Page 32 Summary This chapter has shown how the world economy is becoming more global and reviewed the main drivers of globalization, arguing that they seem to be thrusting nation-states toward a more tightly integrated global economy. It looked at how the nature of international business is changing in response to the changing global economy, discussed concerns raised by rapid globalization, and reviewed implications of rapid globalization for individual managers. The chapter made the following points: 1. Over the past three decades, we have witnessed the globalization of markets and production. 2. The globalization of markets implies that national markets are merging into one huge marketplace. However, it is important not to push this view too far. 3. The globalization of production implies that firms are basing individual productive activities at the optimal world locations for the particular activities. As a consequence, it is increasingly irrelevant to talk about American products, Japanese products, or German products because these are being replaced by “global” products. Or, in some cases, they are simply replaced by products made by specific companies, such as Apple, Sony, or Microsoft products. 4. Two factors seem to underlie the trend toward globalization: declining trade barriers and changes in communication, information, and transportation technologies. 5. Since the end of World War II, barriers to the free flow of goods, services, and capital have been lowered significantly. More than anything else, this has facilitated the trend toward the globalization of production and has enabled firms to view the world as a single market. 6. As a consequence of the globalization of production and markets, in the last decade, world trade has grown faster than world output, foreign direct investment has surged, imports have penetrated more deeply into the world’s industrial nations, and competitive pressures have increased in industry after industry. 7. The development of the microprocessor and related developments in communication and information processing technology have helped firms link their worldwide operations into sophisticated information networks. Jet air travel, by shrinking travel time, has also helped link the worldwide operations of international businesses. These changes have enabled firms to achieve tight coordination of their worldwide operations and to view the world as a single market. 8. In the 1960s, the U.S. economy was dominant in the world, U.S. firms accounted for most of the foreign direct investment in the world economy, U.S. firms dominated the list of large multinationals, and roughly half the world—the centrally planned economies of the communist world—was closed to Western businesses. 9. By the 2020s, the U.S. share of world output will have been cut in half, with major shares now being accounted for by European and Southeast Asian economies. The U.S. share of worldwide foreign direct investment will have fallen by about two-thirds. U.S. multinationals will be facing competition from a large number of multinationals. In addition, the emergence of mini-multinationals was noted. 10. One of the most dramatic developments of the past 30 years has been the collapse of communism in eastern Europe, which has created enormous opportunities for international businesses. In addition, the move toward free market economies in China and Latin America is creating opportunities (and threats) for Western international businesses. 11. The benefits and costs of the emerging global economy are being hotly debated among businesspeople, economists, and politicians. The debate focuses on the impact of globalization on jobs, wages, the environment, working conditions, national sovereignty, and extreme poverty in the world’s poorest nations. 12. Managing an international business is different from managing a domestic business for at least four reasons: ( a ) countries are different, ( b ) the range of problems confronted by a manager in an international business is wider and the problems themselves more complex than those confronted by a manager in a domestic business, ( c ) managers in an international business must find ways to work within the limits imposed by governments’ intervention in the international trade and investment system, and ( d ) international transactions involve converting money into different currencies. Summary This chapter has reviewed how the political, economic, and legal systems of countries vary. The potential benefits, costs, and risks of doing business in a country are a function of its political, economic, and legal systems. The chapter made the following points: 1. Political systems can be assessed according to two dimensions: the degree to which they emphasize collectivism as opposed to individualism and the degree to which they are democratic or totalitarian. 2. Collectivism is an ideology that views the needs of society as being more important than the needs of the individual. Collectivism translates into an advocacy for state intervention in economic activity and, in the case of communism, a totalitarian dictatorship. 3. Individualism is an ideology that is built on an emphasis of the primacy of the individual’s freedoms in the political, economic, and cultural realms. Individualism translates into an advocacy for democratic ideals and free market economics. 4. Democracy and totalitarianism are at different ends of the political spectrum. In a representative democracy, citizens periodically elect individuals to represent them, and political freedoms are guaranteed by a constitution. In a totalitarian state, political power is monopolized by a party, group, or individual, and basic political freedoms are denied to citizens of the state. 5. There are three broad types of economic systems: a market economy, a command economy, and a mixed economy. In a market economy, prices are free of controls, and private ownership is predominant. In a command economy, prices are set by central planners, productive assets are owned by the state, and private ownership is forbidden. A mixed economy has elements of both a market economy and a command economy. 6. Differences in the structure of law between countries can have important implications for the practice of international business. The degree to which property rights are protected can vary dramatically from country to country, as can product safety and product liability legislation and the nature of contract law. Summary This chapter reviewed how the political, economic, and legal systems of countries vary. The potential benefits, costs, and risks of doing business in a country are a function of its political, economic, and legal systems. The chapter made the following points: 1. The rate of economic progress in a country seems to depend on the extent to which that country has a well-functioning market economy in which property rights are protected. 2. Many countries are now in a state of transition. There is a marked shift away from totalitarian governments and command or mixed economic systems and toward democratic political institutions and free market economic systems. 3. The attractiveness of a country as a market and/or investment site depends on balancing the likely long-run benefits of doing business in that country against the likely costs and risks. 4. The benefits of doing business in a country are a function of the size of the market (population), its present wealth (purchasing power), and its future growth prospects. By investing early in countries that are currently poor but are nevertheless growing rapidly, firms can gain first- mover advantages that will pay back substantial dividends in the future. 5. The costs of doing business in a country tend to be greater where political payoffs are required to gain market access, where supporting infrastructure is lacking or underdeveloped, and where adhering to local laws and regulations is costly. 6. The risks of doing business in a country tend to be greater in countries that are politically unstable, subject to economic mismanagement, and lacking a legal system to provide adequate safeguards in the case of contract or property rights violations. Page 117 Summary This chapter has looked at the nature of culture and discussed a number of implications for business practice. The chapter made the following points: 1. Culture is a complex phenomenon that includes knowledge, beliefs, art, morals, law, customs, and other capabilities acquired by people as members of society. 2. Values and norms are the central components of a culture. Values are abstract ideals about what a society believes to be good, right, and desirable. Norms are social rules and guidelines that prescribe appropriate behavior in particular situations. 3. Values and norms are influenced by political forces, economic philosophy, social structure, religion, language, and education. And, the value systems and norms of a country can affect the costs of doing business in that country. 4. The social structure of a society refers to its basic social organization. Two main dimensions along which social structures differ are the individual–group dimension and the stratification dimension. 5. In some societies, the individual is the basic building block of a social organization. These societies emphasize individual achievements above all else. In other societies, the group is the basic building block of the social organization. These societies emphasize group membership and group achievements above all else. 6. Virtually all societies are stratified into different classes. Class- conscious societies are characterized by low social mobility and a high degree of stratification. Less class-conscious societies are characterized by high social mobility and a low degree of stratification. 7. Religion may be defined as a system of shared beliefs and rituals that is concerned with the realm of the sacred. Ethical systems refer to a set of moral principles, or values, that are used to guide and shape behavior. The world’s major religions are Christianity, Islam, Hinduism, and Buddhism. The value systems of different religious and ethical systems have different implications for business practice. 8. Language is one defining characteristic of a culture. It has both spoken and unspoken dimensions. In countries with more than one spoken language, we tend to find more than one culture. 9. Formal education is the medium through which individuals learn knowledge and skills as well as become socialized into the values and norms of a society. Education plays an important role in the determination of national competitive advantage. 10. Geert Hofstede studied how culture relates to values in the workplace. He isolated five dimensions that summarized different cultures: power distance, uncertainty avoidance, individualism versus collectivism, masculinity versus femininity, and long-term versus short-term orientation. 11. Culture is not a constant; it evolves. Economic progress and globalization are two important engines of cultural change. 12. One danger confronting a company that goes abroad is being ill- informed. To develop cross-cultural literacy, companies operating globally should consider employing host-country nationals, build a cadre of cosmopolitan executives, and guard against the dangers of ethnocentric behavior. Summary This chapter discussed the source and nature of ethical issues in international businesses, the different philosophical approaches to business ethics, the steps managers can take to ensure that ethical issues are respected in international business decisions, and the roles of corporate social responsibility and sustainability in practice. The chapter made the following points: 1. The term ethics refers to accepted principles of right or wrong that govern the conduct of a person, the members of a profession, or the actions of an organization. Business ethics are the accepted principles of right or wrong governing the conduct of businesspeople. An ethical strategy is one that does not violate these accepted principles. 2. Ethical issues and dilemmas in international business are rooted in the variations among political systems, law, economic development, and culture from country to country. 3. The most common ethical issues in international business involve employment practices, human rights, environmental regulations, corruption, and social responsibility of multinational corporations. 4. Ethical dilemmas are situations in which none of the available alternatives seems ethically acceptable. 5. Unethical behavior is rooted in personal ethics, societal culture, psychological and geographic distances of a foreign subsidiary from the home office, a failure to incorporate ethical issues into strategic and operational decision making, a dysfunctional culture, and failure of leaders to act in an ethical manner. 6. Moral philosophers contend that approaches to business ethics such as the Friedman doctrine, cultural relativism, the righteous moralist, and the naive immoralist are unsatisfactory in important ways. 7. The Friedman doctrine states that the only social responsibility of business is to increase profits, as long as the company stays within the rules of law. Cultural relativism contends that one should adopt the ethics of the culture in which one is doing business. The righteous moralist monolithically applies home-country ethics to a foreign situation, while the naive immoralist believes that if a manager of a multinational sees that firms from other nations are not following ethical norms in a host nation, that manager should not either. 8. Utilitarian approaches to ethics hold that the moral worth of actions or practices is determined by their consequences, and the best decisions are those that produce the greatest good for the greatest number of people. 9. Kantian ethics state that people should be treated as ends and never purely as means to the ends of others. People are not instruments, like a machine. People have dignity and need to be respected as such. 10. Rights theories recognize that human beings have fundamental rights and privileges that transcend national boundaries and cultures. These rights establish a minimum level of morally acceptable behavior. 11. The concept of justice developed by John Rawls suggests that a decision is just and ethical if people would allow it when designing a social system under a veil of ignorance. 12. To make sure that ethical issues are considered in international business decisions, managers should ( a ) favor hiring and promoting people with a well-grounded sense of personal ethics, ( b ) build an organizational culture and exemplify leadership behaviors that place a high value on ethical behavior, ( c ) put decision-making processes in place that require people to consider the ethical dimension of business decisions, ( d ) establish ethics officers in the organization with responsibility for ethical decision making, ( e ) be morally courageous and encourage others to do the same, ( f ) make corporate social responsibility a cornerstone of enterprise policy, and ( g ) pursue strategies that are sustainable. 13. Multinational corporations that are practicing business-focused sustainability integrate a focus on market orientation, addressing the needs of multiple stakeholders, and adhering to corporate social responsibility principles. Summary This chapter reviewed a number of theories that explain why it is beneficial for a country to engage in international trade and explained the pattern of international trade observed in the world economy. The theories of Smith, Ricardo, and Heckscher–Ohlin all make strong cases for unrestricted free trade. In contrast, the mercantilist doctrine and, to a lesser extent, the new trade theory can be interpreted to support government intervention to promote exports through subsidies and to limit imports through tariffs and quotas. In explaining the pattern of international trade, this chapter shows that, with the exception of mercantilism, which is silent on this issue, the different theories offer largely complementary explanations. Although no one theory may explain the apparent pattern of international trade, taken together, the theory of comparative advantage, the Heckscher–Ohlin theory, the product life-cycle theory, the new trade theory, and Porter’s theory of national competitive advantage do suggest which factors are important. Comparative advantage tells us that productivity differences are important; Heckscher– Ohlin tells us that factor endowments matter; the product life-cycle theory tells us that where a new product is introduced is important; the new trade theory tells us that increasing returns to specialization and first-mover advantages matter; Porter tells us that all these factors may be important insofar as they affect the four components of the national diamond. The chapter made the following points: 1. Mercantilists argued that it was in a country’s best interests to run a balance-of-trade surplus. They viewed trade as a zero-sum game, in which one country’s gains cause losses for other countries. 2. The theory of absolute advantage suggests that countries differ in their ability to produce goods efficiently. The theory suggests that a country should specialize in producing goods in areas where it has an absolute advantage and import goods in areas where other countries have absolute advantages. 3. The theory of comparative advantage suggests that it makes sense for a country to specialize in producing those goods that it can produce most efficiently, while buying goods that it can produce relatively less efficiently from other countries—even if that means buying goods from other countries that it could produce more efficiently itself. 4. The theory of comparative advantage suggests that unrestricted free trade brings about increased world production—that is, that trade is a positive-sum game. 5. The theory of comparative advantage also suggests that opening a country to free trade stimulates economic growth, which creates dynamic gains from trade. The empirical evidence seems to be consistent with this claim. 6. The Heckscher–Ohlin theory argues that the pattern of international trade is determined by differences in factor endowments. It predicts that countries will export those goods that make intensive use of locally abundant factors and will import goods that make intensive use of factors that are locally scarce. 7. The product life-cycle theory suggests that trade patterns are influenced by where a new product is introduced. In an increasingly integrated global economy, the product life-cycle theory seems to be less predictive than it once was. 8. New trade theory states that trade allows a nation to specialize in the production of certain goods, attaining scale economies and lowering the costs of producing those goods, while buying goods that it does not produce from other nations that are similarly specialized. By this mechanism, the variety of goods available to consumers in each nation is increased, while the average costs of those goods should fall. 9. New trade theory also states that in those industries where substantial economies of scale imply that the world market will profitably support only a few firms, countries may predominate in the export of certain products simply because they had a firm that was a first mover in that industry. 10. Some new trade theorists have promoted the idea of strategic trade policy. The argument is that government, by the sophisticated and judicious use of subsidies, might be able to increase the chances of domestic firms becoming first movers in newly emerging industries. Page 177 11. Porter’s theory of national competitive advantage suggests that the pattern of trade is influenced by four attributes of a nation: (a) factor endowments, (b) domestic demand conditions, (c) related and supporting industries, and (d) firm strategy, structure, and rivalry. 12. Theories of international trade are important to an individual business firm primarily because they can help the firm decide where to locate its various production activities. 13. Firms involved in international trade can and do exert a strong influence on government policy toward trade. By lobbying government, business firms can promote free trade or trade restrictions. Summary This chapter described how the reality of international trade deviates from the theoretical ideal of unrestricted free trade reviewed in Chapter 6. In this chapter, we reported the various instruments of trade policy, reviewed the political and economic arguments for government intervention in international trade, reexamined the economic case for free trade in light of the strategic trade policy argument, and looked at the evolution of the world trading framework. While a policy of free trade may not always be the theoretically optimal policy (given the arguments of the new trade theorists), in practice it is probably the best policy for a government to pursue. In particular, the long-run interests of business and consumers may be best served by strengthening international institutions such as the WTO. Given the danger that isolated protectionism might escalate into a trade war, business probably has far more to gain from government efforts to open protected markets to imports and foreign direct investment (through the WTO) than from government efforts to protect domestic industries from foreign competition. The chapter made the following points: 1. Trade policies such as tariffs, subsidies, antidumping regulations, and local content requirements tend to be pro-producer and anticonsumer. Gains accrue to producers (who are protected from foreign competitors), but consumers lose because they must pay more for imports. 2. There are two types of arguments for government intervention in international trade: political and economic. Political arguments for intervention are concerned with protecting the interests of certain groups, often at the expense of other groups, or with promoting goals with regard to foreign policy, human rights, consumer protection, and the like. Economic arguments for intervention are about boosting the overall wealth of a nation. 3. A common political argument for intervention is that it is necessary to protect jobs. However, political intervention often hurts consumers, and it can be self-defeating. Countries sometimes argue that it is important to protect certain industries for reasons of national security. Some argue that government should use the threat to intervene in trade policy as a Page 209 bargaining tool to open foreign markets. This can be a risky policy; if it fails, the result can be higher trade barriers. 4. The infant industry argument for government intervention contends that to let manufacturing get a toehold, governments should temporarily support new industries. In practice, however, governments often end up protecting the inefficient. 5. Strategic trade policy suggests that with subsidies, government can help domestic firms gain first-mover advantages in global industries where economies of scale are important. Government subsidies may also help domestic firms overcome barriers to entry into such industries. 6. The problems with strategic trade policy are twofold: ( a ) Such a policy may invite retaliation, in which case all will lose, and ( b ) strategic trade policy may be captured by special-interest groups, which will distort it to their own ends. 7. The GATT was a product of the postwar free trade movement. The GATT was successful in lowering trade barriers on manufactured goods and commodities. The move toward greater free trade under the GATT appeared to stimulate economic growth. 8. The completion of the Uruguay Round of GATT talks and the establishment of the World Trade Organization have strengthened the world trading system by extending GATT rules to services, increasing protection for intellectual property, reducing agricultural subsidies, and enhancing monitoring and enforcement mechanisms. 9. Trade barriers act as a constraint on a firm’s ability to disperse its various production activities to optimal locations around the globe. One response to trade barriers is to establish more production activities in the protected country. 10. Business may have more to gain from government efforts to open protected markets to imports and foreign direct investment than from government efforts to protect domestic industries from foreign competition. Summary This chapter reviewed theories that attempt to explain the pattern of FDI between countries and to examine the influence of governments on firms’ decisions to invest in foreign countries. The chapter made the following points: 1. Any theory seeking to explain FDI must explain why firms go to the trouble of acquiring or establishing operations abroad when the alternatives of exporting and licensing are available to them. 2. High transportation costs or tariffs imposed on imports help explain why many firms prefer FDI or licensing over exporting. 3. Firms often prefer FDI to licensing when ( a ) a firm has valuable know- how that cannot be adequately protected by a licensing contract, ( b ) a firm needs tight control over a foreign entity in order to maximize its market share and earnings in that country, and ( c ) a firm’s skills and capabilities are not amenable to licensing. 4. Knickerbocker’s theory suggests that much FDI is explained by imitative behavior by rival firms in an oligopolistic industry. 5. Dunning has argued that location-specific advantages are of considerable importance in explaining the nature and direction of FDI. According to Dunning, firms undertake FDI to exploit resource endowments or assets that are location-specific. 6. Political ideology is an important determinant of government policy toward FDI. Ideology ranges from a radical stance that is hostile to FDI to a noninterventionist, free market stance. Between the two extremes is an approach best described as pragmatic nationalism. 7. Benefits of FDI to a host country arise from resource-transfer effects, employment effects, and balance-of-payments effects. 8. The costs of FDI to a host country include adverse effects on competition and balance of payments and a perceived loss of national sovereignty. 9. The benefits of FDI to the home (source) country include improvement in the balance of payments as a result of the inward flow of foreign earnings, positive employment effects when the foreign subsidiary creates demand for home-country exports, and benefits from a reverse resource-transfer effect. A reverse resource-transfer effect arises when the foreign subsidiary learns valuable skills abroad that can be transferred back to the home country. 10. The costs of FDI to the home country include adverse balance-of- payments effects that arise from the initial capital outflow and from the export substitution effects of FDI. Costs also arise when FDI exports jobs abroad. 11. Home countries can adopt policies designed to both encourage and restrict FDI. Host countries try to attract FDI by offering incentives and try to restrict FDI by dictating ownership restraints and requiring that foreign MNEs meet specific performance requirements. Summary This chapter pursued three main objectives: to examine the economic and political debate surrounding regional economic integration; to review the progress toward regional economic integration in Europe, the Americas, and elsewhere; and to distinguish the important implications of regional economic integration for the practice of international business. The chapter made the following points: 1. A number of levels of economic integration are possible in theory. In order of increasing integration, they include a free trade area, a customs union, a common market, an economic union, and full political union. 2. In a free trade area, barriers to trade among member countries are removed, but each country determines its own external trade policy. In a customs union, internal barriers to trade are removed, and a common external trade policy is adopted. A common market is similar to a customs union, except that a common market also allows factors of production to move freely among countries. An economic union involves even closer integration, including the establishment of a common currency and the harmonization of tax rates. A political union is the logical culmination of attempts to achieve ever-closer economic integration. 3. Regional economic integration is an attempt to achieve economic gains from the free flow of trade and investment between neighboring countries. 4. Integration is not easily achieved or sustained. Although integration brings benefits to the majority, it is never without costs for the minority. Concerns over national sovereignty often slow or stop integration attempts. In 2016, these concerns resulted in Britain voting for exit from the EU. 5. Regional integration will not increase economic welfare if the trade creation effects in the free trade area are outweighed by the trade diversion effects. 6. The Single European Act sought to create a true single market by Page 267 abolishing administrative barriers to the free flow of trade and investment among EU countries. 7. Seventeen EU members now use a common currency, the euro. The economic gains from a common currency come from reduced exchange costs, reduced risk associated with currency fluctuations, and increased price competition within the EU. 8. Increasingly, the European Commission is taking an activist stance with regard to competition policy, intervening to restrict mergers and acquisitions that it believes will reduce competition in the EU. 9. Although no other attempt at regional economic integration comes close to the EU in terms of potential economic and political significance, various other attempts are being made in the world. The most notable include NAFTA in North America, the Andean Community and Mercosur in Latin America, and ASEAN in Southeast Asia. 10. The creation of single markets in the EU and North America means that many markets that were formerly protected from foreign competition are now more open. This creates major investment and export opportunities for firms within and outside these regions. 11. The free movement of goods across borders, the harmonization of product standards, and the simplification of tax regimes make it possible for firms based in a free trade area to realize potentially enormous cost economies by centralizing production in those locations within the area where the mix of factor costs and skills is optimal. 12. The lowering of barriers to trade and investment among countries within a trade group will probably be followed by increased price competition. Summary This chapter explained how the foreign exchange market works, examined the forces that determine exchange rates, and then discussed the implications of these factors for international business. Given that changes in exchange rates can dramatically alter the profitability of foreign trade and investment deals, this is an area of major interest to international business. The chapter made the following points: 1. One function of the foreign exchange market is to convert the currency of one country into the currency of another. A second function of the foreign exchange market is to provide insurance against foreign exchange risk. 2. The spot exchange rate is the exchange rate at which a dealer converts one currency into another currency on a particular day. 3. Foreign exchange risk can be reduced by using forward exchange rates. A forward exchange rate is an exchange rate governing future transactions. Foreign exchange risk can also be reduced by engaging in currency swaps. A swap is the simultaneous purchase and sale of a given amount of foreign exchange for two different value dates. 4. The law of one price holds that in competitive markets that are free of transportation costs and barriers to trade, identical products sold in different countries must sell for the same price when their price is expressed in the same currency. 5. Purchasing power parity (PPP) theory states the price of a basket of particular goods should be roughly equivalent in each country. PPP theory predicts that the exchange rate will change if relative prices change. 6. The rate of change in countries’ relative prices depends on their relative inflation rates. A country’s inflation rate seems to be a function of the growth in its money supply. 7. The PPP theory of exchange rate changes yields relatively accurate predictions of long-term trends in exchange rates but not of short-term movements. The failure of PPP theory to predict exchange rate changes