MGT 302 Exam 2
Three main priorities of the World Bank
1) Help create sustainable economic growth 2) Invest in people through healthcare, education, water, sanitation and energy 3) Build resilience to shocks and threats
Import Quota
A direct restriction on the quantity of a good that can be imported into a country.
Carry trade
A kind of speculation that involves borrowing in one currency where interest rates are low, and then using the proceeds to invest in another currency where interest rates are high
Efficient market
A market where prices reflect all available information
Corporate- government relations
As major players in the international trade and investment environment, businesses can influence government policy toward the international monetary system. For example, intense government lobbying by U.S. exporters helped convince the U.S. government that intervention in the foreign exchange market was necessary.
Understand the important implications that international trade theory holds for business practice
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.
Bretton Woods System
Fixed exchange rates established in 1944 with the US dollar as the central currency and the values of every other currency was pegged to it. All currencies were fixed to gold.
International Fisher Effect (IFE) -
For any two countries, the spot exchange rate should change in an equal amount but in the opposite direction to the difference in nominal interest rates between countries
The future of the WTO: Unresolved Issues and the Doha Round
Four issues at the forefront of the current agenda of the WTO are antidumping policies, the high level of protectionism in agriculture, the lack of strong protection for intellectual property rights in many nations, and continued high tariff rates on nonagricultural goods and services in many nations. In 2001, the WTO launched a new round of talks in Doha between member states aimed at further liberalizing the global trade and investment framework. The Doha agenda includes cutting tariffs on industrial goods and services, phasing out subsidies to agricultural producers, reducing barriers to cross-border investment, and limiting the use of antidumping laws. The talks were originally scheduled to last 3 years, although they have already gone on for 12 years and are currently stalled.
Subsidy
Government financial assistance to a domestic producer in the form of cash grants, low-interest loans, tax breaks, and government equity participation in domestic firms.
Strategic trade policy
Government policy aimed at improving the competitive position of a domestic industry and/or domestic firm in the world market.
Law of One Price
In competitive markets 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
Arbitrage
The purchase of securities in one market for immediate resale in another to profit from a price discrepancy
Forward exchange rate
The rate governing a forward exchange transaction
Foreign exchange risk -
The risk that changes in exchange rates will hurt the profitability of a business deal
Role of the IMF (International Monetary Fund) (IMF.org)
The role of the IMF is to maintain order in the international monetary system to avoid a repetition of the competitive devaluations of the 1930s, and to control price inflation by imposing monetary discipline on countries
Economic arguments
for intervention are typically concerned with boosting the overall wealth of a nation (to the benefit of all, both producers and consumers).
Fisher Effect
i=r+l, meaning nominal interest rates (i) in each country equal the required real rate of interest (r) and the expected rate of inflation over the period of time for which the funds are to be lent (l)
why nations trade with each other
international trade allows a country to specialize in the manufacture and export of products that can be produced most efficiently in that country, while importing products that can be produced more efficiently in other countries.
fundamental analysis
is a method of evaluating a security in an attempt to measure its intrinsic value, by examining related economic, financial and other qualitative and quantitative factors
Foreign debt crisis
is a situation in which a country cannot service its foreign debt obligations, whether private-sector or government debt (Greece 2010)
Surveillance
maintain stability and prevent crises in the international monetary system - provides advice
Theory of Comparative Advantage
makes sense for a country to specialize in the production of those goods that it produces most efficiently and to buy the goods that it produces less efficiently from other countries, even if this means buying goods from other countries that it could produce more efficiently itself By engaging in trade, countries increased their combined production. Trade is positive sum game - win/ win
Important debate over the appropriateness of IMF
mandated macroeconomic policies. Critics charge that the IMF often imposes inappropriate conditions on developing nations who are the recipients of its loans.
Currency Crisis
occurs when a speculative attack on the exchange value of a currency results in a sharp depreciation in the value of the currency or forces authorities to expend large volumes of international currency reserves and sharply increase interest rates to defend the prevailing exchange rate (Mexican Peso crisis)
Recognize why many economists believe that unrestricted free trade between nations will...
raise the economic welfare of countries that participate in a free trade system
Banking crisis
refers to a loss of confidence in the banking system that leads to a run on banks, as individuals and companies withdraw their deposits. (Ireland 2008)
international monetary system
refers to the institutional arrangements that govern exchange rates
Currency speculation -
short-term movement of funds from one currency to another in hopes of profiting from shifts in exchange rates
Free trade
situation in which a government does not attempt to restrict what its citizens can buy from or sell to another country.
Jamaica agreement
(1976) floating exchange rate regime was established o Even out unwarranted speculative fluctuations o Gold abandoned as a reserve asset o Total annual IMF quoatas Current managed float system of exchange rate determination has increase the importance of currency management in international businesses
Pegged exchange rate
(popular with smaller developing countries like Vietnam) means the value of the currency is fixed relative to a reference currency, such as the U.S. dollar, and then the exchange rate between that currency and other currencies is determined by the reference currency exchange rate
Freely convertible currency
- Exists when a government allows both residents and non residents to purchase unlimited amounts of foreign currency with the domestic currency
Fixed exchange rate regime
1) The need to maintain a fixed exchange rate imposes monetary discipline on a country 2) Floating exchange rate regimes are vulnerable to speculative pressure 3) Uncertainty that accompanies floating exchange rates dampens the growth of international trade and investment 4) Far from correcting trade imbalances, depreciating a currency on the foreign exchange market tends to cause price inflation
Assumptions of Free trade model
1) World is complex - more than 2 countries and 2 products 2) Transportation costs to move goods from one country to another 3) Price of resources/ exchange rates can fluctuate 4) Immobile resources - Resources move freely from the production of one good to another 5) Constant returns to scale - there are no constant returns to specialization 6) Fixed stock of resources 7) Effects of trade on income distribution 8) Samuelson critique - being able to purchase goods less expensively within a country may not make up for the wages lost in moving production to a less expensive country.
Floating exchange rate system (current system)
1)Provides countries autonomy regarding the monetary policy - monetary policy autonomy - a country's ability to expand or contract its money supply as it sees fit is limited by the need to maintain exchange rate parity. Monetary expansion can lead to inflation which puts a downward pressure on a fixed exchange rate facilitate smooth adjustment of trade imbalances
Inefficient Market School
1. Companies can improve the foreign exchange market's estimate of future exchange rates by investing in forecasting services. - An inefficient market is one in which prices do not reflect all available information - In an inefficient market, forward exchange rates will not be the best possible predictors of future spot exchange rates - CONSIDER investing in forecasting services; BUT reputation isn't good
What is an efficient market school?
1. Forward exchange rates do the best possible job of forecasting future spot exchange rates, and therefore, investing in forecasting services would be a waste of money. - An efficient market is one in which prices reflect all available information - If foreign exchange market is efficient then forward exchange rates should be unbiased predictors of future spot rates - SHOULDN'T waste $ on forecasting services
Uruguay Round contained the following provisions
1. Tariffs on industrial goods were to be reduced by more than one-third, and tariffs were to be scrapped on more than 40 percent of manufactured goods. 2. Average tariff rates imposed by developed nations on manufactured goods were to be reduced to less than 4 percent of value, the lowest level in modern history. 3. Agricultural subsidies were to be substantially reduced. 4. GATT fair trade and market access rules were to be extended to cover a wide range of services. 5. GATT rules also were to be extended to provide enhanced protection for patents, copyrights, and trademarks (intellectual property). 6. Barriers on trade in textiles were to be significantly reduced over 10 years. 7. The World Trade Organization was to be created to implement the GATT agreement.
Need to Balance the disadvantages of Free Trade
1. Tax advantaged peoples and use money to retrain disadvantaged 2. Individuals find their personal strengths through education
Voluntary export restraint (VER)
A quota on trade imposed from the exporting country's side, instead of the importer's; usually imposed at the request of the importing country's government.
Local content requirement (LCR)
A requirement that some specific fraction of a good be produced domestically.
Specific Tariff
A tariff levied as a fixed charge for each unit of good imported.
Ad Valorem Tariff
A tariff levied as a proportion of the value of an imported good.
1947-1979: GATT, Trade Liberalization, and Economic Growth
After the debacle of the Great Depression, opinion in the U.S. Congress had swung strongly in favor of free trade. Under U.S. leadership, the GATT was established in 1947. The GATT was a multilateral agreement whose objective was to liberalize trade by eliminating tariffs, subsidies, import quotas, and the like. From its foundation in 1947 until it was superseded by the WTO, the GATT's membership grew from 19 to more than 120 nations. The GATT did not attempt to liberalize trade restrictions in one fell swoop; that would have been impossible. Rather, tariff reduction was spread over eight rounds.
The Uruguay Round and the World Trade Organization WTO
Against the background of rising pressures for protectionism, in 1986 GATT members embarked on their eighth round of negotiations to reduce tariffs, the Uruguay Round. In the Uruguay Round, member countries sought to extend GATT rules to cover trade in services. They also sought to write rules governing the protection of intellectual property, to reduce agricultural subsidies, and to strengthen the GATT's monitoring and enforcement mechanisms. The Uruguay Round dragged on for seven years before an agreement was reached on December 15, 1993. It went into effect July 1, 1995.
From Smith to the Great Depression
Aimed at avoiding rising unemployment by protecting domestic industries and diverting consumer demand away from foreign products, the Smoot-Hawley Act, passed by U.S. Congress is 1930, erected an enormous wall of tariff barriers. The Smoot-Hawley Act had a damaging effect on employment abroad. Other countries reacted by raising their own tariff barriers. U.S. exports tumbled in response, and the world slid further into the Great Depression.
Administrative trade policies
Bureaucracy rules typically adopted by government, that can be used to restrict imports or boost exports.
The role that business firms can play in promoting free trade or trade barriers.
Business firms are major players on the international trade scene. Because of their pivotal role in international trade, firms can and do exert a strong influence on government policy toward trade. This influence can: - encourage protectionism, or - encourage the government to support the WTO and push for open markets and freer trade among all nations
Lead strategy - Collecting foreign currency receivables early when a foreign currency is expected to depreciate, and paying foreign currency payables before they are due when a currency is expected to appreciate
Collecting foreign currency receivables early when a foreign currency is expected to depreciate, and paying foreign currency payables before they are due when a currency is expected to appreciate
Capital flight -
Converting domestic currency into a foreign currency
Lag strategy - Delaying the collection of foreign currency receivables if that currency is expected to appreciate, and delaying payables if that currency is expected to depreciate
Delaying the collection of foreign currency receivables if that currency is expected to appreciate, and delaying payables if that currency is expected to depreciate
Antidumping policies
Designed to punish foreign firms that engage in dumping and thus protect domestic producers from unfair foreign competition.
1980-1993: Protectionist Trend
During the 1980s and early 1990s, the trading system erected by the GATT came under strain as pressures for greater protectionism increased around the world. There were three reasons for the rise in such pressures during the 1980s. First, the economic success of Japan during that time strained the world trading system. Second, the world trading system was strained by the persistent trade deficit in the world's largest economy, the United States. A third reason for the trend toward greater protectionism was that many countries found ways to get around GATT regulations by using Voluntary Export Restraints VER.
Smoot-Hawley Act
Enacted in 1930 by the U.S. Congress, this act erected a wall of tariff barriers against imports into the United States.
Nonconvertible currency -
Exists when both residents and non residents are prohibited from converting their holdings of that currency into another currency
Quota rent
Extra profit producers make when supply is artificially limited by an import quota.
Regional and Bilateral Trade Agreements
In response to the apparent failure of the Doha Round to progress, many nations have pushed forward with regional or bilateral trade agreements, which are reciprocal trade agreements between two or more partners. Regional and bilateral trade agreements are designed to capture gain from trade beyond those agreements currently attainable under WTO treaties. Regional and bilateral trade agreements are allowed under WTO rules, and countries entering into these agreements are required to notify the WTO.
General Agreement on Tariffs and Trade (GATT)
International treaty that committed signatories to lowering barriers to the free flow of goods across national borders and led to the WTO.
Externally convertible currency -
Limitations on the ability of residents to convert domestic currency, though nonresidents can convert their holdings of domestic currency into foreign currency
Tariff rate quota
Lower tariff rates applied to imports within the quota than those over the quota.
Bandwagon effect
Movement of traders like a herd, all in the same direction at the same time, in response to each other's perceived actions
Why does Japan export automobiles?
New Trade Theory ➢ First movers with fuel efficient/ low cost automobiles ➢ Lucky enough to have one or more firms among the first to produce ➢ Trade increases the specialization of production ➢ Luck, entrepreneurship and innovation leads to first mover advantage
Infant industry argument
New industries in developing countries must be temporarily protected from international competition to help them reach a position where they can compete on world markets with the firms of developed nations.
Explain the arguments of those who maintain that government can play a proactive role in promoting national competitive advantage in certain industries.
New trade theorist 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 a newly emerging industry.
Inefficient market
One in which prices do not reflect all available information
Regional or bilateral trade agreements
Reciprocal trade agreements between two or more partners.
Dumping
Selling goods in a foreign market for less than their cost of production or below their "fair" market value.
Currency swap
Simultaneous purchase and sale of a given amount of foreign exchange for two different value dates
WTO: Experience to Date
Since its formation, the WTO has remained at the forefront of efforts to promote global free trade. Its creators expressed the belief that the enforcement mechanisms granted to the WTO would make it more effective at policing global trade rules than the GATT had been. By 2014, the WTO had 160 members, including China, which joined at the end of 2001, and Russia, which joined in 2012. WTO members collectively account for 98 percent of world trade. The WTO talks in Seattle in late 1999, slow progress with the next round of trade talks (the Doha Round), and a shift back toward some limited protectionism following the global financial crisis of 2008-2009 have raised a number of questions about the future direction of the WTO.
Currency management
The current system is a mixed system in which a combination of government intervention and speculative activity can drive the foreign exchange market. Companies engaged in significant foreign exchange activities need to be aware of this and to adjust their foreign exchange transactions accordingly.
Spot exchange rate -
The exchange rate at which a foreign exchange dealer will convert one currency into another that particular day
Economic exposure
The extent to which a firm's future international earning power is affected by changes in exchange rates
Transaction exposure
The extent to which income from individual transactions is affected by fluctuations in foreign exchange values
Translation exposure -
The extent to which the reported consolidated results and balance sheets of a corporation are affected by fluctuations in foreign exchange values
The foreign exchange market serves two main functions
The first is to convert the currency of one country into the currency of another. The second is to provide some insurance against foreign exchange risk, or the adverse consequences of unpredictable changes in exchange rates
Summarize and explain the arguments against strategic trade policy.
The strategic trade policy arguments of the new trade theorists suggest an economic justification for government intervention in international trade. This justification challenges the rationale for unrestricted free trade found in the work of classic trade theorists such as Adam Smith and David Ricardo. In response to this challenge to economic orthodoxy, a number of economists—including some of those responsible for the development of the new trade theory, such as Paul Krugman—point out that although strategic trade policy looks appealing in theory, in practice it may be unworkable. This response to the strategic trade policy argument constitutes the revised case for free trade.
Countertrade -
The trade of goods and services for other goods and services
Business strategy
The volatility of the current global exchange rate regime presents a conundrum for international businesses. Exchange rate movements are difficult to predict, and yet their movement can have a major impact on a business's competitive position.
David Ricardo (1817)
Theory of Comparative Advantage
The impact of trade barriers on a firm's strategy.
Trade barriers constrain a firm's ability to disperse its productive activities in countries in which these activities can be performed more efficiently. - First, tariff barriers raise the costs of exporting products to a country. - Second, quotas may limit a firm's ability to serve a country from locations outside that country. - Third, to conform to local content regulations, a firm may have to locate more production activities in a given market than it would otherwise. This may increase the firm's costs. - Finally, the threat of antidumping action limits the ability of a firm to use aggressive pricing to gain market share in a country.
Link between trade and growth
We find a strong association between openness and growth, both within the group of developing and the group of developed countries. Within the group of developing countries, the open economies grew at 4.49 percent per year, and the closed economies grew at 0.69 percent per year. Within the group of developed economies, the open economies grew at 2.29 percent per year, and the closed economies grew at 0.74 percent per year
Crisis Recovery
When a country is hit by a severe economic crisis, its currency typically declines on foreign exchange markets. The reason for this is that investors respond to the crisis by taking their money out of the country, selling the local currency, and driving down its value.
Floating exchange rate
When the foreign exchange market determines the relative value of a currency, Four of the world's major trading currencies—the U.S. dollar, the European Union's euro, the Japanese yen, and the British pound—are all free to float against each other.
Forward exchange
When two parties agree to exchange currency and execute a deal at some specific date in the future
Role of the World Bank (International Bank for Reconstruction and Development) (worldbank.org)
Work with countries to end poverty and boost prosperity for the poorest people ➢ To end extreme poverty by reducing the share of the global population that lives in extreme poverty by 3% by 2030 ➢ To promote shared prosperity by increasing the incomes of the poorest 40 percent of the people in every country.
Absolute Advantage
a country has an absolute advantage in the production of a product when it is more efficient than any other country in producing it Factors - climate, topography, politics
Foreign exchange market
a market for converting the currency of one country into that of another country
Free Trade
a situation where a government does not attempt to influence through quotas or duties what its citizens can buy from another country or what they can produce and sell to another country
Tariff
a tax levied on imports (or exports). Tariffs fall into two categories
Financial assistance
aka loans for actual or potential balance of payment problems (international payments between countries) ➢ Loan resources to low-income countries - interest rate for low-income countries 0%
technical analysis
analysis methodology for forecasting the direction of prices through the study of past market data, primarily price and volume.
Countervailing duties
antidumping duties (or special tariff) imposed on foreign firms that engage in dumping practices.
First-mover advantages
are the economic and strategic advantages that accrue to early entrants into an industry.30 The ability to capture scale economies ahead of later entrants, and thus benefit from a lower cost structure, is an important first-mover advantage.
Moral Hazard
arises when people behave recklessly because they know they will be saved if things go wrong.
Gold standard
began around the 1880's and worked reasonably through WWI (1914) - Gold standard contained an automatic mechanism what contributed to the simultaneous achievement of balance- of -payment equilibrium by all countries. The gold standard broke down in the 1930's as countries engaged in competitive devaluations
Technical assistance and training
build better economic institutions and strengthen human capacities
Adam Smith (1776)
countries differ in their ability to produce goods efficiently
Austerity measures invoked by the IMF
cutting governmental spending and raising taxes.
Political arguments
for intervention are concerned with protecting the interests of certain groups within a nation (normally producers), often at the expense of other groups (normally consumers), or with achieving some political objective that lies outside the sphere of economic relationships, such as protecting the environment or human rights.
the fixed exchange rate system collapsed due to
speculative pressure on the dollar following a rise in U.S. inflation and the growing U. S. balance of trade deficit
New Trade Theory (Krugman - 1970)
suggests countries may specialize in the production and export of particular products because in certain industries, the world market can only support a limited number of firms
Trade policy uses seven main instruments
tariffs, subsidies, import quotas, voluntary export restraints, local content requirements, administrative policies, and antidumping duties. Tariffs are the oldest and simplest instrument of trade policy. A fall in tariff barriers in recent decades has been accompanied by a rise in nontariff barriers, such as subsidies, quotas, voluntary export restraints, and antidumping duties.
Mercantilism
that it was in a country's best interests to maintain a trade surplus, to export more than it imported - Think of the United Kingdom in the 1700's Trading is a zero sum game - meaning that there are winners and losers - A zero-sum game is one in which a gain by one country results in a loss by another.) Governments should intervene to help their country achieve a trade surplus
Gold Par Value
the amount of currency needed to purchase one ounce of gold
first-mover advantages
the economic and strategic advantages that accrue to early entrants into an industry •first movers can gain a scale based cost advantage that later entrants find difficult to match
Balance of trade equilibrium
the income its residents earn from exports is equal to the money its residents pay to other countries for imports (the current account of its balance of payments is in balance)
Exchange rate -
the rate at which one currency is converted into another
Fixed exchange rate
the values of a set of currencies are fixed against each other at some mutually agreed-on exchange rate
Economy of scale
unit cost reductions associated with a large scale output
o IMF (International Monetary fund)
was established to maintain order and bring monetary stability 1) avoid competitive devaluations and bring stability to the world trade environment 2) control price inflation by imposing monetary discipline on countries
Dirty-float system
while not adopting a formal pegged rate, try to hold the value of their currency within some range against an important reference currency such as the U.S. dollar, or a "basket" of currencies. It is a float because in theory, the value of the currency is determined by market forces, but it is a dirty float (as opposed to a clean float) because the central bank of a country will intervene in the foreign exchange market to try to maintain the value of its currency if it depreciates too rapidly against an important reference currency
IMF-mandated macro economic policies are under serious debate, with critics charging that at times the IMF imposes inappropriate conditions on developing nations.
• One size fits all approach to macro economic policy that may be inappropriate for many countries • Moral hazard - people behave recklessly because they know that will be saved if things go wrong • Lack of accountability - has become too powerful for an institution that lacks any real mechanism for accountability
Product Life-Cycle Theory (1960's)
• The size and wealth of the U.S. market gave U.S. firms a strong incentive to develop new products • Initially, the product would be produced and sold in the U.S. • As demand grew in other developed countries, U.S. firms would begin to export • Demand for the new product would grow in other advanced countries - foreign producers to begin producing for their home markets • Mature industries leave the U.S. for low cost assembly locations
Hecksher- Ohlin Theory (1933)
➢ comparative advantage arises from differences in national factor endowments ➢ the extent to which a country is endowed with resources like land, labor, and capital ➢ ( Supply and Demand) The more abundant a factor, the lower its cost Primary difference between the Hecksher - Ohlin theory and theory of comparative advantage is pattern of international trade is determined by differences in factor endowments and not productivity
