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• Chapter 4:
– Instruments of Trade
– Arguments for Government Intervention
• Chapter 5:
FDI’s role in the World Economy
Trends and forms of FDI
FDI Theory
Benefits and costs of FDI
FDI in emerging markets
• Chapter 6
– Foreign market entry decisions and
– Foreign market entry modes (pros and
• Chapter 7
– Nature of Regional economic
– Levels of regional economic
– Regional economic integration in
– Arguments for and against regional
economic integration
• Chapter 8
– Functions and nature of foreign
exchange market
– Impact of Foreign Exchange markets
on international business managers
Governments intervene in international trade to protect the interests of politically
important groups
The main instruments of trade policy are:
Import Quotas
Voluntary Export Restraints
Local Content Requirements
Administrative Policies - bureaucratic rules designed to make
it difficult for imports to enter a country
Antidumping Policies - designed to punish foreign firms that
engage in dumping and protect domestic producers from “unfair” foreign
Tariffs - taxes levied on imports
Subsides - government payments to
domestic producers
Who gains:
• Government
• Domestic producers (at least in the
short run)
• Employees of protected industries
keep their jobs
Subsidies aim at lower costs to help:
• Compete against cheaper imports
• Gain export markets
• Increase domestic employment
• Local producers achieve first-mover
advantage in emerging industries
Who loses:
• Consumers who pay higher prices
• The economy which remains
• Employees of protected industries
who don’t develop new skills
Who loses:
• Governments tax individuals… to
pay for subsidies
• Consumers buy more expensive
goods with lower disposable
Import Quotas – restrictions on
quantity imported
Government specifies how much of
what product can be imported from
which countries
Voluntary Export Restraints - quotas
on trade imposed by the exporting
country officially or unofficially
Local Content Requirements demands that some % of a good has to
be produced domestically with local
raw materials and local labor
Used by LDCs to:
• Achieve technology transfer, skills
• Shift manufacturing base to a higher
technological level
Similar effects to those of import
Administrative Policies - bureaucratic
rules designed to make it difficult for
imports to enter a country
Antidumping Policies
Dumping: selling goods in an overseas
market at below their production
costs or
below “fair market value”
Antidumping Policies - designed to
• Punish foreign firms that engage in
dumping and
• Protect domestic producers from
“unfair” foreign competition
• Political arguments - protecting the interests of certain groups within a nation (normally
producers), often at the expense of other groups (normally consumers)
• Economic arguments - boosting the overall wealth of a nation (benefit both producers
and consumers)
Political arguments for government intervention include:
• Protecting jobs - most common political reason for trade restrictions
• Protecting industries deemed important for national security
• Retaliating to unfair foreign competition
• Protecting consumers from “dangerous” products
• Furthering the goals of foreign policy
• Protecting the human rights of individuals in exporting countries
• Results from political pressures by unions or industries that are "threatened" by more
efficient foreign producers
Economic arguments for intervention include:
• Infant industry argument
 Protect industry while it develops, until viable and competitive internationally
 Accepted as a justification for temporary trade restrictions under the WTO
 However, difficult to gauge when an industry has “grown up”
 Critics – if country has the potential to develop a viable competitive position, its
firms should be capable of raising necessary funds without additional support from
the government
• Strategic trade policy
 In cases where there may be important first mover advantages, governments can
help firms from their countries attain these advantages
 Governments can help firms overcome barriers to entry into industries where foreign
firms have an initial advantage
Foreign direct investment (FDI) occurs when a firm invests directly in facilities to
produce or market a product in a foreign country and requires an interest of
10% or more in a foreign business entity
FDI in the world economy
• Flow of FDI – amount of FDI undertaken over a given time period
– Two types:
• Inflow of FDI – refers to the flow of FDI into a country
• Outflow of FDI – refers to the flow of FDI out of a country
• Stock of FDI – total accumulated value of foreign owned assets at a given time
Reasons for rapid growth:
• Means to avoid potential future trade barriers
• Political and economic changes
• Globalisation of world economy
Forms of FDI:
• Most FDI takes the form of mergers and acquisitions because:
– It is more quickly executed than Greenfield ventures
– Acquisition of existing strategic assets are possible
– Opportunity to increase efficiency of the acquired firm is possible due to
the transferring of technology, capital and management skills
Host Country
Resource-Transfer Effects (supply of
Home Country
capital, technology, management)
Balance of Payment Benefits (inward flow
of foreign earnings)
Employment Effects (job creation)
Employment Effects (from outward FDI)
Balance of Payment Effects
Gains from learning valuable skills from
Effect on Competition and Economic
foreign markets (transferred to home
Adverse Effects on Competition
Adverse Effects on Balance of Payments
National Sovereignty and Autonomy
o initial capital outflow to finance FDI
(loss of economic independence)
o If purpose of FDI is to provide home
Adverse Effects on Balance of Payments
market from low cost labour location
o If FDI is a substitute for direct exports
Foreign Direct Investment
Cluster 1:
Cluster 2:
Why FDI?
Patterns of FDI
 Limitations of
 Limitations of
 Strategic
 Product Life
Cluster 3:
• FDI in Africa has been on the increase, although at a slower rate than other
developing nations
• There are significant variations across African countries in FDI performance.
Countries such as South Africa, Egypt and Nigeria have attracted
considerable FDI.
• FDI in Africa previously came from countries such as the United States, the
United Kingdom, Germany and France. However, new investors are
emerging and include Canada, Italy, Portugal and Spain.
• Inward FDI, originating in other African countries is taking place. South
Africa in particular is engaging in FDI in other African Countries.
• FDI in Africa has proven profitable, and even more profitable than in other
developing countries
• This section in very important for exams
• STUDY pages 182–184, 193-194 in detail
Firms expanding internationally must decide:
• which markets to enter
• when to enter them and on what scale
• which entry mode to use
Entry modes include:
• exporting
• licensing or franchising to a company in the host
• establishing a joint venture with a local company
• establishing a new wholly owned subsidiary
• acquiring an established enterprise
Several factors affect the choice of entry mode including:
• transport costs
• trade barriers
• political and economic risks
• costs
• firm strategy
Which market to enter?
When to enter?
On what scale?
1. Depend on long run profit
2. Desirable: Politically stable,
developed & developing
nations with free market
systems, relatively low
inflation rates and private
sector debt, product in
question not widely available
and satisfies an unmet need
3. Less desirable: politically
unstable, developing nations,
mixed or command
economies, developing
nations with excessive levels
of borrowing
Early or late
1. Firms that enter a market on a
significant scale make a
strategic commitment to the
market (the decision has a
long term impact and is
difficult to reverse)
1. First mover advantages
• Ability to pre-empt rivals &
capture demand
• Ability to build up sales
• Gain cost advantage over
later entrants
• Ability to create switching
costs that tie customers into
products or services making
it difficult for later entrants
to win business
2. First mover disadvantages
• pioneering costs – foreign
business system different
from firm’s home market
that firm must devote much
time, effort and expense to
learn the rules of the game
2. Small-scale entry has the
advantage of allowing a firm
to learn about a foreign
market while simultaneously
limiting the firm’s exposure to
that market
based on the
levels of risk
and reward
• Agreements among countries in a geographic region to reduce/remove tariff
& non-tariff barriers to the free flow of goods, services & factors of
production with each other
• Comparative advantage – freer trade within regions will produce gains for all
• Critics worry that there will be a world where regional trading blocs compete
against each other
1. Free trade area
• No barriers to trade among member countries,
• Members determine own trade policies for nonmembers
 European Free Trade Association (Norway, Iceland, Liechtenstein, and
 North American Free Trade Agreement (U.S., Canada, and Mexico)
2. Customs Union
• No trade barriers between member countries and adopts a common
external trade policy
 Andean Pact (Bolivia, Columbia, Ecuador and Peru)
3. Common Market
• No barriers between member countries, a common external trade policy
and free movement of the factors of production
 MERCOSUR (Brazil, Argentina, Paraguay and Uruguay) aims for common
market status
4. Economic Union
• Free flow of products and factors of production between members
• A common external trade policy, a common currency, a harmonized tax rates and a
common monetary and fiscal policy
 European Union (EU) is an imperfect economic union
5. Political Union
• Central political apparatus that coordinates the economic, social and foreign policy
member states
 United States is an example of even closer political union
 The EU is headed toward at least partial political union
• Unrestricted free trade will allow countries to specialize in the production of
goods/services that they can produce most efficiently
Greater world production than is possible with restrictions
Stimulates economic growth creating dynamic gains from trade
FDI can transfer technological, marketing & managerial know-how to host nations
• Linking economies & making them increasingly dependent on each other creates
incentives for political cooperation & reduces potential for violent conflict
By grouping economies, countries can enhance their political weight in the world
Benefits of regional integration have been oversold & the costs have often been
Trade creation (high-cost domestic producers are replaced by low-cost producers
within a region) vs. trade diversion (low-cost external suppliers are replaced by
higher-cost suppliers within the region)
Regional trading blocs could emerge whose markets are protected by high nontariff barriers (WTO does not cover)
Painful adjustments in certain segments of economy
Threat to national sovereignty
• Regional integration was initiated in Africa in the early 1900s with the establishment
of the South African Customs Union (SACU) in 1910 and the East African Community
(EAC) in 1919.
• After the 1970s, further regional economic communities formed across the continent.
In 1994 the African Economic Community Treat (or Abuja Treat) came into force, the
objective of which was to establish economic cooperation and strengthening the
existing regional economic communities
• Africa’s lack of progress due to the reluctance of the governments of African countries
– Surrender sovereignty of macroeconomic policy making to regional authority;
– Face potential consumption costs that may arise by importing from a high cost
member country;
– Accept unequal distribution of gains and losses that may follow an integration
agreement; and
– Discontinue existing economic ties with non-members
• The foreign exchange market as “a market for converting the currency of one
country into that of another country”.
• The foreign exchange market has no central trading floor where buyers and
sellers meet. Rather trades are completed through a network of banks and
foreign exchange dealers via telephone and email.
• As it is a worldwide market it operates 24 hours a day.
• Two main functions:
– currency conversion
– insuring against foreign exchange risk
International companies use the foreign exchange market when:
• Payments are received in foreign currencies for exports
• Income is received in foreign currencies from foreign investments
• Income is received in foreign currencies from licensing agreements with
foreign firms
• When they must pay a foreign company for its products or services in its
country’s currency
• When they have spare cash that they wish to invest for short terms in money
• When they are involved in currency speculation (the short-term movement
of funds from one currency to another in the hopes of profiting from shifts in
exchange rates)
Firms need to understand the influence of exchange rates on the profitability of trade and
investment deals, also called hedging
There are three types of foreign exchange risk:
1. Transaction exposure
• Extent which income from individual transactions is affected by fluctuations in
foreign exchange values
• Includes obligations for purchase or sale of goods and services at previously agreed
prices & borrowing or lending of funds in foreign currencies
2. Translation exposure
• Impact of currency exchange rate changes on the reported financial statements
• Present measurement of past events
3. Economic exposure
• Extent to which future international earning power is affected by changes in
exchange rates
• Economic exposure is concerned with long-term effect of changes in exchange rates
on future prices, sales, and costs
To fully understand hedging, an understanding of spot exchange rates, forward exchange
rates and currency swap is necessary.
• Spot Exchange Rate: refers to the “exchange rate for the transaction that requires
almost immediate delivery of foreign exchange”. Spot rates change continuously, often
on a minute by minute basis, and the value of the currency is determined by the supply
and demand of the currency relative to the supply and demand for other currencies
Forward Exchange Rate: refers to “the exchange rate for a transaction that requires
delivery of foreign exchange at a specified future date (e.g. 30-day, 90-day)” . Forward
exchange rates address the challenges presented by the spot exchange rate, which
could potentially make a transaction unprofitable by the time it is executed. Forward
exchange rates provide a means for international businesses to hedge (insure) against
the risk of exchange rate fluctuations when, for example, importing goods.
Currency Swap: Forward exchanges often take the form of a currency swap which is
sophisticated financial instrument involving “the simultaneous purchase and sale of a
given amount of foreign exchange for two different value dates”. They are conducted
between international businesses and banks, between banks and between
governments in instances where it is necessary to “move out of one currency into
another for a limited period without incurring foreign exchange rate risk”
Foreign Exchange Market present the following challenges for managers within international
Managers need to understand the impact of foreign exchange rates on the profitability of foreign
trade and foreign investment deals. Negative changes in the exchange rate may turn a profitable
business deal into an unprofitable one
Managers need to ensure that their businesses are insured against foreign exchange risk. It is
best to do this through the employment of multiple tactics which may include:
– Exercising centralised oversight over its foreign exchange hedging activities;
– Recognising the difference between transaction exposure (the extent to which fluctuations
in foreign exchange values affect the income from individual transactions) and economic
exposure (the extent to which earning power is affected by exchange rates);
– Forecasting future exchange rate movements;
– Putting in place good monitoring and reporting systems to identify exposure.
Generating regular foreign exchange exposure reports which can serve as the basis for action