INTERNATIONAL BUSINESS AND TRADE

What is International Business?

 International business is any business activity that takes place across national borders.
 International Business encompasses all commercial activities that take place to promote the transfer of
goods, services, resources, people, ideas and technologies across national boundaries.
BUSINESS- refers to the activities that are involved in producing and selling goods or services for profit.
TRADE- refers to the exchange of goods or services between two or more parties.

THE CARAVAN AND THE CARAVEL TRADE

During the ancient and middle ages, hardy and industrious merchants were viewed as foreigners,
regardless of whether they came from nearby towns or from far away, and were treated with suspicion and
distrust, if not outright hatred, by local traders. Because of this, they had to pay a high price for security from
local rulers, and they were constantly watched by merchant guild members.
Bulky products required unduly large caravans to move, hence there was no trade in bulky goods
needed by the masses, just as there was no trade in caravels. In such a situation, transportation costs would
become prohibitively high andcumbersome. As a result, caravan trade was also important for high-value light
and compact articles. The word "caravan" is Persian in origin and was eventually absorbed into the Arabic
lexicon.

CARAVAN- is a group of traders traveling together for the purpose of

avoiding bandits. Merchants risked their lives and fortunes in the name of
trade, bringing goods across unfamiliar and lonely countries where hidden
perils lurked along the trading routes, waiting for their prey.

CARAVEL- trade across the seas as it was known then, was confined
along well known sea routes, generally from one harbor to another. This
trade in luxury appeared too tempting and more over fair game not only
for pirates who continued to infest the high seas but also to rulers who
were hungry for revenues.

REASONS FOR INTERNTIONAL TRADE

OPPURTUNITY COST- This is the value of using a resource; measured in terms of the value of the best
alternative for using that resource.
ABSOLUTE ADVANTAGE- Absolute advantage means that an economy can produce a greater total of goods
for the same quantity of inputs.
COMPETITION- International trade gives more competitors.
ACCESS TO CAPITAL/ GREATER RETURNS ON CAPITAL- International trade enables countries with limited
capital to either borrow fom capital rich countries or attract direct investment into the countries and thus enjoy
the benefits imported capital and technology investment abroad may yield higher return then additional
domestic investment, particularly where the foriegn market is growing.
ECONOMIC AND SOCIAL DEVELOPMENT- International trade increases the economic and social
development of the under developing countries.

PREVAILING PROBELMS OF INTERNATIONAL BUSINESS

 • CULTURAL DIFFERENCE- Deep cultural differences like social expectations, manners and methods of
doing business can be persistent problems to a country who is about to enter into a bilateral or
multilateral agreement.
• CURRENCY PROBLEM- Trading between sovereign nations creates financial complications because
currencies are not equal value and the rates of exchange between currencies are not fixed.
• LEGAL PROTECTION- means the state of being protected by the law or by an insurance policy. Example
tariff, quota and embargo. These protective tariffs and quotas are to encourage the growth of
domestic industries and to protect them from price competition from foreign companies.
• FOREIGN POLITICAL CLIMATES- these are often unpredictable. For example, terrorism and foreign tax
structures may be favoured to business.
DIFFERENCE BETWEEN INTERNATIONALIZATION AND GLOBALIZATION
INTERNATIONALIZATION GLOBALIZATION
• Internationalization refers to a process, to develop  It is the process of connecting the world's
products in a manner which is capable of fulfilling economies in order to promote free trade and
the requirements of customers of different economic policies that will aid the world's
countries. integration into the global community.
• Comprises a company's market growing and
entering new markets in different countries.

THEORIES OF INTERNATIONAL BUSINESS

• Mercantilism
- This concept is based on the belief that the government, rather than individuals, should be
involved in the movement of goods between countries in order to increase the prosperity of
each. At the period, wealth was defined as the accumulation of precious metals, notably
gold.
• Adam Smith and Theory of Absolute Advantage
- Nations profited the most, according to Adam Smith, when they acquired products through
commerce that they could not make with optimum efficiency. What each nation or trading
partner can produce should be determined by cost and production. The absolute advantage
of a country occurred when it only produced goods that made the best use of its natural and
acquired resources, as well as climatic advantages such as pools of appropriately trained
and skilled labor, capital resources, technological advancements, or even a tradition of
entrepreneurship.
• David Ricardo and Theory of Comparative Advantage
- It's very similar to the absolute advantage notion. It said that the exporting country should
consider commodity production efficiencies and manufacture only those things that it could
make most efficiently. This suggested that a country should create only the commodities it
can make inexpensively, rather than all the goods it can make cheaply.
• Porter’s Diamond of National Advantage
Successful international trade, according to management thinker Michael Porter, came from
the interaction of four country-and-firm-specific elements.

o Factor conditions: land, labor, capital, workforce education, and the quality of a country's
 infrastructure.
o Demand Conditions: A strong domestic demand is required to stimulate product and service
innovation.
o Related and supporting industries: a strong domestic industry will boost activity among local
suppliers. Having a plethora of local supplier activity. Having a large number of local suppliers
tends to cut prices, improve quality, and boost the use of technology.
o Firm strategy, structure, and rivalry: Domestic industry rivalry will assist increase the quality of
the product or service, hence improving the company's performance.. A firm can choose to have
an ethnocentric, geometric, orpolycentric strategy
• International Product Cycle Theory
- The idea looked at a product's potential export opportunities at four different points during its
life cycle.

- In the first stage, with low competition in the worldwide market, a new product is produced
and manufactured on the innovative country's internal territory.

- When a product reaches its second stage, its growth tends to accelerate, As more
enterprises enter the market and the product becomes more standardized, so does
competition.

- The company sets up shop in another country to better serve overseas markets and keep up
with the competition.

- Exports from the home nation fall in the third stage due to greater output in other countries.
To combat rising competition and maximize earnings from growing sales levels in overseas
markets, foreign manufacturing units are established. Price has been a critical factor in
determining competitiveness. To take advantage of cheaper production variables,
particularly labor costs, production frequently shifts from overseas industrial markets to less-
developed nations (LDCs).

- The product enters a period of deterioration in the last stage.

-
- This decline is frequently caused by new competitors achieving high enough levels of
production to attain scale economics comparable to those of the original manufacturing.

METHODS OF ENGAGEMENT

EXPORTING & IMPORTING

EXPORTING

• is a simple technique to assess market potential and develop brand recognition.

• Exports are goods and services that are produced in one country and sold to buyers in another.

IMPORTING

• is the process of bringing products or services into a country for sale that have been made
elsewhere.
 • An import is a good or service bought in one country that was produced in another.

LICENSING
• A company (Licensor) transfers intangible rights to a foreign corporation (licensee), this may comprise the
right to a method, a patent, or a software Intellectual property includes things like a trademark, a copyright,
and expertise.
FRANCHISING
• Franchising is a form of business in which a franchisor grants a franchisee the right to use its brand
name, business model, and trading techniques.
OFFSHORING AND OUTSOURCING
OUTSOURCING
• is the business practice of hiring a party outside a company to perform services or create goods that were
traditionally performed in-house by the company's own employees and staff.
• When a corporation subcontracts some specialists or professionals to handle particular activities, this is
known as outsourcing.
OFFSHORING
• refers to relocating business operations, processes, or functions from one country to another,
typically to a lower-cost location.
• Offshoring allows a corporation to outsource a project, work, or task to a location outside of
the country or the world.
MANAGEMENT CONTRACTS
 These are agreements in which a company rents its knowledge or know-how to a government or a
company in the form of individuals who join a foreign setting and run the business for a
predetermined amount of time or until specific eventualities are met.
CONTRACT MANUFACTURING
• Contract manufacturing has close similarities to licensing but the former is a narrower case
where the manufacturing process is clearly involved.
DIRECT INVESTMENT
 When a corporation invests directly in foreign territory and opens a subsidiary, it is committing its
capital, staff, and assets outside of its home country.

BALANCE OF PAYMENT
WHAT IS BALANCE OF PAYMENT?
- Balance of payments (BOP) accounts are an accounting record of all monetary transactions between a
country and the rest of the world. These transactions include payments for the country's exports and
imports of goods & services, financial capital, and financial transfers.
- According to Kindle Berger, "The balance of payments of a country is a systematic record of all economic
transactions between the residents of the reporting country and residents of foreign countries during a
given period of time".

A country has to deal with other countries in respect of 3 items:

 VISIBLE ITEMS which include all types of physical goods exported and imported.
 INVISIBLE ITEMS which include all those services whose export and import are not visible. e.g.
transport services, medical services etc.
 CAPITAL TRANSFERS which are concerned with capital receipts and capital payment.
TWO MAIN ACCOUNT OF BOP
 CURRENT ACCOUNT
- BOP on current account is a statement of actual receipts and payments in short period.
- It includes the value of export and imports of both visible and invisible goods. There can be
either surplus or deficit in current account.
 CAPITAL ACCOUNT
- It refers to all financial transactions.
- The capital account involves inflows and outflows relating to investments, short term
borrowings/lending, and medium term to long term borrowing/lending.
- There can be surplus or deficit in capital account.
- It includes: - private foreign loan flow, movement in banking capital, official capital
transactions, reserves, gold movement etc.
The three major components of the capital account:
 LOANS TO AND BORROWINGS FROM ABROAD- these consist of all loans and borrowings given
to or received from abroad. It includes both private sector loans, as well as public sector loans.
 INVESTMENTS TO/FROM ABROAD- these are investments made by nonresidents shares in the
home country or investment in real estate in any other country.
 CHANGES IN FOREIGN EXCHANGE RESERVES- foreign exchange reserves are maintained by the
central bank to control the exchange rate and ultimately balance of BOP.
Policies to rectify a Current Account deficit:
 Contractionary monetary and fiscal policies
 Protectionists policies
 Allow currencies to depreciate
 Supply side policies to boost international competitiveness
OVER ALL BALNACE OF PAYMENT
- Total of a country’s current and capital account is reflected in overall Balance of payments. It
includes errors and omissions and official reserve transactions.
- The errors may be due to statistical discrepancies & omission may be due to certain transactions
may not be recorded.

INTERNATIONAL MONETARY FUND AND FOREIGN EXCHANGE MARKET

INTERNATIONAL MONETARY SYSTEM- is a set of internationally agreed rules, conventions and supporting
institutions that facilitate interpersonal trade, cross border investment and generally the reallocation of capital
between states that have diff currencies.

EVOLUTION OF INTERNATIONAL MONETARY SYSTEM

 Gold and silver were used as international means of payment and that the exchange
rates among currencies were determined by either gold or silver contents.
 Countries that were on the bimetallic standard often experienced the well-known
phenomenon referred to as "Gresham's Law".
BIMETALLISM  Gresham's Law is a monetary principle stating that when there are 2 forms of
1803-1873 commodity money in circulation which are accepted by law as legal tender and the
same face values, the more valuable one -good money- will be hoarded and will
disappear from circulation, while the less valuable one -bad money- will be passed
on (used for transaction).
  France was effectively on the gold standard beginning in the 1850s and formally
adopted the standard in 1878.
 The newly emerged German Empire, which was to receive a sizable war indemnity
from France, converted to the gold standard in 1875, discontinuing free coinage of
silver. The united stated adopted the gold standard in 1879, Russia and Japan in 1897.
 Majority of countries got off gold in 1914 when World War 1 broke out.
Classical Gold  The classical gold standard as an International Monetary System thus lasted for about
Standard 40 years.
1875-1914  Gold alone is assured of unrestricted coinage; there is two-way convertibility between
gold and national currencies at a stable ratio; and gold may be freely exported or
imported.
 The interwar period was between World War I and World War II (1915-1944).
 Great Britain, France, Germany, and many other countries imposed embargoes on
gold exports and suspended redemption of bank notes in gold.
 During this period, the United Stated replaced Britain as the dominant financial power
of the world. United States returned to a gold standard in 1919.
 Most major countries gave priority to the stabilization of domestic economies and
systematically followed a policy of sterilization of gold by matching inflows and
Interwar Period
outflows of gold with reduction and increase in domestic money and credit.
1915-1944
 - In sum, the interwar period was characterized by economic nationalism, half-hearted
attempts and failure to restore the gold standard, economic and political instabilities,
bank failures and panicky flights of capital across borders. No coherent international
monetary system prevailed during this period, with profoundly detrimental effects on
international trade and investment. It is during this period that the U.S dollar emerged
as the dominant world currency gradually replacing the British pound for the role.
 The Bretton Woods System was established after World War II and was in existence
during the period 1945-1972. In 1944, representatives of 44 nations met at Bretton
Woods, New Hampshire, and designed a new postwar international monetary system.
 Representatives succeeded in drafting and signing the Articles of Agreement of the
International Monetary Fund (IMF), which constitutes the core of the Bretton Woods
System. The agreement was subsequently ratified by the majority of countries to
launch the IMF in 1945.
 IMF embodied an explicit set of rules about the conduct of International Monetary
policies and was responsible for enforcing these rules.
 Delegates also created a sister organization, the International Bank for reconstruction
and Development (IBRD), better known as World Bank, that was chiefly responsible
for financing individual development projects.
 British delegates led by John Maynard Keynes proposed an intetnational reserve
asset called "bancor".
Bretton Woods  Under this system, each country established a par value in relation to the US dollar,
System which was pegged to gold at $35 per ounce. Under this system, the reserve currency
1945-1972 country would aim to run a balance of payments (BOPs) deficit to supply reserves. If
such deficits turned out to be very large then the reserve currency itself would witness
crisis. This condition was often coined the Triffin paradox. Eventually in the early
1970s, the gold exchange standard system collapsed because of these reasons.
 From 1950 onward, the United States started facing trade deficit problems. With
development of the euro markets, there was a huge outflow of dollars.
 The US government took several dollar defense measures, including the imposition
of the Interest Equalization Tax (IET) on US purchases of foreign stock to prevent the
outflow of dollars.
 August 1971, President Richard Nixon suspended the convertibility of the dollar into
gold and imposed a 10 percent import surcharge. The foundation of Bretton woods
system began to crack under strain.
 By March 1973, European and Japanese currencies were allowed to float, completing
the decline and fall of the Bretton woods system.
 The Flexible exchange rate regime that followed the demise of the Bretton Woods
system was ratified after the fact in January 1976 when the IMF members met in
Jamaica and agreed to a new set of rules for the international monetary system. The
key elements of the Jamaica Agreement include:
The Flexible
 Flexible exchange rates were declared acceptable to the IMF members, and central
Exhange rate
banks were allowed to intervene in the exchange markets to iron out unwarranted
Regime
volatilities.
1973-Present
 Gold was officially abandoned (i.e., demonetized) as an international reserve asset.
Half of the IMF’s gold holdings were returned to the members and the other half were
sold, with the proceeds to be used to help poor nations.
  Non-oil-exporting countries were given greater access to IMF funds.
 The IMF continued to provide assistance to countries facing balance-of-payments and
exchange rate difficulties. The IMF, however, extended assistance and loans to the
member countries on the condition that those countries follow the IMF’s
macroeconomic policy prescriptions. This “conditionality”, which often involves
deflationary macroeconomic policies and elimination of various subsidy programs,
provoked resentment among the people of developing countries receiving the IMF’s
balance-of-payment.
 In September 1985, the so-called G-5 countries (France, Japan, Germany, the U.K
and the United States) met at the Plaza Hotel in New York and reached what became
known as the Plaza Accord. They agreed that it would be desirable for the dollar to
depreciate against most major currencies to solve the U.S. trade deficit problem and
expressed their willingness to intervene in the exchange market to realize the
objective. The side of the dollar that had begun in February was further precipitated
by the plaza Accord.
 As the dollar continued its decline, the governments of the major industrial countries
began to worry that the dollar may to far. To address the problem of exchange rate of
volatility and other related issues, the G-7 economic summit meeting was convened
in Paris 1987. The meeting produced the Louvre Accord, according to which:
 The G-7 countries would cooperate to achieve the greater exchange rate stability.
 The G-7 countries agreed to more closely consult and coordinate their
macroeconomic policies.
 The Louvre Accord marked the inception of the manage-float system under which the
G-7 countries would jointly intervene in the exchange market to correct over- or
undervaluation of currencies.

WHAT IS FOREIGN EXCHANGE MARKET?

• is a decentralized and over-the-counter market where all the currency exchange trades occur. It is the
largest (in terms of trading volume) and the most liquid market in the world.
• also known as forex, FX, or the currencies market
• is probably one of the most accessible financial markets.
• The forex market major trading centers are located in major financial hubs around the world,
including New York, London, Frankfort, Tokyo, Hong Kong, and Sydney. Due to this reason, foreign
exchange transactions are executed 24 hours, five days a week (except weekends).
EXCHANGE RATE- refer to the value at which one currency can be exchanged for another
currency.
CURRENCY SWAP- A foreign currency swap is an agreement to exchange currency between two foreign
parties, often employed to obtain loans at more favorable interest rates.

THE FOREIGN EXCHANGE MARKET'S FUNCTIONS

1. Transfer Function: The basic and the most visible function of foreign exchange market is the transfer
of funds (foreign currency) from one country to another for the settlement of payments. It basically
includes the conversion of one currency to another, wherein the role of FOREX is to transfer the
purchasing power from one country to another.
2. Credit Function: FOREX provides a short-term credit to the importers so as to facilitate the smooth
flow of goods and services from country to country. An importer can use credit to finance the foreign
purchases. Such as an Indian company wants to purchase the machinery from the USA, can pay for
the purchase by issuing a bill of exchange in the foreign exchange market, essentially with a three-
month maturity.
3. Hedging Function: The third function of a foreign exchange market is to hedge foreign exchange
risks. The parties to the foreign exchange are often afraid of the fluctuations in the exchange rates, i.e.,
 the price of one currency in terms of another. The change in the exchange rate may result in a gain or
loss to the party concerned. Thus, due to this reason the FOREX provides the services for hedging the
anticipated or actual claims/liabilities in exchange for the forward contracts. A forward contract is usually
a three month contract to buy or sell the foreign exchange for another currency at a fixed date in the
future at a price agreed upon today. Thus, no money is exchanged at the time of the contract.

TYPES OF FOREIGN EXCHANGE MARKET

 Spot Market: A spot market is the immediate delivery market, representing that segment of the foreign
exchange market wherein the transactions (sale and purchase) of currency are settled within two days
of the deal. That is, when the seller and buyer close their deal for currency within two days of the deal,
is called as Spot Transaction. Thus, a spot market constitutes the spot sale and purchase of foreign
exchange. The rate at which the transaction is settled is called a Spot Exchange Rate. It is the prevailing
exchange rate in the market.
 Forward Market: The forward exchange market refers to the transactions – sale and purchase of
foreign exchange at some specified date in the future, usually after 90 days of the deal. That is, when
the buyer and seller enter into a contract for the sale and purchase of foreign currency after 90 days of
the deal at a fixed exchange rate agreed upon now, is called a Forward Transaction. Thus, the forward
market constitutes the forward transactions in foreign exchange. The exchange rate at which the buyers
or sellers settle the transactions in the forward market is called a Forward Exchange Rate.

-PURCHASING POWER PARITY-

When the law of one price is applied internationally to a standard commodity basket, we obtain the
theory of purchasing power parity (PPP).The theory states the the exchange rate between currencies of two
countries should be equal to the ratio of the countries' price levels.
The concept of Purchasing Power Parity is a tool used to make multilateral comparisons between the
national incomes and living standards of different countries. Purchasing Power is measured by the price of a
Specified basket of goods and services. This, parity between two countries implies that a unit of currency in
one country will buy the same basket of goods and services in the other, taking into consideration price levels
in both countries.
A PPP ratio measures deviation from the condition of parity between two countries and represents the
total number of the baskets of goods and services that a single unit of a country's currency can buy.

The exchange rate between two currencies should equal the ratio of the countries' price levels.

S= Ph
Pf
The formula in the context of Purchasing Power Parity (PPP) represents the exchange rate (S) between two
currencies.
Here's the breakdown:
S = Exchange rate between two currencies.
Ph = Price level in the home country.
Pf = Price level in the foreign country.

• The formula suggests that the exchange rate should reflect the ratio of price levels between two
 countries. If the prices of similar goods are the same when expressed in the same currency (law of one
price), then the exchange rate should equal the ratio of the countries' price levels. This is the
fundamental idea behind PPP, indicating that exchange rates should adjust based on relative price
levels to achieve parity.

Let's consider an example using the PPP formula. Suppose the price level in the United States (Ph) is $100,
and the price level in France (Pf) is €80. If we want to find the exchange rate (S), we can plug in these values:
Calculating this, we get S = 1.25. This implies that, according to PPP, the exchange rate should be 1.25 US
dollars for 1 Euro to maintain the same purchasing power in both countries when considering the price levels.

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