Ibus Concept Check #2

The collapse of the gold standard

- 1973: the end of Bretton Woods - gold standard abandoned: $US dollar floats - How to redeem all those $ at $35 per ounce? - Vietnam; petro-dollars; inflation - Weakening export position: deteriorating current account - first time when there was an oil crisis when OPEC flexed their strength and gas prices rose - people would be in line for gas and would run out of gas while in line and would push their cars to get gas - instead of printing money that were printing gas ration coupons

Reality: trade patterns

- Based on Hecksher-Ohlin, US should import labor-intensive and export capital intensive - But the opposite happens: export (skilled labor intensive) software; import capital intensive heavy machinery - this is know as the "Leontief Paradox"

Theory of Absolute Advantage

- Capability of one country to produce more of a product with the same amount of input than another country - Produce only goods where you are most efficient, trade for those where you are not efficient - trade between countries is, therefor, beneficial

WTO Problems and challenges

- Doha Talks collapsed due to disagreement on how to move forward on reducing barriers to trade - WTO bargaining structure unwieldy and complex - Decision making is not democratic in practice: biased towards big, economically powerful countries.

The benefits to open trade and investment

- From a "free trade" perspective, best not to see the world as "us" vs. "them" - instead, "free trade" theory suggests that everyone is better off in the long run through free trade. - in developing countries, open economies grow 4.49% while closed economies grew at .69% - better to open rather than close borders

Bretton Woods Organization (1944)

- IMF: The International Monetary Fund (IMF) was established to maintain order in the international monetary system - The World Bank: The World Bank was established to promote general economic development. - World Trade Organization (WTO): General Agreement on Tariffs and Trade (GATT) was established in 1948 to liberalize trade barriers.In 1995, the GATT evolved into the World Trade Organization

the various terrains of multilateral institutions

- Security (UN, NATO) - Labor (ILO) - Development (FAO, UNDP) - Financial stability (IMF, World Bank, BIS) - Trade (GATT/WTO)

Home-country costs

- The most important concerns center on the balance-of payments and employment effects of outward FDI. The home country's balance of payments may suffer in three ways. First, the balance of payments suffers from the initial capital outflow required to finance the FDI. - Second, the current account of the balance of payments suffers if the purpose of the foreign investment is to serve the home market from a low-cost production location. Third, the current account of the balance of payments suffers if the FDI is a substitute for direct exports. - With regard to employment effects, the most serious concerns arise when FDI is seen as a substitute for domestic production.

NAFTA results

- Trade among the members more than tripled, and now exceeds $1 trillion per year. - Between 1994 and 2008, annual exports from... - Canada to Mexico and the U.S. more than doubled; - Mexico to the U.S. grew from $50 to $220 billion; - the U.S. to Mexico grew from $40 to $150 billion; - the U.S. to Canada grew from $120 to $260 billion. - Both Canada and Mexico now have some 80 percent of their trade with, and 60 percent of their FDI stocks in the United States.

Soft currencies

- currencies that are not freely tradable because of domestic laws or the unwillingness of foreigners to hold them - often lose value - ex: Ruble, Dong, Cuban Peso

A weakening dollar helps:

- domestic, import-competing industries - Exporters: reason why china has been accused of holder their money down because it helps with exporting - MNEs repatriating income from abroad: bringing back currencies and converting them back to dollar

Smith-Ricardian theory of trade

- simple proof that specialization and trade leads to greater overall welfare - even if one producer is more productive in all goods - think in terms of opportunity cost

Economic Arguments for Government Intervention

-infant industry argument -strategic trade policy

Political arguments for government intervention

-protecting jobs and industries -national security -retaliation -protecting consumers -furthering foreign policy objectives -protecting human rights

Levels of Economic Integration

1. Free Trade Area 2. Customs Union 3. Common Market 4. Economic Union 5. Political Union

Policy Options

1. Free float: leave it to supply and demand; let the market forces work; risk: even when it's a really stable currency there is change and little changes make a difference in spending and budget 2. Dirty Float: Allow your exchange rate to go within a certain range and if it goes above or below the banks intervene; how 'dirty' depends on the bandwidth 3. fixed: se at a rate specific to the government (set by the government) 4. Pegged: linked to a single currency (often times currencies are pegged to the US dollar)

host country benefits

1. Resource Transfer Effects 2. Employment Effects 3. Balance-of-Payments Effects 4. Effect on Competition and Economic Growth

Political structure of the EU

1. The European Commission 2. The European Council 3. The European Parliament 4. The Court of Justice

home-country benefits

1. The home country's balance of payments benefits from the inward flow of foreign earnings. 2. benefits to the home country from outward FDI arise from employment effects. 3. benefits arise when the home-country MNE learns valuable skills from its exposure to foreign markets that can subsequently be transferred back to the home country.

Factor Endowments

A country's endowment with resources such as land, labor, and capital.

Central American Common Market

A trade pact among Costa Rica, El Salvador, Guatemala, Honduras, and Nicaragua, which began in the early 1960s but collapsed in 1969 due to war. - It collapsed in 1969, when war broke out between Honduras and El Salvador after a riot at a soccer match between teams from the two countries.

multipoint competition definition

Arises when two or more enterprises encounter each other in different regional markets, national markets, or industries.

Porter's Diamond Theory

Competitive advantage of certain industries in different nations

economies of scale

Cost advantages associated with large-scale production.

New Trade Theory (Paul Krugman)

Economies of Scale (increase variety of good, reduce costs), First mover advantages

offshore production

FDI undertaken to serve the home market

Inflows of FDI

Flow of foreign direct investment into a country

Why Transform from GATT to WTO?

GATT was outdated: - Trade more complex - Trade in services growing - International investment growing - Failure to liberalize agriculture, other non-tariff barriers

Product Life Cycle Theory

Proposed by Raymond Vernon, this theory suggests that early in their life cycle, most new products are produced in and exported from the country in which they were developed. As a new product becomes widely accepted internationally, however, production starts in other countries. As a result, the theory suggests, the product may ultimately be exported back to the country of its original innovation.

Spot transactions

See what you get when the account is due - When it is due, you pay the amount (whatever the exchange rate is at the time) High risk, high return, you don't know what the exchange rate is going to be in 3 days so it can be very volital so a lot of companies use currency hedging

Non-tariff barriers to trade

Subsidies/cheap exports - cotton: US budget 3-4 billion p.a. - European cows: 2 euro per cow per day - 2 billion people with less than $2 per day Trade-related aspects of intellectual property rights (TRIPS) Patent protection is essential to the recovery of R&D costs Problems with lack of enforcement / keep companies from trading Trade-related investment measures (TRIMs) - A part of trims is the local content requirement, part of NAFTA had a rule that was 62.5% of automobiles needed to be manufactures in a NAFTA country (Canada, US, or Mexico). If it was, they would get a huge tax break by doing that. What happened in reality was the car would be made overseas, completely disassembled, shipped over to a NAFTA country, reassembled, and then it qualified.

Court of Justice

Supreme appeals court for EU law - comprised of one judge from each country

European Council

The heads of state of EU members and the president of the European Commission - represents the interests of member states. It is clearly the ultimate controlling authority within the EU because draft legislation from the commission can become EU law only if the council agrees. The council is composed of one representative from the government of each member state.

Trade Creation

Trade created due to regional economic integration; occurs when high-cost domestic producers are replaced by low-cost foreign producers in a free trade area.

Political Union

a central political apparatus coordinates economic, social, and foreign policy

Import quota

a direct restriction on the quantity of a good that can be imported into a country - The restriction is usually enforced by issuing import licenses to a group of individuals or firms. For example, the United States has a quota on cheese imports. The only firms allowed to import cheese are certain trading companies, each of which is allocated the right to import a maximum number of pounds of cheese each year. In some cases, the right to sell is given directly to the governments of exporting countries.

export ban

a policy that partially or entirely restricts the export of a good

zero-sum game

a situation in which an economic gain by one country results in an economic loss by another

Administrative Trade Policies

administrative policies, typically adopted by government bureaucracies, that can be used to restrict imports or boost exports - bureaucratic rules designed to make it difficult for imports to enter a country. It has been argued that the Japanese are the masters of this trade barrier. In recent decades, Japan's formal tariff and nontariff barriers have been among the lowest in the world. However, critics charge that the country's informal administrative barriers to imports more than compensate for this. For example, at one point, the Netherlands exported tulip bulbs to almost every country in the world except Japan. In Japan, customs inspectors insisted on checking every tulip bulb by cutting it vertically down the middle, and even Japanese ingenuity could not put any back together.

first-mover advantage

advantages accruing to the first to enter a market

countervailing duties

antidumping duties

David Ricardo, The Principles of Political Economy and Taxation

argued that efficiency of resource utilization leads to more productivity - should import even if country is more efficient in the product's production than country from which it is buying (comparative advantage)

Trade

better use of resources; more total output

Externalities

knowledge spillovers

Tariff Rate Quota (TRQ)

lower tariff rates applied to imports within the quota than those over the quota

A strong dollar buys; a weak dollar buys...

more foreign currency; less foreign currency

Balance of payments accounts

national accounts that track both payments to and receipts from foreigners

Autarky

no trade, poor employment of resources

Foreign exchange

one of the key issues that differentiates international business from domestic business - companies can either win lots of money or lose on currency exchange - the key take away is the product or service, they can gain a lot of money by just doing currency exchange, or they can completely lose their shirt

Multilateral or Bilateral Trade Agreements

reciprocal trade agreements between 2 or more partners - In response to the apparent failure of the Doha Round to progress, many nations have pushed forward with multilateral or bilateral trade agreements. Multilateral and bilateral trade agreements are designed to capture gain from trade beyond those agreements currently attainable under WTO treaties. Multilateral and bilateral trade agreements are allowed under WTO rules, and countries entering into these agreements are required to notify the WTO.

exporting

sale of products produced in one country to residents of another country

Specific tariffs

tariff levied as a fixed charge for each unit of good imported (e.g. $3 per barrel of oil)

Stock of FDI

the total accumulated value of foreign-owned assets at a given time

related and supporting industries

the presence of suppliers or related industries that are internationally competitive. The benefits of investments in advanced factors of production by related and supporting industries can spill over into an industry, thereby helping it achieve a strong competitive position internationally. - One consequence of this process is that successful industries within a country tend to be grouped into clusters of related industries.

Trade Diversion

Trade diverted due to regional economic integration; occurs when low-cost foreign suppliers outside a free trade area are replaced by higher-cost suppliers within a free trade area.

Current account balance affects exchange

Trade surplus= more money coming into the country than leaving it; pushing dollar up - Trade deficit = more money leaving the county, this pushes the dollar down - US used to have a current account surplus: it exported more than it imported, which propped the dollar's value up

Maastricht Treaty

Treaty agreed to in 1992, but not ratified until January 1, 1994, that committed the 12 member states of the European Community to a closer economic and political union.

Market Imperfections

imperfections in the operation of the market mechanism

current account

in the balance of payments, records transactions involving the export or import of goods and services

Political ideology and FDI

Historically, political ideology toward FDI within a nation has ranged from a dogmatic radical stance that is hostile to all inward FDI at one extreme to an adherence to the noninterventionist principle of free market economics at the other. Between these two extremes is an approach that might be called pragmatic nationalism.

What country is the hub of global trade?

Hong Kong

what would you want in your primary currency?

1. stable 2. convertible 3. commonly traded

Product Life Cycle (Vernon)

Comparative advantage initially resides with the lead innovation nation and go to others as the product goes through its life cycle stages

North American Free Trade Agreement (NAFTA)

Free trade area among Canada, Mexico, and the United States - The governments of the United States and Canada in 1988 agreed to enter into a free trade agreement, which took effect January 1, 1989. The goal of the agreement was to eliminate all tariffs on bilateral trade between Canada and the United States by 1998. This was followed in 1991 by talks among the United States, Canada, and Mexico aimed at establishing a North American Free Trade Agreement (NAFTA) for the three countries.

Hecksher-Ohlin Theorem (HOT)

countries have advantages in different goods due to factor endowments

New Trade Theory

economists such as Paul Krugman developed what has come to be known as the new trade theory. New trade theory: the observed pattern of trade in the world economy may be due in part to the ability of firms in a given market to capture first-mover advantages. - countries specialize in the production and export of particular products not because of underlying differences in factor endowments but because in certain industries the world market can support only a limited number of firms. (This is argued to be the case for the commercial aircraft industry.) In such industries, firms that enter the market first are able to build a competitive advantage that is subsequently difficult to challenge. Thus, the observed pattern of trade between nations may be due in part to the ability of firms within a given nation to capture first-mover advantages.

Quota rent

extra profit producers make when supply is artificially limited by an import quota - If a domestic industry lacks the capacity to meet demand, an import quota can raise prices for both the domestically produced and the imported good.

Host countries encouraging inward FDI

governments to offer incentives to foreign firms to invest in their countries. Such incentives take many forms, but the most common are tax concessions, low-interest loans, and grants or subsidies.

the reality of trade

the only difference between theory and reality is that, in theory, there is no difference, while in reality, there is

154 Rue de Lausanne, Geneva

responsible for setting international trade standards and settling trade disputes

Shifting exchange rate risk:

shifting the risk onto your partner usually when there's more demand than supply. If you want to buy X you'll pay me n US dollars. Bypassing any exchange rate with that.

Levels of Regional Integration

start at the most basic level which is really the Free trade area and each of the levels beyond that level add something to it

Money Supply

the aggregate value of the money supply should reflect the value of the national economy - changes in the national supply will put pressure on exchange rates

Flow of FDI

the amount of FDI undertaken over a given time period (normally a year)

The WTO: A significant accomplishment

- A forum for trade negotiations (164 members) with a secretariat - DSPs (dispute settlement procedures): 'binding' through counter-measures (don't have sovereign control over the various countries, but countries want to become part of the WTO and so if they are fined for a violation, they pay those fines so they can continue being a member) - Includes services & intellectual property (GATS/TRIPS) - Reviews national policies to check for discrimination against other members (Illegal to discriminate against other countries) - Assists less-developed countries (LDCs) in trade policy through technical assistance and training

Contents of the NAFTA

- Abolition by 2004 of tariffs on 99 percent of the goods traded among Mexico, Canada, and the United States. - Removal of most barriers on the cross-border flow of services, allowing financial institutions, for example, unrestricted access to the Mexican market by 2000. - Protection of intellectual property rights. - Removal of most restrictions on foreign direct investment among the three member countries, although special treatment (protection) will be given to Mexican energy and railway industries, American airline and radio communications industries, and Canadian culture. - Application of national environmental standards, provided such standards have a scientific basis. Lowering of standards to lure investment is described as being inappropriate. - Establishment of two commissions with the power to impose fines and remove trade privileges when environmental standards or legislation involving health and safety, minimum wages, or child labor are ignored.

Unresolved issues of the WTO

- As the public face of globalization, some politicians and nongovernmental organizations blame the WTO for a variety of ills, including high unemployment, environmental degradation, poor working conditions in developing nations, falling real wage rates among the lower paid in developed nations, and rising income inequality. - Antidumping actions proliferated during the 1990s and 2000s. WTO rules allow countries to impose antidumping duties on foreign goods that are being sold cheaper than at home or below their cost of production when domestic producers can show that they are being harmed. Unfortunately, the rather vague definition of what constitutes "dumping" has proved to be a loophole that many countries are exploiting to pursue protectionism. - Another focus of the WTO has been the high level of tariffs and subsidies in the agricultural sector of many economies. Tariff rates on agricultural products are generally much higher than tariff rates on manufactured products or services. The implication is that consumers in these countries are paying significantly higher prices than necessary for agricultural products imported from abroad, which leaves them with less money to spend on other goods and services. the WTO argues that removing tariff barriers and subsidies could significantly boost the overall level of trade, lower prices to consumers, and raise global economic growth by freeing consumption and investment resources for more productive uses. - Another issue that has become increasingly important to the WTO has been protecting intellectual property. The TRIPS regulations oblige WTO members to grant and enforce patents lasting at least 20 years and copyrights lasting 50 years. Rich countries had to comply with the rules within a year. Poor countries, in which such protection was generally much weaker, had five years' grace, and the very poorest had 10 years. The basis for this agreement was a strong belief among signatory nations that the protection of intellectual property through patents, trademarks, and copyrights must be an essential element of the international trading system. Inadequate protections for intellectual property reduce the incentive for innovation. - tariffs on services remain higher than on industrial goods. - The WTO would like to bring down tariff rates still further and reduce the scope for the selective use of high tariff rates. The ultimate aim is to reduce tariff rates to zero. Although this might sound ambitious, 40 nations have already moved to zero tariffs on information technology goods, so a precedent exists. - Looking farther out, the WTO would like to bring down tariff rates on imports of nonagricultural goods into developing nations. Many of these nations use the infant industry argument to justify the continued imposition of high tariff rates; however, ultimately these rates need to come down for these nations to reap the full benefits of international trade.

Impediments to Integration

- Despite the strong economic and political arguments in support, integration has never been easy to achieve or sustain for two main reasons. First, although economic integration aids the majority, it has its costs. While a nation as a whole may benefit significantly from a regional free trade agreement, certain groups may lose. Moving to a free trade regime can involve painful adjustments. Due to the establishment of NAFTA, some Canadian and U.S. workers in such industries as textiles, which employ low-cost, lowskilled labor, lost their jobs as Canadian and U.S. firms moved production to Mexico. - A second impediment to integration arises from concerns over national sovereignty. For example, Mexico's concerns about maintaining control of its oil interests resulted in an agreement with Canada and the United States to exempt the Mexican oil industry from any liberalization of foreign investment regulations achieved under NAFTA.

The establishment of the Euro

- EC members signed the Maastricht Treaty, which committed them to adopting a common currency by January 1, 1999.13 The euro is now used by 19 of the 28 member states of the European Union; these 19 states are members of what is often referred to as the euro zone. - fulfilled certain economic criteria—a high degree of price stability, a sound fiscal situation, stable exchange rates, and converged long-term interest rates - Establishment of the euro was an amazing political feat with few historical precedents. It required participating national governments to give up their own currencies and national control over monetary policy. - By adopting the euro, the EU has created the second most widely traded currency in the world after that of the U.S. dollar.

Enlargement of the EU

- Enlargement of the EU into eastern Europe has been discussed since the collapse of communism - To qualify for EU membership, the applicants had to privatize state assets, deregulate markets, restructure industries, and tame inflation. They also had to enshrine complex EU laws into their own systems, establish stable democratic governments, and respect human rights.16 - Left standing at the door is Turkey. Turkey, which has long lobbied to join the union, presents the EU with some difficult issues. - full membership has been denied because of concerns over human rights issues (particularly Turkish policies toward its Kurdish minority). - The campaign for leaving - The vote was also split by age and education. The younger and more educated voted to stay in the EU, while the older and less educated voted to leave. - Britain is the EU's second largest national economy. It is seen by many smaller member countries as an important counterweight to the economic power of Germany. - As for Britain, most experts predict that the country will bear significant short- to medium-term costs as a result of this decision. Britain is now less likely to attract inward investment from foreign multinationals, some multinationals may move operations to other EU countries to maintain access to the single market, and exports to the EU may fall, London risks losing its position as the financial capital of Europe, and economic growth will probably be lower than it otherwise might have been.

Why do firms go to the trouble of establishing operations abroad through foreign direct investment when two alternatives, exporting and licensing, are available to them for exploiting the profit opportunities in a foreign market?

- Exporting involves producing goods at home and then shipping them to the receiving country for sale. Licensing involves granting a foreign entity (the licensee) the right to produce and sell the firm's product in return for a royalty fee on every unit sold. The question is important, given that a cursory examination of the topic suggests that foreign direct investment may be both expensive and risky compared with exporting and licensing. - The answer can be found by examining the limitations of exporting and licensing as means for capitalizing on foreign market opportunities.

A strengthening dollar helps:

- Importers (& consumers of imported goods): money will be coming into their country - US firms with offshore outsourcing: they're having to pay foreign workers in their own currency - Foreign debt holders: because they're converting it back into dollars

Gov. encouraging outward FDI

- Many investor nations now have government-backed insurance programs to cover major types of foreign investment risk. The types of risks insurable through these programs include the risks of expropriation (nationalization), war losses, and the inability to transfer profits back home. - special funds or banks that make government loans to firms wishing to invest in developing countries. - eliminated double taxation of foreign income (i.e., taxation of income in both the host country and the home country). - Last, and perhaps most significant, a number of investor countries (including the United States) have used their political influence to persuade host countries to relax their restrictions on inbound FDI.

Ibus in the news

- Misinformation from Russia and other countries like that on the coronavirus - Sweden continuing their less strict approach on the coronavtirus, daily cases and deaths are increasing more than most countries and it's projected that 26% of the population will be infected. They're trying to get like long term immunity - Foreign exchange: the amero, the US once changed the dollar to the amero, this would be hard because the countries that were going to be apart of this were very different - When the Romanians first went with the euro, it was very hard because they're so much smaller than say Germany

Regional Trade blocs in Africa

- Nominally there are now 17 trade blocs on the African continent. Many countries are members of more than one group. Although the number of trade groups is impressive, progress toward the establishment of meaningful trade blocs has been slow. - Many of these groups have been dormant for years. Significant political turmoil in several African nations has persistently impeded any meaningful progress. Also, deep suspicion of free trade exists in several African countries. - Kenya, Uganda, and Tanzania, member states of the East African Community (EAC), committed themselves to relaunching their bloc, 24 years after it collapsed. The three countries, with 80 million inhabitants, intend to establish a customs union, regional court, legislative assembly, and, eventually, a political federation. - Their program includes cooperation on immigration, road and telecommunication networks, investment, and capital markets. - The EAC established a common market in 2010 and is now striving toward an eventual goal of monetary union. In 2015, in what is a promising sign, - representatives from 26 African nations signed an agreement pledging to work together to establish a free trade area that would remove or reduce many tariffs and eliminate time-consuming customs procedures between them. Know as the Tripartite Free Trade Area (TFTA)

NAFTA: the results

- On average, studies indicate that NAFTA's overall impact has been small but positive.20 NAFTA was meant to increase trade between the three member states, and that it appears to have done. - Canada and Mexico are now among the top three trading partners of the United States (the other is China), suggesting the economies of the three NAFTA nations have become more closely integrated. - All three countries also experienced strong productivity growth in the first 10 years NAFTA was in place. - Estimates suggest that employment effects of NAFTA have been moderate to small. - "the net employment effects were relatively small, although there were adjustments across sectors displacing workers." - real wages increased for all NAFTA members, with Mexico registering the largest gain. This study supports the general conclusion that contrary to political rhetoric, the impact of NAFTA has been quite small.

Oligopolistic industries

- One theory is based on the idea that FDI flows are a reflection of strategic rivalry between firms in the global marketplace. An early variant of this argument was expounded by F. T. Knickerbocker, who looked at the relationship between FDI and rivalry in oligopolistic industries.14 An oligopoly is an industry composed of a limited number of large firms (e.g., an industry in which four firms control 80 percent of a domestic market would be defined as an oligopoly). A critical competitive feature of such industries is interdependence of the major players: What one firm does can have an immediate impact on the major competitors, forcing a response in kind. - Thus, the interdependence between firms in an oligopoly leads to imitative behavior; rivals often quickly imitate what a firm does in an oligopoly. Imitative behavior can take many forms in an oligopoly. One firm raises prices, and the others follow; one expands capacity, and the rivals imitate lest they be left at a disadvantage in the future. Knickerbocker argued that the same kind of imitative behavior characterizes FDI. Consider an oligopoly in the United States in which three firms—A, B, and C—dominate the market. Firm A establishes a subsidiary in France. Firms B and C decide that if successful, this new subsidiary may knock out their export business to France and give a first-mover advantage to firm A. Furthermore, firm A might discover some competitive asset in France that it could repatriate to the United States to torment firms B and C on their native soil. Given these possibilities, firms B and C decide to follow firm A and establish operations in France.

Assumptions of the Smith-Ricardian theory of trade

- Only two countries and two goods - No transportation costs - Countries have similar prices and values - Fixed amounts of resources - Resources are mobile between goods within countries, but not across countries - Constant returns to scale - No effects on income distribution within countries

The GATT

- Origins of GATT (predecessor WTO) - GATT (General Agreement on Tariffs and Trade) dates from 1948 - Aimed to address isolationism/protectionism, which were seen as causes of WWII - First round (1948 ) among 23 original members led to 45,000 concessions affecting 20% of world trade - GATT and WTO each time they meet is considered a round. In the first round there were only 23 members, but it affected 20% of trade

Regional Economic Integration

- Over 50 percent of world trade today occurs under some form of preferential trade agreements signed by groups of countries. - Cooperating nations obtain: - increased product choices, productivity, living standards - lower prices, and - more efficient resource use.

Firm strategy, structure, and rivalry

- Porter makes two important points here. First, different nations are characterized by different management ideologies, which either help them or do not help them build national competitive advantage. - Porter's second point is that there is a strong association between vigorous domestic rivalry and the creation and persistence of competitive advantage in an industry. Vigorous domestic rivalry induces firms to look for ways to improve efficiency, which makes them better international competitors. Domestic rivalry creates pressures to innovate, to improve quality, to reduce costs, and to invest in upgrading advanced factors.

Porter's Diamond Model

- Porter's work was driven by a belief that existing theories of international trade told only part of the story. For Porter, the essential task was to explain why a nation achieves international success in a particular industry. - Porter theorizes that four broad attributes of a nation shape the environment in which local firms compete, and these attributes promote or impede the creation of competitive advantage (see Figure 6.5). These attributes are: - Factor endowments—a nation's position in factors of production, such as skilled labor or the infrastructure necessary to compete in a given industry. - Demand conditions—the nature of home demand for the industry's product or service. - Related and supporting industries—the presence or absence of supplier industries and related industries that are internationally competitive. - Firm strategy, structure, and rivalry—the conditions governing how companies are created, organized, and managed and the nature of domestic rivalry. - Porter speaks of these four attributes as constituting the diamond. He argues that firms are most likely to succeed in industries or industry segments where the diamond is most favorable. He also argues that the diamond is a mutually reinforcing system. The effect of one attribute is contingent on the state of others. For example, Porter argues favorable demand conditions will not result in competitive advantage unless the state of rivalry is sufficient to cause firms to respond to them. - Porter maintains that two additional variables can influence the national diamond in important ways: chance and government.

The Single European Act proposed the following changes:

- Remove all frontier controls among EC countries, thereby abolishing delays and reducing the resources required for complying with trade bureaucracy. - Apply the principle of "mutual recognition" to product standards. A standard developed in one EC country should be accepted in another, provided it met basic requirements in such matters as health and safety. - Institute open public procurement to nonnational suppliers, reducing costs directly by allowing lower cost suppliers into national economies and indirectly by forcing national suppliers to compete. - Lift barriers to competition in the retail banking and insurance businesses, which should drive down the costs of financial services, including borrowing, throughout the EC. - Remove all restrictions on foreign exchange transactions between member countries by the end of 1992. - Abolish restrictions on cabotage—the right of foreign truckers to pick up and deliver goods within another member state's borders—by the end of 1992. Estimates suggested this would reduce the cost of haulage within the EC by 10 to 15 percent.

Formation of the GATT

- 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. - In its early years, the GATT was by most measures very successful. - 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 (much as the success of China has created strains today). - 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. Bilateral voluntary export restraints (VERs) circumvent GATT agreements, because neither the importing country nor the exporting country complains to the GATT bureaucracy in Geneva—and without a complaint, the GATT bureaucracy can do nothing. - 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 (so named because it occurred in Uruguay). This was the most ambitious round of negotiations yet. Until then, GATT rules had applied only to trade in manufactured goods and commodities. 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.

Costs of the Euro

- The drawback, for some, of a single currency is that national authorities have lost control over monetary policy. Thus, it is crucial to ensure that the EU's monetary policy is well managed. The Maastricht Treaty called for establishment of the independent European Central Bank (ECB), similar in some respects to the U.S. Federal Reserve, with a clear mandate to manage monetary policy so as to ensure price stability. - Among other things, the ECB sets interest rates and determines monetary policy across the euro zone. - The implied loss of national sovereignty to the ECB underlies the decision by Great Britain, Denmark, and Sweden to stay out of the euro zone. - In theory, the design of the ECB should ensure that it remains free of political pressure. - The Maastricht Treaty prohibits the ECB from taking orders from politicians.

Trends in FDI

- The past 35 years have seen a marked increase in both the flow and stock of FDI in the world economy. - Over the past 30 years, the flow of FDI has accelerated faster than the growth in world trade and world output. - FDI has grown more rapidly than world trade and world output for several reasons. First, despite the general decline in trade barriers over the past 30 years, firms still fear protectionist pressures. Executives see FDI as a way of circumventing future trade barriers. Second, much of the increase in FDI has been driven by the political and economic changes that have been occurring in many of the world's developing nations. The general shift toward democratic political institutions and free market economies that we discussed in Chapter 3 has encouraged FDI. Across much of Asia, eastern Europe, and Latin America, economic growth, economic deregulation, privatization programs that are open to foreign investors, and removal of many restrictions on FDI have made these countries more attractive to foreign multinationals. - The globalization of the world economy is also having a positive effect on the volume of FDI. Many firms see the whole world as their market, and they are undertaking FDI in an attempt to make sure they have a significant presence in many regions of the world.

The case against regional integration

- They point out that the benefits of regional integration are determined by the extent of trade creation, as opposed to trade diversion. Trade creation occurs when high-cost domestic producers are replaced by low-cost producers within the free trade area. It may also occur when higher-cost external producers are replaced by lowercost external producers within the free trade area. Trade diversion occurs when lower-cost external suppliers are replaced by higher-cost suppliers within the free trade area. A regional free trade agreement will benefit the world only if the amount of trade it creates exceeds the amount it diverts. - The only way to guard against this possibility, according to those concerned about this potential, is to increase the scope of the WTO so it covers nontariff barriers to trade. There is no sign that this is going to occur anytime soon, however, so the risk remains that regional economic integration will result in trade diversion.

The Case against NAFTA

- Those who opposed NAFTA claimed that ratification would be followed by a mass exodus of jobs from the United States and Canada into Mexico as employers sought to profit from Mexico's lower wages and less strict environmental and labor laws. - Falling trade barriers would expose Mexican firms to highly efficient U.S. and Canadian competitors that, when compared to the average Mexican firm, had far greater capital resources, access to highly educated and skilled workforces, and much greater technological sophistication. The short-run outcome was likely to be painful economic restructuring and unemployment in Mexico. But advocates of NAFTA claimed there would be long-run dynamic gains in the efficiency of Mexican firms as they adjusted to the rigors of a more competitive marketplace. - Mexico could degrade clean air and toxic waste standards across the continent. - There was also opposition in Mexico to NAFTA from those who feared a loss of national sovereignty. Mexican critics argued that their country would be dominated by U.S. firms that would not really contribute to Mexico's economic growth but instead would use Mexico as a low-cost assembly site while keeping their high-paying, high-skilled jobs north of the border.

Bretton Woods System

- US dollar as world currency - all others pegged to the dollar - dollar was convertible to gold at $35/ounce - Why? US economy accounted for 70% of global GDP in 1944, had highest productivity and greater trade surplus

Ibus in the news

- Virgin Australia might go out of business and so the other airline could form a monopoly - It might take 3-5 years for airline industry to bounce back to where they were before - Oil prices went to -37 a barrel and by the end of the month could go to -100 a barrel. Production is staying constant while demand is decreasing so when companies store oil they have to sell it at a loss to offset the price of storing - Oil prices are effecting the stock market as well

What happens to trade if one country has an absolute advantage in both products?

- according to the theory of absolute advantage, no trade would occur - a theory of competitive advantage (Ricardo) suggests that countries should: produce and export those goods and services for which they are relatively more productive than other countries, and import those goods and services for which other countries are relatively more productive

comparative advantage

- exploring what might happen when one country has an absolute advantage in the production of all goods - According to Ricardo's theory of comparative advantage, it 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. - Ghana can produce 4 times as much cocoa as South Korea, but only 1.5 times as much rice. Ghana is comparatively more efficient at producing cocoa than it is at producing rice. - The basic message of the theory of comparative advantage is that potential world production is greater with unrestricted free trade than it is with restricted trade. Ricardo's theory suggests that consumers in all nations can consume more if there are no restrictions on trade. - to an even greater degree than the theory of absolute advantage, the theory of comparative advantage suggests that trade is a positive-sum game in which all countries that participate realize economic gains.

After Bretton Woods

- following the collapse of the Bretton Woods agreement, a floating exchange rate regime was formalized in 1976 in Jamaica (the Jamaican agreement) - The rules for the international monetary system that were agreed upon at the meeting are still in place today

Gov. restricting outward FDI

- limit capital outflows out of concern for the country's balance of payments. - countries have occasionally manipulated tax rules to try to encourage their firms to invest at home. The objective behind such policies is to create jobs at home rather than in other nations. - countries sometimes prohibit national firms from investing in certain countries for political reasons.

Institutions (rules) can be made at multiple levels

- national, regional, global - From 1648-1944: national From 1944-1985: global From 1985-2000: regional From 2000-: ...? - The various eras show us the level of globalization, the question is are we becoming more global or more national? - 'Patchwork' of rules: Which levels matter for firms? - How do they facilitate or constrict international expansion by firms? - E.g.: Less national, more global rule-making => more international expansion

New Trade Theory

- the ability of firms to attain economies of scale might have important implications for international trade. - New trade theory makes two important points: First, through its impact on economies of scale, trade can increase the variety of goods available to consumers and decrease the average cost of those goods. Second, in those industries in which the output required to attain economies of scale represents a significant proportion of total world demand, the global market may be able to support only a small number of enterprises. Thus, world trade in certain products may be dominated by countries whose firms were first movers in their production. - Individual national markets are combined into a larger world market. As the size of the market expands due to trade, individual firms may be able to better attain economies of scale. The implication, according to new trade theory, is that each nation may be able to specialize in producing a narrower range of products than it would in the absence of trade, yet by buying goods that it does not make from other countries, each nation can simultaneously increase the variety of goods available to its consumers and lower the costs of those goods; thus, trade offers an opportunity for mutual gain even when countries do not differ in their resource endowments or technology.

exchange rates expanded

- the price of your currency in terms of my own currency - why does it matter to me or my company? - determines how much I have to export to pay for imports, so it affects the terms of trade

Provisions of the Uruguay Round

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.

Simple free trade model includes many unrealistic assumptions:

1. We have assumed a simple world in which there are only two countries and two goods. In the real world, there are many countries and many goods. 2. We have assumed away transportation costs between countries. 3. We have assumed away differences in the prices of resources in different countries. We have said nothing about exchange rates, simply assuming that cocoa and rice could be swapped on a one-to-one basis. 4. We have assumed that resources can move freely from the production of one good to another within a country. In reality, this is not always the case. 5. We have assumed constant returns to scale; that is, that specialization by Ghana or South Korea has no effect on the amount of resources required to produce one ton of cocoa or rice. In reality, both diminishing and increasing returns to specialization exist. The amount of resources required to produce a good might decrease or increase as a nation specializes in production of that good. 6. We have assumed that each country has a fixed stock of resources and that free trade does not change the efficiency with which a country uses its resources. This static assumption makes no allowances for the dynamic changes in a country's stock of resources and in the efficiency with which the country uses its resources that might result from free trade. 7. We have assumed away the effects of trade on income distribution within a country.

The Andean Community

A 1969 agreement among Bolivia, Chile, Ecuador, Colombia, and Peru to establish a customs union - Bolivia, Chile, Ecuador, Colombia, and Peru signed an agreement in 1969 to create the Andean Pact. The Andean Community was largely based on the EU model but was far less successful at achieving its stated goals. The integration steps begun in 1969 included an internal tariff reduction program, a common external tariff, a transportation policy, a common industrial policy, and special concessions for the smallest members, Bolivia and Ecuador. - By the mid-1980s, the Andean Pact had all but collapsed and had failed to achieve any of its stated objectives. - Political and economic problems seem to have hindered cooperation among member countries. - 1990, the heads of the five current members of the Andean Community—Bolivia, Ecuador, Peru, Colombia, and Venezuela— met in the Galápagos Islands. The resulting Galápagos Declaration effectively relaunched the Andean Pact, which was renamed the Andean Community in 1997. The declaration's objectives included the establishment of a free trade area by 1992, a customs union by 1994, and a common market by 1995. This last milestone has not been reached. - The Andean Community now operates as a customs union.

Treaty of Lisbon

A European Union-sanctioned treaty that will allow the European Parliament to become the co-equal legislator for almost all European laws - After significant debate, in December 2007, the member states signed a new treaty, the Treaty of Lisbon, under which the power of the European Parliament was increased. When it took effect in December 2009, for the first time in history the European Parliament was the co-equal legislator for almost all European laws.10 The Treaty of Lisbon also created a new position, a president of the European Council, who serves a 30-month term and represents the nation-states that make up the EU.

Internationalization theory

A branch of economic theory known as internalization theory seeks to explain why firms often prefer foreign direct investment over licensing as a strategy for entering foreign markets (this approach is also known as the market imperfections approach).12 According to internalization theory, licensing has three major drawbacks as a strategy for exploiting foreign market opportunities. First, licensing may result in a firm's giving away valuable technological know-how to a potential foreign competitor. - A second problem is that licensing does not give a firm the tight control over manufacturing, marketing, and strategy in a foreign country that may be required to maximize its profitability. - A third problem with licensing arises when the firm's competitive advantage is based not as much on its products as on the management, marketing, and manufacturing capabilities that produce those products. The problem here is that such capabilities are often not amenable to licensing. While a foreign licensee may be able to physically reproduce the firm's product under license, it often may not be able to do so as efficiently as the firm could itself. - FDI is more profitable than licensing: (1) when the firm has valuable know-how that cannot be adequately protected by a licensing contract, (2) when the firm needs tight control over a foreign entity to maximize its market share and earnings in that country, and (3) when a firm's skills and know-how are not amenable to licensing.

absolute advantage

A country has an absolute advantage in the production of a product when it is more efficient than any other country at producing it. - In his 1776 landmark book The Wealth of Nations, Adam Smith attacked the mercantilist assumption that trade is a zero-sum game. - According to Smith, countries should specialize in the production of goods for which they have an absolute advantage and then trade these goods for those produced by other countries. - Smith's basic argument, therefore, is that a country should never produce goods at home that it can buy at a lower cost from other countries. Smith demonstrates that by specializing in the production of goods in which each has an absolute advantage, both countries benefit by engaging in trade. - as a result of specialization and trade, output of both cocoa and rice would be increased, and consumers in both nations would be able to consume more. Thus, we can see that trade is a positive-sum game; it produces net gains for all involved.

European Free Trade Association (EFTA)

A free trade association including Norway, Iceland, Liechtenstein, and Switzerland. - The most enduring free trade area in the world is the European Free Trade Association (EFTA). Established in January 1960, the EFTA currently joins four countries—Norway, Iceland, Liechtenstein, and Switzerland - The EFTA was founded by those western European countries that initially decided not to be part of the European Community (the forerunner of the EU). Its original members included Austria, Great Britain, Denmark, Finland, and Sweden, all of which are now members of the EU. The emphasis of the EFTA has been on free trade in industrial goods. Agriculture was left out of the arrangement, each member being allowed to determine its own level of support. Members are also free to determine the level of protection applied to goods coming from outside the EFTA.

Customs Union

A group of countries committed to (1) removing all barriers to the free flow of goods and services between each other and (2) the pursuit of a common external trade policy. - eliminates trade barriers between member countries and adopts a common external trade policy. Establishment of a common external trade policy necessitates significant administrative machinery to oversee trade relations with nonmembers. - The EU began as a customs union, but it has now moved beyond this stage. Other customs unions include the current version of the Andean Community (formerly known as the Andean Pact) among Bolivia, Colombia, Ecuador, and Peru. The Andean Community established free trade between member countries and imposes a common tariff, of 5 to 20 percent, on products imported from outside.

Common Market

A group of countries committed to (1) removing all barriers to the free flow of goods, services, and factors of production between each other and (2) the pursuit of a common external trade policy. - has no barriers to trade among member countries, includes a common external trade policy, and allows factors of production to move freely among members. Labor and capital are free to move because there are no restrictions on immigration, emigration, or cross-border flows of capital among member countries. - For years, the European Union functioned as a common market, although it has now moved beyond this stage. Mercosur—the South American grouping of Argentina, Brazil, Paraguay, and Uruguay—hopes to eventually establish itself as a common market.

Economic Union

A group of countries committed to (1) removing all barriers to the free flow of goods, services, and factors of production between each other, (2) the adoption of a common currency, (3) the harmonization of tax rates, and (4) the pursuit of a common external trade policy. - An economic union entails even closer economic integration and cooperation than a common market. Like the common market, an economic union involves the free flow of products and factors of production among member countries and the adoption of a common external trade policy, but it also requires a common currency, harmonization of members' tax rates, and a common monetary and fiscal policy. Such a high degree of integration demands a coordinating bureaucracy and the sacrifice of significant amounts of national sovereignty to that bureaucracy. The EU is an economic union, although an imperfect one because not all members of the EU have adopted the euro, the currency of the EU; differences in tax rates and regulations across countries still remain; and some markets, such as the market for energy, are still not fully deregulated.

Free Trade Area

A group of countries committed to removing all barriers to the free flow of goods and services between each other, but pursuing independent external trade policies. - In a free trade area, all barriers to the trade of goods and services among member countries are removed. In the theoretically ideal free trade area, no discriminatory tariffs, quotas, subsidies, or administrative impediments are allowed to distort trade between members. Each country, however, is allowed to determine its own trade policies with regard to nonmembers. - Free trade agreements are the most popular form of regional economic integration, accounting for almost 90 percent of regional agreements.

protecting jobs and industries

A political motive also underlay establishment of the Common Agricultural Policy (CAP) by the European Union. The CAP was designed to protect the jobs of Europe's politically powerful farmers by restricting imports and guaranteeing prices. However, the higher prices that resulted from the CAP have cost Europe's consumers dearly. This is true of many attempts to protect jobs and industries through government intervention. For example, the imposition of steel tariffs in 2002 raised steel prices for American consumers, such as automobile companies, making them less competitive in the global marketplace.

Voluntary export restraints (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. - Foreign producers agree to VERs because they fear more damaging punitive tariffs or import quotas might follow if they do not. Agreeing to a VER is seen as a way to make the best of a bad situation by appeasing protectionist pressures in a country. As with tariffs and subsidies, both import quotas and VERs benefit domestic producers by limiting import competition. As with all restrictions on trade, quotas do not benefit consumers.

Doha Round

A series of negotiations under the World Trade Organization that began in Doha, Qatar, in 2001. It followed the Uruguay Round and has focused on agricultural subsidies, intellectual property, and other issues. - 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 are currently ongoing. They have been characterized by halting progress punctuated by significant setbacks and missed deadlines.

Tariffs

A tariff is a tax levied on imports (or exports). Tariffs fall into two categories (specific and Ad valorem). - In most cases, tariffs are placed on imports to protect domestic producers from foreign competition by raising the price of imported goods. However, tariffs also produce revenue for the government. - two conclusions can be derived from economic analysis of the effect of import tariffs.1 First, tariffs are generally pro-producer and anticonsumer. While they protect producers from foreign competitors, this restriction of supply also raises domestic prices. - Second, import tariffs reduce the overall efficiency of the world economy. They reduce efficiency because a protective tariff encourages domestic firms to produce products at home that, in theory, could be produced more efficiently abroad. - export tariffs have two objectives: first, to raise revenue for the government, and second, to reduce exports from a sector, often for political reasons.

location-specific advantages

Advantages that arise from using resource endowments or assets that are tied to a particular foreign location and that a firm finds valuable to combine with its own unique assets (such as the firm's technological, marketing, or management know-how).

Regional Economic Integration

Agreements among countries in a geographic region to reduce and ultimately remove tariff and nontariff barriers to the free flow of goods, services, and factors of production between each other - The past two decades have witnessed a proliferation of regional trade blocs that promote regional economic integration. World Trade Organization (WTO) members are required to notify the WTO of any regional trade agreements in which they participate. By 2016, nearly all members had notified the WTO of participation in one or more regional trade agreements. - Nowhere has the movement toward regional economic integration been more ambitious than in Europe. On January 1, 1993, the European Union formally removed many barriers to doing business across borders within the EU in an attempt to create a single market with 340 million consumers. - Canada, Mexico, and the United States have implemented NAFTA. Ultimately, this aims to remove all barriers to the free flow of goods and services among the three countries. - South America too has moved toward regional integration. For example, in 1991, Argentina, Brazil, Paraguay, and Uruguay implemented an agreement known as Mercosur to start reducing barriers to trade between each other, and although progress within Mercosur has been halting, the institution is still in place.

CARICOM

An association of English-speaking Caribbean states that are attempting to establish a customs union. - A customs union was to have been created in 1991 between the English-speaking Caribbean countries under the auspices of the Caribbean Community. Referred to as CARICOM, it was established in 1973. However, it repeatedly failed to progress toward economic integration.

European Union (EU)

An economic and political union of 28 countries (2015) that are located in Europe. - the product of two political factors: (1) the devastation of western Europe during two world wars and the desire for a lasting peace, and (2) the European nations' desire to hold their own on the world's political and economic stage.

Adam Smith, The Wealth of Nations

Argued that specialization increases productivity, and exchange allows for benefits of specialization (Absolute Advantage)

Brexit

Brexit is a big part about what's happening in the EU which is the UK leaving the EU which a big reason is because they don't use the euro. Everyone in London voted against leaving and everyone else in the more rural parts were for it and it won. The biggest stumbling block is Ireland because the southern part is part of the EU and the northern part is part of the UK. There is a ton of trade that happens between the north and south

Political Case for Integration

By linking countries together, making them more dependent on each other, and forming a structure where they regularly have to interact, the likelihood of violent conflict and war will decrease. By linking countries together, they have greater clout and are politically much stronger in dealing with other nations. - These considerations underlay the 1957 establishment of the European Community (EC), the forerunner of the EU.

Strategic hedging

By spreading sales / production over many currency areas, it all "balances out in the end" - or geographic hedging, spreading your eggs all outside of one basket and diversifying. If one countries exchange rate is up, the other may be down, so you hope it's kind of a wash when you do it that way

protecting national security

Countries sometimes argue that it is necessary to protect certain industries because they are important for national security. Defense-related industries often get this kind of attention (e.g., aerospace, advanced electronics, and semiconductors). Although not as common as it used to be, this argument is still made.

hard currencies

Currencies that are freely tradable or convertible - tend to maintain value - ex: euro, US dollar, Canadian dollar, Japanese yen

Antidumping policies

Designed to punish firms that engage in dumping and thus protect domestic producers from unfair foreign competition - The ultimate objective is to protect domestic producers from unfair foreign competition. - If a domestic producer believes that a foreign firm is dumping production in the U.S. market, it can file a petition with two government agencies, the Commerce Department and the International Trade Commission (ITC). If a complaint has merit, the Commerce Department may impose an antidumping duty on the offending foreign imports (antidumping duties are often called countervailing duties). These duties, which represent a special tariff, can be fairly substantial and stay in place for up to five years.

effect on competition and economic growth

Economic theory tells us that the efficient functioning of markets depends on an adequate level of competition between producers. When FDI takes the form of a greenfield investment, the result is to establish a new enterprise, increasing the number of players in a market and thus consumer choice. In turn, this can increase the level of competition in a national market, thereby driving down prices and increasing the economic welfare of consumers. Increased competition tends to stimulate capital investments by firms in plant, equipment, and R&D as they struggle to gain an edge over their rivals.

European Parliament

Elected EU body that provides consultation on issues proposed by European Commission - the European Parliament has 751 members and is directly elected by the populations of the member states. The parliament, which meets in Strasbourg, France, is primarily a consultative rather than legislative body. It debates legislation proposed by the commission and forwarded to it by the council. It can propose amendments to that legislation, which the commission and ultimately the council are not obliged to take up but often will. - One major debate waged in Europe during the past few years is whether the council or the parliament should ultimately be the most powerful body in the EU.

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. - By the 1930s, the British attempt to stimulate free trade was buried under the economic rubble of the Great Depression. Economic problems were compounded in 1930, when the U.S. Congress passed the Smoot-Hawley tariff. Aimed at avoiding rising unemployment by protecting domestic industries and diverting consumer demand away from foreign products, the Smoot-Hawley Act erected an enormous wall of tariff barriers. Almost every industry was rewarded with its "made-to-order" tariff. 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.

Regional economic integration in Europe

Europe has two trade blocs—the European Union and the European Free Trade Association. Of the two, the EU is by far the more significant, not just in terms of membership (the EU currently has 28 members, although the British have voted to exit the union; the EFTA has four) but also in terms of economic and political influence in the world economy. Many have argued that the EU as an emerging economic and political superpower of the same order as the United States.

Benefits of the Euro

Europeans decided to establish a single currency in the EU for a number of reasons. 1. they believe that businesses and individuals realize significant savings from having to handle one currency, rather than many. These savings come from lower foreign exchange and hedging costs. 2. perhaps more important, the adoption of a common currency makes it easier to compare prices across Europe. This has been increasing competition because it has become easier for consumers to shop around. 3. faced with lower prices, European producers have been forced to look for ways to reduce their production costs to maintain their profit margins. 4. the introduction of a common currency has given a boost to the development of a highly liquid pan-European capital market. Over time, the development of such a capital market should lower the cost of capital and lead to an increase in both the level of investment and the efficiency with which investment funds are allocated. 5. the development of a pan-European, euro-denominated capital market will increase the range of investment options open to both individuals and institutions.

Balance of payment effects

FDI's effect on a country's balance-of-payments accounts is an important policy issue for most host governments. A country's balance-of-payments accounts track both its payments to and its receipts from other countries. Governments normally are concerned when their country is running a deficit on the current account of their balance of payments. The current account tracks the export and import of goods and services. A current account deficit, or trade deficit as it is often called, arises when a country is importing more goods and services than it is exporting. Governments typically prefer to see a current account surplus than a deficit. The only way in which a current account deficit can be supported in the long run is by selling off assets to foreigners - For example, the persistent U.S. current account deficit since the 1980s has been financed by a steady sale of U.S. assets (stocks, bonds, real estate, and whole corporations) to foreigners. - they prefer their nation to run a current account surplus. There are two ways in which FDI can help a country achieve this goal. First, if the FDI is a substitute for imports of goods or services, the effect can be to improve the current account of the host country's balance of payments. - A second potential benefit arises when the MNE uses a foreign subsidiary to export goods and services to other countries.

Demand Conditions

Firms are typically most sensitive to the needs of their closets customers. Thus, the characteristics of home demand are particularly important in shaping the attributes of domestically made products and in creating pressures for innovation and quality. Porter argues that a nation's firms gain competitive advantage if their domestic consumers are sophisticated and demanding. Such consumers pressure local firms to meet high standards of product quality and to produce innovative products.

Outflows of FDI

Flow of foreign direct investment out of a country

FDI

Foreign direct investment (FDI) occurs when a firm invests directly in facilities to produce or market a good or service in a foreign country. According to the U.S. Department of Commerce, FDI occurs whenever a U.S. citizen, organization, or affiliated group takes an interest of 10 percent or more in a foreign business entity. Once a firm undertakes FDI, it becomes a multinational enterprise.

resource transfer effects

Foreign direct investment can make a positive contribution to a host economy by supplying capital, technology, and management resources that would otherwise not be available and thus boost that country's economic growth rate. With regard to capital, many MNEs, by virtue of their large size and financial strength, have access to financial resources not available to host-country firms. - Research supports the view that multinational firms often transfer significant technology when they invest in a foreign country. - Also, a study of FDI by the Organisation for Economic Cooperation and Development (OECD) found that foreign investors invested significant amounts of capital in R&D in the countries in which they had invested, suggesting that not only were they transferring technology to those countries but they may also have been upgrading existing technology or creating new technology in those countries.30 Foreign management skills acquired through FDI may also produce important benefits for the host country.

Association of Southeast Asian Nations (ASEAN)

Formed in 1967, an attempt to establish a free trade area among Brunei, Cambodia, Indonesia, Laos, Malaysia, Myanmar, the Philippines, Singapore, Vietnam, and Thailand. - The basic objective of ASEAN is to foster freer trade among member countries and to achieve cooperation in their industrial policies. Progress so far has been limited, however. - Until recently, only 5 percent of intra-ASEAN trade consisted of goods whose tariffs had been reduced through an ASEAN preferential trade arrangement. This may be changing. In 2003, an ASEAN Free Trade Area (AFTA) among the six original members of ASEAN came into full effect. The AFTA has cut tariffs on manufacturing and agricultural products to less than 5 percent. - ASEAN and AFTA are at least progressing toward establishing a free trade zone. - ASEAN signed a free trade agreement with China that removes tariffs on 90 percent of traded goods.

Subsidy

Government financial assistance to a domestic producer - a government payment to a domestic producer. Subsidies take many forms, including cash grants, low-interest loans, tax breaks, and government equity participation in domestic firms. By lowering production costs, subsidies help domestic producers in two ways: (1) competing against foreign imports and (2) gaining export markets. - The main gains from subsidies accrue to domestic producers, whose international competitiveness is increased as a result. Advocates of strategic trade policy (which, as you will recall from Chapter 6, is an outgrowth of the new trade theory) favor subsidies to help domestic firms achieve a dominant position in those industries in which economies of scale are important and the world market is not large enough to profitably support more than a few firms (aerospace and semiconductors are two such industries). According to this argument, subsidies can help a firm achieve a first-mover advantage in an emerging industry - government subsidies must be paid for, typically by taxing individuals and corporations.

Strategic trade policy

Government policy aimed at improving the competitive position of a domestic industry and/or domestic firm in the world market - The strategic trade policy argument has two components. First, it is argued that by appropriate actions, a government can help raise national income if it can somehow ensure that the firm or firms that gain first-mover advantages in an industry are domestic rather than foreign enterprises. Thus, according to the strategic trade policy argument, a government should use subsidies to support promising firms that are active in newly emerging industries. - The second component of the strategic trade policy argument is that it might pay a government to intervene in an industry by helping domestic firms overcome the barriers to entry created by foreign firms that have already reaped first-mover advantages.

the revised case for free trade- domestic policies

Governments do not always act in the national interest when they intervene in the economy; politically important interest groups often influence them. The European Union's support for the Common Agricultural Policy (CAP), which arose because of the political power of French and German farmers, is an example. The CAP benefits inefficient farmers and the politicians who rely on the farm vote but not consumers in the EU, who end up paying more for their foodstuffs. Thus, a further reason for not embracing strategic trade policy, according to Krugman, is that such a policy is almost certain to be captured by special-interest groups within the economy, which will distort it to their own ends.

furthering foreign policy objectives

Governments sometimes use trade policy to support their foreign policy objectives.9 A government may grant preferential trade terms to a country with which it wants to build strong relations. Trade policy has also been used several times to pressure or punish "rogue states" that do not abide by international law or norms. - The theory is that such pressure might persuade the rogue state to mend its ways, or it might hasten a change of government.

Factor Endowments

He recognizes hierarchies among factors, distinguishing between basic factors (e.g., natural resources, climate, location, and demographics) and advanced factors (e.g., communication infrastructure, sophisticated and skilled labor, research facilities, and technological know-how). He argues that advanced factors are the most significant for competitive advantage. Unlike the naturally endowed basic factors, advanced factors are a product of investment by individuals, companies, and governments. Thus, government investments in basic and higher education, by improving the general skill and knowledge level of the population and by stimulating advanced research at higher education institutions, can upgrade a nation's advanced factors.

The Direction of FDI

Historically, most FDI has been directed at the developed nations of the world as firms based in advanced countries invested in the others' markets (see Figure 8.2). During the 1980s and 1990s, the United States was often the favorite target for FDI inflows. The United States has been an attractive target for FDI because of its large and wealthy domestic markets, its dynamic and stable economy, a favorable political environment, and the openness of the country to FDI. - Even though developed nations still account for the largest share of FDI inflows, FDI into developing nations and the transition economies of eastern Europe and the old Soviet Union has increased markedly

International trade theories

International trade theories have shaped the economic policy of many nations for the past 60 years. They have been the driver behind the formation of the World Trade Organization and regional trade blocs such as the European Union and the North American Free Trade Agreement. They underlie the current push to ratify the TPP, as well as ongoing negotiations

international trade theory and FDI

International trade theory tells us that home-country concerns about the negative economic effects of offshore production may be misplaced. The term offshore production refers to FDI undertaken to serve the home market. Far from reducing home-country employment, such FDI may actually stimulate economic growth (and hence employment) in the home country by freeing homecountry resources to concentrate on activities where the home country has a comparative advantage. In addition, home-country consumers benefit if the price of the particular product falls as a result of the FDI.

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 - The GATT and WTO are the creations of a series of multinational treaties.

Three Rounds of GATT

Kennedy Round (1960s): focused on antidumping Tokyo Round (1970s): limited; tariff reduction but general economic crisis precipitated new protectionism, esp. in agriculture; hard to get anything done because at that time there was the general economic crisis in Asia Uruguay Round (1980s): aimed at transforming the GATT into the WTO

multipoint competition

Knickerbocker's theory can be extended to embrace the concept of multipoint competition. Multipoint competition arises when two or more enterprises encounter each other in different regional markets, national markets, or industries.18 Economic theory suggests that rather like chess players jockeying for advantage, firms will try to match each other's moves in different markets to try to hold each other in check. The idea is to ensure that a rival does not gain a commanding position in one market and then use the profits generated there to subsidize competitive attacks in other markets. Although Knickerbocker's theory and its extensions can help explain imitative FDI behavior by firms in oligopolistic industries, it does not explain why the first firm in an oligopoly decides to undertake FDI rather than to export or license. Internalization theory addresses this phenomenon. The imitative theory also does not address the issue of whether FDI is more efficient than exporting or licensing for expanding abroad. Again, internalization theory addresses the efficiency issue. For these reasons, many economists favor internalization theory as an explanation for FDI, although most would agree that the imitative explanation tells an important part of the story.

economic union

Like a common market, but members also aim for common fiscal and monetary policies, and standardized commercial regulations. The EU is moving toward an economic union by forming a monetary union with a single currency, the euro.

Common Market

Like a customs union, except products, services, and factors of production such as capital, labor, and technology can move freely among the member countries. E.g., the EU countries put in place many common labor and economic policies. - Leta puts the EU here because the EU doesn't all have the euro which a common market usually has a common currency, but the book puts it in economic union, either one could be correc

Protecting consumers

Many governments have long had regulations to protect consumers from unsafe products. The indirect effect of such regulations often is to limit or ban the importation of such products. For example, in 2003 several countries, including Japan and South Korea, decided to ban imports of American beef after a single case of mad cow disease was found in Washington state.

Internationalization Theory

Marketing imperfection approach to foreign direct investment

Theory of National Competitive Advantage

Michael Porter developed a theory referred to as the theory of national competitive advantage. This attempts to explain why particular nations achieve international success in particular industries. In addition to factor endowments, Porter points out the importance of country factors such as domestic demand and domestic rivalry in explaining a nation's dominance in the production and export of particular products.

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. - by far the oldest economic argument for government intervention. Alexander Hamilton proposed it in 1792. According to this argument, many developing countries have a potential comparative advantage in manufacturing, but new manufacturing industries cannot initially compete with established industries in developed countries. To allow manufacturing to get a toehold, the argument is that governments should temporarily support new industries (with tariffs, import quotas, and subsidies) until they have grown strong enough to meet international competition. - many economists remain critical of this argument for two main reasons. First, protection of manufacturing from foreign competition does no good unless the protection helps make the industry efficient. In case after case, however, protection seems to have done little more than foster the development of inefficient industries that have little hope of ever competing in the world market. - Second, the infant industry argument relies on an assumption that firms are unable to make efficient long-term investments by borrowing money from the domestic or international capital market. Consequently, governments have been required to subsidize long-term investments.

The revised case for free trade - Paul Krugman and retaliation and trade war

New trade theory - points 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. - Krugman argues that a strategic trade policy aimed at establishing domestic firms in a dominant position in a global industry is a beggar-thy-neighbor policy that boosts national income at the expense of other countries. A country that attempts to use such policies will probably provoke retaliation. In many cases, the resulting trade war between two or more interventionist governments will leave all countries involved worse off than if a hands-off approach had been adopted in the first place. If the U.S. government were to respond to the Airbus subsidy by increasing its own subsidies to Boeing, for example, the result might be that the subsidies would cancel each other out. In the process, both European and U.S. taxpayers would end up supporting an expensive and pointless trade war, and both Europe and the United States would be worse off.

Liscensing

Occurs when a firm (the licensor) licenses the right to produce its product, use its production processes, or use its brand name or trademark to another firm (the licensee). In return for giving the licensee these rights, the licensor collects a royalty fee on every unit the licensee sells.

Theories of direct investment

One set of theories seeks to explain why a firm will favor direct investment as a means of entering a foreign market when two other alternatives, exporting and licensing, are open to it. Another set of theories seeks to explain why firms in the same industry often undertake foreign direct investment at the same time and why they favor certain locations over others as targets for foreign direct investment. Put differently, these theories attempt to explain the observed pattern of foreign direct investment flows. A third theoretical perspective, known as the eclectic paradigm, attempts to combine the two other perspectives into a single holistic explanation of foreign direct investment (this theoretical perspective is eclectic because the best aspects of other theories are taken and combined into a single explanation).

Mercosur

Pact among Argentina, Brazil, Paraguay, and Uruguay to establish a free trade area - Mercosur originated in 1988 as a free trade pact between Brazil and Argentina. The modest reductions in tariffs and quotas accompanying this pact reportedly helped bring about an 80 percent increase in trade between the two countries in the late 1980s.24 This success encouraged the expansion of the pact in March 1990 to include Paraguay and Uruguay. In 2006, the pact was further expanded when Venezuela joined Mercosur, although it may take years for Venezuela to become fully integrated into the pact. - The initial aim of Mercosur was to establish a full free trade area by the end of 1994 and a common market sometime thereafter. - For its first eight years or so, Mercosur seemed to be making a positive contribution to the economic growth rates of its member states. - Yeats pointed out that the fastest-growing items in intraMercosur trade were cars, buses, agricultural equipment, and other capital-intensive goods that are produced relatively inefficiently in the four member countries. - Mercosur countries might not be able to compete globally once the group's external trade barriers come down. In the meantime, capital is being drawn away from more efficient enterprises. - Hope for a revival arose in 2003, when new Brazilian President Lula da Silva announced his support for a revitalized and expanded Mercosur modeled after the EU with a larger membership, a common currency, and a democratically elected Mercosur parliament.29 In 2010, the members of Mercosur did agree on a common customs code to avoid outside goods having to pay tariffs more than once, an important step toward achieving a full customs union. Since 2010, however, Mercosur has made little forward progress, and the jury is still out on whether it will become a fully functioning customs union.

The Samuelson Critique

Paul Samuelson's critique looks at what happens when a rich country—the United States—enters into a free trade agreement with a poor country—China— that rapidly improves its productivity after the introduction of a free trade regime (i.e., there is a dynamic gain in the efficiency with which resources are used in the poor country). Samuelson's model suggests that in such cases, the lower prices that U.S. consumers pay for goods imported from China following the introduction of a free trade regime may not be enough to produce a net gain for the U.S. economy if the dynamic effect of free trade is to lower real wage rates in the United States. - Samuelson goes on to note that he is particularly concerned about the ability to offshore service jobs that traditionally were not internationally mobile, such as software debugging, call-center jobs, accounting jobs, and even medical diagnosis of MRI scans - the effect on middle-class wages in the United States, according to Samuelson, may be similar to mass inward migration into the country: It will lower the market clearing wage rate, perhaps by enough to outweigh the positive benefits of international trade. - Samuelson concedes that free trade has historically benefited rich counties - "Free trade may turn out pragmatically to be still best for each region in comparison to lobbyist-induced tariffs and quotas which involve both a perversion of democracy and non-subtle deadweight distortion losses."11 - Other economists have dismissed Samuelson's fears.13 While not questioning his analysis, they note that as a practical matter, developing nations are unlikely to be able to upgrade the skill level of their workforce rapidly enough to give rise to the situation in Samuelson's model.

political union

Political organization coordinates the economic, social and foreign policy of its member states; usually don't see these today, example is the former USSR

The Case for NAFTA

Proponents of NAFTA have argued that the free trade area should be viewed as an opportunity to create an enlarged and more efficient productive base for the entire region. Advocates acknowledge that one effect of NAFTA would be that some U.S. and Canadian firms would move production to Mexico to take advantage of lower labor costs. Movement of production to Mexico, they argued, was most likely to occur in low-skilled, labor-intensive manufacturing industries in which Mexico might have a comparative advantage. Advocates of NAFTA argued that many would benefit from such a trend. Mexico would benefit from much-needed inward investment and employment. The United States and Canada would benefit because the increased incomes of the Mexicans would allow them to import more U.S. and Canadian goods, thereby increasing demand and making up for the jobs lost in industries that moved production to Mexico. U.S. and Canadian consumers would benefit from the lower prices of products made in Mexico. In addition, the international competitiveness of U.S. and Canadian firms that moved production to Mexico to take advantage of lower labor costs would be enhanced, enabling them to better compete with Asian and European rivals.

protecting human rights

Protecting and promoting human rights in other countries is an important element of foreign policy for many democracies. Governments sometimes use trade policy to try to improve the human rights policies of trading partners. For example, as discussed in Chapter 5, the U.S. government long had trade sanctions in place against the nation of Myanmar, in no small part due to the poor human rights practices in that nation.

Seattle protests

Protested the World Trade Organization and increasing globalization. - Uruguay round was the round and talks were supposed to be in Seattle but they couldn't even meet because of the violent protests by the anarchists. So then in 2001 1 they went to Doha in Qatar which is a remote, totalitarian state where you're not going to have protests like there were in Seattle - US Fortune 500 firms lost a little over 1% of their market value, or about $200 million each - ...Why? - Lost opportunities stemming from stalled multilateral trade and investment regime: - Firms with no overseas activity lost 0.9%; MNEs lost 1.8%

Economic Case for Integration

Regional economic integration is an attempt to achieve additional gains from the free flow of trade and investment between countries beyond those attainable under international agreements such as the WTO. Since it is easier to form an agreement with a few countries than across all nations, there has been a push toward regional economic integration . - economic theories suggest that free trade and investment is a positive-sum game, in which all participating countries stand to gain.

Immobile Resources

Resources do not always move freely from one economic activity to another. The process creates friction and human suffering too. While the theory predicts that the benefits of free trade outweigh the costs by a significant margin, this is of cold comfort to those who bear the costs. Accordingly, political opposition to the adoption of a free trade regime typically comes from those whose jobs are most at risk.

European Commission

Responsible for proposing EU legislation, implementing it, and monitoring compliance - The commission makes a proposal, which goes to the Council of the European Union and then to the European Parliament. - The commission is also responsible for implementing aspects of EU law, although in practice much of this must be delegated to member states. Another responsibility of the commission is to monitor member states to make sure they are complying with EU laws. In this policing role, the commission will normally ask a state to comply with any EU laws that are being broken. - The European Commission's role in competition policy has become increasingly important to business in recent years. - the role of the competition commissioner is to ensure that no one enterprise uses its market power to drive out competitors and monopolize markets.

Dumping

Selling goods in a foreign market for less than their cost of production or below their "fair" market value. - Dumping is viewed as a method by which firms unload excess production in foreign markets. Some dumping may be the result of predatory behavior, with producers using substantial profits from their home markets to subsidize prices in a foreign market with a view to driving indigenous competitors out of that market. Once this has been achieved, so the argument goes, the predatory firm can raise prices and earn substantial profits.

customs union

Similar to a free trade area except the members harmonize their trade policies toward nonmember countries by enacting common tariff and nontariff barriers on imports from nonmember countries. MERCOSUR is an example.

Free trade area

Simplest, most common arrangement. Member countries agree to gradually eliminate formal trade barriers within the bloc, while each member maintains an independent international trade policy with countries outside the bloc. One example is NAFTA.

The source of FDI

Since World War II, the United States has consistently been the largest source country for FDI. Other important source countries include the United Kingdom, France, Germany, the Netherlands, and Japan. Collectively, these six countries accounted for 60 percent of all FDI outflows for 1998-2014 (see Figure 8.3). As might be expected, these countries also predominate in rankings of the world's largest multinationals.8 These nations dominate primarily because they were the most developed nations with the largest economies during much of the postwar period and therefore home to many of the largest and best-capitalized enterprises. - Chinese firms have started to emerge as major foreign investors

retaliating

Some argue that governments should use the threat to intervene in trade policy as a bargaining tool to help open foreign markets and force trading partners to "play by the rules of the game." The U.S. government has used the threat of punitive trade sanctions to try to get the Chinese government to enforce its intellectual property laws. Lax enforcement of these laws had given rise to massive copyright infringements in China that had been costing U.S. companies such as Microsoft hundreds of millions of dollars per year in lost sales revenues. After the United States threatened to impose 100 percent tariffs on a range of Chinese imports and after harsh words between officials from the two countries, the Chinese agreed to tighter enforcement of intellectual property regulations.

possible effects on national sovereignty and autonomy

Some host governments worry that FDI is accompanied by some loss of economic independence.

The Single European Act

The Single European Act was born of a frustration among members that the community was not living up to its promise. By the early 1980s, it was clear that the EC had fallen short of its objectives to remove barriers to the free flow of trade and investment among member countries and to harmonize the wide range of technical and legal standards for doing business. Against this background, many of the EC's prominent businesspeople mounted an energetic campaign in the early 1980s to end the EC's economic divisions. The EC responded by creating the Delors Commission. Under the chairperson Jacques Delors, the commission proposed that all impediments to the formation of a single market be eliminated by December 31, 1992. The result was the Single European Act, which became EC law in 1987. - To signify the importance of the Single European Act, the European Community also decided to change its name to the European Union once the act took effect.

Trans-Pacific Partnership (TPP)

The TPP will eliminate or reduce about 18,000 tariffs, taxes, and nontariff barriers such as quotas on trade between the 12 member countries. By expanding market access and lowering prices for consumers, economists claim that the deal will boost economic growth rates among TPP countries and add about $285 billion to global GDP by 2025. Since the United States already has very low tariff barriers, most of the tariff reductions will occur in other countries. - U.S. agriculture looks to be a big beneficiary. - Several technology companies including Intel voiced support for the deal, - Ford opposed the deal because it would phase out a 2.5 percent tariff on imports of Japanese cars into the United States - Labor unions were quick to oppose the deal, arguing that it would result in further losses of U.S. manufacturing jobs and lead to lower wages. Several big drug companies also opposed the deal because it only protected new biotechnology products from generic competition for five years, rather than the 12 years they had before. - To put this in context, between 2010 and 2015, the U.S. economy created 13 million new jobs, so the worst-case estimate of losses amounted to no more than two months of job growth during the 2010-2015 period.

The WTO

The WTO acts as an umbrella organization that encompasses the GATT along with two new sister bodies, one on services and the other on intellectual property. The WTO's General Agreement on Trade in Services (GATS) has taken the lead to extending free trade agreements to services. The WTO's Agreement on Trade-Related Aspects of Intellectual Property Rights (TRIPS) is an attempt to narrow the gaps in the way intellectual property rights are protected around the world and to bring them under common international rules. WTO has taken over responsibility for arbitrating trade disputes and monitoring the trade policies of member countries. - By 2016, the WTO had 162 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 first two decades in the life of the WTO suggest that its policing and enforcement mechanisms are having a positive effect.19 Between 1995 and 2015, more than 415 trade disputes between member countries were brought to the WTO. - The WTO was also encouraged to extend its reach to encompass regulations governing foreign direct investment, something the GATT had never done. Two of the first industries targeted for reform were the global telecommunication and financial services industries.

Free trade

The absence of barriers to the free flow of goods and services between countries - refers to a situation in which 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. - the invisible hand of the market mechanism, rather than government policy, should determine what a country imports and what it exports

Central American Free Trade Agreement (CAFTA)

The agreement of the member states of the Central American Common Market joined by the Dominican Republic to trade freely with the United States. - The proposed common market was given a boost in 2003, when the United States signaled its intention to enter into bilateral free trade negotiations with the group. These culminated in a 2004 agreement to establish a free trade agreement between the six countries and the United States. Known as the Central America Free Trade Agreement (CAFTA), the aim is to lower trade barriers between the United States and the six countries for most goods and services.

The eclectic paradigm

The eclectic paradigm has been championed by the British economist John Dunning.19 Dunning argues that in addition to the various factors discussed earlier, location-specific advantages are also of considerable importance in explaining both the rationale for and the direction of foreign direct investment. By location-specific advantages, Dunning means the advantages that arise from utilizing resource endowments or assets that are tied to a particular foreign location and that a firm finds valuable to combine with its own unique assets (such as the firm's technological, marketing, or management capabilities). - he argues that combining location-specific assets or resource endowments with the firm's own unique capabilities often requires foreign direct investment. - An obvious example of Dunning's arguments are natural resources, such as oil and other minerals, which are by their character specific to certain locations. Dunning suggests that to exploit such foreign resources, a firm must undertake FDI. - Another obvious example is valuable human resources, such as low-cost, highly skilled labor. - knowledge being generated in Silicon Valley with regard to the design and manufacture of computers and semiconductors is available nowhere else in the world. To be sure, that knowledge is commercialized as it diffuses throughout the world, but the leading edge of knowledge generation in the computer and semiconductor industries is to be found in Silicon Valley. In Dunning's language, this means that Silicon Valley has a location-specific advantage - this advantage comes from the sheer concentration of intellectual talent in this area, and in part, it arises from a network of informal contacts that allows firms to benefit from each other's knowledge generation. Economists refer to such knowledge "spillovers" as externalities, and there is a well-established theory suggesting that firms can benefit from such externalities by locating close to their source.2

Two forms of FDI

The first is a greenfield investment, which involves the establishment of a new operation in a foreign country. The second involves acquiring or merging with an existing firm in the foreign country. - In the case of developing nations, only about one-third or less of FDI is in the form of cross-border mergers and acquisitions. The lower percentage of mergers and acquisitions may simply reflect the fact that there are fewer target firms to acquire in developing nations. - mergers and acquisitions are quicker to execute than greenfield investments. This is an important consideration in the modern business world where markets evolve very rapidly. Many firms apparently believe that if they do not acquire a desirable target firm, then their global rivals will. Second, foreign firms are acquired because those firms have valuable strategic assets, such as brand loyalty, customer relationships, trademarks or patents, distribution systems, production systems, and the like. It is easier and perhaps less risky for a firm to acquire those assets than to build them from the ground up through a greenfield investment. Third, firms make acquisitions because they believe they can increase the efficiency of the acquired unit by transferring capital, technology, or management skills

the free market view

The free market view argues that international production should be distributed among countries according to the theory of comparative advantage. Countries should specialize in the production of those goods and services that they can produce most efficiently. Within this framework, the MNE is an instrument for dispersing the production of goods and services to the most efficient locations around the globe. Viewed this way, FDI by the MNE increases the overall efficiency of the world economy. Imagine that Dell decided to move assembly operations for many of its personal computers from the United States to Mexico to take advantage of lower labor costs in Mexico. According to the free market view, moves such as this can be seen as increasing the overall efficiency of resource utilization in the world economy. Mexico, due to its lower labor costs, has a comparative advantage in the assembly of PCs.

The Link between Trade and Growth

The message seems clear: Adopt an open economy and embrace free trade, and your nation will be rewarded with higher economic growth rates. Higher growth will raise income levels and living standards. This last point has been confirmed by a study that looked at the relationship between trade and growth in incomes. The study, undertaken by Jeffrey Frankel and David Romer, found that on average, a 1 percentage point increase in the ratio of a country's trade to its gross domestic product increases income per person by at least 0.5 percent.20 For every 10 percent increase in the importance of international trade in an economy, average income levels will rise by at least 5 percent.

The radical view

The radical view traces its roots to Marxist political and economic theory. Radical writers argue that the multinational enterprise (MNE) is an instrument of imperialist domination. They see the MNE as a tool for exploiting host countries to the exclusive benefit of their capitalist-imperialist home countries. They argue that MNEs extract profits from the host country and take them to their home country, giving nothing of value to the host country in exchange. - FDI by the MNEs of advanced capitalist nations keeps the less developed countries of the world relatively backward and dependent on advanced capitalist nations for investment, jobs, and technology. Thus, according to the extreme version of this view, no country should ever permit foreign corporations to undertake FDI, because they can never be instruments of economic development, only of economic domination. Where MNEs already exist in a country, they should be immediately nationalized. - By the early 1990s, the radical position was in widespread retreat. There seem to be three reasons for this: (1) the collapse of communism in eastern Europe; (2) the generally abysmal economic performance of those countries that embraced the radical position, and a growing belief by many of these countries that FDI can be an important source of technology and jobs and can stimulate economic growth; and (3) the strong economic performance of those developing countries that embraced capitalism rather than radical ideology (e.g., Singapore, Hong Kong, and Taiwan). Despite this, the radical view lingers on in some countries, such as Venezuela

diminishing returns

The simple comparative advantage model developed above assumes constant returns to specialization. By constant returns to specialization we mean the units of resources required to produce a good (cocoa or rice) are assumed to remain constant no matter where one is on a country's production possibility frontier (PPF). - it is more realistic to assume diminishing returns to specialization. Diminishing returns to specialization occur when more units of resources are required to produce each additional unit. - Diminishing returns imply a convex PPF for Ghana (see Figure 6.3), rather than the straight line - It is more realistic to assume diminishing returns for two reasons. First, not all resources are of the same quality. As a country tries to increase its output of a certain good, it is increasingly likely to draw on more marginal resources whose productivity is not as great as those initially employed. The result is that it requires ever more resources to produce an equal increase in output. A second reason for diminishing returns is that different goods use resources in different proportions. - Diminishing returns show that it is not feasible for a country to specialize to the degree suggested by the simple Ricardian model outlined earlier. Diminishing returns to specialization suggest that the gains from specialization are likely to be exhausted before specialization is complete. In reality, most countries do not specialize, but instead produce a range of goods. However, the theory predicts that it is worthwhile to specialize until that point where the resulting gains from trade are outweighed by diminishing returns. Thus, the basic conclusion that unrestricted free trade is beneficial still holds, although because of diminishing returns, the gains may not be as great as suggested in the constant returns case.

Caribbean Single Market and Economy (CSME)

The six CARICOM members that agreed to lower trade barriers and harmonize macroeconomic and monetary policies between member states

benefits of trade

The theories of Smith, Ricardo, and Heckscher-Ohlin go beyond this commonsense notion, however, to show why it is beneficial for a country to engage in international trade even for products it is able to produce for itself. This is a difficult concept for people to grasp. For example, many people in the United States believe that American consumers should buy products made in the United States by American companies whenever possible to help save American jobs from foreign competition. The same kind of nationalistic sentiments can be observed in many other countries. However, the theories of Smith, Ricardo, and Heckscher-Ohlin tell us that a country's economy may gain if its citizens buy certain products from other nations that could be produced at home. One of the key insights of international trade theory is that limits on imports are often in the interests of domestic producers but not domestic consumers.

Implications of New Trade Theory

The theory suggests that nations may benefit from trade even when they do not differ in resource endowments or technology. Trade allows a nation to specialize in the production of certain products, attaining scale economies and lowering the costs of producing those products, while buying products that it does not produce from other nations that specialize in the production of other products. By this mechanism, the variety of products available to consumers in each nation is increased, while the average costs of those products should fall, as should their price, freeing resources to produce other goods and services. - The theory also suggests that a country may predominate in the export of a good simply because it was lucky enough to have one or more firms among the first to produce that good. Because they are able to gain economies of scale, the first movers in an industry may get a lock on the world market that discourages subsequent entry. First-movers' ability to benefit from increasing returns creates a barrier to entry. - New trade theorists argue that the United States is a major exporter of commercial jet aircraft not because it is better endowed with the factors of production required to manufacture aircraft but because one of the first movers in the industry, Boeing, was a U.S. firm. - Perhaps the most contentious implication of the new trade theory is the argument that it generates for government intervention and strategic trade policy.33 New trade theorists stress the role of luck, entrepreneurship, and innovation in giving a firm first-mover advantages.

Host countries restricting inward FDI

The two most common are ownership restraints and performance requirements. Ownership restraints can take several forms. In some countries, foreign companies are excluded from specific fields. They are excluded from tobacco and mining in Sweden and from the development of certain natural resources in Brazil, Finland, and Morocco. - Performance requirements can also take several forms. Performance requirements are controls over the behavior of the MNE's local subsidiary. The most common performance requirements are related to local content, exports, technology transfer, and local participation in top management.

Limitations of exporting

The viability of an exporting strategy is often constrained by transportation costs and trade barriers. When transportation costs are added to production costs, it becomes unprofitable to ship some products over a large distance. This is particularly true of products that have a low value-to-weight ratio and that can be produced in almost any location. - Thus, Cemex, the large Mexican cement maker, has expanded internationally by pursuing FDI, rather than exporting - Transportation costs aside, some firms undertake foreign direct investment as a response to actual or threatened trade barriers such as import tariffs or quotas.

Heckscher-Ohlin Theory

They argued that comparative advantage arises from differences in national factor endowments.22 By factor endowments they meant the extent to which a country is endowed with such resources as land, labor, and capital. Nations have varying factor endowments, and different factor endowments explain differences in factor costs; specifically, the more abundant a factor, the lower its cost. The Heckscher-Ohlin theory predicts that countries will export those goods that make intensive use of factors that are locally abundant, while importing goods that make intensive use of factors that are locally scarce. Thus, the Heckscher-Ohlin theory attempts to explain the pattern of international trade that we observe in the world economy. Like Ricardo's theory, the Heckscher-Ohlin theory argues that free trade is beneficial. Unlike Ricardo's theory, however, the Heckscher-Ohlin theory argues that the pattern of international trade is determined by differences in factor endowments, rather than differences in productivity. - Note that it is relative, not absolute, endowments that are important; a country may have larger absolute amounts of land and labor than another country but be relatively abundant in one of them.

Dynamic Effects and Economic Growth

This static assumption makes no allowances for the dynamic changes that might result from trade. If we relax this assumption, it becomes apparent that opening an economy to trade is likely to generate dynamic gains of two sorts.9 First, free trade might increase a country's stock of resources as increased supplies of labor and capital from abroad become available for use within the country. - Second, free trade might also increase the efficiency with which a country uses its resources. - Dynamic gains in both the stock of a country's resources and the efficiency with which resources are utilized will cause a country's PPF to shift outward. - As a consequence of this outward shift, the country in Figure 6.4 can produce more of both goods than it did before introduction of free trade. The theory suggests that opening an economy to free trade not only results in static gains of the type discussed earlier but also results in dynamic gains that stimulate economic growth.

Currency Hedging

Through forward contracts - Hinges on predictions of x-rate fluctuations - you lock in a rate, use a financial institution to do this. There's a fee to do it but there's no risk of not knowing what the rate will be in 30 days

the Leontief paradox

Using the Heckscher-Ohlin theory, Leontief postulated that because the United States was relatively abundant in capital compared to other nations, the United States would be an exporter of capital intensive goods and an importer of labor-intensive goods. To his surprise, however, he found that U.S. exports were less capital intensive than U.S. imports. Because this result was at variance with the predictions of the theory, it has become known as the Leontief paradox. - No one is quite sure why we observe the Leontief paradox. One possible explanation is that the United States has a special advantage in producing new products or goods made with innovative technologies. Such products may be less capital intensive than products whose technology has had time to mature and become suitable for mass production. Thus, the United States may be exporting goods that heavily use skilled labor and innovative entrepreneurship, such as computer software, while importing heavy manufacturing products that use large amounts of capital. - This leaves economists with a difficult dilemma. They prefer the Heckscher-Ohlin theory on theoretical grounds, but it is a relatively poor predictor of real-world international trade patterns. On the other hand, the theory they regard as being too limited, Ricardo's theory of comparative advantage, actually predicts trade patterns with greater accuracy.

The Product Life-Cycle Theory

Vernon's theory was based on the observation that for most of the twentieth century, a very large proportion of the world's new products had been developed by U.S. firms and sold first in the U.S. market (e.g., mass-produced automobiles, televisions, instant cameras, photocopiers, personal computers, and semiconductor chips). To explain this, Vernon argued that the wealth and size of the U.S. market gave U.S. firms a strong incentive to develop new consumer products. In addition, the high cost of U.S. labor gave U.S. firms an incentive to develop cost-saving process innovations. - As the market in the United States and other advanced nations matures, the product becomes more standardized, and price becomes the main competitive weapon. As this occurs, cost considerations start to play a greater role in the competitive process. Producers based in advanced countries where labor costs are lower than in the United States (e.g., Italy and Spain) might now be able to export to the United States. If cost pressures become intense, the process might not stop there. The cycle by which the United States lost its advantage to other advanced countries might be repeated once more, as developing countries (e.g., Thailand) begin to acquire a production advantage over advanced countries. Thus, the locus of global production initially switches from the United States to other advanced nations and then from those nations to developing countries. The consequence of these trends for the pattern of world trade is that over time, the United States switches from being an exporter of the product to an importer of the product as production becomes concentrated in lower-cost foreign locations.

Local Content Requirement (LCR)

a requirement that some specific fraction of a good be produced domestically - The requirement can be expressed either in physical terms (e.g., 75 percent of component parts for this product must be produced locally) or in value terms (e.g., 75 percent of the value of this product must be produced locally). Local content regulations have been widely used by developing countries to shift their manufacturing base from the simple assembly of products whose parts are manufactured elsewhere into the local manufacture of component parts. They have also been used in developed countries to try to protect local jobs and industry from foreign competition. - Local content regulations provide protection for a domestic producer of parts in the same way an import quota does: by limiting foreign competition. The aggregate economic effects are also the same; domestic producers benefit, but the restrictions on imports raise the prices of imported components. In turn, higher prices for imported components are passed on to consumers of the final product in the form of higher final prices.

Ad Valorem Tariff

a tariff levied as a proportion of the value of an imported good

export tariff

a tax placed on the export of a good - The goal behind an export tariff is to discriminate against exporting in order to ensure that there is sufficient supply of a good within a country. - Since most countries try to encourage exports, export tariffs are relatively rare.

Mercantilism

an economic philosophy advocating that countries should simultaneously encourage exports and discourage imports - it was in a country's best interests to maintain a trade surplus, to export more than it imported. By doing so, a country would accumulate gold and silver and, consequently, increase its national wealth, prestige, and power. - the mercantilist doctrine advocated government intervention to achieve a surplus in the balance of trade. - imports were limited by tariffs and quotas, while exports were subsidized. - The classical economist David Hume pointed out an inherent inconsistency in the mercantilist doctrine in 1752. According to Hume, if England had a balance-of-trade surplus with France (it exported more than it imported), the resulting inflow of gold and silver would swell the domestic money supply and generate inflation in England. In France, however, the outflow of gold and silver would have the opposite effect. France's money supply would contract, and its prices would fall. This change in relative prices between France and England would encourage the French to buy fewer English goods (because they were becoming more expensive) and the English to buy more French goods (because they were becoming cheaper). The result would be a deterioration in the English balance of trade and an improvement in France's trade balance, until the English surplus was eliminated. Hence, according to Hume, in the long run no country could sustain a surplus on the balance of trade and so accumulate gold and silver as the mercantilists had envisaged. The flaw with mercantilism was that it viewed trade as a zero-sum game. (A zero-sum game is one in which a gain by one country results in a loss by another.) - Unfortunately, the mercantilist doctrine is by no means dead. Neo-mercantilists equate political power with economic power and economic power with a balance-of-trade surplus.

Other Trade Agreements

following the failure of the Doha Round of talks to extend the WTO, the United States and many other nations have placed renewed emphasis on bilateral and multilateral trade agreements. The United States is currently pursuing two major multilateral trade agreements, the Trans Pacific Partnership (TPP) with 11other Pacific Rim countries, including Australia, New Zealand, Japan, South Korea, Malaysia, and Chile, and the Transatlantic Trade and Investment Partnership (TTIP) with the European Union.

Mercantilism

it is in a country's best interest to maintain a trade surplus- to export more than it imports - Government should intervene to achieve a surplus in the balance of trade - protectionism (was big back in the 16th century and it is here to stay today - it viewed trade as a zero sum game (somebody wins at somebody else's expense) - the international finance system at that time is based on gold/silver standard

Pragmatic Nationalism

many countries have adopted neither a radical policy nor a free market policy toward FDI but instead a policy that can best be described as pragmatic nationalism.26 The pragmatic nationalist view is that FDI has both benefits and costs. FDI can benefit a host country by bringing capital, skills, technology, and jobs, but those benefits come at a cost. When a foreign company rather than a domestic company produces products, the profits from that investment go abroad. Many countries are also concerned that a foreign-owned manufacturing plant may import many components from its home country, which has negative implications for the host country's balance-of-payments position. - FDI should be allowed so long as the benefits outweigh the costs - Another aspect of pragmatic nationalism is the tendency to aggressively court FDI believed to be in the national interest by, for example, offering subsidies to foreign MNEs in the form of tax breaks or grants.

Arguments for government intervention take two paths:

political and economic. 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. Economic arguments for intervention are typically concerned with boosting the overall wealth of a nation (to the benefit of all, both producers and consumers).

Optimal Currency Area

region in which similarities in economic activity make a single currency and exchange rate feasible instruments of macroeconomic policy - According to critics, another drawback of the euro is that the EU is not what economists would call an optimal currency area. In an optimal currency area, similarities in the underlying structure of economic activity make it feasible to adopt a single currency and use a single exchange rate as an instrument of macroeconomic policy. Many of the European economies in the euro zone, however, are very dissimilar. For example, Finland and Portugal have different wage rates, tax regimes, and business cycles, and they may react very differently to external economic shocks. - when euro economies are not growing in unison, a common monetary policy may mean that interest rates are too high for depressed regions and too low for booming regions. - One way of dealing with such divergent effects within the euro zone is for the EU to engage in fiscal transfers, taking money from prosperous regions and pumping it into depressed regions. Such a move, however, opens a political can of worms. Would the citizens of Germany forgo their "fair share" of EU funds to create jobs for underemployed Greece workers? Not surprisingly, there is strong political opposition to such practices.

Treaty of Rome

the 1957 treaty that established the European Community - With the signing of the Treaty of Rome in 1957, the European Community (EC) was established. The name changed again in 1993 when the European Community became the European Union following the ratification of the Maastricht Treaty (discussed later). The Treaty of Rome provided for the creation of a common market. Article 3 of the treaty laid down the key objectives of the new community, calling for the elimination of internal trade barriers and the creation of a common external tariff and requiring member states to abolish obstacles to the free movement of factors of production among the members. - the treaty committed the EC to establish common policies in agriculture and transportation.

International Institutions and the Liberalization of FDI

the WTO has become involved in regulations governing FDI. - the thrust of the WTO's efforts has been to push for the liberalization of regulations governing FDI, particularly in services. Under the auspices of the WTO, two extensive multinational agreements were reached in 1997 to liberalize trade in telecommunications and financial services. Both these agreements contained detailed clauses that require signatories to liberalize their regulations governing inward FDI, essentially opening their markets to foreign telecommunications and financial services companies.

The Euro Experience

the euro has had a volatile trading history against the world's major currency, the U.S. dollar. After starting life in 1999 at €1 = $1.17, the euro steadily fell until it reached a low of €1 = $0.83 in October 2000, leading critics to claim the euro was a failure. A major reason for the fall in the euro's value was that international investors were investing money in booming U.S. stocks and bonds and taking money out of Europe to finance this investment. In other words, they were selling euros to buy dollars so that they could invest in dollar-denominated assets. This increased the demand for dollars and decreased the demand for the euro, driving the value of the euro down. - The fortunes of the euro began improving in late 2001, when the dollar weakened; the currency stood at a robust all-time high of €1 = $1.54 in early March 2008. - Since 2008 however, the euro has weakened, reflecting persistent concerns over slow economic growth and large budget deficits among several EU member states, particularly Greece, Portugal, Ireland, Italy, and Spain. During the 2000s, all these governments had sharply increased their government debt to finance public spending.

bound tariff rates

the highest rate that can be charged, which is often, but not always, the rate that is charged - while average tariffs are low, high tariff rates persist on certain imports into developed nations, which limit market access and economic growth. For example, Australia and South Korea, both OECD countries, still have bound tariff rates of 15.1 percent and 24.6 percent, respectively, on imports of transportation equipment