A4. Management of international trade and finance Flashcards
Multinational enterprise:
Multinational enterprise: one which owns or controls production facilities or subsidiaries or services facilities outside the country in which it is based. Multinationals operate in an international trading environment.
Theory of international trade.
In the modern economy production is based on high degree of specialisation. International trade originated on the basis of nations exchanging their products for others which they could not produce for themselves. International trade arises for a number of reasons:
• Different goods required different proportions of factor inputs in their production
• Economic resources are unevenly distributed throughout the world
• The international mobility of resources is extremely limited.
The main reason for trade therefore is that there are differences in the relative efficiency with which different countries can produce different goods and services.
The law of comparative advantage.
The significance of the law is that it provides a justification for the following beliefs:
• Countries should specialise in what they produce, even when they are less efficient (in absolute terms) in producing every type of good. They should specialise in the goods where they have a comparative advantage (they are relatively more efficient in producing).
• International trade should be allowed to take place without restrictions on imports or exports – ie there should be free trade.
In practice, although countries do specialise to a degree in the production of certain goods and services, there are certain limitations or restrictions on how it operates:
• Free trade does not always exist. Some countries take action to protect domestic industries and discourage imports.
• Transport costs can be very high in international trade so that it is cheaper to produce goods in the home country rather to import them.
The advantages of international trade.
The law of comparative advantages is major advantage, but other advantages from encouraging international trade include:
• Some countries have a surplus of raw materials to their needs, and others have a deficit. A country with surplus can take advantage of its resources to export them. A country with deficit of a raw material must either import it, or accept restrictions on its economic prosperity and standard of living.
• International trade increases competitions among suppliers in the world’s markets. The greater competition will force firms to be competitive and so will increase the pressures on them to be efficient, produce goods of high quality, reduce prices, innovate.
• International trade creates larger markets for a firm’s output, and so some firms can benefit from economies of scale by engaging in export activities.
• There may be political advantages to international trade, because the development of trading links provides a foundation for closer political links (like EU).
Trade agreements.
Multinational companies will encounter a variety of different types of international trade agreements. These may provide protection to the company in the sense that competitors operating outside these areas may find it difficult to enter the market, or may create problems if the company is itself operating outside these areas and creates barriers to trade as they try to enter this markets.
Free trade agreements.
- Free trade area. This exists when there is no restrictions on the movement og goods and services between countries, but individual member countries impose their own restrictions on non-members (eg North American Free Trade Agreement – NAFTA).
- Customs Union. Involves a free trade area between member countries and, in addition common external tariffs applying to imports from non-member countries (Mercosur in South America).
- Common market. Encompasses the idea of customs union but in addition there are moves towards creating free markets in each of the factors of production (eg labour, capital) and a move to standardise market regulations (eg safety rules).
- Single market. Eventually common market becomes a single market with no restriction of movement in each of the factors of production and no regulatory differences (citizen in EU can work in any EU country).
- Economic Union. A common/single market may eventually evolve into economic and monetary union which will also involve a common Central Bank, a common interest rate and a single currency.
Barriers to entry.
Multinational may face various entry barriers.
• Product differentiation. An existing major supplier would be able to exploit its position as supplier of an established product that the consumer can be persuaded to believe is better. A new entrant to the market would have to design a better product, or convince customers of its quality which involves substantial money spend (R&D, promotion).
• Cost barriers. This can exist where an existing supplier has access to cheaper raw material sources or know-how that the new entrant would not have. Also, existing firms may be large, so new entrants to the market would have to be able to achieve a substantial market share before they could be competitive (in terms of economies of scales).
• Legal barriers. These are barriers where a supplier is fully or partially protected by law (legal monopolies, patents).
Protectionist measures.
There are a number of ways that a country can seek to restrict imports.
• Tariffs. Tariffs or custom duties are taxes on imported goods. The effect of a tariff is to raise the price paid for the imported goods by domestic consumers, while leaving the price paid to foreign producers the same, or even lower. The difference is transferred to the government sector.
• Quotas. Import quotas are restrictions on the quantity of a products that is allowed to be imported into the country (e.g. quotas on the number of cars manufactured outside of Europe that can be imported into the EU). The quota has a similar effect on consumer welfare to that of import tariffs, but the overall effects are more complicated. An embargo on imports from one particular country is a total ban, i.e. effectively a zero quota.
• Exchange controls – domestic companies wishing to buy foreign goods will have to pay in the currency of the exporter’s country. To do this they will need to buy the currency involved by selling sterling. If the government controls the sale of sterling it can control the level of imports purchased.
• Administrative controls – a domestic government can subject imports to excessive levels of administration, paperwork and red tape to slow down and increase the cost of importing goods into the home economy (eg increasing the safety standards that imported goods must comply with).
• Ban on Import. An outright ban on imports (or on imports of certain products).
• Subsidies. Offering subsidies to domestic producers.
Arguments against protection:
- Reduced international trade. Protection measures taken by one country will provoke retaliation by others and will reduce the volume of international trade. So, benefits of specialisation, greater competition and economies of scale will be reduced.
- Retaliation. Because of retaliation by other countries, protectionist measures to reverse a balance of trade deficit are unlikely to succeed. Imports might be reduced, but so too would exports.
- Effect on economic growth. It is argued that widespread protection will damage the prospects for economic growth among the countries of the world, and protectionist measures ought to be restricted to special cases which might be discussed and negotiated with other countries.
- Political consequences. Although from a nation’s own point of view protection may improve its position, protectionism leads to a worse outcome for all. Protection also creates political ill-will amount the countries of the world and so there are political disadvantages in a policy of protection.
Arguments for protection:
- Imports of cheap goods. Measures can be taken against imports of cheap g that compete with higher priced domestically produced goods, and so preserve output and employment in domestic industries.
- Dumping. Measures might be necessary to counter dumping of surplus production by other countries at an uneconomically low price. Although dumping has short-term benefits for the countries receiving the cheap goods, the longer-term consequences would be a reduction in domestic output and employment, even when domestic industries in the linger term might be more efficient.
- Retaliation. Any country that does not take protectionist measures when other countries are doing so is likely to find that it suffers all of the disadvantages and none of the advantages of protection.
- Infant industries. Protectionism can protect a country’s infant industries that have not yet developed to the size where they can compete in international markets (especially less developed countries).
- Declining industries. Without protection the industries might collapse and there would be severe problems of sudden mass unemployment among workers in the industry.
The World Trade Organisation (WTO).
Supports development of international trade, the WTO provides a mechanism for Identifying and reducing trade barriers and resolving trade disputes. It acts as a forum for negotiation and offering settlement processes to resolve disputes between countries. The WTO will impose fines, if members are in breach of their rules. Members of the WTO cannot offer selective free trade deals with another country without offering it to all other members of the WTO (the most favoured nation principle).
The International Monetary Fund (IMF).
The role of IMF is to oversee the global financial system, in particular to stabilise exchange rates, helping countries to achieve a balance of payments and influencing economic policies to help in the development of countries. The IMF can provide financial support to member countries in the form of a loan which is typically repayable in 3-5 years. The pre-conditions that IMF places on these loans vary, but general position is as follows:
• It wants countries that borrow to get into position to start repaying the loans fairly quickly. To do this, countries must take effective action to improve their balance of payment position.
• To make this improvements IMF believes that a country should take action to reduce demand for goods and services in the economy (eg increased taxes and cutting government spending). This will reduce imports and help to put brake on price rises. The countries industries will be then able to divert more resources into export markets.
• With deflationary measures, standards of living will fall, and unemployment may rise. IMF regards this as necessary to sort out balance of payments and international debt problems.
IMF has been criticized for the conditions imposed on countries, including specific criticism for the suggestion that its policies cause austerity measures, which impact more on those with lower or mid-range incomes. This in turn hinders long-term growth and development.
The World Bank.
Lends to creditworthy governments of developing nations to finance projects and policies that will stimulate economic development and alleviate poverty. The World Bank consists of two institutions:
• The International Bank for Reconstruction and Development (IBRD) which focuses on middle-income and creditworthy poorer countries
• The International Development Association (IDA) which focuses exclusively on the world’s poorest countries (with very high credit risk).
Both provide finance for projects which are likely to have impact on poverty. Loans are normally interest free and have a maturity of up to 40 years. Bank directly affects multinational companies by helping to finance infrastructure projects in developing economies. This creates a platform for other investment by multinationals.
Central banks.
Central banks normally have control over interest rates and support the stability of the financial system (eg managing risk of financial contagion). Financial contagion is where a crisis in one country spills to many other countries. One of the roles of central banks is to monitor the risk of financial contagion carefully and to increase their stimulus programmes where necessary. Collaboration between central banks is supported by the Bank of International Settlements (BICS). In the context of international trade, a key role of the central bank is to guarantee the convertibility of a currency (eg from £s to $s).
European Central Bank
European Central Bank was established in 1998 and is based in Frankfurt. It is responsible for administering the monetary policy of the EU Eurozone member states and is thus one of the world’s most powerful central banks. The main objective of the ECB is to maintain price stability within the Eurozone (keep inflation low). The main relevance to a multinational organization is that by keeping inflation low, the ECB can help to create a long-term financial stability (eg protect euro value over long term).
