The International Business Environment Chapter 2: The Global Economy

LEARNING OUTCOMES This lecture on the global economy will enable you to: identify the global pattern of income analyse the pattern of international trade explain why countries trade with each other explain the pattern and reasons for FDI

Measuring the Global Economy Gross Domestic Product market value of total output of goods and services produced within a nation, usually over a year. Problems of comparison Which Currency? – local or $US Purchasing Power Parity

Gross National Income ( IMF, World Economic Outlook Database, 2008) % WORLD POP % OF WORLD GDPGDP PER CAPITA Current $US PPPCurrent $US PPP $US G USA ,118 CHINA ,0124,650 INDIA ,405

GDP and the standard of living Population – per capita income Shadow economy Environmental degradation Resource depletion Distribution of income Composition of spending

Human Development Index (UNDP) Measure combining: – life expectancy – Education (adult literacy + average years schooling) – Standard of living (PPP per capita income)

Income Inequality Source: UNDP, Human Development Report 2006 HDI rank CountryPoorest 10% (1) Poorest 20% Richest 10% (3) Richest 20% Ratio of (3) to (1) 8USA UK CHINA BOLIVIA INDIA

Economic Growth Key to raising living standards Measured by annual % change in GDP Source: IMF ( annual average %) World3.65 G72.23 Developing Economies 6.14 China9.63 India6.79 Brazil3.16 Russia6.87

Implications for Business Attraction of high growth emerging economies Demand for infrastructure investment – Capital equipment – Construction materials – Power transmission equipment – Transport

Demand for consumer goods from growing middle class – Cars – Electronic goods – Household appliances – Entertainment – International travel Implications for Business

World Merchandise Trade 2005 WTO ExportsImports Share (%) Germany9.3USA16.1 USA8.7Germany7.2 China7.3China6.1 Japan5.7Japan4.8 France4.4UK4.7 Netherlands3.9France4.6 UK3.7Italy3.5 Italy3.5Netherlands3.3

WHY DO COUNTRIES TRADE Mercantilism Absolute advantage Comparative advantage Hecksher Ohlin Leontief paradox Vernon Linder

Mercantilism The country has to export more and import less so that to keep and increase “the precious metals”, i.e. money which pays for the imports M. protects mainly the interests of the state and of the traders The poverty of the working class and farmers was seen as desirable and the increase of their spending power – as weakening the economy

Absolute advantage Adam Smith (1776). An Inquiry into the Nature and Causes of the Wealth of Nations Against the restrictions on trade, as well as all sorts of intervention of the government in business. Except for the national security. free export and import of commodities, i.e. import of cheap grain, export of manufactured products

Comparative advantage Absolute advantage is a rare case. Also the countries can be interested in the trade with each other even if one has an absolute advantage in the production of many goods David Ricardo (1817) England and Portugal, cloth and wine, Portugal is more efficient in the production of both. Ricardo states that they still can trade with benefit to both if say each of them specializes in one commodity based on the opportunity cost of producing both products in both countries

Comparative advantage If Portugal is 2 time more productive in producing cloth and 3 times more productive in wine, then Portugal has comparative advantage in producing wine.

Hecksher-Ohlin Theory Theory of factor endowments Comparative advantage of one country over another in the production of something comes from the fact that the first country has advantage in a factor which plays substantial role in that production process. The original theory: labour and capital, two commodities and two countries (2x2x2) Examples: better soil, more sun, specific row materials, qualification of labor, etc.

Hecksher-Ohlin Theory Limitations: – This theory assumes perfect competition in factor and production markets. – Important factors as transportation are not considered. – Capital and labor are mobile in the country of analysis but not internationally

Leontief paradox In 1954, Leontief found that the US exported labour-intensive commodities and imported capital-intensive commodities, in contradiction with Heckscher-Ohlin theory The country with the world's highest capital-per-worker has a lower capital/labour ratio in exports than in imports.

Raymond Vernon Vernon’s model : all countries (might) benefit from any innovation, no matter if it was invented there or not. Critics say that it fails to address “the complexity of socio-economic implications of technology and production transfer over time”.

Linder hypothesis Linder hypothesis states that demand plays a more important role than comparative advantage as a determinant of trade --with the hypothesis that countries which share similar demands will be more likely to trade. For instance, both the U.S. and Germany are developed countries with a significant demand for cars, so both have large automotive industries. Rather than one country dominating the industry with a comparative advantage, both countries trade different brands of cars between them.

COMPETITIVE ADVANTAGE OF NATIONS Factor conditions Demand conditions Related and supporting industries Firm strategy, structure and rivalry Chance Government

PORTER’S DIAMOND

TRADE INTERVENTION Import restrictions tariffs non-tariff barriers –quotas – licences – rules or origin – product requirements – procedures Export promotion subsidies Exchange rate manipulation

WHY INTERVENE? National defence Infant industries Declining industry protection To spread risk Political reasons Strategic trade policy- first in the market Protection from dumping Retaliation To protect against undesirable products To resist cultural imperialism

CONTROL OF TRADE GATT/WTO non-discrimination reciprocity transparency predictability and stability freeing of trade special assistance and trade concessions for developing countries

GATT/WTO ROUNDS PeriodRoundCountriesSubjects 1947Geneva23Tariffs 1949Annecy13Tariffs Torquay38Tariffs Geneva26Tariffs Dillon26Tariffs Kennedy62Tariffs, anti-dumping measures Tokyo102Tariffs, non-tariff measures and framework agreements Uruquay123Tariffs, agriculture, textiles and clothing brought into GATT Agreement on services (GATS) Intellectual property (TRIPS) Trade related Investment (TRIMS) Creation of WTO and dispute settlement Doha141Not yet resolved

FOREIGN DIRECT INVESTMENT

REASONS FOR FDI A quest for natural resources – Minerals and energy – Increased competition from developing economies Lower production costs – Offshoring Market access