What Is Counter Trade? Essay Example

faith in money.

BRIEF HISTORICAL BACKGROUND OF COUNTER TRADE

Beginning in the 1950’s, countertrade and barter transactions were mainly carried our with the Eastern bloc countries. This is because:

• The currencies of these countries were not acceptable elsewhere as they were not freely convertible.
• The countries did not want their currencies distributed outside of their economic bloc.
• They did not possess sufficient foreign “hard” currency to make purchases of crucial goods that were not available within the COMECON countries.

These countries solved their currency problem by depleting their gold reserves - which, because if the world market price of gold, was an indirect financial transactions. However, many Eastern bloc countries also insisted in their dealings with Western nations that the goods they produced be taken in exchange for imports so as to reduce their need for foreign currencies.

Throughout the decades, the official use of countertrade steadily increased. In 1972, countertrade was in regular use by only 15 countries. By 1983 and 1995, there were 88 and 105 participating countries respectively .

Increasingly, countries and companies are deciding that countertrade transactions are more beneficial to then than transactions based on financial exchange alone. This reasons include:

World debt crisis has made ordinary trade financing very risky. Many countries particularly in the developing world, simply cannot obtain trade credit or financial assistance necessary to pay for desired imports. Heavily indebted countries, faced with the possibility of not being able to afford imports at all hasten to use countertrade to maintain at least some product inflow.

Counter trade does not reduce commercial risk and will, therefore, be

encouraged by stability and economic progress. Countertrade appears to increase with a country’s credit worthiness, since good credit encourages traders to participate in unconventional trading practices .

Many countries are responding favorably to the notion of bilateralism. Countries prefer to exchange goods with countries that are their major business partners (A notion of scratch my back and I’ll scratch yours).

The use of countertrade permits the covert reduction of prices. It allows for circumvention of price and exchange controls. Particularly in commodity markets with operative cartel arrangements i.e. oil and/or agriculture, this benefit may be very useful to a producer e.g. by using oil as a countertrade product for industrial equipment, a surreptitious discount(by using a higher price for the acquired product) may expand market share.

Viewed by many nations and countries are excellent mechanisms to gain entry into new markets. When a producer believes that marketing is not its strong suit, particularly in product areas that face strong international competition, it often see countertrade as useful. The producer often hopes that the party receiving the goods will serve as a new distributor, opening up new international marketing channels and ultimately expanding the original market.

Countertrade can be a good way to attract new buyers. By providing countertrade services theseller is in effect differentiating its product from those of its competitors.

Countertrade also can provide stability for long-term sales. For example, if a firm is tied to a countertrade agreement, it will need to source the product from a particular supplier whether or not it wants to do so. This stability is often values very highly because it eliminates, or at least reduces, vast swings in demand and this allows

for better planning. It, therefore, can serve as a major mechanism to shift risk from the producer to another party.

Under certain conditions, countertrade can ensure the quality of an international transaction. In instances where the seller of technology is paid in output produced by the technology delivered, the sellers revenue depends on the success of the technology transfer and maintenance services in production.

In spite of all the apparent benefits of countertrade, there are strong economic arguments against the activity. These arguments are based on the following grounds that Countertrade erodes the quality and efficiency or products and as lowering world consumption. This means that instead of balances being settled on a multilateral basis, with surpluses from one country being balanced by deficits with another, accounts must now be settled on a country-by-country or even transaction-by transaction basis. Trade then results from the ability of two parties or countries to purchase specified goods from one another rather than from competition. As a result, un-competitive goods may be traded. Consequently the ability of countries and their industries to adjust structurally to more efficient production may be restricted.

Counterpurchase or parallel barter agreement.

The participating parties sign two separate contracts that specify the goods and services to be exchanged. In this way, one transaction can go forward even though the second transaction needs more time. Such an agreement can be particularly advantageous if delivery performance is dependent on a future event - for example, the harvest. Frequently, the exchange is not of precisely equal value; therefore, some amount of cash will be involved. However, despite the lack of linkage in terms of timing, an exchange of goods does not

take place. A special case of parallel barter is that of reverse reciprocity “whereby parallel contracts are signed, granting each party access to needed resources (for example, oil in exchange for nuclear power plants).”

Buy-back or compensation arrangement.

In this case, one party agrees to supply technology and equipment that enables the other party to produce goods with which the price of the supplied products or technology is repaid. The arrangements often “include larger amounts of time, money, and products than straight barter arrangements.” They originally evolved in response to the reluctance of communist countries to permit ownership of productive resources by the private sector thus restricting foreign direct investment.

Here, clearing accounts are established to track debits and credits of trades. The entries merely represent purchasing power, however, and re not directly withdrawable in cash. As a result, each party can agree in a single contract to purchase goods or services of specified value. Although the account may be out of balance on a transaction-by-transaction basis, the agreement stipulates that over the long term a balance in the account will be restored. Frequently, the goods available for purchase with clearing account funds are tightly stipulated. Sometimes additional flexibility is given to the clearing account by permitting switch-trading, in which credits in the account can be sold or transferred to a third party. Doing so can provide creative intermediaries with opportunities for deal making by identifying clearing account relationship with major imbalances and structuring business transactions to reduce them.

These arrangements are most frequently found in defense-related sector and in sales of large scale, high priced items such as aircraft. They are designed to “offset” the negative effects of

large purchases from abroad on the current account of a country. For example, a country purchasing aircraft from the United States might require that certain portions of the aircraft be produced and assembled in the our chasing country. Such a requirement us often a condition for awarding the contract or is used as a determining factor in contract decision. Offset arrangements can take on many forms, such as coproduction, licensing, subcontracting, or joint ventures; they typically are long term.

These swaps are carried out particularly with less-developed countries in which both the government and the private sector face large debt burdens. The debtors are unable to repay the debt anytime soon, therefore, debt holders have grown increasingly amenable to exchange of the debt for something else. There are five types of debt swaps, namely;

1. Debt-for-debt swap: This takes place when a loan held by one creditor is simply exchanged for a loan held by another creditor. For example, a U.S bank may swap Kenyan debt for Tanzanian debt with a Swiss bank. Through this mechanism, debt holders are able to consolidate their outstanding loans and concentrate on particular countries or regions.
2. Debt-for-equity swaps: These arise when debt is converted into foreign equity in a domestic firm. The swap therefore serves as the vehicle for foreign direct investment. Although the equity itself is denominated in local currency, the terms of the conversion may allow the investor future access to foreign exchange for dividend remittances and capital repatriation. In some countries, the debt-for-equity swaps have been very successful. For example within a few years, investments in Chile retired about $13 billion of the countries external debt .
3. Debt-for-product
   

swaps: Here, debt is exchanged for products. Usually, the transactions require that an additional cash payment be made for the product.

Pepsi/USSR trade whereby Pepsi-Cola delivers syrup that is paid for with Stolichnaya Vodka. Pepsi has the marketing rights of all Stolichnaya Vodka in the U.S. Recently Pepsi has made another innovative step by taking 17 submarines, a cruiser, a frigate, and a destroyer in payment for Pepsi products. In turn, this rag tag fleet of 20 naval vessels will be sold for scrap steel, thereby paying for Pepsi products being moved to the Soviet Union.

Fisher Controls International, a subsidiary of Monsanto, counterpurchased ball bearings and chair frames to be sold in Western Europe in a countertrade opportunity for control valves sold to Romania. This countertrade purchase activity set Fisher apart from its competitors, and enabled it to be awarded the contract.

Monsanto is helping one of its customers in Argentina gain increased exports goods of finished goods. The

exported goods contain Monsanto products, which results in increased sales.

Kenya exchanges tea and coffee for farm input and machinery from Japan and fertilizer from Egypt respectively.

THE ADVANTAGES AND DISADVANTAGES OF COUNTERTRADE

• Countertrade conserves cash and hard currency.
• Improves trade imbalances (BOP) - narrows the gap between imports and exports.
• Enhances economic development - leaves a country with the option to excel in what they are able to produce by looking for the most effective and efficient methods of production.
• Increases employment, technology transfer, market expansion and profitability.
• It is a less costly sourcing of supply reduction of surplus goods from inventory.
• Develops International marketing expertise.
• Some claim that such transactions tamper with the fundamental operation of free markets, and therefore resources will be used inefficiently.
• Transactions that do not make use of money represent a huge step backwards in economic development.

COUNTERTRADE: THE PERSPECTIVE FOR AFRICAN COUNTRIES

In the late seventies and eighties a great deal of academic research was conducted in Europe and in North America in an attempt to explain the causes and motives for engaging in countertrade and to estimate its share of world trade. Countertrade was generally considered as any form of bilateral trade in which reciprocal business transactions are the central aspects of the agreement. The share of countertrade in world trade was generally estimated at 5% (OECD, 1983), 8% (GATT, 1984) and 20% (IW, Cologne, 1988).

American experts even suggested then that countertrade would have accounted for about 40% of world trade in 1985 , if trade-offsets and BOT-deals were considered. Other Experts even predicted a 50% share of world trade by the end of this century. Some economists regard countertrade as

a form of international transaction that allows the horizontal or vertical integration of business ventures without immediate effect on the constellation of property or ownership rights. Countertrade is therefore seen “as a hybrid of joint-venture, franchising, vertical integration, and foreign direct investments, under political and ownership constraints.”

Firms and individuals engage in foreign direct investments in order to benefit from certain specific advantages of vertical or horizontal integration such as owning or securing control over relevant raw materials (e.g. copper, gold, diamonds, raw oil or other mineral products) or producing close to the source of the raw materials. Taking advantage of cheap labor, capitalizing on favorable production costs, increasing the firms market share or trying to obtain a foothold in a competitive or potentially interesting market are additional motives for engaging in foreign direct investments through countertrade schemes.

Economic market systems are characterized by:

• Latent institutional deficiencies and as a result, industries within these market / economies often perform unsatisfactorily.
• There are often no clearly defined ownership or property rights, free and competitive pricing systems or market transparency are usually lacking and the legal frameworks for business transactions are often underdeveloped.
• Inadequate labor skills and management-know-how increase the cost of running a business and create additional problems for the potential investor.
• The political systems in most developing and transformation countries are fragile and unstable.
• Business regulations are subject to frequent changes and the host governments are prone to sudden interventions in the economy - e.g. licenses, foreign exchange controls and import restrictions.
• In some countries foreign ownership of land, property and natural resources is not generally encouraged.
• All these factors raise the risks of long term business
  

transactions or productive investments. In such cases countertrade provides an alternative economic solution acceptable to the potential foreign investor as well as to the host country.

THE EMERGENCE OF NEW INTERMEDIARIES

The rise of countertrade transactions has resulted in the emergence of new specialists to handle such transactions. These intermediaries can either be in-house or outside corporations. Some companies have been found to facilitate countertrade transactions for other firms. By purchasing unwanted inventories from companies at a steep discount, sometimes very high profit margins can be obtained.

Other intermediaries that have benefited from the rise of countertrade are trading companies or trading houses that frequently act as third-party intermediaries. Some of them are subsidiaries of larger corporations that seek to supplement the trading volume generated by their corporation with business from other firms.

Firms that deal

with trading houses to receive assistance in their countertrade transactions need to be aware that the fees charged are often quite steep and may increase cumulatively.

International banks also have some involvement in countertrade to serve their clients better and to increase their own profitability. Banks may be able to use their experience in international trade finance and apply it to their financial aspects of countertrade transactions. Banks may also have a comparative advantage over trading firms by having more knowledge and expertise about financial risk management and more information about contacts with the global market.

The advantages and disadvantages of organizing for countertrade in the two ways mentioned above include:

• More controlRecruitment and training costs
• More learningProblems coordinating interfunctional staff.
• Customer contactsDistanced from customers

The countertrade profession is in its infancy in corporations. Frank Horwitz of UniSource Global Corporation in New York said it best when he said, "In the future the in-house countertrade organization will become the coordinating point for the business team, assuming responsibility for all activities other than the sale itself."

The countertrade organization will utilize internal assets such as corporate purchasing, future investments, licensing and technology transfers to get their job done. In other words, the countertrade department becomes a "basket" of assets. We will also see an increased professionalism in countertrade, as it is now beginning to be taught as a means of market success in business schools.

Countertrade is being promoted through corporate newsletters, company magazines, and staff meetings as a way to gain market access. Countertrade, along with superior quality, financing and pricing, is the key element in international contracts.

Countertrades are business transactions in which the sale of goods is linked to

other goods performance rather than only to money. In spite of their economic inefficiency, such transactions are emerging with increasing frequency in many nations around the world.

New intermediaries have emerged to facilitate countertrade transactions, yet their services can be very expensive. However, they can enable firms without countertrade experiences to participate in this growing business practice. In addition, the development of intermediary skills may offer profitable opportunities for small businesses and entrepreneurs.

Bibliography

1. Raj Aggarwal, “International Business Through Barter and Countertrade,” Long Range Planning, June 1989, 75-81.
2. “Current activities of International Organizations in the filed of Barter and Barter-like transactions,” Reports of Secretary General, United Nations, General Assembly, 1984 ,
3. Jean-Francois Hennart and Erin Anderson, “Countertrade and the Minimization of Transaction Costs: An emperical Examination,” The Journal of Law, Economics and Organization, September 2, 1993, 290-313.
4. Christopher M. Korth, “The Promotion of Exports with barter,” in Export Promotion, ed. M. Czinkota (New York: Praeger, 1983), 42.
5. Michael R. Czinkota, Ikka A Ronkainen and Michael H. Moffett “International Business”