What are the sociocultural, political, legal, and ethical challenges to conducting business in a global marketplace?
In this chapter, we will study:
Implications of the globalization of markets and the globalization of production
Why globalization accelerated so rapidly
The costs and benefits of international trade
Different types of trade barriers
Three basic strategies of international business
Strategies for entering foreign markets
Exchange rates and how they affect international business
Economic factors that challenge global business
Sociocultural, political, legal, and ethical factors that challenge global business
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What Is Globalization?
Globalization: the movement toward a more interconnected and interdependent world economy
Globalization of markets
Globalization of production
Learning Objective 1: What are the implications of the globalization of markets and the globalization of production?
Globalization, the movement toward a more interconnected and interdependent world economy, may be one of the most profound factors affecting people around the globe.
Globalization of markets refers to the movement away from thinking of the market as being the local market or the national market to the market being the entire world.
Globalization of production, the other facet of globalization, refers to the trend of individual firms moving production to different locations around the globe to take advantage of lower costs or to enhance quality.
Globalization is why you’ll notice that many products you own were made in countries other than the United States. Not only has globalization affected individual lives, it has also affected the way companies conduct business around the world.
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4. How Does Globalization Make It Easier to Produce Products?
Outsourcing—the assignment of certain tasks, such as production or accounting, to an outside company or organization
- Offshore outsourcing (offshoring)— movement of production or other functions from a domestic site to a foreign location
An interconnected world economy helps companies to manufacture and produce products.
When a company assigns tasks, such as production or accounting to an outside organization, they are outsourcing. Outsourcing allows companies to focus on what they do best.
Through globalization, companies can outsource to other countries, where costs may be lower. This is referred to as offshore outsourcing (or offshoring).
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5. Why Has Globalization Accelerated?
Decline in trade and investment barriers
Technological innovations
Communications
Transportation
Information technology
Learning Objective 2: Why has globalization accelerated so rapidly?
Trade and investment barriers are government restrictions that prevent the flow of goods, services, and financial capital across national boundaries.
The lowering of trade barriers makes global business much cheaper and easier.
The lowering of trade and investment barriers also lets international firms move their production facilities to the location with the lowest cost for that activity, serving the world market from that location.
Technological innovations have also made it possible to manage the global production and marketing of products. Consider the dramatic advances in communications, transportation, and information technology.
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6. Global Business Trends
Growing role for developing nations
Increase in non-U.S. foreign direct investment
Rise in multinational enterprises
Increasing democratization
Four noteworthy global business trends exist:
A growing role for developing nations. In the last decade, U.S. dominance of world output and world exports has declined in relative terms due to the rapid economic growth of other countries.
A rise in non-U.S. foreign direct investment, or FDI. Over the last 30 years, U.S. dominance of foreign direct investment, which is the purchasing of property and businesses in foreign nations, has declined. More FDI is flowing into the United States and into developing nations.
A rise in non-U.S. multinational enterprises. Over the last several decades, there has been a rise in the importance of non-U.S. multinational enterprises, or businesses that manufacture and market products in two or more countries. Moreover, mini-multinationals (small and medium-sized multinational enterprises) have become prominent on the world stage.
Increasing democratization. With movement to democratization and the adoption of free-market economies around the globe, many more nations are becoming involved in the global economy.
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7. International Trade and Competition
International competition:
Comparative advantage
Absolute advantage
National competitiveness
Learning Objective 3: What are the costs and benefits of international trade?
Let’s take a closer look at why countries participate in international trade, how trade affects competitiveness, and what costs and benefits are associated with international trade.
Many theories apply to international trade. The best theory is the theory of comparative advantage. To possess a comparative advantage means that a country can produce a good or service relatively more efficiently compared with other countries. It suggests that a country should sell to other countries the goods that it manufactures most efficiently and effectively, and buy from other countries the goods it cannot manufacture as efficiently or effectively.
Each nation will have a greater quantity and variety of higher-quality products to consume at lower prices.
Comparative advantage is really a relative advantage—relative to the competition.
Absolute advantage is the ability to produce more of a good or service than any other country. This doesn’t say that the country is more efficient at producing the item, just that they make more.
In many nations, governments focus on improving the nation’s resources—natural resources, labor, capital (plant, equipment, and infrastructure), technology, and innovation and entrepreneurialism—to improve competitiveness.
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8. Benefits and Costs of International Trade
Benefits: Higher standard of living Costs: Threat to domestic businesses and their workers
Benefits of international trade include that countries that participate in international trade will experience higher standards of living because of the greater quantity and variety of higher-quality products offered at lower prices. These results stem from the increased competition associated with more open trade.
The costs of international trade are borne by those businesses and their workers whose livelihoods are threatened by foreign competition. Domestic businesses may lose market share to foreign companies, stunting their profitability and ability to create jobs. They may even be forced to close.
The costs are huge for the victims. After all, they might lose their livelihoods. The benefits, on the other hand, are not always easily recognizable, as they are spread out among millions of consumers.
Do the benefits outweigh the costs? Whereas the costs (including lost jobs) are often very visible, it is harder to measure the benefits that may be spread across millions of consumers.
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9. Free Trade and Trade Barriers
What is free trade?
Trade barriers
Tariffs
Subsidies
Quotas
Embargoes
Local content requirements
Learning Objective 4: What are the different types of trade barriers?
Free trade refers to the unencumbered flow of goods and services across national borders.
When countries try to limit free trade, they may use a variety of methods, often called trade barriers:
Tariffs, taxes imposed on an imported good or service, are the most common trade barrier. Governments prefer to impose tariffs because they raise tax revenues.
Subsidies are government payments to domestic producers to help them remain competitive against foreign competitors.
A quota is a quantity limitation on the amount of an import allowed to enter a country.
An embargo is a total restriction on an import (or export).
A local content requirement is a requirement that some portion of a good be produced domestically.
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10. Protectionism and Trade Barriers
There are benefits as well as costs to both free trade and protectionism.
With free trade, there will be a greater quantity and variety of higher quality products at lower prices. However, reduced sales and lower prices can result for domestic firms that find it difficult to compete internationally. This reduces their profitability and lowers job security for workers.
Protectionism can increase sales and create greater profits for domestic companies, which creates job security for workers. However, consumers will see a lower quantity and variety of lower-quality products at higher prices.
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11. Arguments in Favor of Protectionist Trade Barriers
National security
Infant industry
Cheap foreign labor
Threat of retaliation
Four main arguments exist for protectionist trade barriers:
1. The national security argument states that certain industries critical to national security should be protected from foreign competition.
2. The infant industry argument states that an undeveloped domestic industry needs time to grow and develop in order to acquire a comparative advantage in the global economy.
3. The cheap foreign labor argument centers on the sometimes significantly lower wages paid to workers of foreign companies.
4. The threat of retaliation (or bargaining chip) argument says that if a trading partner increases its trade barriers on your exports, or fails to reduce trade barriers as you reduce yours, then an uneven, unfair playing field is created.
Domestic companies may also be put at a disadvantage if a foreign firm is dumping its product. Dumping refers to selling a product at a price below the price charged in the producing country; it is illegal and can be difficult to prove. The intent of dumping is to dominate an industry and then control it.
The threat of trade barriers can be a risky policy. It can escalate into a trade war.
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12. Economists’ Arguments Against Protectionist Trade Barriers
Trade barriers benefit domestic producers and their workers but hurt domestic consumers.
It is more effective to educate displaced individuals so they may move into a line of business with comparative advantage and rising demand.
Most economists are free-trade advocates because they believe that the economic benefits of free trade outweigh the economic costs. They say trade barriers benefit domestic producers and their workers, but hurt domestic consumers.
Economists insist that the best way to address the concerns of those industries and their workers whose livelihoods are threatened by foreign competition is not to impose protectionist trade barriers. Instead, these displaced individuals need to be equipped with the education, training, and the skills necessary to smooth their transition into a line of business or work in which the nation has a comparative advantage and demand is rising.
Although all governments have protectionist trade barriers in place, they have been working to reduce them because they believe the economic benefits of doing so generally outweigh the costs. This political position explains the recent trend toward reduced trade and investment barriers that have fueled globalization.
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13. International Organizations Promoting Free Trade
General Agreement on Tariffs and Trade (GATT)
- Created in 1948 with 23 member nations
- Negotiated international trade treaties
- Replaced by the WTO in 1995
World Trade Organization (WTO)
member countries
- Arbitrates global trade disputes
- Has power to enforce decisions
There are a number of international organizations promoting free trade.
The General Agreement on Tariffs and Trade (GATT) was created in 1948 with 23 member nations, and it grew to a membership of 123 by 1994.
Although GATT was not an organization with any real enforcement powers, its eight rounds of negotiated treaties were very successful in reducing tariffs and other barriers on trade of goods.
GATT was not as successful in reducing trade barriers on services, protecting intellectual property rights, or enforcing agreements among member nations.
The World Trade Organization (WTO) replaced GATT in It has strengthened the world trading system by extending GATT rules to services and increasing protection for intellectual property rights.
The WTO has taken on the responsibility for arbitrating trade disputes and monitoring the trade policies of member countries.
The WTO operates as GATT did—on the basis of consensus—in the area of dispute settlement. The WTO has the power to enforce decisions.
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14. Regional Trade Agreement: The European Union
1957: European Economic Community
27 member countries
Largest free trade area
- 1/3 of the world’s production
- Largest exporter/second largest importer
Free trade areas are compacts abolishing trade barriers among member countries.
The greatest free trade area exists among member nations of the European Union (EU), which is the oldest and largest free trade area.
The EU’s predecessor, the European Economic Community (or Common Market), was created in 1957 with Belgium, France, Germany, Italy, Luxembourg, and the Netherlands.
The EU has grown to its current membership of 28 independent countries.
The EU’s success is due, in large part, to its demonstrated commitment to the free flow of goods, services, capital, and people across borders in Europe.
The EU is currently the world’s largest single market with approximately one-third of the world’s total production. The EU is the largest exporter in the world and the second largest importer.
In 1999, the EU surpassed all other free trade areas with respect to economic integration by adopting a common currency—the euro. The euro is currently used by 18 of the 28 member states and has become a major currency in global financial markets.
The EU has a population of nearly 500 million people and will continue to grow as many other apply to join.
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15. North American Free Trade Agreement (NAFTA)
Free trade agreement between the United States, Mexico, and Canada
Established on January 1, 1994
Quadrupled trade between the three countries
The North American Free Trade Agreement (NAFTA) is an ongoing agreement to move the United States, Mexico, and Canada closer to true free trade.
NAFTA was established on January 1, 1994, after considerable political opposition.
The experience of NAFTA so far indicates that earlier claims made by both advocates and critics were exaggerated.
Trade between the three countries has quadrupled to more than $19 million.
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16. Other Regional Free Trade Areas
Mercosur
Brazil, Argentina, Paraguay, Uruguay
ASEAN (Association of Southeast Asian Nations)
Indonesia, Malaysia, the Philippines, Singapore, Thailand, Brunei, Vietnam, Laos, Myanmar, and Cambodia
APEC (Asia-Pacific Economic Cooperation)
21 member countries, including the United States, Japan, and China
Many other free trade areas exist in the world.
The Association of Southeast Asian Nations includes Indonesia, Malaysia, the Philippines, Singapore, Thailand, Brunei, Vietnam, Laos, Myanmar, and Cambodia. Progress toward integration has been very limited.
The Asia-Pacific Economic Cooperation was founded in 1989 at the suggestion of Australia and currently has 21 member countries, including the United States, Japan, and China.
Most free trade areas haven’t had the kind of success that the EU and NAFTA have had in reducing trade barriers. However, it’s clear that most countries are eager to come together to reduce trade barriers in an attempt to realize the economic benefits of greater free trade.
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17. Three Strategies of International Business
Global
- Standardized product
- Price competition
Multidomestic
- Custom products to meet unique local needs
- Price considerations are secondary
Transnational
- Customized product
- Lowest price possible
Learning Objective 5: What are the three basic strategies of international business?
Two major factors determine an international firm’s strategy:
How important is it for a business to keep its costs down and prices low?
How necessary is it for a company to customize or differentiate its product to adapt to different customer tastes and preferences around the globe?
In a global strategy, businesses compete primarily on the basis of price while selling a standardized product.
In a multidomestic strategy, businesses compete primarily by customizing or differentiating the product to meet unique local needs, tastes, or preferences. Firms pursuing a multidomestic strategy face relatively low pressures for cost reduction. Customers want products that meet their needs or are distinct from the product of competitors.
In a transnational strategy, businesses compete by offering a customized product while simultaneously selling at the lowest possible price. They face strong cost pressures and strong pressures for differentiation.
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18. Strategies for Entering Foreign Markets
Companies may
- Export their product
- Implement turnkey projects
- Sell franchises
- Enter into licensing agreements, joint ventures, or strategic alliances
- Engage in contract manufacturing
- Establish wholly-owned subsidiaries
Learning Objective 6: How can international firms successfully enter foreign markets?
Exporting is the sale of a domestically produced good in a foreign market. Most businesses typically begin serving a foreign market by exporting and may later switch to another mode.
Turnkey projects occur when firms export their technological know-how in exchange for a fee, usually for sophisticated and complex manufacturing. Once the facility is up and running, the locals are trained, then the keys are turned over to the foreign owners.
Franchising involves selling a well-known brand name or a proven method of doing business to an investor in exchange for a fee and a percentage of sales or profits. Franchising, popular domestically and internationally, will be discussed in depth in Chapter 5.
Licensing is an agreement in which the licensor’s intangible property—patents, trademarks, service marks, copyrights, trade secrets, or other intellectual property—may be sold or made available to a licensee in exchange for a royalty fee.
Joint ventures involve shared ownership in a subsidiary firm. International joint venture partners involve an international business teaming up with a local partner in order to enter a foreign market.
Strategic alliances are cooperative arrangements. Unlike a joint venture, each partner retains its business independence. The agreement lasts for a specific period of time.
Contract manufacturing occurs when a firm subcontracts part or all of its good to an outside firm as an alternative to owning and operating its own production facility. International contract manufacturing is really a form of offshore outsourcing.
A wholly-owned subsidiary establishes a foreign facility owned entirely by the investing firm.
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19. Entry Mode Considerations
The optimal entry mode depends on many factors, including the firm’s strategy. Companies must weigh the advantages and disadvantages of each when making a decision.
For example, exporting is a quick way to enter a market, but transportation costs can be high.
Franchises transfer the risk to the franchisee, but it can be difficult to maintain quality control over franchises in other countries.
Joint ventures occur when a company takes on a partner in another country. This allows the companies to combine resources and knowledge, but there are risks in shared control.
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20. The Role of Exchange Rates in Global Expansion
Exchange rates: The rates at which currencies are converted into another currency
Strong dollar
Weak dollar
Learning Objective 7: What are exchange rates, and how do they affect international business?
Foreign exchange markets determine exchange rates, the rates at which currencies are converted into another currency.
Depending on a firm’s perspective, it may prefer a strong or weak dollar. U.S. exporters prefer a weak dollar because their products will be more affordable to foreigners. However, U.S. importers prefer a strong dollar because the cost of importing foreign goods is cheaper. If goods are imported cheaply, then those savings can be either passed on to the consumer or kept as higher profits.
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21. How Exchange Rates Affect International Business
Deficits and surpluses:
Trade deficits
Trade surpluses
Exchange rate systems
Fixed
Freely floating
Nonconvertible currency and countertrade
Countries may experience a trade deficit or trade surplus:
A trade deficit exists when the value of a country’s imports exceeds the value of its exports.
A trade surplus occurs when the value of a country’s exports exceeds the value of its imports.
One factor that influences the amount of a surplus or deficit is exchange rates:
Fixed exchange rates can be manipulated or fixed by governments. For example, China has fixed its currency to a rate that is weak compared to the dollar.
In a freely floating (or flexible) exchange rate system, the global supply and demand for currencies determine exchange rates.
Other factors influencing exchange rates and international trade are nonconvertible currencies and countertrade:
Many developing countries have a nonconvertible currency, a currency that can’t be converted into another currency in the foreign exchange market. This protects from capital flight, where the country’s domestic funds are exchanged into foreign currency held outside the country.
Countertrade is a form of international barter, the swapping of goods and services for other goods and services, conducted out of necessity or for enhanced profitability.
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22. Other International Economic Challenges
Growth and development
Government policies and the economic environment
Socioeconomic factors
Learning Objective 8: What economic factors and challenges play a role in conducting business on a global scale?
There are many economic challenges to conducting international business.
Many developing countries are experiencing more rapid growth than advanced economies are with eager new customers ready to buy products and services. However, these countries may still lack the basic infrastructure necessary for effective transportation, utilities, communication systems, and technological tools.
Government economic policies and the economic environment can also pose challenges. International businesses prefer free market economies to state-run or socialized economies because the bureaucratic hassles associated with government intervention drive costs up. The debt load of a nation, its unemployment and inflation rates, and its fiscal and monetary policies impact decisions about where to conduct business.
Socioeconomic factors to consider include demographics of population density, age distribution, and birth rates, as well as income distribution, ethnicity, and the cultural behaviors of a community.
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23. Sociocultural Challenges
What is culture?
Cultural challenges:
Aesthetics
Attitudes toward time and work
Religion
Language
Learning Objective 9: What are the sociocultural, political, legal, and ethical challenges to conducting business in a global marketplace?
There are numerous sociocultural challenges to conducting business globally.
Culture is the complex set of values, behaviors, lifestyles, arts, beliefs, and institutions of a population that are passed on from generation to generation. Cross-cultural awareness is an understanding, appreciation, and sensitivity to foreign culture. Ethnocentrism, a belief that one’s own culture is superior to all other cultures, is a guaranteed recipe for disaster when undertaking international business.
Aesthetics refers to what is considered beautiful or in good taste. Aesthetics encompasses etiquette, customs, and protocol.
Attitudes toward time vary considerably across the world.
International businesses are well-advised to educate themselves on varying religious value systems, customs, and practices if they don’t wish to offend customers in marketing campaigns, among other things.
Language, both spoken and unspoken, is also extremely important as different things have different meanings and interpretations around the world.
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24. Political, Legal, and Ethical Challenges
There are many political challenges to conducting international business. International businesses thrive in nations that have a firm commitment to free market principles with a stable, democratically elected government. Well-established educational systems and well-maintained infrastructures can also be significant factors.
There are many legal challenges to conducting international business. Laws, regulatory standards, and access to unbiased judicial systems based on a rule of law differ considerably around the world. No universal laws, regulatory standards, or global court exist to settle disputes in the global economy. The different laws governing contracts, product safety and liability standards, and property rights are of particular importance when conducting global business.
There are many ethical challenges to conducting international business. Bribery is just one of the many ethical dilemmas surrounding global business. But even when something isn’t illegal, that doesn’t mean it isn’t unethical. Unique differences in economic conditions and cultural values give rise to many ethical dilemmas surrounding global business. For example, should a firm conform to its home country’s environmental, workplace, and product safety standards—even though it’s not legally required to do so—while operating in another country? Should a company do business with a repressive totalitarian regime? When conducting international business, companies must decide whether they’re willing to defy their ethical codes to make a larger profit or even to survive.
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Chapter Summary
1. What are the implications of the globalization of markets and the globalization of production? 2. Why has globalization accelerated so rapidly? 3. What are the costs and benefits of international trade? 4. What are the different types of trade barriers? 5. What are the three basic strategies of international business? 6. How can international firms successfully enter foreign markets? 7. What are exchange rates and how do they affect international business? 8. What economic factors and challenges play a role in conducting business on a global scale? 9. What are the sociocultural, political, legal, and ethical challenges to conducting business in a global marketplace?
Chapter Summary
What are the implications of the globalization of markets and the globalization of production? The globalization of markets views the world as one market, but products must still appeal to local customers. The globalization of production refers to offshore outsourcing to reduce costs.
Why has globalization accelerated so rapidly? This is due to a decline in trade and investment barriers and technological advances.
What are the costs and benefits of international trade? Benefits include a higher standard of living with more higher-quality, lower-priced products. Costs include the heavy competition for domestic businesses and threat of worker job loss.
What are the different types of trade barriers? Different types of trade barriers include tariffs, subsidies, quotas, and administrative trade barriers such as local content requirements.
What are the three basic strategies of international business? The three basic strategies of international business are the global strategy, the multi-domestic strategy, and the transnational strategy.
How can international firms successfully enter foreign markets? International firms can enter foreign markets through exporting, turnkey projects, franchising, licensing, joint ventures, strategic alliances, contract manufacturing, and wholly-owned subsidiaries.
What are exchange rates and how do they affect international business? Exchange rates are the rates at which one currency is converted into another. Currency appreciation increases the rate and causes the price of imports to fall and the cost of exports to rise. Currency depreciation is the decrease and creates the opposite effect.
What economic factors and challenges play a role in conducting business on a global scale? Economic growth and development present a challenge because some countries lack the infrastructure necessary to effectively transport goods, among other factors.
What are the sociocultural, political, legal, and ethical challenges to conducting business in a global marketplace? Sociocultural challenges include ethnocentric views and differences in aesthetics, religion, and attitudes toward time and work. Politically, businesses prefer countries with free markets and less government control. Legally, there are differences in laws and regulations and government decisions on taxes, and so on. Ethical values vary; for example, bribery may be accepted.
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