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  • 1. INTERNATIONAL BUSINESS ENVIRONMENT & MANAGEMENTUnit-IInternational Business : An overview-types of international business; theexternal environment; the economic and political environment, thehuman cultural environment; influence on trade and investmentpatterns; recent world trade and foreign investment-trends, countryrisk.Qu1. Define International Business? What are the types ofInternational business?Ans: business is increasingly becoming international or global in its competitiveenvironment, orientation, content and strategic intent. This is manifested or necessitatedor facilitated by following:(a) The competition can be in a firm local, national or foreign-now encounters, in manycases, is global, i.e. besides the competition from the domestic it has to competitive withproducts manufactured in India by foreign firms and imports.(b) Because of liberalization, a firm has the challenging opportunity to improve itscompetitiveness and scope of business by global sourcing of technology, material,finance, human resources etc.(c) Globalisation is facilitating globalization of operations management to optimizeoperations and to improve competitiveness. Global value chain management is indeed akey factor of success.(d) The universal liberalization and the resultant global market opportunities are takenadvantage of by the firms to consolidate and expand of business. Growing competition athome pushing many companies overseas.(e) The global orientation of an increasing number of companies I evident from theirmission statements and corporate strategies.Types: International business is divided into following:(a) Trading: Import and exports of goods and services have been very fast. Incountries like Japan, there are international trading houses, which transact enormousvolume of business. The export house, trading house, stare trading houses andsuperstar trading houses are merchant exporters they buy and resell goods. They arecomparatively small in size from giant trading house of Japan.(b) Manufacturing and Marketing: The manufacturing exports are those who exportgoods manufactured by them. Many MNCs and other firms both small and large domanufacturing and marketing(c) Sourcing and Marketing: There are many MNCs and firms which outsource theirproducts which they market at home and abroad.(d) Global Sourcing for Production: There are many firms that outsource globallytheir raw material, intermediates etc required for their manufacturing.(e) Services: Services is an enormous and fast growing sector of internationalbusinesses. There is a large variety of services rendered internationally. The broadsegment includes tourism and transportations, IT, banking, insurance, consultancies etc.(f) Investments: International portfolio investment has been growing fast, as aresult of globalization. FDI are associates with establishment of manufacturing ormarketing facilities abroad.
  • 2. So, in short we can say that every business in today’s world is growing internationally andworld is coming closer and with this there are greater chances of revenue generation.Quip. 2 What is economic environment? Explain different kinds ofeconomic system and their influence on international business.Ans. Apart from the political and legal environment, the economic environment alsoinfluences international business decision. This is because the decision to trade or locatemanufacturing operations varies from one host country to other, depending upon the formof economic system existing there and various economic parameters prevailing there, forexample, level of income and inflation, health of industrial, financial and external sectorand many others.Types: There are three types of economic system:(a) Centrally Planned Economy: It is an economy where production anddistribution system is owned by the Government. The Govt designs the investments andcoordinates the activities of different economic sectors. Ownership of the means ofproduction and the whole process of production lays in the hands of Govt. the formerUSSR and other Eastern countries were examples of these types of economic system. Ininternational trade, normally the state trading corporation participates that highlyinfluences the consumers and business.(b) Market Based Economy: It is an economy where the decision to produce anddistribute goods is taken by individual firm based on the forces of demand and supply.They take such decision for the purpose of maximising profit or wealth. Consumers arefree to decide what they want to buy. The United States of America and WesternEuropean countries are example of market based economy. In market based economy,trade is handled by individual firms that affect the international business.(c) Mixed Economy: It is a compromise between CPE and market based economywhere private and public sectors exist side by side. There is no country that representsany of the two systems in its purest form. Indian economy system represents mixedeconomic system. Economic activities that are fraught with social considerations areowned and regulated by the Govt. The others are owned and performed by privatesectors.Qu. 3Write note on Political environnent.Ans. The political environment is an important factor that influences the internationalbusiness, especially when it is different between the home and host country. Politicalsetups vary widely between the two extremes:(a) Democracy: A democratic political system involves citizens directly or indirectly, inthe policy formulation of a country.(b) Totalitarianism: It is a political system, where political power lies in few hands withvirtually no opposition. Constitutional guarantees are denied to the citizens. Germanyunder the rule of Hitler and Stalin’s Soviet Union were historical examples oftotalitarianism regime. Myanmar is the example of totalitarianism Government.Political Risk: Political risk is unexpected changes in political set up in the hostcountry leading to unexpected discontinuities that bring about changes in very businessenvironment. For example, if a rightist party wins election in the country and the policy
  • 3. towards the foreign investment turns liberal, it would create appositive impact on theoperation of MNCs. On the other hand, if a left party comes in power in the host country,it will have a negative impact on the operation of MNCs.Types of Political Risk: Stephen Koran classifies political risk as:(1) Macro Risk: It is also called country specific risk that affects all foreign firms in thecountry. (a) Expropriation: It means seizure of private property by the Govt. It involvespayment of compensation. The reason behind expropriation has mainly been politicalturmoil. In the post war period, foreign and domestic firms were nationalized in China in1960. The Swedish Govt nationalized the ship building industry at a time when thisindustry was hit by world wide recession. An estimate revels that around 12 % of allforeign investment made in 1967 was nationalised within less than a decade.(b) Currency Inconvertibility: Sometimes the host Govt enacts law prohibiting foreigncompanies from taking their money out of the country or exchanging the host countrycurrency for any other currency. The reason is both economic and political. The Govt ofNigeria imposed such restrictions a couple of decades back in order to serve its economicand political objectives.(c) Credit Risk: Credit risk is refusal to honor a financial contract with a foreigncompany or foreign debts. For example when Khomeini came into power in Iran, theIranian Govt refuse to pay its debts on grounds that loans were taken during Shah’sregime. (d) Ethnic, Religious or Civil Strife: Macro political risk arises on account of war andviolence and racial, ethnic, religious and civil strife within a country. Recent example ofthese risks is slaughter in Bosnia and Herzegovina, breakdown of local authority inSomalia and Rwanda, the upsurge of Islamic fundamentalism in Algeria and Egypt. Suchrisks become major political risks for MNCs operating in these countries.(2) Micro Risk: The micro or firm specific risk affecting a particular industry or firm.The micro risks are: (a) Conflict of interest: The host Govt desires to have a sustainable growth rate, pricestability, comfortable balance of payment, and so on, but the policy of MNCs operatingthere is to maximize corporate wealth. For example, transfer of funds by MNCs mayinfluence the money supply and may cause inflation or deflation. MNCS may adopttransfer pricing techniques that may cause loss of tax revenue. It is not simply economicissues that cause conflicts but also non-economic issues like national security. The USGovt did not permit the Japanese purchase of Fairchild Industries on the grounds ofnational security.(b) Corruption: It is endemic in many countries; as a result MNCs have to faceserious problems. Foreign firms in Kenya had to sell a part of equity to powerfulpolitician. Transparency International has surveyed 85 countries and has brought aboutthe corruption perception index. Many countries rank high in the index. In 1999 34countries, including OECD members and five other signed a convention to ban bribery offoreign public officials in international business transaction.Evaluation of Political risk: Assessment of political risk is first step before a firm movesto abroad. It is because if such risks are very high, the firm would no like to operate inthat country. If the risk is moderate or low, the firm will operate in that country but with asuitable political risk management. There are two ways of risk assessment:(a) Qualitative Approach: It involves inter-personal contacts. Person may comefrom within the enterprise or may come from out side the firm. Those persons are oftenwell acquainted with the political structure of a particular country or region. Kraar has
  • 4. cited the example of Gulf Oil, which hired person in Govt since and from universities tofind out whether investment in Angola would be safe. Sometimes company sends a team of experts for on-the spot study of the politicalsituation of a particular country. This step is only taken after a preparatory study yieldsfavorable features. This method always gives a more reliable picture subject to availabilityof correct information from the local people. This approach also involves the examination and interpretation of diversesecondary facts and figures. For this purpose, companies maintain an exclusive riskanalysis division.(b) Quantitative Approach; Quantitative tools are also used to estimate political risk.American Can uses a computer programme known as primary risk investment screeningmatrix involving about 200 variables and reducing them to two numbers. It represents anindex economic variability as also an index of political stability. The variables includes, ingeneral, frequency of change of Govt, level of violence in the country, number of armedinsurgencies, conflicts with other nations and economic factors such as inflation rate,external balance deficit, growth rate of economy and so on.Management of political Risk: The political risk management strategy depends uponthe types of the risk and the degree of risk the investment carries. It also depends uponthe timing of the steps taken. There are two types of strategies:(a) Management Prior to Investment: there are five ways to manage it: (I) Capital budgeting: in this method , the factor of political risk is included in the very process of capital budgeting and the discount rate is increased. (ii) By Reducing the Investment Flow: The risk can be reduced by reducing the investment flow from the parent to the subsidiary and filling the gap through local borrowing in the host country. In this strategy, it is possible that the firm may not get the cheapest fund, but the risk will be reduced. (iii) Agreement: The political risk can also be reduced by negotiating agreements with the host Govt. prior to making any investment. (iv) Planned Divestment: It is yet another method of reducing risk. If the company plans to orderly shifting of ownership and control of business to the local shareholders and it implements the plan, the risk of expropriation will be minimal. (v) Insurance of Risk: The investing firm can be insured against political risk. Insurance can be purchased from governmental agencies, private financial service organisation or from private property-centred insurers.(b) Risk Management during the Life Time of the Project: Management of risk duringpre-investment phase reduces the intensity of risk, but does not eliminate it. There arefour ways to handle the risk in this phase: (I) Joint Venture and Concession Agreement: In a joint venture agreement, the participants are local shareholders who have political power to pressurize the govt to take a decision in their favour or in favour of enterprise. The govt is interested in earning from the venture and so it does not cancel the agreement (ii) Political Support: Risk can be managed with political support. International companies act sometimes as a medium through which the host govt fulfills its political needs. (iii) Structured Operating Environment: Political risk can be reduced by creating a linkage of dependency between the operation of the firm in high risk country and the operations of other units of the same firms in other countries. (iv) Anticipatory Planning: It is also a useful tool in risk management. The company should take necessary precautions quite in advance. For example,
  • 5. during Marco’s regime in Philippines, the foreign countries begin to foresee the fall of Marco regime and they took necessary measures well in advance.Risk Management following Nationalisation: Despite care taken by internationalcompanies for minimizing the impact of political risk, there are occasions whennationalisation takes place. There are many ways to minimise this effect:(a) Negotiation: The investing company negotiates with the host govt on variousissues and shows its willingness to support the policy and programmes.(b) Political and Economic Pressure: On failure of negotiations with the host govt, theinvesting company tries to put political and economic pressure.(c) Arbitration: If nationalisation is not reversed through negotiations and politico-economic pressure, the firm goes for arbitration. It involves the help of a neutral thirdparty who mediates and asks for payment of compensation.(d) Court of Law: when arbitration fails, the only way out is to approach the court oflaw. The international law suggests that the company has, first of all, to seek justice inthe host country itself. If it is not satisfied with the judgment of the court, the companycan go to international courts of justice for fixation of adequate compensation. However,there are occasions when the host govt failed to honor the verdict of court. For example,the Cuban Government failed to pay compensation to US companies expropriated during1959-1961.Quip. 4 Write note on recent world trade and foreign investment trends.Ans. World Trade: For quite a long time, global trade has grown faster than wordoutput and the trend is likely to continue in future. Exports of developing countries havebeen growing faster than those of the developed. The growing faster means growingproportion of the national output is traded internationally. For more than two and half decade until the oil stock of the early 1970’s there wasa tremendous of world trade propelled by the progressive trade liberalization and highgrowth rates of output. There after there has been a substantial growth of non-tariffbarriers and a fall in the growth rates of the developed economies causing a slow down ofthe pace of trade growth. However, the growth of the world trade has been significantlyhigher than that of the world output. A trade growth continued to exceed output growth, the ratio of the world trade ingoods and services to world GDP reached 29% in 2000. Since, 1990, this ratio has beenincreased 10% points, more than in two preceding decades combined. The first rank in terms of the value of exports had been occupied by US, withGermany and Japan in second and third position respectively, followed by France, UKand Italy in that order. An important aspect of global trade is the large intra-regionaltrade. India’s share in global exports was 0.4% in 1980. Since around the mid 1980’sthere has been a slightly improvement. Export of developing countries, as a group, has been growing faster than those ofthe developed countries. As a result their share in the global exports increased verysignificantly so that their share in world trade exports today is merely 30% while theirshare in global GNP is about 20%. Many countries have been marginalized by globaltrading system. The share of the 50 least developed countries (LDC) in the global tradeis very dismal about 0.5%. A major part of this is the contribution of a small numberamong them. In short, developing countries present a mixed picture of trade performance. Onthe one side there is a picture of spectacular performance of some countries and on the
  • 6. other there is a dismal presented by many. One is therefore tempted to draw ahypothesis that trade performance has something to do with the domestic economicfactors, including the development and trade strategies.Foreign Investment: Foreign investment takes two forms:(1) Foreign Portfolio Investment: It is an investment in the share and debtsecurities of companies abroad in the secondary market nearly for sake of returns and notin the interest of the management of the company. It does not involve the production anddistribution of goods and services. It simply gives the investors, a non-controlling interestin the company. Investment in the securities on the stock exchange of foreign country orunder the global depository receipt mechanism is an example.(2) Foreign Direct Investment: It is very much concerned with the operations andownership of the host country. It is an investment in the equity capital of a companyabroad for the sake of the management of the company or investment abroad throughopening of branches. It is found inform of:(a) Green-field Investment: It takes place either through opening of branches inforeign countries or through foreign financial collaboration. If the firm buys entire equityshares of a foreign company, the later is known as wholly-owned subsidiary of the buyingfirm. In case of purchase of more than 50% shares, the later is known as subsidiary ofthe buying firm. In case of less than 50%, the later is known as equity alliances. GeneralMotors of USA has 20% shares in the equity of the Italian firm Fiat and Fiat maintains 5%shares in equity of General Motors.(b) Merger and Acquisition: M &A are either out right purchase of running companyabroad or an amalgamation with a running foreign company. There are three forms of M& A: (I) based on corporate structure: Acquisition, where one firm acquire or purchase another firm. Amalgamation, in this two merging firms lose their identity into a new firm that comes into exist representing the interest of the two. (ii) Based on Financial Relationship: It can be vertical, horizontal and conglomerate. In horizontal, two or more firms are engaged in similar lines of activities join hands. Horizontal m & a helps to create economies of scales in occurs among firms involved in different stages of production of a single final product. If oil exploration and refinery firms merge, it will be called a vertical integration. Conglomerate merger involves two or more firms in unrelated activities. There are financial conglomerates where a company manages the financial function of other companies in the group. Similarly, there are managerial conglomerates combining the management of several companies under one roof. (iii) Based on techniques: M & A are either hostile or Friendly. In the hostile takeovers, the time devoted to negotiations is minimized as much as possible because it is just the discreet purchase of shares of the target company. In friendly takeovers, there are a lot of negotiations. The takeover deal is not disclosed until it is finalised. To this end, the acquiring company signs the confidentiality letter whereby it promises not to disclose the fact to third party. Finally, after the announcement is made to the press, a contract is signed.Motivation of Merger & Acquision: There are following motives behind M & A:(a) M & A provides synergistic advantages. For example, when the fixed costs in firmA does not cross the relevant range even after it acquires firm B, the combination will leadto saving of fixed costs that firm B was previously incurring.
  • 7. (b) It enables the overnight growth of firm. At the same time very risk of competitionreduces after merger.(c) It reduces financial risks through greater amount of diversitification. Moreparticularly in case of conglomerates, assets of completely differently risk classes areacquired and there are possibilities of negative correlation between the rates of return.(d) It leads to diversification, which raises the debt capacity of the firm. It helps thecost of capital to move downward and raises the value of corporate wealth.(e) The tax savings sometimes leads firms to combine. In international business, M & A are very common now a day because of abovesaid reasons. However, international M & A sometimes becomes an essential step whenthe domestic market is saturated and firm is desirous of further expansion for reapinggains from external economies.Unit – II Balance of payment accounts and macro economic management; theories and institutions; trade and investment; govt. influence on trade and investment.Quip. 5. Define Balance of Payments?Ans Balance of payments is a statement showing a country’s commercial transactionwith rest of the world. It shows outflow and inflow of foreign exchange. The systemrecordings are based on the concept of double entry book keeping, where the credit sideshows the receipt of foreign exchange from abroad and debit side shows payment inforeign exchange to foreign resident.Types: There are three types of payments:(a) Current account Transaction: Current account is a part of BOP statementshowing flow of real income or foreign exchange transactions on account of trade ofgoods and invisibles. The current account records the receipt and payments of foreignexchange in the following way:Current Account receipt(I) Export of goods: The export of goods effect the inflow of foreign exchange intothe country.(ii) Invisibles such as services, unilateral transfers and investment income.(iii) Non-monetary movement of gold: This is for industrial purpose and shown incurrent account, either separately from, or along with, trade in merchandise.Current account Payments(I) Import of Goods import of goods cause outflow of foreign exchange from thecountry.(ii) Invisibles such as services, unilateral transfers and investment income.(iii) Non-monetary movement of gold: This is for industrial purpose and shown incurrent account, either separately from, or along with, trade in merchandise. The debit and credit side of two accounts are balanced. If the credit side is greaterthan the debit side, the difference shows the current account surplus. On the contrary,the excess of debit side over the credit indicates current account deficit.(b) Capital account Transactions: Capital account is a part of BOP statementshowing flow of foreign loans / investment and banking funds. Capital accounttransactions take place in following ways:Capital account Receipt:
  • 8. (I) long term inflow of funds(ii) Short term inflow of fundsCapital account Payments;(I) long term Outflow of funds(ii) Short term outflow of fundsErrors and Omission: It is also termed as ‘statistical discrepancy’. It is an important itemon BOP statement, and is taken into account for arriving at overall balance. Following aresome reasons:(a) It arises because of difficulties involved in collecting balance of payment data.There are different sources of data, which sometimes differs in approach.(b) Movement of funds may lead or leg transaction that funds are supposed to finance.For example goods are shipped in March, but the payments are received in April. In thiscase figures complied on 31 March, will record the shipment that has been sent, but thepayment would be recorded in the following year.(c) Certain figures are derived on the basis of estimates. For example, figures forearning on travel and tourism accounts are estimated on the basis of sample cases. Ifthe sample is defective, there is every possibility of error and omission.(d) Errors and omission are explained by unrecorded illegal transaction that may beeither on the debit side, or on credit side, or on both sides. Only the net amount is writtenon the balance of payments. When the country is politically or economically stable, creditbalance is normally found because unrecorded inflows of funds occur. The experiencereveled that when Iraq invaded Kuwait, the US balance of payments witnessed such flowson credit side.Accommodating Capital Inflows: After the errors and omission is located, the overallbalance of payments is arrived at. If the overall balance of payment is surplus, thesurplus amount is used for repaying the borrowings from IMF and then the rest istransferred to the official reserve account. On the contrary, if the balance is found indeficit, the monastery authorities arrange for capital inflows to cover up the deficit.Accommodating of capital flow is the inflow of foreign exchange to meet the balance ofpayments deficit, normally from the IMF.Autonomous capital flow: It refers to flow of loans / investments in normal course of abusiness. A foreigner paying back the loan or the inflow of foreign direct investment is anapposite example of such inflow. These account goes ‘above-the-line’ whileaccommodating capital account inflow goes ‘below-the-line’.(C) Official Reserve Account: Official reserve is held by the monetary authorities ofa country. They comprise of monetary gold, SDR allocations by the IMF and foreigncurrency assets. Foreign currency assets are normally held in the form of balance withforeign central banks and investment in foreign government securities. The surplus ofbalance is transferred to this account. But if the overall balance of payment is in deficit,and if accommodating capital is not available, the official reserve account is debited bythe amount of deficit.EQUILIBRIUM, DISEQUILIBRIUM AND ADJUSTMENTEquilibrium: since the BOP is constructed on the basis of double entry book keeping,credit is always equal to debit. If debit on the current account is greater than the creditside, funds flow into the country, which are recorded on the credit side of capital account.The excess of debit is wiped out. Thus the concept of BOP is based on the concept ofaccounting equilibrium, that is:Current account + capital account +0
  • 9. The accounting balance is ex post concept that describes what has happened over aspecific past period.Disequilibrium: In economic terms, BOP equilibrium occurs when surplus or deficit iseliminated from the balance of payments. In real such equilibrium is not found, ratherdisequilibrium in the BOP which is a normal phenomenon. There are external economicalvariables influencing the BOP and giving rise to disequilibrium. Some important variablesare:(I) National Output and Spending: If the national income exceeds spending, theexcess amount will be invested abroad, resulting in capital account deficit. Excess ofspending over income causes borrowings from abroad, pushing the capital account intosurplus zone.(ii) Money Supply: Increase in money supply rises the price level and export turnuncompetitive. Fall in export earnings leads to deficit in current account. The higherprice of domestic goods makes the price of imported commodities competitive and importrise, leading to enlargement in the current account.(iii) Exchange Rate: If the currency of a country depreciates, export becomescompetitive. Export earnings improve. On the other hand import becomes costlier. If asa result import is restricted, the trade account balance will improve. But if imports are notrestrained, deficit will appear in the trade account. The net effect depends upon how farthe demand for export and import is price elastic.(iv) Interest Rate: The increase in domestic interest rate causes capital inflow in lureof higher returns. Capital account runs surplus. The reverse is the case when theinterest rate falls.Adjustments: Disequilibrium becomes a cause of concerns when it is associated with thecurrent account. This is because current account represents shift in real income and atthe same time any adjustments in this account is not very easy. If balance of trade is insurplus, its correction is not difficult. The surplus amount is used in meeting the deficit oninvisible account or it may be invested abroad. But if the balance of trade is in deficit andthe deficit is large, so as not to be covered by invisibles trade surplus, current accountdeficit will occur. If the deficit on the current account continues to persist, official reservewill be eroded. If a country borrows large amount to meet the deficit, it may fall to avicious debt trap. This is why adjustment measures are primarily aid at correctingdisequilibrium in the trade account.Quip. 6 Explain theories of Trade and Investment.Ans. There have been a number of theoretical explanations on international trade andinvestment.TRADE THEORY: Following are the trade theories:Classical theory: there are two classical theories:(I) Theory of Absolute Cost Advantage: Adam Smith compounded this theory ofinternational trade in 1976. He was of the opinion that productive efficiency differedamong different countries because of diversity in natural and acquired resourcespossessed by them. The theory explains that a country having absolute cost advantage inthe production of a product on the account of greater efficiency should specialize in itsproduction and export. For example, suppose country ‘A’ produces 1 kg of rice with 10units of labour or it produces 1 kg of wheat with 20 units of labour. Country ‘B’ producesthe same amount of rice with 20 units of labour and same amount of wheat with 10 units
  • 10. of labour. Each of countries has 100 units of labour. Equal amount of labour is used forthe production of two goods in the absence of trade between them. But when the trade ispossible between two countries, ‘A’ will produce only rice and exchange a part of riceoutput with wheat from country ‘B’. Similarly country ‘B’ will do. The total output of boththe countries will rise because of trade.(ii) Theory of Comparative Cost Advantage: This theory is compounded by DavidRicardo. The theory explains that a country should specialize in the production andexport of a commodity in which it possesses greatest relative advantage. For example,Bangladesh and India, each of the two has 100 units of labour. In Bangladesh, 10 unitsof labour are required to produce to produce either one kg of rice or one kg of wheat. Onthe contrary, in India, 5 units are required to produce one kg of wheat and 8 units arerequired to produce one kg of rice. From the viewpoint of absolute cost advantage, therewill be no trade as India possesses absolute cost advantage in the production of both thecommodities. But Ricardo is of the view that from the viewpoint of comparative costadvantage, there will be trade, because India possesses comparative cost advantage inthe production of wheat. This is because the ratio of cost between Bangladesh and Indiais 2:1 in case of wheat, while it is 1.25: 1 in case of rice. Because of this comparativecost advantage, India will produce 20 kg of wheat with 100 units of labour and exportapart of wheat to Bangladesh. On the other hand, Bangladesh will produce 10 kg of ricewith 100 units of labour and export apart of rice to India. The total output of foodgrain inthe two rises because of trade.Limitations: Despite of being simple, the classical theory of international businesssuffers of following limitations:(I) it takes into consideration only one factor of production that is labour. But in realworld, there are other factors that play a decisive role in production.(ii) The theory assumes the existence of full employment, but in practical, fullemployment is not possible.(iii) Theory stress too much on specialization that is expected to improve efficiency.But it is not always the case in real life.(iv) Classical economist feel that resources are mobile domestically and immobileinternationally. But neither of the two assumptions is correctSummary : The Classical theory holds good even today insofar as it suggest how anation could achieve the consumption level beyond what it would in absence of trade.Factor Proportions Theory or Heckschar and Ohlin Model The theory was compounded by two Swedish economists, Eli Heckscher and BertilOhlin. The theory explains that a country should produce and export a commodity thatprimarily involves a factor of production abundantly available in the country. For example,country ‘A’ has large population and large labour resources. Thus it will be able toproduce the goods at a lower cost using a labour intensive mode of production. Country‘B’ has abundance of capital but is short of labour resources and will specialize in goodsthat involve a capital intensive mode of production. After the trade, both the countries willhave two types of goods at the lest cost. Mr. Samuelson went a few steps ahead sayingthat in this way the prices of factors of production tend to equalize among differentcountries. Leontief found in his empirical study that the USA being the capital abundanteconomy, exported labour intensive goods. But he was of this view that such possibilitiescould not be ruled out because the USA was able to produce labour intensive goods in acapital intensive fashion.Neo-Factor proportion Theory
  • 11. Extending Leontief’s view, some of the economist emphasis on the point that it isnot only the abundance of a particular factor, but also the quality of that factor ofproduction that influences the pattern of international trade. The quality is so important intheir view that they analysis the trade theory in a three-factor framework:(a) Human capital: It is the result of better education and training. Human capitalshould be treated as a factor input like physical labour and capital. A country with humancapital maintains an edge over other countries with regards to the export of commoditiesproduces with the help of improved human capital.(b) Skill Intensity: The skill intensity hypothesis is similar to human capital hypothesisas both of them explain the capital embodied in human beings. It is only empiricalspecification that differs.(c) Economies of Scale: It explains that with rising output, unit cost decreases. Theproducers achieve internal economies of scales. A country with large productionpossesses an edge over other countries with regards to export. However, a small countrycan reap such advantages if it produces exportable in large quantities. National Competitive Advantage The theory is compounded by Porter. This theory explains that countries seek toimprove their national competitiveness by developing successful industries. The successof targeted industries depends upon a host of factors that are termed the diamond ofnational advantage. The factors are:(a) Factor Conditions: It shows how far the factors of production in a country can beutilised successfully in a particular industry. This concept goes beyond the factorproportion theory and explains that an availability of the factor of production per se is notimportant; rather their contribution to the creation and upgradation of products is crucialfor competitive advantages.(b) Demand Condition: The demand for the product must be present in the domesticmarket from the very beginning of production. Porter is of view that it is not merely size ofthe market that is important, but it is intensity and sophistication of demand that issignificant for competitive advantage.(c) Related and Supported Industries: The firm operating along with its competitors aswell as its complementary firms gathers benefit through a close working relationship inform of competition or backward and forward linkage.(d) Firm Strategy, Structure and Rivalry: The firm’s own strategy helps in augmentingexport. There is no fixed rule regarding the adoption of a particular strategy. It dependson the numbers of factors present in the home country or the importing country.Limitations: There are various criticism put forth against Porter’s theory:(a) There are cases when absence of any factors embodied in Porters diamond doesnot affect the competitive advantage. For example, when a firm is exporting its entireoutput, the intensity of demand at home does not matter.(b) If the domestic supplier of input is not available, the backward linkage will bemeaningless.(c) Porter’s theory is based on empirical findings covering 10 countries and fourindustries. A majority of countries in the sample have different economic background anddon’t necessarily support the findings. (d) Availability of natural resources, according to Porter is not the only conditions forattaining competitive advantage. And there must be other factors too for it. But in 1985,some Canadian industries emerged on the global map only on the basis of naturalresources.
  • 12. (e) Porter feels that sizable domestic demand must be present for attainingcompetitive advantage. But there are industries that have flourished because of demandfrom foreign sales.Summary: Nevertheless these limitations do not undermine the significance of Porter’stheory.INVESTMENT THEORYThere are a number of investment theories. Except for MacDougall hypothesis,investment theories are primarily based on imperfect market conditions. A few of them arebased on imperfect capital market.MacDougall-Kemp Hypothesis: Assuming a two-country model- one being the investingand other being the host country and the price of capital being equal, the investmentflows from abundant economy to a capital scare economy until the marginal productivityof capital in both the countries are equal or till the returns from investment is greater thanthe loss of output in home country.Industrial Organisation Theory: The theory is based on oligopolistic or imperfect marketin which the investing firm operates. Market imperfection arises in many cases, such asproduct differentiation, market skills, proprietary technology, managerial skills, betteraccess to capital, economies of scales, government imposed market distortion and so on.Such advantages confer MNCs an edge over their competitors in foreign locations andthus helps in compensate the additional cost of operating in an unfamiliar environment. Itrefers to technological and similar other advantages possessed by a firm that enable it toproduce new and differentiated products.Location Specific Theory: This theory is compounded by hood and Young. It refers toadvantages like cheap labour, abundantly available raw material, and so on for theproduction of a commodity to be established in a particular location or country. Since realwage cost varies among countries, firms with low cost technology move to low wagecountry.Product Cycle Theory: Raymond Vernon feels that most products follow a life cycle thatis divided into three stages:(a) Innovation Stage: It is a stage in the product cycle when the product is in demandbecause of its new and improved quality, irrespective of its price. The product ismanufactured in the home country primarily to meet the domestic demand but a portion ofthe output is exported to the other developed countries.(b) Maturing Product Stage: At this stage, the demand for the new product growsand it turns price elastic. Rival firms in the host country begin to supply similar product ata lower price owing to lower distribution cost, whereas the product of innovator is costlieras it involves transportation cost and tariff that is imposed by the importing government.Thus to compete with the rival firms, innovator decides to set up a production unit in hostcountry itself which would lead to internationalization of product.(c) Standardised Product; It is the stage in the product cycle when technologydoes not remain the exclusive possession of innovator and competition turns stiffer. Atthis stage price competitiveness becomes even more important and the innovator shiftsthe production to a low cost location, preferably a developing country where labour ischeap.(d) Denaturing Stage: It is the stage when development in technology or inconsumer’s preference breaks down product standradisation. Cheap labour does notmatter at this stage as sophisticated model involves a capital intensive mode ofproduction.
  • 13. Internalization Approach : Buckley and Casson too assumes market imperfection, butimperfection in their view, is related to transaction cost that is involved in intra-firmtransfer of intermediate product such as knowledge or expertise. It is internalizationbenefit is cost free intra-firm flow of technology development by the parent unit.Currency Based Approaches: It is compounded by Aliber. Such theories are normallybased on imperfect foreign exchange and capital market. The theory postulates thatinternationalization of firms can best be explained in terms of the relative strength ofdifferent currencies. Firms from strong currency country moves to a weak currencycountry. In a weak currency country, income stream is fraught with greater exchangerisk. As a result the income of strong currency country firm is capitalized at a higher rate.Politico-Economic Theories: These theories concentrate on political risk. Politicalstability in the host country leads to foreign investments. Similarly, political instability inthe home country encourages investment in foreign countries.Modified theories for Third World Firms: Developing country MNCs posses firm specificadvantages in form of modified technology. They move abroad also to reap advantagesof cheap labour and abundance of natural resources. These firms have long beenimporting technology from industrialized countries. But since imported technology ismainly designed to cope with a large market, firm export a part of their output aftermeeting their domestic demand.Unit- III World financial environment-tariff and non-tariff barriers, forex market mechanism, exchange rate determination, euro-currency market; international institutions (IMF, IBRD, IFC, IDA, MIGA) NBFC’s and stock markets.Quip. 7 Explain various types of tariff and non-tariff barriers. What arethe objectives of these barriers?Ans. International trade is affected by a number of factors including government policies.The government endeavor to promote export and import in many countries are hit byprotectionism and trade barriers.Types: There are two types of barriers:(a) Tariff Barriers: Tariff in international trade refers to the duties or taxes imposed on theimport traded goods when they cross the national borders. After Second World War,there has been a reduction in the average level of Tariffs in the advanced countries.Tariff rates are generally high in developing countries. With the recent economicliberalization across the world, many developing countries have reduced the tariff as apart of their trade liberalization. In most economies and organisation like WTO preferstariff to non-tariff barriers because tariff are transparent and less regressive than non-tariffbarriers. The developed countries tariff continues to be very strenuously loaded againstthe developing ones.Characteristic: • Tariff applied on to consumer goods are often higher than on the cheaper goods of luxury version. • There is also tariff escalation, when tariff increases with degree of processing involved in the product.(b) Non-Tariff Barriers: Non-tariff barriers are new protectionism measures that havegrown considerably, particularly since around the beginning of 1980s. The export growthof many developing countries has been seriously affected by non-tariff barriers.
  • 14. Categories of NTBs:(I) those which are generally adopted by developing countries to prevent foreignoutflow or result from their chosen strategy of economic development. These are mostlytraditional NTBs like import licensing, import quotas, foreign exchange regulations andcanalization imports.(ii) Those which are mostly used by developed countries to protect domesticindustries which have lost international competitiveness or which are politically sensitivefor government. For example Import Prohibition, Quantitative Restrictions, VariableLevi’s, Multi-Fiber Arrangements, Voluntary Export Restraint and Non-AutomaticLicensing. Example of NTBs excluded from the group includes technical barriers(including health and safety restriction and standards), Minimum Pricing Regulations andUse of Price Investigation and Pricing Surveillance.Quip. 8 Explain the theories of exchange rate determinants.Ans The theories of exchange rate are divided into following categories:DETERMINANTS OF EXCHANGE RATE IN SPOT MARKET There are following twotheories under this category:(a) Process of determination: It is the interplay of demand and supply that determinesthe exchange rate between two countries in a floating rate-regime. For example, theexchange rate of Indian rupee and the US dollar depends upon the demand for the USdollar and supply of dollar in Indian foreign exchange market. The demand for foreigncurrency comes from individuals and firms who have to make payments to foreigners inforeign currency, mostly on account of import exchange result, services and purchase ofsecurities. The supply of foreign exchange results from the receipt of foreign currency,normally on account of export or sale of financial securities to the foreigners. In the following figure, the demand curve slopes downwards to the right becausethe higher the value of US dollar, the costlier the imports and the importers curtails thedemand for higher value of the US dollar makes export cheaper and thereby, stimulatesthe demand for export. The supply of US dollar increases in the form of export earnings.This why, the supply curve of US dollar moves downwards to the right with a rise in itsvalue? The equilibrium exchange rate arrives where the supply curve intersects thedemand curve at Q1. This rate, as shown in the figure, is Rs 40/US $. S Rs/US$ S1 42 40 D1 D Q1 Q2 Q3 Demand for and supply of US$
  • 15. If the demand for import rises owing to some factors at home, the demand for theUS dollar will rise to D1 and intersect the supply curve at Q2. The exchange rate will beRs 42/US$. But if the export rises as a result to decline in value of rupee and supply ofthe dollar increase to S1, the exchange rate will again be Rs 40/US$. So the frequentshifts in demand and supply condition cause the exchange rate to adjust to a newequilibrium.(b) Purchasing Power Parity Theory (PPP): This theory was compounded by Casselin 1921. There are two version of this theory:(I) Absolute Version; The theory suggest that at any point of time, the rate ofexchange between two currencies is determined by their purchasing power. If e is theexchange rate and Pa and Pb are the purchasing power of the currencies in the twocountries, A and B, the equation can be written as: e = P a / Pb This theory is based on the theory of one price in which the domestic price of anycommodity equals its foreign quoted in the same currency. For example, if the exchangerate is Rs 2/US$, the price of a particular commodity must be US $ 50 in the USA if it isRs 100 in India. US$ price of commodity x price of US$ = Rupee price of the commodityThe exchange rate adjustment resulting from inflation may be explained further. If theIndian commodity turns costlier, its export will fall. At the same time, its import from theUSA will expand as the import gets cheaper. Higher import will raise the demand for theUS dollar raising, in turn its value vis-à-vis.Limitation: however this theory holds good if the same commodity is included in the sameproportion in the domestic market and world market. Since it is normally not so, thetheory faces a serious limitation as it does not cover non-traded goods and services,where the transaction costs are significant.(ii) Relative version: To overcome the limitation of absolute version, this theory hasevolved. This version of PPP theory states that the exchange rate between the currenciesof two countries should be constant multiple of the general price indices prevailing in thetwo countries. In other words, the percentage change in the exchange rates should equalthe percentage change in the ratio of price indices in the two countries. For example, ifIndia has inflation rate of 5% and the USA has a 3% rate of inflation and if the initialexchange rate is Rs 40/US$, the value of the rupee in two years period will be e2 = 40[1.05/1.03]2 or Rs 41.75/US$The theory suggests that a country with a high rate of inflation should devalue its currencyrelative to the currency of the countries with lower rate of inflation.Assumption: The theory holds good if: • Changes in the economy originate from the monetary sector. • The relative price structure remains stable in different sectors in view of the fact that change in the relative price of various goods and services may lead differently constructed indices to deviate from each other. • There is no structural change in the economy, such as change in tariff, in technology and in autonomous capital flow.Limitation of PPP: A number of studies have empirically tested the two version of thePPP theory. There are three factors why this theory does not hold good in real life: • The assumptions of this theory do not necessarily hold well in real life.
  • 16. • There are other factors such as interest rate, governmental interference and so on that influences the exchange rate. In 1990, some of the European Countries experienced a higher inflation rate than in the USA, but their currency did not depreciate against dollar in view of high interest rate attracting capital from the USA. • When no domestic substitute is available for import, goods are imported even after their prices rise in the exporting countries.DETERMINANTS OF EXCHANGE RATE IN FORWARD MARKET Forward exchange rates are normally not equal to the spot rate. There are twotheories:(I) Interest Rate Parity Theory (IRP): The determination of exchange rate in a forwardmarket finds an important in the theory of Interest Rate Parity (IRP). The IRP theorystates that equilibrium is achieved when the forward rate differential is approximatelyequal to the interest rate differential. In other word, the forward rate differs from the spotrate by an amount that represents the interest rate differential. In this process, thecurrency of a country with lower interest rate should be at forward premium in relation tothe currency of a country with higher rate of interest rate. On the basis of IRP theory, theforward exchange rate can easily be determined. One has simply to find out the value ofthe forward rate (F) in the equation. The equation should be: F = S/A [1 +rA/1+rB -1] +SFor example, suppose interest rate in India and the USA is, respectively, 10% and 7%.The spot rate is Rs 40/US$. The 90-days forward rate can be calculated as follows: F = 40/4[1.10/1.07-1]+40 = Rs 40.28/US$It means a higher interest rate in India will push down the forward value of the rupee from40 a dollar to 40.28 a dollar.(ii) Covered Interest Arbitrage: This theory states that if interest rate differential ismore than forward rate differential, covered interest arbitrage manifests in borrowing in acountry with low interest rate and investing in a country with high interest rate so as toreduce the interest rate differential. For example, suppose the spot rate is Rs 40/US$and three month forward rate is Rs 40.28/US$ involving a forward differential of 2.8%.Interest rate is 18% in India and 12% in the USA, involving an interest rate differential of5.37%. Since the two differentials are not equal, covered interest arbitrage will begin. Solong as the inequality continues between the forward rate differential and the interest ratedifferential, arbitrageurs will reap profit and the process of arbitrage will go on. However,with this process, the differential will be wiped out because: • Borrowings in USA will raise the interest rate there. • Investing in India shall increase the invested funds and thereby lower the interest rate there. • Buying rupees at spot rate will increase the spot rate of rupee • Selling rupee in forward will depress the forward rate of rupee.
  • 17. Limitation: The study of Martson shows that the theory held good with greater accuracyin the Euro-currency in view of the fact that there exist Ed complete freedom from controlsand restrictions. But there are some limitations that as follows: • Since different rates prevails in bank deposits, loans, treasury bills, and so on, the short term interest rate can not be specific and chosen rate can hardly be the definite rate of formula. • Marginal rate of interest applicable to borrowers and lenders differs from the average rate of interest in view of the fact that interest rate changes with successive amount of borrowing. • The investment in foreign assets is more risky than that of domestic assets. • There are cases when interest rate parity is disturbed owing to the play of extraordinary forces which leads to speculation. It is basically the market expectation of future spot that influences the spot rate that influences the forward the forward rate. • The proponents of modern theory feel that it is not only the role of arbitrageurs but of all participants in foreign exchange market, such as traders, hedgers and speculators that influences the forward rate. •Quip. 9 Write short note on Euro-currency, IMF, IDA and IBRD.Ans. Euro-currency: The growth of Euro-currency market, also known asEurodollar market, is one of the significant developments in the internationaleconomic shape after world war-II. Its phenomenon development, though posesproblem for the national monetary authorities and international monetary stability,has helped the growth of international trade, transnational corporation andeconomies of certain countries.Scope: The scope of Euro-currency is as follows:(a) These are financial assets and liabilities denominated in US dollar but tradedin Europe. US dollar still predominates the market and most of transactions in themoney market of Europe, especially London. But today the scope of marketstretches far beyond the Europe and the dollar in the sense that the “Euro-dollar’transactions are also held also in money markets other than European andcurrencies other than the US dollar. Interpreted in a currency deposited outsidethe country of issue. Thus any currency internationally supplied and demandedand in which a foreign bank is willing to accept liabilities and loan assets is eligibleto become Euro-currency. It is interpreted this way that dollar deposited withbanks in Montreal, Toronto, Singapore, Beirut, etc are also Euro-dollar, so are thedeposits denominated in European currencies in the money markets of USA andthe above centers.(b) Euro-currency market would be the appropriate term to describe thisexpanding market. The term Euro-dollar came to be used because the market hadits origin and earlier developments with dollar transactions in the European moneymarkets. Despite the emergence of other currencies and the expansion of marketto other area, Europe and the dollar still hold the key to the market. Today thisterm is in popular use.
  • 18. (c) The Euro-currency market, the commercial banks accept interest bearingdeposited denominated in a currency other than the currency of the country inwhich they operate and re-land these funds either in the same currency of a thirdcountry. The acquisition of dollars by banks located out side the USA, mostlythrough the taking of deposit, but also to some extent by swapping othercurrencies into dollar, and the re-landing of these dollars, often after redepositingwith other banks, to non-bank borrows any where in the world.(d) The currencies involved in Eurodollar market are not in any way differentfrom the currencies deposited with banks in the respective home countries. Butthe Euro-dollar is out side the orbit of this monetary policy whereas the currencydeposited with banks in the respective home country is enveloped by the nationalmonetary policy.INTERNATIONAL MONETARY FUND (IMF)It was created in 1945 to help and promote the health of world economy. It has itsHeadquarters in Washington DC. It is governed by and accountable to thegovernments of 184 countries. It was conceived at a United Nations conference inBretton Woods, New Hampshire, US in July 1944. The 45 countries govtrepresented at that conference and sought to build a framework for economiccooperation that would avoid a repetition of the disastrous economic policies thathad contributed to great depression in 1930s.About IMF: • Current membership : 184 countries • Staff: approximately 2680 from 139 countries. • Total Quotas : $321 Billion (as of 31/8/2005) • Loans Outstanding: $71 billion to 82 countries, of which $10 billion to 59 on concessional terms. • Technical Assistance provided: 381 person year during FY 2005 • Surveillance consultations concluded: 129 countries during FY-2005, of which 118 voluntarily published information on their consultation.Responsibilities of IMF: The main responsibilities of IMF as per article 1 of ‘Articleof Agreement’ are as follows: • To promote international monetary cooperation. • Facilitating the expansion and balanced growth of international trade • To promote exchange stability. • Assisting in the establishment of multilateral system of payments. • To make its resources available to members experiencing balance of payments difficulties.IMF Activities:(a) Promote Global Growth and Economic Stability: The IMF works to promoteglobal growth and economic stability and thereby prevent economic crisis byencouraging countries to adopt sound economic policies.
  • 19. (b) Help in Recovery: Whenever member countries experience difficulty tofinance their balance of payments, the IMF is the fund that can be tapped to help inrecovery.(c) Reduce Poverty: The IMF is also working actively to reduce poverty incountries around the globe, independently and in collaboration with World Bankand other organisations.(d) Poverty Reduction strategy Papers : In most low-income countries, thesepapers are prepared by country authorities in consultation with civil society andexternal development partners to describe comprehensive economic, structuraland social policy framework that is being implemented to promote growth andreduce poverty in the country.IMF Governance and Organisation: The IMF is accountable to the governments ofits member countries. At apex of its organizational structure is its Board ofGovernors that consists of one Governor from each of the IMF’s 184 countries. AllGovernors meet once each year at IMF-World Bank Annual Meeting, 24 ofGovernors sit on The International Monetary and Finance Committee (IMFC) andmeet twice each year. The day-to-day work of the IMF is conducted at WashingtonDC headquarters by its 24-members Executive Board. This work is guided by theIMFC and supported by the IMF’s professional staff. The Managing Director isHead of IMF staff and Chairman of Executive Board and assisted by three DeputyManaging Directors.INTERNATIONAL DEVELOPMENT ASSOCIATION (IDA)It is a subsidiary of IBRD. It was established in 1960 to provide assistance for thesame purpose as the IBRD, but primarily in the poorer developing countries and onterms that would bear less heavily on their balance of payments than IBRD loans.IDA’s assistance is therefore concentrated on the very poor countries. The funds used by IDA, called credits to distinguish them from IBRD loans,come mostly in the form of subscriptions, general replenishment from IDA is moreindustrialized and developed members and transfers from the net earnings of theIBRD. The term of IDA credits that are made to governments only, are ten yearsgrace period, fifth year maturities and no interests. The IDA provides soft loans tomember countries. Its object is to provide loan to member countries on liberalterms in so far as these relate to the rate of interest and the period of repayment.Another attraction of Ida loans is that they can be repaid in currency of membercountries. Developing countries can avail themselves of IDA loans on very liberal termsfor projects which are not eligible for assistance from the World Bank eitherbecause loans for such projects do not carry the guarantee of the government ofthe borrowing country or because such projects do not contribute directly andimmediately to the productive capacity of the borrowing country.IDA Credit Approval: In approving an IDA credits following criteria are observed:
  • 20. (a) Poverty Test: IDA’s assistance is limited to poorest countries and whichcontinue to face such severe handicap as excessive dependence on volatileprimary product market, heavy debt servicing burdens and often rate of populationgrowth that outweighs the gains of production.(b) Performance Test: Within the range of difficulties of establishing objectivesstandards of performance, these factors serve as the yardstick for an adequateperformance test. Satisfactory overall economic policies and past success inproject execution.(C) Project Test: The purpose of IDA is to advance soft loans, not financesoft projects. IDA projects are appraised according to the same standard as thatapplied to bank projects. The test essentially requires that the proposed projectsyield financial and economic returns, which are adequate to justify the use of scarecapital.IBRD OR WORLD BANKThe international Bank for Reconstruction and Development (IBRD) or the WorldBank was established in 1945. The IBRD has two subsidiaries the InternationalDevelopment Association (IDA) and International Finance Corporation (IFC).The IBRD whose capital is subscribed by its member countries, finance its lendingoperation primarily from its own borrowings in the world capital market. Asubstantial contribution to the bank’s resources also comes from its retainedearnings and the flow of repayments on its loan. IBRD loans generally have agrace period of five years and are repayable over twenty years, or less. They aredirected towards developing countries at more advanced stages of economic andsocial growth. The interest rate that IBRD charges on its loan is calculated inaccordance with a guideline to its cost borrowing.Purpose: The purpose of banks as lay down in its articles of agreement, are asunder: • To assist in reconstruction and development of the territories of the member countries by facilitating the investment of capital for productive purpose. • The restoration of economies destroyed by war, the reconversion of productive facilities to peace time needs and the encouragement of the development of productive facilities and resources in less developed countries. • To promote private foreign investment by means of guarantee or participation in loans and other investments made by private investors. • When private capital is not available on reasonable terms, to supplement private investment by providing on suitable conditions. • Finance for productive purposes out of its own capital funds raised by it and other resources. • To promote the long range balanced growth of international trade and the maintenance of equilibrium in the balance of payment, by encouraging international investment of the productive resources of members, thereby assisting in raising productivity, the standard of living and conditions of labour in the territories.
  • 21. Policy: The bank is guided by certain policies which have been formulated on thebasis of the article of Agreement:(a) The bank should properly assess the repayment prospects of the loans. Forthis purpose it should consider the availability of natural resources and existingproductive plant capacity to exploit the resources and operate the countries pastdebt record.(b) The bank should lend only for specific projects, that are economically andtechnically sound and of a high priority nature. As a matter of general policy, itshould concentrate on lending for projects which are designed to contributedirectly to productive capacity, normally does not finance projects that areprimarily of social character such as education, housing etc.(c) The bank lends only to enable a country to meet the foreign exchangecontent of any project cost, it normally expects the borrowing country to mobliseits domestic resources.(d) The bank does not expect the borrowing country to spend the loan in aparticular country, in fact it encourages the borrowers to procure machinery andgoods for bank finance in the cheapest possible market consistent withsatisfactory performance.(e) It is the banks policy to maintain continuing relations with borrowers with aview to check the progress of projects and keep in touch with financial andeconomic developments in borrowing countries. This also helps in the solution ofany problem that might arise in the technical and administrative fields.(f) The bank indirectly attaches special importance to the promotion of localprivate enterprises.Unit-IV Regional blocks and trading agreements; global competitiveness; global competition, HRD development, social responsibility; world economic growth and physical environment.Qu.10 what do you mean by regional blocks? Explain tradingagreements between different countries.Ans. There has been a proliferation of regional economic integration schemes or tradeblocks, designed to achieve economic, social and political purposes. The term economicintegration is commonly used to refer to the type of the arrangements that removesartificial trade barriers, like tariffs and quantitative restrictions, between the integratingeconomies. More than one third of world trade already takes place within the existingRIAs. There are also a number of other international cooperation schemes.Benefit: The expected benefits from RIA include:(a) Efficiency improvements due to economies of scales arising out of enlargedmarket.(B) Enhanced bargaining strength of members in multilateral trade negotiations.(c) Promotion of regional infant industries.(d) Prevention of further damage to trading strength due to further trade diversion fromthird countries.(e) Ensure increased security of market access for smaller countries by formingregional trading blocks with larger countries.
  • 22. (f) To peruse non-economic objectives such as strengthening political ties andmanaging migration flows.Types: It is used to refer the types of arrangements that remove artificial trade barriers,like tariffs and quantitative restrictions between integrating economies. Following are thefew types of integration:(a) Free trade Area: in this free trade is carried out among members.(b) Custom Union: Beside free trade among members, common external commercialactivities are also occurs in this type.(c) Common Market: Free trade, common external commercial activities and freemobility within the market.(d) Economic Union: Free trade, common external commercial activities, free mobilitywithin the market and harmonized economic policy.(e) Economic Integration: Free trade, common external commercial activities, freemobility within the market, harmonized economic policy and supranational organizationalstructure.Examples : Industrial and Developing economies such as European Union (EU), TheNorth American Free Trade and Agreement (NAFTA) and Asia Pacific Cooperation(APEC). Latin American and Caribbean.Quip. 11 What is global competitiveness? What factors determines thecompetitiveness of a country?Ans. Global competitiveness is defined as “the ability of a national economy to achievesustained high rates of economic growth on the basis of suitable policies, industrial andother economic characteristics”.Factors Determining Competitiveness: Following are some factors that determine theglobal competitiveness of a country:(a) Openness: This factor measures openness to foreign trade and investments,foreign direct investment and financial flows, exchange rates policy and ease ofexporting.(b) Government: This factor measures the role of the state in the economy. Thisincludes the overall burden of govt expenditure, fiscal deficit, rates public saving, marginaltax rates and the overall competence of the civil service.(c) Finance : Finance measures how efficiently the financial intermediaries channelssavings into productive investments, the level of competition in financial market, theperceived stability and solvency of key institutions, level of national saving and investmentand credit ratings given by outside observers.(d) Infrastructure: It measures the quality of roads, railways, ports,telecommunications, cost of air transportation and overall infrastructure investments.(e) Technology: This factor measures computer uses, the spread of new technology,the ability of the economy to absorb new technologies and the level and quality ofresearch and developments.(f) Management: Management measures overall management quality, marketing,staff training and motivation practice, efficiency of compensation schemes and the qualityof internal financial control system.(g) Labour: This factor measures the efficiency and competitiveness of the domesticlabour market. It combination of the level of country’s labour costs relative to internationalnorms, together with measures of labour market efficiency, the level of basic educationand skills and the extent of distortionary labour taxes.
  • 23. (h) Institutions: This factor measures the extent of business competition, quality oflegal institution and practice, the extent of competition and vulnerability to organisedcrime.