2. Economic Environment 1

Chapter Overview 1. Intertwined World Economy 2. Country Competitiveness 3. Evolution of Cooperative Global Trade Agreements 4. U.S. Position in Foreign Direct Investment and Trade 5. Information Technology and the Changing Nature of Competition 6. Regional Economic Arrangements 7. Multinational Corporations 2

Introduction  In 2008, the annual global merchandise trade amounted to $16.8 trillion.  From 1997 to 2007, world GDP grew more than 30 percent.  In the same period, total world exports of merchandise increased by more than 60 percent.  The World Bank (at the time of this writing) predicted that the global GDP growth would slow down to 2.5 percent in 2012 and 3.1 percent in

Exhibit 2-1: Growth in the Volume of World Merchandise Trade and GDP,

Introduction According to the World Trade Organization (WTO), the top five merchandise exporting countries in 2012 were: China ($1,904 billion), European Union ($1,791 billion) United States ($1,497 billion) Germany ($1,408 billion) Japan ($788 billion) 5

Introduction Collectively, the top five export nations accounted for 35% of global trade in The Triad Regions (North America, Western Europe, and Japan) of the world collectively produced nearly 60 percent of world GDP in 2007, down from 78 percent in

Introduction The net result of these factors? – Increased interdependence of countries/economies – Increased competitiveness – Need for firms to keep a constant watch on the international economic environment. Consumers and companies in the U.S. and Japan are able to find domestic sources for their needs because of their diversified and extremely large economies. 7

1. Intertwined World Economy Despite the increasingly intertwined world economy, the United States is still relatively more insulated from the global economy than other nations. In 2011, the U.S. economy was about $15.1 trillion and about 15 percent of what Americans consumed was imported in the United States. 8

Exhibit 2-2: Top 10 Exporters and Importers in World Merchandise Trade,

1. Intertwined World Economy The larger the country’s domestic economy, the less dependent it tends to be on exports and imports relative to its GDP. Intertwining of economies by the process of specialization due to international trade leads to job creation in both the exporting and importing country. Foreign direct investment (FDI) involves investment in manufacturing and service facilities in a foreign country. 10

1. Intertwined World Economy As firms invest in manufacturing and distribution facilities outside their home countries to expand into new markets around the world, they have added to the stock of foreign direct investment. The increase in foreign direct investment has also been promoted by the efforts of many national governments to woo multinationals. Portfolio investment or indirect investment refers to investments in foreign countries that are withdrawable at short notice, such as investments in foreign stocks and bonds. 11

Exhibit 2-3: Foreign Direct Investment Inflows,

1. Intertwined World Economy The weekly volume of international trade in currencies exceeds the annual value of the trade in goods and services. All nations with even partially convertible currencies are exposed to the fluctuations in the currency markets. A rise in the value of the local currencies make exports more expensive; a rising currency value also deters foreign investment in a country and may encourage outflow of investment. 13

1. Intertwined World Economy Examples of severe currency fluctuations are the 1995 Mexican meltdown, and the Asian financial crisis ( ). Unfortunately, the influence of these short-term money flows are nowadays far more powerful regarding exchange rates than an investment by a Japanese or German automaker. Recent examples of financial crisis occurred in Argentina and Brazil (2002). 14

2. Country Competitiveness Country competitiveness refers to the productiveness of a country, which is represented by its firms’ domestic and international productive capacity. Country competitiveness is not fixed. The role of human skill resources has become increasingly important as a primary determinant of industry and country competitiveness. 15

2. Country Competitiveness 16 In , one Asian Tiger (Singapore at #5) was among the world’s top 10 economies. Others were the U.S., Switzerland, Denmark, Sweden, Finland, Germany, Netherlands, Japan and Canada (see Exhibit 2-4). Taiwan, another Asian Tiger, dropped from #5 to #17 between 2005 and The U.S. and Switzerland have been the most innovative in the last three decades Other OECD countries (especially Japan) have been increasingly catching up.

World Competitiveness Scoreboard 17 The 2015 IMD World Competitiveness Scoreboard USA1 1 2 China Hong Kong2 4 3 Singapore3 3 4 Switzerland4 2 5 Canada5 7 6 Luxembourg Norway Denmark8 9 9 Sweden Germany United Kingdom Israel China Mainland Korea Rep Japan France32 27

Exhibit 2-4: Global Competitiveness Ranking 18

Exhibit 2-5: Change in Country Innovativeness: A Key to a Country’s Long-Term Competitiveness 19

3. Emerging Economies 20 Over the next two decades, the big emerging markets (BEMs) will hold the greatest potential for U.S. exports Largest BEMs: Chinese economic area (including China, Hong Kong region, and Taiwan), India, C.I.S. (Russia, Central Asia, and the Caucasus states), South Korea, Mexico, Brazil, and Argentina B.R.I.C.- Brazil, Russia, India, China Each BEM offers opportunities and challenges for local policy makers, businesses and the international business and economic community

Exhibit 2-6: Leading Emerging Economies in

4. Evolution of Cooperative Global Trade Agreements GATT (General Agreements on Tariffs & Trade): – After 1950, GATT succeeded ITO. – The main operating principle of GATT was the concept of most favored nations (MFN). – GATT was successful in lowering trade barriers. 22

4. Evolution of Cooperative Global Trade Agreements WTO (World Trade Organization): – The eighth and last round of GATT talks – called the Uruguay Round ( ) established an international body called the WTO which took effect on January 1, – As of July 2008, WTO had 153 member countries. – WTO has statutory powers to adjudicate trade disputes among nations and has its own secretariat. – WTO is the new legal and institutional foundation for a multilateral trading system. 23

4. Evolution of Cooperative Global Trade Agreements 24 WTO’s ninth round---called the “Doha Development Agenda” (Doha Round) was launched in Doha, Qatar in November 2001 (see Exhibit 2-7). Interim deal in December 2005 to end farm export subsidies by 2013 prevented collapse of the latest round of the talks. The Doha Round of 2001 facilitated the way for China and Taiwan to get full membership in the WTO.

Exhibit 2-7: Agenda for the Doha Round 25

4. Evolution of Cooperative Global Trade Agreements Although WTO is a global institutional proponent of free trade, it is not without critics. The WTO dispute settlement mechanism is faster, more automatic, and less susceptible to blockages than the old GATT system. The WTO Work Program on Electronic Commerce is in the process of defining the trade-related aspects of electronic commerce that would fall under the parameters of WTO mandates. 26

5. Information Technology and the Changing Nature of Competition Information technology and the changing nature of competition have created many challenges for the firms. Over the Internet, any piece of electronically represented intellectual property can be copied. The Trade Related Aspects of Intellectual Property Rights (TRIPS) Agreement was concluded as part of the GATT Uruguay Round. Update to accord ensuring patent protection does not block developing countries’ access to affordable medicines is the top of the agenda. 27

5. Information Technology and the Changing Nature of Competition Proliferation of E-Commerce and Regulations: Countries’ regulators have not kept pace with the rapid proliferation of international e-commerce and Internet- related activities. In many countries, rules and regulations are vague regarding e-commerce transactions. The United Nations Commission on International Trade Law (UNCITRAL) has formed a Working Group on Electronic Commerce to reexamine these treaties. 28

6. Regional Economic Arrangements An evolving trend in international economic activity is the formation of multinational trading blocs. There are over 120 regional free trade areas worldwide. Market groups take many forms, depending on the degree of cooperation and inter-relationships, which lead to different levels of integration among the participating countries. 29

6. Regional Economic Arrangements Types of Regional Economic Arrangements: – Free Trade Areas: Formal agreement among two or more countries to reduce or eliminate customs duties and nontariff barriers. Examples: NAFTA, MERCOSUR, CAFTA- DR & FTAA (proposed and currently stalled) – Customs Union: Addition of common external tariffs to the provisions of free trade agreements. Example: ASEAN. 30

6. Regional Economic Arrangements – Common Market: Eliminates all tariffs and other barriers, adopts a common set of external tariffs on nonmembers, and remove all restrictions on the flow of capital and labor among member nations. Example: European Union. – Monetary Union: Represents the fourth level of integration with a single currency among politically independent countries. Example: EU and the euro. – Political Union: Highest level of integration resulting in a political union. Sometimes, countries come together in a loose political union for historical reasons, as in the case of the British Commonwealth which exists as a forum for discussion and common historical ties. 31

7. Multinational Corporations The U.S. government defines a multinational corporations (MNC) for statistical purposes as a company that owns or controls 10 percent or more of the voting securities, or the equivalent, of at least one foreign business enterprise. At present, there are 78,000 MNCs with 780,000 affiliates in foreign countries. The outward FDI stock reached $21.2 trillion in 2011—a little more than a tenfold increase since 1990 ($2 trillion). 32

7. Multinational Corporations In 1970, of the 7,000 multinationals identified by the United Nations, more than half were from two countries: the United States and Britain. By 1995, less than half of the 36,000 multinationals identified by the United Nations came from four countries: the United States, Japan, Germany, and Switzerland. The nation-state, while considerably weaker than its nineteenth century counterpart, is likely to remain alive and well. 33

Exhibit 2-8: Selected Indicators of Foreign Direct Investment and International Production,

7. Multinational Corporations Currently, factors such as currency movements, capital surpluses, faster growth rates, and falling trade and investment barriers have all helped multinationals from other countries join the cross-border fray. It is not unusual for a start-up firm to become global at its inception. Those firms are known as “born global.” 35