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International Political Economy Termiflex, Wally, and the EU Termiflex Industrial Computer Terminals MBB-Aerospatiale Surface-to-Surface Missiles Rediffusion Flight Simulators Volvo Robotics Factors/Issues of Globalization Economic Political Cultural Legal Globalization The Objective Realities The integration of national economies into the international economy through: Trade Foreign direct investment Capital flows Technology Page 4 Global Corporate “Chess Board” Globalization The Human Factor …driven by a combination of economic, technological, sociocultural, political and biological factors …the transnational dissemination of ideas, languages, or popular culture Page 6 Fair Trade and Outsourcing …in the media In politics… Globalization and Life Off-shoring manufacturing to Honduras, El Salvador Page 8 Globalization and Life In-shoring of manufacturing to Louisiana, Texas via immigration Page 9 Globalization and Life Appliance Call Center Bangalore Unemployment Center Detroit Page 10 Globalization Some Unintended Consequences Unemployment in some industry sectors and some skill levels Bankruptcies in some industry sectors Resurgence in economic and cultural nationalism Brain drain Easier transmission of H1N1 virus Transnational pollution and CO2 flows Page 11 What is Globalization? Perspective of Countries o o o o o How are countries connected globally? How big is globalization? Why does it happen? Who’s doing it? Is it connected to prosperity? A.T. Kearney/Foreign Policy Globalization Index Foreign Policy and A.T. Kearney Annual Globalization Report Global Top-20 Ireland Singapore U.S. Czech Republic Globalization Index = Politica • Political Engagement + • Technology Contact/Transfer + • Personal Contact + • Trade and FDI Merchandise Exports France Japan U.S. Germany (US$ billions) UK Kor Mex Ire Merchandise Imports (US$ billions) France Japan Germany U.S. UK Kor Mex Ire Foreign Direct Investment - Out (% of World Total) France Japan Germany U.S. UK Foreign Direct Investment - In (% of World Total) France Germ U.S. UK Comparative Advantage o Germany: o 10 units of factor inputs (labor & capital) to produce 1 keg of beer o 2 units of factor inputs (labor & capital) to produce 1 box of pretzels o United States: o 15 units of factor inputs to produce 1 keg of beer; o 5 units of factor inputs to produce 1 box of pretzels; Which country should manufacture and export only beer? Which country should manufacture and export only pretzels? Comparative Advantage Germany: 10 labor pretzels = 5 pretzels per beer * beer 2 labor = US: 15 labor pretzels = 3 pretzels per beer * beer 5 labor = * Opportunity Costs … price of beer in terms of pretzels, using labor as common denominator Comparative Advantage Germany: 10 labor pretzels = 5 pretzels per beer beer 2 labor US: 15 labor pretzels = 3 pretzels per beer beer 5 labor o o o Germany has absolute advantage in both beer and pretzels U.S. has comparative advantage in beer, and should manufacture and export beer to Germany Germany has comparative advantage in pretzels, and should manufacture and export pretzels to the U.S. Growth in Trade Indexed: 1950 = 100 1600 1200 800 Trade 400 GDP 100 1950 1960 1970 1980 1990 2000 2010 What is Globalization? Perspective of Multinational Corporations (MNCs) o o o o Motivations for global operations and reach How are companies engaging in globalization? How big is their involvement? What are the effects on managers, customers, employees, profits, etc.? Rank Firm or Country 1 United States 2 Japan 3 Germany 4 France 5 United Kingdom 6 Italy 7 China 8 Brazil 9 Canada 10 Spain 11 Russia 12 South Korea 13 Mexico 14 Microsoft 15 Australia Value (in $bil) $8,110.9 4191.5 2104.6 1394.1 1288.2 1145.4 902.1 802.1 618.3 531.3 449.9 438.2 409.6 407.2 390.8 16 17 18 19 20 21 22 23 24 25 26 27 28 29 30 31 32 India Netherlands General Electric Argentina Taiwan Belgium Sweden IBM Indonesia Austria Exxon Royal Dutch Shell Wal-Mart Turkey AT&T Intel Cisco Systems 380.8 360.5 333.1 326.4 283.4 242.4 227.8 214.8 214.6 207.5 193.9 191.3 189.5 186.4 186.1 180.2 174.1 Extent of Globalization for MNCs Foreign Sales as Percent of Total Foreign Assets as Percent of Total Exxon 72% 64% IBM 57% 44% Ford 31% 44% General Electric 32% 48% Citigroup 35% 41% Hewlett-Packard 55% 52% Orange = Percentage of exports to the U.S. by intra-firm trade (via FDI) to total exports (This is NOT volume of total exports) Green = Globalization Index Growth in Trade Indexed: 1950 = 100 1600 1200 800 Trade 400 GDP 100 1950 1960 1970 1980 1990 2000 2010 Trade and Investment Policy Free Trade? How Nations Influence Trade and Investment Activity Through Policy o Overt/Visible Policies Supporting/Strategic Policies o Follow-up Questions: o o How well to these policies work? o What are the side effects? o Retaliation? o How might managers of MNCs respond? Overt Policy Alternatives o o Restrict Imports (tariffs, quotas, VERs) Restrict FDI o Incoming (F/X controls, local content) o Outgoing (tax code, expatriation disincentives) o o o o Restrict Exports (DoD restrictive munitions) Export Promotion (subsidies, tax credits) Import Promotion (tax credits, favors) FDI Incentives (subsidies for infrastructure, training & development, market access) o Preferential Govt. Procurement Cost of Import Protection Japanese Rice Market Domestic Supply World Price Domestic Demand Domestic Quantity Produced Domestic Quantity Consumed Cost of Import Protection Japanese Rice Market Domestic Supply Tariff Price World Price Domestic Demand New New Domestic Domestic Quantity Quantity Produced Consumed Cost of Import Protection Japanese Rice Market Domestic Supply Deadweight Loss Tariff Price World Price Extra Revenue Tariff Domestic Demand New New Domestic Domestic Quantity Quantity Produced Consumed Cost of Import Protection Japanese Rice Market Domestic Supply Deadweight Loss Tariff Price World Price Extra Revenue Tariff Domestic Demand # Jobs saved? At what price? New New Domestic Domestic Quantity Quantity Produced Consumed Cost to Domestic Consumers per Job Saved Extra Revenue for Firm Tariff Revenue to Government + Deadweight Loss $800 million $800 million 10,000 jobs = $80,000 /job What is Globalization? Perspective of Consumers vs. “Regular Joes” o o o Outsourcing Cheaper Products vs. Job Loss Fair Trade -- Product and Production Standards o Working standards o Living wage o Environmental standards Outsourcing Bogeyman “…a new way of doing international trade…a good thing” Gregory Mankiw, Bush Administration Economic Adviser “…CEOs who outsource are economic ‘Benedict Arnolds’” John Kerry, 2004 Presidential Candidate “…owe apology to every worker in America” Tom Daschle, 2004 Senate Minority Leader Job Losses in Manufacturing…? What kind of jobs? Causal factors – Outsourcing vs. technology and productivity gains? Would occur anyway “Voluntary” Export Restraints Managerial Responses to VERs TMM-K Georgetown Shift Sell Production to U.S. pricier, more profitable cars 1971 Honda 2008 Acura MDX FDI: Host Country Perspective Primary Impact Capital Employment Favorable Aspects Capital inflow Creates new jobs Entrepreneurship Creates new industries Technology Government Revenues Unfavorable Aspects Loss of control Policy Response Ownership restriction Career limits/ Employment low wages regulations Displaces local ideas Restrict market acess Appropriate techology?? ?? Increase tax Foreign base dependency ?? Access to new technol. FDI: Home Country Perspective Primary Impact Favorable Aspects Unfavorable Aspects Capital Profitable opportunities Capital flight Employment Access to lower wages Export jobs Technology Government Revenues Expand usage Lose control into new markets over sensitive technol Tax income on Loss of profits domestic wage tax base Economic Integration Global Linkages Country A Policy Linkages Country B Global Linkages Country A Integration Country B Regionalization of Economic Activity o Levels of Economic Integration o Free Trade Area o Customs Union o Common Market o Economic Union o Questions and Issues o Effects on trade and FDI patterns o Evolution toward worldwide integration o Impact on management of MNCs Trade in Isolation 20% 15% Prevailing Tariff Rates on Imports 10% 33% 40% 100% Free Trade Area o o No tariffs among members Tariffs with non-members unchanged 20% 33% 100% Trade and Investment in Isolation 33% 40% Cheapest Producer Trade Creation from FTA Formation 33% Cheapest Producer Trade and Investment in Isolation Cheapest Producer 33% 40% Trade Diversion from FTA Formation Cheapest Producer 33% Customs Union o o FTA plus... Common tariff policy for nonmembers 33% 33% 33% Common Market No Non-Tariff Barriers o o Customs Union plus... Reduction of non-tariff barriers among members Economic Union o o o Common Market plus... Single currency Harmonization of Monetary and Fiscal Policies F/X Foreign Exchange o o o o What is it? Why does it change? Risk for international managers How to manage risk Trade, FDI, and the Economy Computers Cash $$ o o o o Increase demand for Japanese computers – trade deficit Increase demand for computer inputs (components, labor, etc.) – inflationary Increase demand for Yen – appreciates Stronger Yen increases U.S. prices – decreases demand for Japanese computers Foreign Exchange Fluctuations and Volatility Index of Swiss Franc vs. Dollar 1990 = 100 1980 1990 2000 Sharply Depreciating Peso vs. Dollar A Medium of Exchange: The Linkage Between Currencies World Market for Euros Price = $ / € Price = € / $ World Market for Dollars S S € .77 / $ $1.30 / € D Same “market”…different perspective. D Linkage Between Currencies Price = $/€ World Market for Euros Price = € /$ S $1.35/ € $1.30/ € World Market for Dollars S S’ € .77/$ € .74/$ D D’ D Other Forces Causing Change o o Foreign Direct Investment Foreign Portfolio Investment o o o o MNCs Government Debt Instruments Currency Arbitrage and Speculation Governmental Intervention o o o Official and Unofficial “pegs” International Agreements (e.g., G-7, the Euro) Posturing (e.g., “talking” the dollar down) The Big Mac Index Big Mac: in Implied US$ PPP Rate % Under/ Over Value Big Mac: Local F/X Actual F/X Rate U.S. $2.55 – $2.55 – – EU ℮ 2.44 ℮ 1.08/$ $ 2.26 ℮ .96/$ - 11% Japan Y 253 Y 118.2/$ $ 2.14 Y 99.2/$ - 16% England ₤ 2.99 ₤ .69/$ $ 4.33 ₤ 1.17/$ + 70% Poland Z 1.34 Z 4.12/$ $ .32 Z .52/$ - 87% www.economist.com Short-term F/X Management o Currency Hedges o o o o Forward Contracts Options Negotiation of Ratcheted Pricing Schedule Adjustment of Prices and Target Profits o o Lower foreign prices to keep market share when home currency appreciates … lowers profit margin Raise foreign prices to keep profit margins when home currency depreciates … less price competitive Today: US Dealer to Import BMWs o Sales Contract: o o o o Quantity: 100 BMW 750s Price: € 100,000 each Payment: Due in 3 months Value of Sales Contract = o o o € 10.0 million Spot Rate = $1.30 / € $13.0 million In Three Months: Payment is Due Uncovered Transaction o Euro appreciates o o o Adjusted Value of Sales Contract o o o New spot rate = $1.35 / € € 10.0 million “Risk penalty” = $0.05 per € traded $13.5 million US Dealer’s Loss = $500,000 Today: US Dealer to Import BMWs Hedged Transaction o Sales Contract: o o o o Quantity: 100 BMW 535s Price: € 100,000 each Payment: Due in 3 months Value of Sales Contract = o o o o € 10 million at 90-day Forward Rate = $1.305 / € “Insurance premium” = $0.005 per € traded $13.05 million In Three Months: Payment is Due Hedged Transaction o Euro appreciates o o o Adjusted Value of Sales Contract o o o New spot rate = $ 1.35 / € (Doesn’t matter!!!) € 10 million Locked-in Forward Rate = $ 1.305 / € $13.05 million Cost of Hedge (insurance premium) = $50,000 In Three Months: Payment is Due Hedged Transaction o Euro Depreciates o o o Adjusted Value of Sales Contract o o o New spot rate = $ 1.25 / € € 10 million Locked-in Forward Rate = $ 1.305 / € (Spot better!!) $12.5 million Currency Windfall - Cost of Hedge = $450,000 Medium-Term F/X Management o Balance sheet hedge o o Match foreign assets with same level of foreign liabilities in same currency Cash flow hedge o Match foreign A/P with A/R in same currency Long-Term F/X Management o o o Shift sourcing and procurement Shift production Cut costs / improve productivity