Effects of Globalization on Business in the United States

Effects of Globalization on Business in the United States Discussion Boards

Effects of Globalization on Business in the United States
Effects of Globalization on Business in the United States
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How is globalization affecting businesses in the US? Discuss how it is impacting Regional Economic Integration and FDI.

You are expected to:

  1. Define globalization the context of an industry / product/ service. It could be your class projects’ product/service.
  2. Display understanding of Regional Economic Integration, apply it in a situation with an example and also discuss FDI in the context.
  3. Discuss the role of IMF and exchange rates briefly.
  4. Discuss the role of culture in business across nations.

Lesson 1

Effects of Globalization on Business in the United States Learning Outcomes

By the end of this portion of the  module, you should be able to:

  1. Identify why trade and foreign investment are good for society as a whole which will be assessed in Exam 1.
  2. Identify the major international trade theories and how they operate which will be assessed in Exam 1.
  3. Evaluate trade policy, the main instruments of trade policy, and their impact on business, consumers, and governments which will be assessed by the International Business Project.
  4. Evaluate rationale behind a country’s choice of managing trade which will be assessed in Exam 1.

The Rise of Globalization

Business has become increasingly global in nature, and the success of business depends on the domestic economic environment and on developments abroad.

Globalization encompasses the socio-economic reform process of eliminating trade, investment, cultural, information technology, and political barriers across countries, which could lead to increased economic growth and geo-political integration and interdependence among nations of the world.

Globalization and international trade and investment are interlinked. Globalization has been based upon changes in national policies:

  • Strengthening the role of the private sector
  • Supporting free-market pricing
  • Eliminating barriers to free movement of goods, services, capital, and information technology
  • Promoting institutions that enforce transparency, disclosure, and rule of law

Emerging Economies

Prior to 2000, globalization generally implied that business expanded from developed countries to developing or emerging economies. Now the flow of business had moved in both directions.

Emerging economies are countries that have been moving toward more open trade and free-market policies

  • BRICS economies – Brazil, Russia, India, China and South Africa
  • Decoupling refers to a fundamental global shift in which developing economies that were once dependent upon industrialized countries for economic advancement begin to solidly grow based on their own underlying economic strengths.
  • Decoupling will eventually lead to a multipolar world, a world economy in which the engines of growth could comprise the U.S., the E.U., China, India, Brazil, Russia, and South Africa.

Key International Institutions that Facilitate Globalization. Globalization gained momentum after World War II, when governments of the free world recognized the importance of international cooperation and coordination, which has led to the emergence of three major international organizations: the International Monetary fund (IMF), the World Bank, and World Trade Organization (WTO). The IMF and the World Bank (IBRD) were conceived in July 1944, when representatives of 44 countries met in Bretton Woods, New Hampshire, U.S.A., and agreed upon a framework for international economic cooperation.

The International Monetary Fund – an institution charged with overseeing the international monetary system and providing global financial stability.

  • Came into formal existence in December 1945
  • Began operations on March 1, 1947, in Washington, DC
  • As of September 18, 2014, 188 countries were members
  • IMF continues to:

O Provide a forum for cooperation on international monetary problems

O Facilitate sustainable growth of international trade

O Promote exchange rate stability

O Lend countries foreign exchange when needed

The World Bank

  • Primary role was to aid the reconstruction of Europe after the war.
  • Today WB focuses on reconstruction and restructuring economies.
  • The World Bank has several affiliated institutions.

The World Bank Group’s Developmental Institutions include:

  • IBRD
  • IDA
  • IFC
  • MIGA
  • The World Trade Organization.

O Began in 1948 under the General Agreement on Tariffs and Trade (GATT).

O GATT primarily dealt with merchandise trade; the mandate of the WTO is much broader.

O WTO is based in Geneva, Switzerland, and has 160 members; an additional 23 countries are negotiating to join.

O WTO helps global trade to flow smoothly, freely, fairly, and predictably by:

? Administering trade agreements

? Acting as a forum for trade negotiations

? Settling trade disputes

? Reviewing national trade policies

? Assisting developing countries

? Cooperating with IMF and IBRD

Institutional Structure and Its Impact of Globalization

Institutions are the rules, enforcement mechanisms, and organizations that support market transactions. Successful institutions play three important roles: they efficiently channel information about market conditions; they define property rights and contracts; and they promote competition and innovation.

  • Transparency of Political Institutions. The foundations of a globalized world are political. Political institutions and leaders have to be transparent, otherwise social unrest will arise.
  • Adaptive Institutions to Strengthen Public Participation. Adaptive institutions are government organizations that create strong incentives or private investment and operate under a system of checks and balances.
  • Independent Judiciary and Free Press. Investors have greater confidence when conducting business in countries with low crime, effective courts, dependable contract enforcement, and free press.

Effective Policy Measures that Promote Globalization.  Countries cannot thrive on high-quality institutions alone; they also need effective policies as complements to globalization.

  • Good Governance. Policy transparency, competent administrators, and consistency over time are measures of effective governance.
  • Competitive Markets. Countries must enforce regulations that promote free markets, such as antitrust laws – national laws aimed at maintaining competition in all sectors of the economy and preventing monopolistic behavior of firms.
  • Property Rights. Weak physical and intellectual property rights protection discourages domestic and foreign investors from making long-term commitments.
  • Anticorruption Policies. Illicit dealings undermine economic performance by raising costs, creating uncertainty, and thwarting competition and transparency.

Impact of Information Technology on Globalization. Innovation in information technology is radically changing the way people live all over the world.

  • The Digital Generation. Communication has become the fastest-growing part of household expenditures since 1993. Millions of people all over the world use the Internet for everything.
  • Expanding the Global Use of Information Technology. Internet-based applications underlie major advances in science, business organization, environment monitoring, transparent management, education, and e-government. Broadband prices have been falling, which enables policymakers to maximize the economic potential of remote communities.
  • The Digital Divide Myth. Digital divide describes the perceived IT gap between developed and developing countries. The fall in prices of digital IT equipment and services accelerated globalization and narrowed the digital gap.
  • How Countries “Leapfrog” into the Internet and Cell Phone Era. As of 2014, about 43 percent of the world’s population of 7 billion had access to the Internet. The next billions of Internet users will be vastly different. The majority of them will be from developing countries, and they will connect to the Internet principally via wireless networks. In developing countries the number of cell phone subscribers outnumbers those for fixed-line networks by more than 20 to 1. Developing countries are skipping the use of land-line technology and moving directly to wireless systems.

The Globalization Controversy. Globalization can be viewed as a force for exploitation and injustice. Arguments against globalization highlight problems such as the costs of disruptive economic change, including job losses and stagnant wages, the loss of local control over economic policies, the disappearance of old industries, and the related erosion of communities.

  • Job Losses and Income Stagnation. Critics argue that globalization harms the poor through loss of jobs and stagnant wages. FDI may take jobs from workers in advanced industrial economies and transfer them to less expensive workers in developing countries, while workers in developing countries might be drawn into jobs that may exploit them.
  • Sustainable Development and Environmental Degradation. Sustainable development is defined as the development that meets the needs of the present without compromising the ability of future generations to meet their own needs. Finding solutions depends upon a shared vision by governments, businesses, non-governmental organizations, and society. Corporate Social Responsibility (CSR) practices are becoming a significant factor in determining where multinational corporations (MNCs) conduct business; rather than FDI sparking a “race to the bottom,” MNCs are looking for long term commitment to host countries.

Making Globalization Work for All. The globalization debate should center on how to best manage the globalization process, so that the benefits are widely shared and costs are kept to a minimum.

  • Globalization’s Winners and Losers. Globalization does create winners and losers. Millions have climbed out of poverty. Additionally, globalization has promoted civil liberties by proliferating information and increasing choices.
  • Globalization’s Losers Need Support. Countries that have not been able to seize the opportunities to participate in globalization suffer most. National policies ought to be implemented to help retain and educate displaced workers.

Lesson 2

Learning Outcomes

By the end of this portion of the  module, you should be able to:

  1. Identify why trade and foreign investment are good for society as a whole which will be assessed in Exam 1.
  2. Identify the major international trade theories and how they operate which will be assessed in Exam 1.
  3. Evaluate trade policy, the main instruments of trade policy, and their impact on business, consumers, and governments which will be assessed by the International Business Project.
  4. Evaluate rationale behind a country’s choice of managing trade which will be assessed in Exam 1.

Effects of Globalization on Business in the United States Introduction

  1. Business has become increasingly international in nature and has been accelerated by the low cost of communications technology. This chapter discusses the role of international business and how it developed.
  2. Benefits of Trade and Foreign Direct Investment. Trade is the earliest and simplest form of international business.
  3. It benefits consumers by providing:
  • A greater choice in the availability of goods and services
  • Lower prices
  • Higher living standards
  • New jobs in the export and import sectors of the economy
  1. At the same time it has a negative impact on economies due to disruptive changes such as:
  • Outsourcing of jobs
  • Stagnant wages
  • Lower or sluggish standard of living in globally uncompetitive industries
  1. Foreign Direct Investment (FDI) brings funds and business culture from abroad, creates new jobs, introduces innovative technologies, and enhances the skills of domestic workers. Emerging countries tend to attract sizeable amounts of FDI.
  2. Major Theories of International Trade. No single nation in the world is capable of producing all the goods and services it needs. Neither does any nation have the required resources. Therefore, nations of the world need to trade. Theories of international trade provide an appreciation for the progress made in understanding how trade works. They also present a rationale for why restriction to trade should be minimized.
  3. Wealth Accumulation as a Basis for Trade Theory: Mercantilism. Mercantilism is a theory of international trade that supports the premise that a nation could only gain from trade if it had a trade surplus.
  • It’s the oldest trade theory. Mercantilists believed that for a nation to become wealthy, the nation had to export as much as possible, and the value of exports should exceed those of imports, which are viewed as a cost.
  • If every trading nation decided to increase its exports, the surplus of exported goods in the world market would depress prices and decrease earnings of exporting countries.
  1. Specialization as a Basis for Trade Theory: Absolute and Comparative Advantage. Adam Smith argued and proved that free trade without restrictions would increase the wealth of nations.
  2. Absolute Advantage exists when one country can produce a good more efficiently than another.
  3. Theory of comparative advantage is a refinement of Adam Smith’s theory and is attributed to David Ricardo. It claims that a country should produce the commodity in which it has the greatest advantage. Resources in the countries are scarce, and countries must choose to produce goods/services that most efficiently use their scarce resources. When all countries follow this approach, resources can be used most efficiently, and the total output and standard of living of the world can be increased.
  4. Factor Endowments as a Basis for Trade Theory: Hecksher-Ohlin and Factor Price Equalization.
  5. Eli Heckscher and Bertil Ohlin showed that nations primarily export goods and services that intensely use their abundant factors of production.
  6. The Heckscher-Ohlin (H-O) Theory attributes the comparative advantage of a nation to its factor endowments. The key assumptions for the H-O theory to work are:
  7. Perfect competition
  8. Perfect immobility of factors of production
  9. Factor price equalization theory states that when factors are allowed to move freely among trading nations, efficiency increases, and leads to superior allocation of production of goods and services among countries.
  10. Porter’s “Diamond” Model of National Competitive Advantage. In 1990 American economist Michael Porter found that trade theories broadly explained the basis upon which countries exported certain goods. Porter looked more closely at the theory of firm and industry specifics to identify characteristics that made firms and industries in countries “winners” or “losers” in international trade. Porter explains this hybrid model in terms of a “diamond” that consists of four groups of company-specific and country-specific characteristics.
  11. Factor Conditions. Porter’s model looks more closely at the quality of the factor endowments described in the Hecksher-Ohlin theory.
  12. Demand Conditions. Porter stresses the importance of domestic demand for goods and services. When domestic demand is high, domestic competition will intensify and lead to lower prices and sophisticated new products.
  13. Related and supporting industries. The presence of supporting industries and companies in a country will always be important for its competitive advantage.
  14. The final set of characteristics relate to firm strategy, structure, and rivalry.

According to Porter’s model, the success or comparative advantage of a nation at the global stage would crucially depend upon the interaction of the four groups of characteristics. Porter also identified two other critical variables outside the diamond that play an important role in the competitiveness of nations: chance and government.

  1. The Practice of Trade Policy. Despite the benefits of the free trade individuals, firms, and lobby groups pressure governments to impose barriers to imports or subsidize exports of goods and services. Their efforts are aimed at saving good-paying jobs and preventing increased competition in their industries at home. Trade policy refers to all government actions that seek to alter the free flow of merchandise or services between countries.
  2. Tariffs, Preferential Duties, and Most Favored Nation Status. Tariffs are taxes on imports. They generate revenues for governments. Tariffs come in two forms:
  3. Specific tariff – an import tax that assigns a fixed dollar amount per physical unit.
  4. Ad valorem tariff – an import levied as a constant percentage of the monetary value of one unit of the imported good.
  5. Preferential duties refer to low tariff rates applied to specific imports coming from certain countries. Under this system, the same good imported from a country outside of a preferred group will be subject to higher tariff. For example, in the Generalized System of Preferences, a large number of developed countries have agreed to permit duty-free imports of a selected list of products that originate from specific developing countries.
  6. Some countries interfere with the free flow of exports by enforcing export subsidies, or export taxes, meant to encourage or discourage exports.
  7. The General Agreement on Tariffs and Trade (GATT) was established in 1948 by 22 member countries, who committed to lower approximately 45,000 tariff rates within rules laid down by that organization.
  8. GATT was renamed the World Trade Organization (WTO) in 1995, which now sets rules of trade among nations on a near-global basis. The WTO’s objective is to extend tariff reduction to agriculture and services, and to settle trade disputes among member countries. By June 26, 2014, 160 nations had become members of the WTO.
  9. Under the most favored nation (MFN) principle, any tariff concession granted by one member to any other country will automatically be extended to all other WTO member countries.
  10. Nontariff Barriers. Since 1948 GATT and later the WTO managed to significantly lower tariffs. During that period countries have resorted to various forms of non-tariff barriers such as quality and environmental standards to restrict trade.
  11. Import quotas or quantitative restrictions (QR) limit the amount of products that can be imported into a country. They are generally worse than import tariffs because when the quota is reached, that particular product can no longer be imported.
  12. Voluntary export restraint (VER) occurs when an efficient exporting nation agrees to temporarily limit exports of a product to another country to allow competitors in the importing country to become more efficient within a set period of time.
  13. Domestic content provisions are another form of non-tariff barrier. Countries may require that a certain percentage of the value of an import be domestically sourced.
  14. Current Practice of “Managed” Trade. Global trade cannot be completely based upon the economics of free trade, but encompasses a response to geopolitical and socioeconomic factors. Managed trade refers to agreements between countries that aim to achieve certain trade outcomes for the countries involved.
  15. Socioeconomic Rationale. Socioeconomics explores the relative negative impact of free trade upon society’s welfare, as well as government policy measures that are implemented to minimize the negative outcomes to society.
  16. Several forms of managed trade are part of this category:
  17. In countertrade an exporter of goods or services commits to import goods or services of corresponding value. The terms of export and import exchange are predetermined through negotiations. Countertrade can be inefficient. Countries participate in countertrade especially when they do not have adequate amounts of foreign currencies to pay for imports.
  18. Export Cartels. Several developing countries depend upon non-renewable natural resources for economic growth. Since business cycles cause fluctuations in export volume and prices, some of these countries form export cartels to control prices and export revenues. For export cartels to be successful, all cartel members must agree not to cheat on the agreement, substitutes for the good in question must not exist, and demand for a particular product must be relatively inelastic.
  19. Infant Industry Argument. At times when a country gets a “late start” in a particular industry where it has a potential to become a world class competitor, short-term protection is justified. The infant industry argument implies that economies of scale and the comparative advantage of an industry can only be exploited by providing temporary protection. During this period, the firm or industry will strive to become globally competitive.
  20. Questionable Labor Practices and Environmental Considerations. Developed countries often resort to managed trade for reasons of unethical labor practices and violation of basic human rights. Developed countries may restrict imports from developing countries that implement such policies.
  21. Health and Safety. Every country has the right to protect the health and physical safety of its citizens from contaminated imports.
  22. Geopolitical Rationale. The geopolitical objective is to sacrifice some economic efficiency for the greater good of the country in terms of national security, protection of critical industries, and international commerce.
  23. National Security. For national security reasons, U.S. exports of certain types of high-technology defense equipment are generally restricted to allies and friendly countries. Because the need to receive government approval prevents the affected firms from openly competing and increasing sales, these firms receive special treatment and protection.
  24. Strategic Industries. Some countries provide protection to strategic industries that have a significant employment impact on certain sectors of an economy.
  25. When trade sanctions are imposed upon a country for political reasons, an embargo is in force, and trade will be restricted with that country. Embargoes, which may not be universally enforced, are meant to punish a country for perceived unacceptable international behavior.

Lesson 3

Learning Outcomes

By the end of this portion of the  module, you should be able to:

  1. Explain regional economic integration, its evolution, and its benefits and costs which will be assessed in Discussion Board 1.
  2. Identify how economic geography helps explain, promote, and segment regional integration blocs which will be assessed in the Exam 1.
  3. Identify the primary reasons why countries are now seeking to pursue regional integration at the expense of multilateral trade liberalization which will be assessed in the Exam 1.
  4. Identify examples why the European Union is seen as the most advanced regional integration bloc which will be assessed in Exam 1.
  5. Describe how NAFTA has affected U.S.–Mexico bilateral trade in goods and services which will be assessed in Discussion Board 1.
  6. Describe the importance of ASEAN and indicate why Asia may become the most important free trade region for this century which will be assessed in Exam 1.
  7. Identify why regional integration in Latin America is challenging, and why there is potential for a grouping like MERCOSUR to become more predominant which will be assessed in Exam 1.


Regional integration is an ongoing process. Reasons for regional integration are economic, political, or combination of both. Regional integration can bridge barriers between national borders, and increase interdependence within a region and the rest of the world.

Some countries prefer to work closely within a regional setting. Because the future of the Doha Round of trade liberalization is uncertain, there has been a sharp increase in the number of regional trade and integration agreements.

Regional Integration includes a multitude of economic and/or political steps.

  1. Stages of Regional Integration can take several forms, representing varying degrees of integration.
  2. Countries that create a free-trade area eliminate all barriers to trade among themselves while keeping their external tariffs with non-members.
  3. In a customs union all free trade member countries will adopt a common external tariff with nonmember countries.
  • Removal of barriers to allow free movement of capital and labor within the customs union leads to a common market.
  1. Within the common market, the implementation of common social programs and coordinated macroeconomic policies could lead to economic and monetary union.
  2. Finally, the urge to have common defense and foreign policies may lead to the creation of political union.

Pros and Cons of Regional Integration depend upon the level of integration the countries in the group achieve.

  1. The benefits of regional integration include:
  2. Creating a larger pool of consumers with growing incomes and similar culture and values.
  3. Encouraging economies of scale, increasing the region’s level of competitiveness, and enhancing growth.
  4. Freeing the flow of capital, labor, and technology to the most productive areas of economic activity.
  5. Increasing cooperation, peace and security.
  6. Encouraging member states to enhance their social welfare.
  7. The costs of regional integration include:

o          Undermining the almost global most-favored-nation status rule.

o          Imposing laws and regulations that are not globally uniform.

o          Eliminating jobs and increasing unemployment in protected industries.

o          Losing sovereignty, national independence, and identity.

o          Reducing the powers of the national government.

o          Increasing the probability of rising crime associated with ease of cross-border movements.

The Economic Geography of Regional Integration. The World Bank concludes that positive changes related to market size, location, and openness to trade are essential for successful regional integration. Hence, the policy instruments needed for successful integration include institutions that unify the markets, infrastructure that efficiently connects these markets, and lower economic barriers to facilitate trade.

Some Steps to Regional Integration.

  • Regional integration is more than just cross-border trade liberalization. The appropriate approach includes the following three fundamentals:
  • Start Small. Regional integration should have clear goals and initially address a narrow, well-defined area of cooperation in which the costs and benefits are easily defined.
  • Think Global. Regional integration should not create unconnected or isolated countries. Instead, it should help countries gain access to world markets.
  • Compensate the Least Fortunate. Regional integration will lead to a concentration of economic activity in fewer places with increased efficiency and competitiveness. It also means that some regions will gain more than others. Explicit compensation programs may be required to ensure access to social services and basic infrastructure in lagging areas.

Major Classes and Characteristics of Regional Integration.

In global trade agreements, tariff and non-tariff barriers are reduced or eliminated using MFN rules. Under regional trade agreements, tariff and non-tariff barriers are reduced only among member countries. When the various regional integration blocs are analyzed from an economic geography perspective, they fall under three general categories:

  • Regional Blocs Close to World Markets. Market access is essential for economic growth, and proximity to world markets is an asset for just-in-time production, exports of perishable goods, and tradable services.
  • Remote Regions with Large Local Markets. Sizeable countries that are far from large world markets can benefit by attracting industrial activities because of their large local market. If the country’s infrastructure is well connected to world markets, this advantage is reinforced. Regions with Some Large Local Markets but Located Far from World Markets.
  • Remote Regions with Small Local Markets. International integration is most difficult for countries in regions that are divided, far from world markets, and lack the economic size of a large local economy.
  • Regional integration is paramount for their growth and can be achieved through institutional reform, increasing infrastructure investments to improve market access, and incentives such as preferential access to world markets, liberalized rules of origin, and skills development.

Effects of Globalization on Business in the United States and The European Union (EU).

The EU, headquartered in Brussels, is the most highly evolved example of regional integration. It is in the fourth stage of the integration process, and is moving toward political union with common defense and foreign policy institutions.

  • The origins of the EU can be traced back to the creation of the European Coal and Steel Community (ECSC) in 1952. The objective of ECSC was to encourage member countries to cooperate in steel production, preventing the member countries from warring with each other.
  • The second major step was the Treaty of Rome signed in 1957. It established the European Economic Community (EEC) that called for free trade among members as well as a common external tariff for non-members.
  • In 1992 the Maastricht Treaty was signed and the EEC became a full economic union or single market with free movement of labor among member countries.
  • The EU’s enlargement was mostly gradual, reaching 28 member countries by 2013. The European Union and the United States: A Comparison.
  • The fate of EU candidate country Turkey is uncertain. Geographically, about 5% of Turkey’s land mass is in Europe. Due to its low per-capita income level, significant EU budgetary resources may be needed for Turkey’s infrastructure development. Some other issues of concern to existing members are the powerful role of the military within a nascent democracy, a questionable human rights record, and a large and predominantly Muslim population.
  • The Euro. The Eurozone’s single currency was introduced on January 1, 1999. Its performance until the start of the European sovereign debt crisis in 2009 was remarkable. The international role of the euro as a foreign exchange reserve currency is gaining ground. After meeting strict fiscal and monetary criteria, 18 of 28 EU countries that formed the Eurozone were allowed to use the euro as their currency. The European Central Bank (ECB), based in Frankfurt, is the apex central bank for the Eurozone countries. It maintains responsibility for the Eurozone’s monetary policy–maintaining annual Eurozone inflation at below but close to 2%–and the stability of the euro.

The North American Free Trade Agreement (NAFTA).

NAFTA is a comprehensive free-trade agreement among Canada, the United States, and Mexico. It addresses issues ranging from protection of workers’ rights and the environment to phased reduction of tariff and non-tariff barriers by 2009. NAFTA has three major objectives:

  • Expansion of trade in goods and services
  • Protection of intellectual property rights
  • Creation of institutions to address potential environmental and labor problems
  • Until 2004, the United States’ top two trade partners were Canada and Mexico. However, since that time, China has surpassed Mexico and has become the United States’ second largest trade partner.

Association of South East Asian Nations (ASEAN).

ASEAN, headquartered in Jakarta, was established in 1967. ASEAN’s current membership stands at 10. As of 2013, the ASEAN region had a population of 625 million, a land area of 4.4 million square kilometers, and a combined GDP of $2.4 trillion.

ASEAN’s two main objectives are:

  • To accelerate economic growth, social progress, and cultural development
  • To promote regional peace and stability through the rule of law

In 2003 ASEAN leaders agreed to establish an ASEAN Community based on three pillars:

  • ASEAN Security Community (ASC). ASC’s objective is to ensure that countries in the region live in peace with one another. Since ASEAN’s establishment, tension has never escalated into armed confrontation among ASEAN members.
  • ASEAN Economic Community. The goal is to create a stable, prosperous, and highly competitive economic region. The ASEAN Economic Community calls for the establishment of a single market, but it does not call for the free movement of labor across member countries.
  • ASEAN Sociocultural Community. The goal is to ensure that the ASEAN workforce is well prepared to benefit from the economic integration. Programs are being put into place through investments in basic and higher education, training, R&D, and raising the standard of disadvantaged groups and the rural population through better health care and social protection.

The Future of ASEAN. ASEAN’s Vision 2020 calls for aggressive outward-looking economic policies. If all goes as planned, ASEAN inspired FTAs will create the world’s largest free trade area,comprising much of Asia. A growing ASEAN concern is the economic ascendancy of China.

Regional Integration in Latin America.

The first step toward free trade in Latin America was taken with the signing of the Treaty of Montevideo in 1960, which created the Latin American Free Trade Association (LAFTA).

  • In 1969, the Andean Group was created in frustration due to the lack of progress in LAFTA.
  • The Treaty of Asuncion, signed in 1991, created the Southern Cone Common Market, or MERCOSUR. The treaty called for progressive tariff reduction, the adoption of sectoral agreements, a common external tariff, and the ultimate creation of a common market. Much remains to materialize in MERCOSUR. The newest member to join Mercosur was Venezuela in July 2012. Guyana and Surinam signed a framework agreement with Mercosur in July 2013 to become associate states.
  • Formal discussion to establish a Free Trade Area of the Americas (FTAA) began in 1994 under the Clinton administration, but the outlook remains uncertain.
  • The Bush administration began free-trade talks with the five Central American countries and the Dominican Republic. DR-CAFTA became effective in 2005.

Lesson 4

Learning Outcomes

By the end of this module, you should be able to:

  1. Identify the balance of payments for a country which will be assessed in Exam 1.
  2. Describe the foreign exchange market and its components which will be assessed by the International Business Project.
  3. Discuss the development of international monetary systems which will be assessed in Discussion Board 1.
  4. Explain exchange rate changes over time which will be assessed in Discussion Board 1.
  5. Forecast exchange rates using different methodologies which will be assessed in the Exam 1.

World economic and financial markets have become increasingly integrated. Balance of payments accounts document trade and finance interactions between countries. This chapter discusses international trade patterns, examines the foreign exchange market, and discusses the behavior of international currencies.

The Balance of International Payments.

Balance of Payments (BOP) refers to a statement of account that summarizes all transactions between the residents of one country and the rest of the world for a given period of time.

  • A country’s BOP is an objective standard that shows how well the country’s economy and government policies are performing.
  • BOP is generally split into two major components: the current account and the financial account.
  • Analyzing the BOP statistics is based upon the “flow of funds” analysis, where money moving into a country is a credit, while money leaving the country is a debit.
  • The Current Account of the BOP is largely driven by activities of consumers and business. It consists of four subaccounts, which add up to give the current account balance:
  1. Trade Balance is the net of merchandize exports and merchandize imports. When a country imports more than it exports, it has a merchandize trade deficit. Services Balance is the net of exports of services and imports of services. A surplus in the services balance will indicate that a country is competitive in its services industry. The U.S. is primarily a service economy, with services provided for customers in other countries comprising more of its exports.
  2. Income Balance is the net of investment income from abroad and investment income paid to foreigners.
  3. Balance of Transfers is the net transfer payments between countries based on outflows and inflows.
  4. Current Account Balance. The sum of these subaccounts equals the current account balance, which is more important than the trade balance.
  • The Financial Account shows how the country’s current account balance is financed. The financial account of the BOP consists of three subaccounts: U.S.-owned assets abroad, foreign-owned assets in the U.S., and financial derivatives.
  1. Foreign Direct Investment encompasses the purchases of fixed assets abroad used in the manufacture and sales of goods and services for local consumption or exports. The flow of FDI is dictated by opportunities to earn profit overseas.
  2. Security Investments also have a significant impact on the BOP’s financial account. Financial capital flows between countries in search of higher rates of return on foreign stocks and bonds. Capital flows generally represent investments for the long term. Central banks hold foreign exchange of major countries as part of their reserves in addition to their local currency. In addition, large financial institutions finance international trade. These security investment inflows and outflows of funds affect a country’s BOP.
  3. The Statistical Discrepancy line item in BOP statistics reconciles any imbalance to ensure that all debit and credit entries in the BOP statement sum to zero. This line captures statistical inconsistencies in the recording of the credit and debit entries as well as illegal trade.
  • World Trade and the BOP. Asian countries’ exports are growing the fastest. The U.S. has slowed its import growth from 4% to only 0.5% and has increased its exports in recent years. Europe is a net exporter with exports and imports growing at an average of 3.5% and 3%, respectively. Over the past 6 years, the growth of international trade has been driven by world economic growth as well as the elimination of barriers to trade.

The Foreign Exchange Market.

The exchange of currencies takes place in foreign exchange markets which consist of a network of international banks and currency traders. The three largest foreign exchange markets are in London, New York, and Tokyo, each of them catering to the foreign exchange needs of certain regions of the world. The foreign exchange market is a 24-hour market with international financial institutions connected by means of sophisticated telecommunications systems that enable instant, real time exchange rate quotations. The function of the foreign exchange market is to facilitate international trade and investment. Hence, there is a close relationship between the balance of payments and foreign exchange rates.

Effects of Globalization on Business in the United States The Exchange Rate

An exchange rate is a price at which one currency can be converted to another currency. In a free-market-oriented foreign exchange market, major currency values are determined by the demand for and supply of currencies, known as an independent floating exchange rate system. The values of some currencies are determined by the managed floating exchange rate system, when a currency’s value depends partly upon demand and supply in the foreign exchange market and partly on active government intervention in the foreign exchange market. A fixed exchange rate system is one in which the country pegs its currency at a fixed rate to a major currency or basket of currencies and the exchange rate fluctuates within a narrow margin around a central rate.

Components of the Foreign Exchange Market.

The forex market consists of spot, forward, and future markets. The spot market trades currencies on a real time basis for immediate delivery. The forward market enables purchases and sales of currencies in the future with prices established at a previous time. Firms use the forward market to lock in future exchange rates and ensure against uncertain future currency movements.

International Monetary Systems.

Over time, various international monetary systems have developed to facilitate international trade. Governments around the world have worked together to promote stable exchange rates and world trade.

Money and Inflation.

Many governments have used money to meet the political goals of stimulating economic growth and providing employment for citizens. Printing more money could increase economic activity. Excess supplies of money could cause inflation: When the supply of money exceeds the demand for goods and services, the prices of goods and services can rise.

The Bretton Woods System.

In 1944, the Bretton Woods Agreement established a global currency system based on a gold standard with the U.S. dollar pegged at a fixed rate of exchange to gold in an effort to control inflation. After World War II, the U.S. dollar became a standard of value for all world currencies, and the currencies of 43 other countries were fixed to the dollar. The International Monetary Fund (IMF) was established under the Bretton Woods Agreement to help ensure the stability of the international monetary and financial system. It seeks to foster the smooth functioning of the international monetary system, provide emergency funds as a lender of last resort to countries with BOP problems, and offer financing to countries conditional on recommended economic changes. Member countries contribute to the fund in return for temporary access to pooled resources. Over time, the U.S. dollar became overvalued. Major nations met to consider abandoning the Bretton Woods agreement. Under the resulting Smithsonian Agreement in December 1971, the U.S. devalued the dollar against other countries’ currencies. In August 1974, the U.S. closed the gold window and relinquished the dollar-gold exchange standard. In January 1976, IMF members adopted the Jamaica Agreement. Its key principles were:

  • Members could adopt their own exchange systems

o          A system of global fixed exchange rates would only be implemented if approved by a vote of 85% of the membership

o          Gold would no longer be a common denominator of the monetary system

o          The special drawing right (SDR) created by the IMF was recommended as the primary reserve asset of the international monetary system. Today the SDR is a basket of currencies consisting of dollars, euros, pounds, and yen, with relative weights set by the IMF based on trade patterns.

The Flexible Exchange Rate System.

After 1971, a flexible exchange rate system began to emerge with market forces of supply and demand determining the prices of different currencies. A clean float currency has minimal government intervention, and with few exceptions, is market determined. A dirty float currency has varying degrees of government intervention to maintain a range of acceptable values against other currencies. Some countries practice dollarization by using the dollar or some other foreign currency together with or instead of a domestic currency. Dollarization can be unofficially adopted by citizens in a country or officially approved by a country as legal tender in transactions.

The European Euro.

The European community established the European Exchange Rate Mechanism (ERM) in 1979. Under ERM, a weighted basket of European currencies known as the ECU (European Currency Unit) was defined based on a managed-float system with fixed exchange rates varying within 2.25% margins. European nations formed the European Monetary Union (EMU) in 1999. The EMU introduced the euro as a new currency to replace the currencies of the member countries in the Eurozone. In 2002, euro coins and notes were distributed. For countries using the euro, problems of currency fluctuations, inflation, and related economic downturns were substantially reduced. For individual European consumers and businesses, the euro put an end to the expensive and time-consuming need to convert one currency to another. By 2009, 17 countries had joined the Eurozone. The European Central Bank (ECB) and Eurosystem of central banks in Eurozone countries maintain responsibility for managing the euro. It is expected that the Eurozone will continue to expand in the future.

Hard and Soft Currencies.

Hard currencies are used by emerging market countries to peg the values of the soft currencies. Even though each hard currency is fairly stable within its own region, its value can considerably fluctuate against its counterparts around the world.

International Flows of Goods and Capital.

World trade and foreign investment have expanded over the past 100 years. According to the law of one price, identical goods should sell for the same price in different countries according to the local currencies. If the law of one price does not hold, one could make arbitrage profits by purchasing goods in one country and selling them in the other country.

Effects of Globalization on Business in the United States Purchasing Power Parity

The law of one price is the underlying principle of purchasing power parity (PPP) theory. By comparing the prices of identical goods in different countries, assuming efficient markets that arbitrage away price differences, the real or PPP exchange rate can be computed.

The Big Mac Index.

In 1986, The Economist began publishing the Big Mac Index based upon the McDonalds’ restaurant sandwich and consisting of a number of goods. The Economist computes the parity ratio of foreign cost to U.S. cost. This ratio should be 1 under PPP. Differential costs of the Big Mac over time and across nations should be related to changes in currency values as PPP tends to push prices up or down to one price.

Inflation and PPP.

PPP posits that exchange rate changes are explained by relative prices across countries. Empirical tests of PPP have found mixed results. While PPP appears to hold for periods exceeding five years, it may not hold in shorter periods. For countries with large price disparities due to inflation or other reasons, PPP is predictive of exchange rate movements. For other countries with little difference in inflation rates, PPP is less reliable. Some of the problems that explain the failure of PPP include transportation costs and trade barriers, government interventions, and MNCs with pricing power on a global basis. The value of a country’s currency is attributable to more than the difference in price levels between countries. Market expectations about economic growth, global competitiveness, monetary and fiscal policy, and many other factors could affect a country’s currency value.

Interest Rate Parity (IRP).

Relative interest rates on financial securities are another possible determinant of exchange rate changes. Under the law of one price, the rates of return on different countries’ government bonds of similar maturity and risk should be comparable. According to interest rate parity theory, the interest rate on such bonds should be the same. Otherwise there would be arbitrage opportunities for investors to purchase the higher interest rate bond and sell the lower interest rate bond to make riskless profits. According to the uncovered interest rate parity theory, it is possible that the expected future spot rate is not equal to the forward exchange rate. This difference is possible if a risk premium exists in expected future spot rates due to risk-averse investor behavior. IRP argues that the interest rate earned on assets in different countries will tend toward equality after taking into account exchange rate changes. If IRP does not hold, global capital flows will take place to arbitrage away excess profit opportunities in international investments.

Problems with IRP.

Empirical evidence on IRP theories is mixed. Transaction cost is one possible impediment to IRP. As the investment time horizon increases, deviations from IRP may be more likely due to political risk, legal restrictions, tax effects, managed-float exchange rate regimes, and other unpredictable circumstances. Additionally, market psychology can play a role in exchange rate movements. While IRP may not strictly hold at all times, market efficiency due to traders seeking arbitrage profits would tend to cause relative interest rates and exchange rates between countries to change in integrated financial markets.

Forecasting Exchange Rates.

The PPP and IRP theories can be used to forecast future exchange rates. The forecasts of relative inflation rates can be used to estimate the future exchange rate of domestic currencies to foreign currencies. Inflation forecasts are readily available from private and public sources.

Lesson 5

Learning Outcomes

By the end of this portion of the  module, you should be able to:

  • Define culture and identify the four characteristics of culture that companies doing business abroad need to recognize which will be assessed in Exam 1
  • Name several elements of culture which will be assessed in the Exam 1.
  • Name and distinguish among the cultural dimensions proposed by Hofstede and Trompenaars which will be assessed in the Exam 1.
  • Identify the primary and secondary sources that can be used to learn about foreign countries’ cultures which will be assessed in the Exam 1.
  • Describe the cultural aspects of doing business in various countries, including East Asian countries, Arab countries, and Latin America which will be assessed in Discussion Board 1.
  • Explain why culture is important in global management and marketing which will be assessed in Discussion Board 1


Culture is “learned behavior; a way of life for one group of people living in a single, related, and independent community.” There are four characteristics of culture that are important:

  • Culture is not inherited; it is learned.
  • Culture is relatively static and not easily modified.
  • It is a responsibility of the global firm to ascertain the level of importance of various aspects of culture.
  • Companies’ operations need to recognize and adjust to the cultural environment existing in foreign markets served.

Elements of Culture. Culture affects numerous aspects of a society.


Verbal and non-verbal communication are two primary types of language. Language is important to managers in their intra-company communications and when providing access to local markets through advertising. One way to eliminate language gaffes is to use backward translation. In this technique, a message is translated from English into another language, then someone skilled in that foreign language translates it back into English. This second translation is then compared to the original English version.


Religion is a powerful cultural aspect that must be recognized as companies manage their overseas operations. Different religions observe different holidays; weekends and work hours vary according to different religions; companies marketing food products overseas must be aware of religious differences.

Values and Attitudes.

Values are basic beliefs or philosophies that are pervasive in a society. Attitudes are feelings or opinions.

Manners and Customs.

Manners and customs refer to the way a society does things that prevail in foreign countries. Gift-giving is one aspect of manners and customs.

Material Elements.

Material culture in a society is often a direct result of technology. It is best demonstrated by a country’s infrastructures: economic, social, financial, and marketing.


Color, form, and music are the major components of aesthetics. Colors often represent different things in different countries.


The level of education held by people in foreign countries is a major factor in explaining economic growth. The level of education must be such that high-tech products can be accepted because the market knows how to use them.

Social Institutions.

Social institutions refer to the way people relate to one another within group settings in a society. Sociologists refer to groups that are important to individuals as reference groups. Some countries have a high level of social stratification, which means that the groups at the top of the social pyramid exert a great deal of control over others at lower levels of the pyramid.

Clustering Countries and Regions by Culture.

There have been several attempts to group countries and regions of the world according to their cultural dimensions and similarities:

Hofstede’s Research.

Hofstede pioneered research into cultures with a study focusing on IBM employees in 64 countries. Hofstede’s findings led him to identify clusters of countries and regions according to five cultural dimensions:

  • Individualism vs. Collectivism: the worth of the individual versus the worth of the groups of which that person is a member.
  • Power Distance: egalitarianism (equity) versus authority.
  • Masculine vs. Feminine: the extent to which a society values traditionally masculine attributes (assertiveness and competitiveness) versus traditionally feminine ones (modesty and caring for others).
  • Uncertainty Avoidance: the extent to which societies tolerate risk or are risk averse.
  • Time Orientation: the extent to which a society emphasizes short-run or long-run time horizons.

Trompenaars’s Cultural Dimensions.

Building on the work of Hofstede, Fons Trompenaars added a number of cultural variables to the theory:

  • Universalism vs. Particularism refers to the importance of rules versus relationships in a society.
  • Neutral vs. Emotional involves the extent to which persons within a society emotionally express themselves.
  • Specific vs. Diffuse refers to the compartmentalization of roles.
  • Achievement vs. Ascription refers to how rewards in a society are handed out.

The GLOBE Project.

The Global Leadership and Organizational Behavior Effectiveness (GLOBE) project involved surveying thousands of business executives from 61 countries about nine cultural dimensions.

Sources of Cultural Information. Companies considering conducting business overseas, and those already doing business abroad, have a number of sources they can access to learn more about the culture of foreign countries.

  • Primary sources include employees, executives, training programs, and consulting firms.
  • Various secondary sources are also helpful (e.g., The U.S. Department of Commerce Country Commercial Guide).

Cultural Dimensions of Conducting Business in Individual Countries.

Although it is more important to have an overall flexible and open attitude about foreign cultures, individual countries have specific business customs that are worth learning.

  • Cultural Dimensions of Doing Business in Japan
  • Cultural Dimensions of Doing Business in Korea
  • Cultural Dimensions of Doing Business in China
  • Cultural Dimensions of Doing Business in Arab Countries
  • Cultural Dimensions of Doing Business in Latin America

The Importance of Culture for Managing and Marketing in Overseas Markets. When managing people and resources in a foreign country, close attention to host-countries’ cultures is critical.

  • Management Styles. U.S. companies have management styles that frequently conflict with the management styles preferred in other cultures.
  • Product Development and Management. When developing new products, management styles must be considered along with many other aspects of marketing strategies. Products that are wildly successful in home-country markets may need to be modified for an international market. There are many examples of American brands that have not been successful in foreign markets because their names were not culturally acceptable.
  • Advertising Campaigns. Like brands, advertising campaigns must be carefully tailored to local cultures.
  • Communication is a key function in business, and culture has an impact on communication styles. The use of jargon is usually inappropriate, as it greatly increases the risk of misunderstanding.

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