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Cross cultural literacy

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An understanding of how cultural differences across and within nations can affect the way in which business is practiced.

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Culture

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A system of values and norms that are shared among a group of people and that when taken together constitute a design for living. The fundamental building blocks of culture are values and norms

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Values

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Abstract ideas about what a group believes to be good, right, and desirable.

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Norms

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The social rules and guidelines that prescribe appropriate behavior in particular situations.

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Folkways

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Routine conventions of everyday life (ex. good social manners, neighborly behavior, being on time, rituals such as Japanese business card exchange)

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Mores

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Norms that are seen as central to the functioning of a society and to its social life (ex. Theft, Adultery, consumption of alcohol in Saudi Arabia)

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Society

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A group of people who share a common set of values and norms.

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Determinants of Culture

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Include six determinants (language, religion, education, political philosophy, economic philosophy, and social structure)

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Social structure

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The basic social organization of a society. Two dimensions stand out when explaining differences between social structures. The first is the degree to which the basic unit of social organization is the individual, as opposed to the group. The second dimension is the degree to which a society is stratified into classes or castes. (i.e. degree of social stratification and mobility between strata)

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Individuals and Groups

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An emphasis on individual achievement has positive and negative implications. On the positive side, the dynamism (new products and new ways of doing business) of the U.S. economy owes much to the philosophy of individualism. On the other hand, individualism can lead to a lack of company loyalty and failure to gain company specific knowledge, competition between individuals in a company rather than team building, and can limit people's ability to develop a strong network of contacts within a firm.

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Social strata

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Hierarchical social categories often based on family background, occupation, and income.

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Social mobility

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The extent to which individuals can move out of one strata into which they are born.

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Caste system

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A closed system of stratification in which social position is determined by the family into which a person is born, and change in that position is usually not possible during an individual's lifetime

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Class System

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An open system of social stratification in which the position a person has by birth can be changed through his or her achievement or luck

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Class consciousness

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Tendency for people to perceive themselves in terms of their class background, and this shapes their relationships with others. In cultures where there is a great deal of consciousness over the class of others, the way individuals from different classes work together (i.e. management and labor) may be very prescribed and strained in some cultures (i.e. Britain), or have almost no significance in others (i.e. Japan).

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Religion

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A system of shared beliefs and rituals that are concerned with the realm of the sacred.

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Ethical Systems

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A set of moral principles or values that are used to guide and shape behavior.

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World Religions

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Christianity - most widely practiced religion in the world (approximately 20%, 1.7 billion Christians) "Protestant work ethic" - belief that focus on hard work, wealth creation, and frugality encourages capitalism Islam - second largest religion (1 billion Muslims) (major principles on page 106.) Forbids consumption or pork or alcohol. "Islamic fundamentalist" - associated in the media with militants, terrorists, and violent upheavals. However, this characterization may be misleading as the vast majority of Muslims point out that Islam teaches peace, justice, and tolerance. Fundamentalists demand a rigid commitment to traditional religious beliefs and rituals. Hinduism - most in Indian sub-continent (750 million Hindus). Believe in karma, reincarnation, and nirvana. Cow is a sacred gift of the Gods to the human race. Most devout Hindus do not eat beef. Buddhism - 350 million followers, stresses afterlife and spiritual achievement rather than involvement in this world. Confucianism - (not officially a religion - has little to say about a supreme being or an afterlife) 200 million followers mainly in China, Korea, and Japan. Attaining personal salvation through right action. Stresses loyalty, reciprocal obligations, and honesty in dealings with others.

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Language

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While English may be the language of international business, Chinese is spoken the largest number of people in the world, followed by English, and Hindi (spoken in India). Learning a second or third language will only help you in international business. International business people need to be careful with unspoken language as well. (Example, OK or thumbs up can mean different things, p 114)

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Education

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Cultural norms are often taught directly and indirectly in schools. The strength of a country's education system can be a major determinant of a nation's competitive advantage or likelihood of economic success.

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Hofstede's Cultural dimensions

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Power Distance is focused on how a society deals with the fact that people are unequal in physical and intellectual capabilities. High power distance cultures let inequalities grow over time into inequalities of power and wealth. Individualism Versus Collectivism is focused on the relationship between the individual and his or her fellows. In individualistic societies, individual achievement and freedom are highly valued. Uncertainty Avoidance measures the extent to which different cultures socialize their members into accepting ambiguous situations and tolerating ambiguity. High uncertainty avoidance cultures place a premium on job security, career patterns, retirement benefits, etc. Masculinity Versus Femininity looks at the relationship between gender and work roles and the differentiation between men and women in the same job. Confucian dynamism, which captures attitudes toward time, persistence, ordering by status, protection of face, respect for tradition, and reciprocation of gifts and favors

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beware of ethnocentrism or ethnocentric behavior

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A belief in the superiority of one's own culture. Individuals who are ethnocentric frequently demonstrate disregard or contempt for other cultures.

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Free trade

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Absence of government barriers to the free flow of goods and services between countries. Refers to a situation where a government does not attempt to influence through quotas or duties what its citizens can buy from another country or what they can produce and sell to another country.

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Mercantilism

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A sixteenth century English economic philosophy advocating that countries should simultaneously encourage exports and discourage imports. Its principle assertion was that it is in a country's best interest (accumulation of wealth - gold and silver) to maintain a trade surplus, to export more than it imports. Consistent with this belief, the mercantilist doctrine advocated government intervention to achieve a surplus in the balance of trade.

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Zero-sum game

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A situation in which an economic gain by one country results in a loss by another. It was left to Adam Smith and David Ricardo to show the shortsightedness of this approach and to demonstrate that trade is a positive-sum game. As an economic philosophy, mercantilism is problematic and not valid.

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Absolute advantage

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A country has an absolute advantage in the production of a product when it is more efficient than any other country in producing it. According to Smith, countries should specialize in the production of goods for which they have an absolute advantage and then trade these goods for the goods produced by other countries. The text provides a numerical example of Smith's theory.

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1. Theory of comparative advantage

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It makes sense for a country to specialize in the production of those goods that it produces most efficiently and to buy the goods that it produces less efficiently from other countries, even if this means buying goods from other countries that it could produce more efficiently itself. The textbook provides a detailed example to explain the rationale of this theory.

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Constant returns to specialization

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The units of resources required to produce a good are assumed to remain constant no matter where one is on a country's production possibility frontier.

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Heckscher-Ohlin

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Heckscher and Ohlin argued that comparative advantage arises from differences in national factor endowments (land, labor, and capital). As a result, the Heckscher-Ohlin theory predicts that countries will export goods that make intensive use of those factors that are locally abundant, while importing goods that make intensive use of factors that are locally scarce

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The Leontief Paradox

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Using the Heckscher-Ohlin theory, Leontief, in 1953 postulated that since the United States was relatively abundant in capital compared to other nations, the United States would be an exporter of capital intensive goods and an importer of labor-intensive goods. To his surprise, however, he found that U.S. exports were less capital intensive than U.S. imports. Since this result was at variance with the predictions of the theory, it has become known as the Leontief Paradox.

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Product Life-Cycle Theory

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According to the theory as products mature, both the location of sales and the optimal production location will change affecting the flow and direction of trade. While the product life cycle theory accurately explains what has happened for products like photocopiers and a number of other high technology products developed in the United States in the 1960s and 1970s, the increasing globalization and integration of the world economy has made this theory less valid in today's world.

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New trade theory

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Theory that sometimes countries specialize in the production and export of particular products not because of underlying differences in factor endowments, but because in certain industries the world market can support only a limited number of firms. So a country's pattern of trade may be a reflection of the ability of firms in that nation to capture first-mover advantages and economies of scale.

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First mover advantages

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Economic and strategic advantages that accrue to early entrants into an industry.

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Economies of scale (v. dis-economies of scale)

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Unit cost reductions associated with a large scale of output (area where total costs per unit are rising per additional unit of production)

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National Competitive Advantage: Porter's Diamond National Competitive Advantage: Porter's Diamond

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Porter's 1990 study tried to explain why a nation achieves international success in a particular industry. This study found four broad attributes - factor endowments, demand conditions, relating and supporting industries, and "firm strategy, structure, and rivalry" - that promote or impede the creation of competitive advantage. These are shown as a diamond in Figure 5.6. Porter argues that firms are most likely to succeed in industries where the diamond is favorable.

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Foreign Direct Investment

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(from chapter 1) A direct investment in business operations in a foreign country. FDI occurs when a firm invests directly in new facilities to produce and/or market in a foreign country. Once a firm undertakes FDI it becomes a multinational enterprise.

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Greenfield Investment [v. Merger/acquisition]

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Involves the establishment of a wholly new operation in a foreign country [versus acquiring or merging with an existing firm in the foreign country. There are three types of acquisitions: minority (10 percent to 49 percent stake), majority 50 percent to 99 percent), or full (100 percent)]

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Flow of FDI

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The amount of FDI undertaken over a given time period (normally a year) viewed in terms of outflow and inflow.

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Outflow of FDI

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The flow of FDI out of a country

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Inflow of FDI

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The flow of FDI into a country

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Stock of FDI

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The total accumulated value of foreign-owned assets at a given time.

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Gross Fixed Capital Formation

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Summarizes the total amount of capital invested in factories, stores, office buildings, and the like. The greater the capital investment in an economy, the more favorable its future growth prospects. Measuring the inward flows of FDI as a percentage of gross fixed capital formation may support FDI role as an important driver of a country's economic growth. (E.g. Inward flows = $ of FDI/Gross fixed capital formation x 100.)

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Exporting

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Producing goods at home and then shipping them to the receiving country for sale. The viability of exporting is often constrained by transportation costs and trade barriers.

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Licensing

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Granting a foreign entity the right to produce and sell the firm's product in return for a royalty fee on every unit that the foreign entity sells

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Internalization theory

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There is a branch of economic theory known as internalization theory (also known as the market imperfections approach) that seeks to explain why firms often prefer foreign direct investment to licensing as a strategy for entering foreign markets. According to internationalization theory, licensing has three major drawbacks as a strategy for exploiting foreign market opportunities. (1) First, licensing may result in a firm's giving away valuable technological know-how to a potential foreign competitor. (2) Second, licensing does not give a firm the tight control over manufacturing, marketing, and strategy in a foreign country that may be required to maximize its profitability. (3) Third, a problem arises with licensing when the firm's competitive advantage is based not so much on its products as on the management, marketing, and manufacturing capabilities that produce those products. Such capabilities are often not amenable to licensing.

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Strategic behavior in Oligopolistic industries.

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Theory based on the idea that FDI flows are a reflection of strategic rivalry between firms in the global marketplace. F.T. Knickerbocker that FDI may be a result of imitative behavior in an oligopoly.

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Oligopoly

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Industry composed of a limited number of large firms. (e.g. US cell phone providers)

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Multipoint Competition

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When two or more enterprises encounter each other in different regional markets, national markets, or industries.

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Eclectic Paradigm

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The eclectic paradigm attempts to combine the other two perspectives into a single holistic explanation of FDI (championed by the British economist John Dunning). Dunning argues that in addition to the various factors discussed above, location-specific advantages (that arise from using resource endowments or assets that are tied to a particular location and that a firm finds valuable to combine with its own unique assets) and externalities (knowledge spillovers that occur when companies in the same industry locate in the same area) are also of considerable importance in explaining both the rationale for and the direction of foreign direct investment.

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Location-Specific advantages

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Arise from using resource endowments or assets that are tied to a particular location and that a firm finds valuable to combine with its own unique assets

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Externalities

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Knowledge spillovers that occur when companies in the same industry locate in the same area (e.g. High tech FDI in silicon valley, Automotive FDI in Southeast KY/TN/SC/AL/MS)

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Product life Cycle

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Raymond Vernon's product life cycle theory (chapter 5) is also used to explain FDI. Vernon argued that often the same firms that pioneer a product in their home markets may undertake FDI to produce a product for consumption in foreign markets.

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Balance-of-payments accounts

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A record of a country's payments to and receipts from other countries. (discussed in detail in Appendix A, pp. 197-201)

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Current account

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The current account is a record of a country's export and import of goods and services.

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Offshore production

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FDI undertaken to serve the home market.

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The Radical View

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MNE are tools for exploiting host countries to the exclusive benefit of capitalist/imperialist home countries.

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Free Market View

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Argues that international production should be distributed among countries according to the theory of comparative advantage. Within this framework, FDI is an instrument used by MNE's for dispersing the production of goods and services to the most efficient locations around the globe.

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Pragmatic Nationalism

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Ideology between the two above extremes. The pragmatic nationalist view is that FDI has both benefits (such as inflows of capital, technology, skills and jobs) and costs (such as repatriation of profits to the home country and a negative balance of payments effect). According to this view, FDI should be allowed only if the benefits outweigh the costs.

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Political Economy

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The political, economic, and legal systems of a country.

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Political System

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The systems of government in a nation. A political system can be assessed according to two related dimensions. The first is the degree to which they emphasize collectivism as opposed to individualism. The second dimension is the degree to which they are democratic or totalitarian.

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Collectivism

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A political system that emphasizes collective goals over individual goals. When collectivism is emphasized, the needs of the society as whole are generally viewed as being more important than individual freedoms.

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Socialism

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A political philosophy advocating substantial public involvement, through government ownership, in the means of production and distribution.

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Communists

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Those who believe socialism can be achieved only through revolution and totalitarian dictatorship.

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Social Democrats

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Those committed to achieving socialism by democratic means.

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(Privatization)

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The sale of state owned enterprises to private investors.

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Individualism

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An emphasis on the importance of guaranteeing individual freedom and self-expression. In contrast to collectivism, individualism stresses that the interests of the individual should take precedence over the interests of the state

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Democracy

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Political system in which government is by the people, exercised either directly or through elected representatives.

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Representative Democracy

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A political system in which citizens periodically elect individuals to represent them.

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Totalitarianism

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Form of government in which one person or political party exercises absolute control over all spheres of human life and prohibits opposing political parties.

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Communist Totalitarianism

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Form of totalitarianism that advocates achieving socialism through totalitarian dictatorship

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Theocratic Totalitarianism

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Form of totalitarianism in which political power is monopolized by a party, group, or individual that governs according to religious principles

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Tribal Totalitarianism

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Form of totalitarianism (found mainly in Africa) in which a political party that represents the interests of a particular tribe monopolizes power

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Right-Wing Totalitarianism

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Form of totalitarianism in which individual economic freedom is allowed but individual political freedom is restricted in the belief that it could lead to communism.

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Economic Systems

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Three broad types of economic systems can be identified-a market economy, a command economy, and a mixed economy.

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Market economy

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An economic system in which the interaction of supply and demand determines the quantity in which goods and services are produced.

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Command economy

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An economic system in which the government plans the goods and services that a country produces, the quantity in which they are produced, and the prices at which they are sold.

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Mixed economy

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A mixed economy includes some elements of both a market and command economy. Until recently, Great Britain, France, and Sweden were all considered mixed economies. Today, however, as a result of extensive privatization, these countries function as market economies.

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Legal System (of a country)

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Refers to the system of rules, or laws, that regulate behavior, along with the processes by which the laws of a country are enforced and through which redress for grievances is obtained.

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Common Law system

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The common law system (based on tradition, precedent, and custom) evolved in England over hundreds of years. It is now found in most of Great Britain's former colonies, including the United States.

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Civil Law system

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A civil law system is based on a very detailed set of laws organized into codes. Over 80 countries, including Germany, France, Japan, and Russia, operate with a civil law system.

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Theocratic Law system

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A system of laws based on religious teachings.

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Contracts

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A contract is a document that specifies the conditions under which an exchange is to occur and details the rights and obligations of the parties involved.

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Contract Law

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The body of law that governs contract enforcement.

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Property Rights

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The bundle of legal rights over the use to which a resource is put and over the use made of any income that may be derived from that source.

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Private Action

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Private action refers to theft, piracy, blackmail, and the like by private individuals or groups.

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Public Action

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Public action to violate property rights occurs when public officials extort income or resources from property holders using various legal mechanisms including excessive taxation, requiring expensive licenses or permits from property holders, or taking assets into state ownership without compensating the owners.

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Foreign Corrupt Practices Act

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Makes it a violation of the United States law to bribe a foreign government official in order to obtain or maintain business over which the foreign official has authority, and requires all publicly traded companies to keep detailed records so that it is clear whether a violation of the act has occurred or not

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Intellectual Property

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Products of the mind, such as computer software, a screenplay, or the chemical formula for a new drug that is the product of intellectual activity. Intellectual property rights include patents, copyrights, and trademarks.

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Patent

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Documents giving the inventor of a new product or process exclusive rights to the manufacture, use, or sale of that invention

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Copyright

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Exclusive legal rights of authors, composers, playwrights, artists, and publishers to publish and dispose of their work as they see fit

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Trademark

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Designs and names, often officially registered, by which merchants or manufacturers designate and differentiate their products

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World Intellectual Property Organization

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An international organization whose members (183 countries) sign treaties designed to protect intellectual property.

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Paris Convention for the Protection of Industrial Property

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An international agreement signed about 170 nations to protect intellectual property rights (dates to 1883)

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Product Safety Laws

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Set certain safety standards to which a product must adhere.

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Product liability

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Involves holding a firm and its officers responsible when a product causes injury, death, or damage.

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Gross National Income (GNI)

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The yardstick for measuring the economic activity of a country; it measures the total annual income received by a nation's residents.

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Purchasing Power Parity (PPP)

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An adjustment in GNI per capita to reflect differences in the cost of living.

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Human Development Index (HDI)

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An attempt by the United Nations to assess the impact of a number of factors (life expectancy, education attainment, and whether average incomes are sufficient to meet the basic needs) on the quality of human life in a country.

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Innovation

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The development of new products, new processes, new organizations, new management practices, and new strategies. Innovation is often seen as the product of entrepreneurial activity.

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Entrepreneurs

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Those who first commercialize new innovations.

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Deregulation

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Involves removing restrictions on the free operation of markets, the establishment of private enterprises, and the manner in which private enterprises operate.

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First Mover Advantages

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Advantages that accrue to early entrants into a market.

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Late Mover Advantages

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Handicaps experienced by being a late entrant into a market.

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Political Risk

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The likelihood that political forces will cause drastic changes in a country's business environment that adversely affects the profit and other goals of a business enterprise

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Economic Risk

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The likelihood that economic mismanagement will cause drastic changes in a country's business environment that adversely affects the profit and other goals of a business enterprise

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Legal Risk

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The likelihood that a trading partner will opportunistically break a contract or expropriate property rights.

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Ethics

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Refers to accepted principles of right or wrong that govern the conduct of a person, the members of a profession, or the actions of an organization

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Business Ethics

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The accepted principles of right or wrong governing the conduct of business people

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Ethical Strategy

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A strategy, or course of action, that does not violate these accepted principles of right or wrong governing the conduct of business people.

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Tragedy of the commons

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When a resource held in common by all, but owned by no one, is overused by individuals resulting in its degradation. Corporations can contribute to the global tragedy of the commons by moving production to locations where they are free to pump out pollutants into the environment, thereby harming these valuable global commons. The question here is whether the decision to do so, while perhaps legal, is ethical

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Foreign Corrupt Practices Act

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A U.S. law regulating behavior regarding the conduct of international business in the taking of bribes and other unethical actions

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Convention on Combating Bribery of Foreign Public Officials in International Business Transactions

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Organization for Economic Cooperation and Development (OECD) convention that obliges member states to make the bribery of foreign public officials a criminal offense adopted in 1999.

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Social responsibility

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The idea that business people should take the social consequences of economic actions into account when making business decisions, and presumes that decisions should be favored that have both good economic and good social consequences.

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Ethical dilemmas

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Situations in which none of the available alternatives seems ethically acceptable.

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Organization culture

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The values and norms that are shared among employees of an organization.

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Cultural relativism

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Belief that ethics are culturally determined and that firms should adopt the ethics of the cultures in which they operate, or in other words, "when in Rome, do as the Romans do."

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Righteous moralist

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Belief that a multinational's home country standards of ethics are the appropriate ones for companies to follow in foreign countries. This approach is typically associated with managers from developed nations.

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Naïve immoralist

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Belief that if a manager of a multinational sees that firms from other nations are not following ethical norms in a host nation, that manager should not either.

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Utilitarian approaches

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These approaches to ethics hold that the moral worth of actions or practices is determined by their consequences. An action is judged to be desirable if it leads to the best possible balance of good consequences over bad consequences.

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Kantian ethics

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The belief that people should be treated as ends and never purely as means to the ends of others.

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Rights theories

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Twentieth century theories that recognize human beings have fundamental rights and privileges that transcend national boundaries and culture. Moral theorists argue that fundamental human rights form the basis for the moral compass that managers should navigate by when making decisions that have an ethical component.

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United Nations' Universal Declaration of Human Rights

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A UN document that specifies the basic principles that should always be adhered to irrespective of the culture in which one is doing business

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Justice theories

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Focus on the attainment of a just distribution of economic goods and services. A just distribution is one that is considered fair and equitable

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Code of Ethics

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A business' formal statement of ethical priorities.

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Ethical algorithm (5 Step Model to think through ethical issues)

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Others have recommended a five step process to think through ethical problems.

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In Step 1

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business people should identify which stakeholders (the individuals or groups who have an interest, stake, or claim in the actions and overall performance of a company) a decision would affect and in what ways. Internal stakeholders include those who work for or who own the business such as employees, the board of directors, and stockholders. External stakeholders are the individuals or groups who have some claim on a firm such as customers, suppliers, and unions.

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Step 2

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involves judging the ethics of the proposed strategic decision given the information gained in Step 1. Managers need to determine whether a proposed decision would violate the fundamental rights of any stakeholders.

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Step 3

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requires managers to establish moral intent (the business must resolve to place moral concerns ahead of other concerns in cases where either the fundamental rights of stakeholders or key moral principles have been violated).

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Step 4

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requires the company to engage in ethical behavior.

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Step 5

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requires the business to audit its decisions, reviewing them to make sure that they are consistent with ethical principles.

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Regional economic integration

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Refers to agreements between countries in a geographic region to reduce tariff and nontariff barriers to the free flow of goods, services, and factors of production between each other.

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a. Free trade area

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A group of countries committed to (1) removing all barriers to the free flow of goods and services between each other. Each country, however, is allowed to determine its own trade policies with regard to nonmembers. In a theoretically ideal free trade area, no discriminatory tariffs, quotas, subsidies, or administrative impediments are allowed to distort trade between member nations. [Examples - European Free Trade Association (EFTA) joins four countries-Norway, Iceland, Liechtenstein, and Switzerland; and North American Free Trade Agreement (NAFTA)]

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b. Customs union

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A group of countries committed to (1) removing all barriers to the free flow of goods and services between each other and (2) the pursuit of a common external trade policy. A customs union is one step further along the road to full economic and political integration. A customs union eliminates trade barriers between member countries and adopts a common external trade policy. [Examples - The European Union (EU) began as a customs union, but has moved beyond this stage; the Andean community - Bolivia, Columbia, Ecuador, Peru, and Venezuela]

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c. Common market

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A group of countries committed to (1) removing all barriers to the free flow of goods and services between each other and (2) the pursuit of a common external trade policy, and (3) allows factors of production to move freely between members. [Example - Mercosur (Argentina, Brazil, Paraguay, and Uruguay) are working towards a common market]

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d. Economic Union

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A group of countries committed to (1) removing all barriers to the free flow of goods and services between each other, (2) the pursuit of a common external trade policy, (3) allows factors of production to move freely between members, and (4) common currency, harmonization of tax rates, and a common monetary and fiscal policy. [Example-the EU is an example of an (imperfect) economic union]

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e. Political Union

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A central political apparatus that coordinates economic, social, and foreign policy. [Examples - The EU is on the road to at least partial political union. The United States provides an example of even closer political union]

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Trade creation v.s Trade diversion

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Trade creation occurs when low cost producers within the free trade area replace high cost domestic producers. Trade diversion occurs when higher cost suppliers within the free trade area replace lower cost external suppliers. A regional free trade agreement will only make the world better off if the amount of trade it creates exceeds the amount it diverts.

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European Union

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An economic group of 27 European nations; established as a customs union, it is moving towards economic union with a population of almost 500 million, and a GDP of €11 trillion; formerly the European Community created by the Treaty of Rome in 1957. The EU is a product of two political factors: (1) the devastation of two world wars on Western Europe and the desire for a lasting peace, and (2) the European nations' desire to hold their own on the world's political and economic stage

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The structure of the EU is composed of four main institutions:

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(1) the European Commission, (2) the Council of the European Union, (3) the European Parliament, and (4) the Court of Justice.

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(1) European Commission

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Body responsible for proposing EU legislation, implementing it, and monitoring compliance (consisting of 1 commissioner from each member state)

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(2) Council of the European Union (European Council)

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The ultimate controlling authority within the EU. The council is composed of one representative from the government of each member state. The membership, however, varies depending on the topic being discussed.

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(3) European Parliament

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Elected EU body that debates legislation proposed by the commission and forwarded to it by the council. Now has 732 members.

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(4) Court of Justice

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Supreme appeals court for EU law

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Single European Act

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A 1987 act, adopted by members of the European Community that committed member countries to establishing an economic union.

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Treaty of Maastricht

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Signed in 1991, committed the EU to adopt a single currency, the euro, by January 1, 1999. The euro is now used by 16 of the 27 member states. By adopting the euro, the EU has created the second largest currency zone in the world after that of the U.S. dollar. For now, three long term EU countries, Britain, Denmark, and Sweden, are opting out of the euro-zone

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Treaty of Lisbon

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Treaty signed in 2007 that made the European Parliament the co-equal legislator for almost all European laws and also created the position of the president of the European Council

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Optimal Currency Area

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An area where similarities in the underlying structure of economic activities make it feasible to adopt a single currency and use a single exchange rate as an instrument of macro-economic policy. Many of the European economies in the euro-zone, however, are very dissimilar.

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Free Trade

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The absence of government barriers to the free flow of goods and services between countries.

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Seven main instruments of trade policy

answer

1. Tariff 2. Specific Tariff 3. Ad Valorem Tariff 4. Subsidy 5. Import Quota 6. Tariff Rate Quota 7. Voluntary Export Restraint (VER)

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Tariff

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Tariff A tax levied on imports

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Specific Tariff

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A tariff levied as a fixed charge for each unit of good imported (e.g. $3 per barrel of oil)

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Ad Valorem Tariff

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A tariff levied as a proportion of the value of an imported good (e.g. 17% ad valorem tax on raw materials)

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Subsidy

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Government financial assistance to a domestic producer

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Import Quota

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A direct restriction on the quantity of some good that may be imported into a country.

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Tariff Rate Quota

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The process of applying a lower tariff rate to imports within the quota than those over the quota.

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Voluntary Export Restraint (VER)

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A quota on trade imposed by the exporting country, typically at the request of the importing country's government

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Quota Rent

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The extra profit producers make when supply is artificially limited by an import quota.

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Local Content Requirement

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A requirement that some specific fraction of a good be produced domestically.

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Administrative Trade Policies

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Bureaucratic rules designed to make it difficult for imports to enter a country.

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Dumping

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Selling goods in a foreign market at below their costs of production or below their fair market value.

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Anti-dumping Policies

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Policies designed to punish foreign firms that engage in dumping and thus protect domestic producers from unfair foreign competition.

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Countervailing Duties

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Anti-dumping duties.

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Political Arguments for Intervention

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Political arguments for government intervention cover a range of issues including protecting jobs, protecting industries deemed important for national security, retaliating against unfair foreign competition, protecting consumers from "dangerous" products, furthering the goals of foreign policy, and protecting the human rights of individuals in exporting countries.

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Helms-Burton Act

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Act passed in 1996 that allowed Americans to sue foreign firms that use Cuban property confiscated from them after the 1959 revolution.

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D'Amato Act

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Act passed in 1996, similar to the Helms-Burton Act, aimed at Libya and Iran.

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Economic Arguments for Intervention

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Economic arguments for intervention include the infant industry argument and strategic trade policy.

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Infant Industry Argument

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New industries in developing countries must be temporarily protected from international competition to help them reach a position where they can compete on world markets with the firms of developed nations.

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Strategic Trade Policy

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Government policy aimed at improving the competitive position of a domestic industry or domestic firm in the world market.

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Smoot-Hawley Act

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Enacted in 1930 by the U.S. Congress, this tariff erected a wall of barriers against imports into the United States. As other nations took similar steps, ultimately the world slipped into the Great Depression.

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GATT/WTO

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An international trading framework that enables governments to negotiate a set of rules to govern cross-border trade and lower trade barriers. For the first 50 years, the framework was known as the General Agreement on Tariffs and Trade (GATT). For the last 16 years, it has been known as the World Trade Organization (WTO). 1947-1979: GATT, Trade Liberalization, and Economic Growth. Membership grew from 19 countries to 120 countries. World trade grew at 8.9% annually, and world income grew at 5.1% annually. 1980-1993: Protectionist Trends

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Foreign exchange market

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Market for converting the currency of one country into that of another country.

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Exchange rate

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Rate at which one currency is converted into another.

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Foreign exchange risk

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The risk that changes in exchange rates will hurt the profitability of a business deal.

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Currency Speculation

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Involves the short-term movement of funds from one currency to another in the hopes of profiting from shifts in exchange rates

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Carry Trade

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Involves borrowing in one currency where interest rates are low and then using the proceeds to invest in another currency where interest rates are high.

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Hedging

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The process of insuring one's business against foreign exchange risk by using forward exchanges or currency swaps

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Spot Exchange Rate

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The exchange rate at which a foreign exchange dealer converts one currency into another currency on a particular day

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Forward Exchange

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When two parties agree to exchange currency and execute the deal at some specific date in the future.

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Forward Exchange Rate

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The exchange rate governing forward exchange transactions. For most major currencies, forward exchange rates are quoted for 30, 90, and 180 days.

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Currency Swap

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The simultaneous purchase and sale of a given amount of foreign exchange for two different value dates. Swaps are transacted between international businesses and their banks, between banks, and between governments when it is desirable to move out of one currency into another for a limited period without incurring foreign exchange rate risk.

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Arbitrage

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The purchase of securities in one market for immediate resale in another to profit from a price discrepancy.

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Law of One Price

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In competitive markets free of transportation costs and barriers to trade (such as tariffs), identical products sold in different countries must sell for the same price when their price is expressed in terms of the same currency

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Big Mac Index

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Every year, the newsmagazine The Economist publishes its own empirical test of the PPP theory. McDonald's Big Mac is used as a proxy for a "basket of goods" because it is produced according to an almost identical recipe in over 100 countries. The Big Mac PPP is a test on whether a currency is undervalued or overvalued at any given time. (Refer to Table 9.2, p. 323)

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Efficient market

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A market which has no impediments to the free flow of goods and services (such as trade barriers) and prices reflect all available public information. To express PPP theory in symbols, in efficient markets, the exchange rate E$/¥=P$/P¥. where E$/¥ is the dollar/yen exchange rate, P$ is the US dollar price of a basket of particular goods, and P¥ is the price of the same basket of goods in Japanese yen.

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Fisher Effect

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Nominal interest rates (i) in each country equal the required real rate of interest (r) and the expected rate of inflation over the period for which the funds are to be lent (I). That is, i = r + I

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International Fisher Effect

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For any two countries the spot exchange rate should change in an equal amount but in the opposite direction to the difference in nominal interest rates between two countries. Stated more formally: [(S1 - S2) / S2] x 100 = i$ - i¥

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Bandwagon Effect

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When traders move like a herd, all in the same direction and at the same time, in response to each other's perceived actions

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Inefficient market

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One in which prices do not reflect all available information

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Fundamental Analysis

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Draws on economic theory to construct sophisticated econometric models for predicting exchange rate movements.

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Technical Analysis

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Forecasters that use price and volume data to chart trends, and believe that past trends and waves are reasonable predictors of future trends and waves

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Freely convertible currency

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A currency is said to be freely convertible when a government of a country allows both residents and non-residents to purchase unlimited amounts of foreign currency with the domestic currency.

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Externally convertible currency

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Non-residents can convert their holdings of domestic currency into a foreign currency, but the ability of residents to convert currency is limited in some way

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Non-convertible currency

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A currency is nonconvertible when both residents and non-residents are prohibited from converting their holdings of domestic currency into a foreign currency.

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Capital flight

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A run on foreign exchange reserves when residents and nonresidents rush to convert their holdings of domestic currency into a foreign currency.

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Countertrade

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A range of barter like agreements by which goods and services can be traded for other goods and services. It can be used in international trade when a country's currency is nonconvertible.

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Transaction exposure

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Extent to which the income from individual transactions is affected by fluctuations in foreign exchange values

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Translation exposure

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Impact of currency exchange rate changes on the reported financial statements of a company

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Economic Exposure

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The extent to which a firm's future international earning power is affected by changes in exchange rates. Economic exposure is concerned with the long-term effect of changes in exchange rates on future prices, sales, and costs.

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Lead strategy

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Attempting to collect foreign currency receivables early when a foreign currency is expected to depreciate and paying foreign currency payables before they are due when a currency is expected to appreciate.

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Lag strategy

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Delaying collection of foreign currency receivables if that currency is expected to appreciate and delaying payables if the currency is expected to depreciate.

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3 Basic decisions facing firms contemplating international expansion

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1. Which market(s) to enter 2. When to enter the market and on what scale 3. How to enter (choice of entry modes) Ultimately, the firm wants to enter the markets with the greatest long term profit potential.

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Timing of Entry

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Entry is early when a firm enters a foreign market before other foreign firms and late when a firm enters after other international firms have established themselves

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First Mover Advantages

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Advantages accruing to the first to enter a market (Advantages include establishing a strong brand name, capturing dominant market share, develop a cost advantage, and create loyalty and significant switching costs)

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First Mover Disadvantages

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Disadvantages associated with entering a foreign market before other international businesses.

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Pioneering Costs

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Costs that an early entrant has to bear that a later entrant can avoid, such as time and effort in learning the rules, failure costs if the firm makes major mistakes, and the costs of promoting and establishing a product offering, as well as the costs of educating consumers about the product.

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6 modes to enter foreign markets

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1. Exporting 2. Turnkey Project 3. Licensing 4. Franchising 5. Joint Venture 6. Wholly Owned Subsidiaries

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1. Exporting

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Sale of products produced in one country to residents of another.

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2. Turnkey Project

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A project in which a firm agrees to set up an operating plant for a foreign client and hand over the "key" when the plant is fully operational.

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3. Licensing

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Occurs when a firm (the licensor) licenses the rights to produce its product, its production process, or its brand name or trademark to another firm (the licensee); in return, the licensor collects a royalty fee from the licensee.

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4. Franchising

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A specialized form of licensing in which the franchiser sells intangible property to the franchisee and insists on rules to conduct the business.

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5. Joint Venture

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Establishing a firm that is jointly owned by two or more otherwise independent firms.

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6. Wholly Owned Subsidiary

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A subsidiary in which the firm owns 100 percent of the stock

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Greenfield venture/startup

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Building a subsidiary (or joint venture) from the ground up

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Acquisition

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Acquiring an established enterprise in the target market

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Key Production and Logistics Questions

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1. Where to locate productive activities 2. What the long-term strategic role of foreign production sites should be 3. Whether to own foreign production activities or outsource those activities 4. How to manage a globally dispersed supply chain and what the role of Internet-based information technology should be in the management of global logistics 5. Whether to manage global logistics or outsource

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Production

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Activities involved in creating a product.

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Logistics

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The procurement and physical transmission of material through the supply chain, from suppliers to customers.

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Total Quality Management (TQM)

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TQM is a management philosophy that takes as its central focus the need to improve the quality of a company's products and services

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Six Sigma

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Statistically based philosophy that aims to reduce defects, boost productivity, eliminate waste, and cut costs throughout a company.

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ISO 9000

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Certification process that requires certain quality standards must be met.

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Minimum Efficient Scale

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The level of output at which most plant-level scale economies are exhausted.

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Flexible Manufacturing

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Lean Production

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(Lean Production)

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Manufacturing Technology designed to improve job scheduling, reduce setup time, and improve quality control. Lean production covers a range of manufacturing technologies that are designed to (i) reduce set up times for complex equipment (ii) increase the utilization of individual machines through better scheduling, and (iii) improve quality control at all stages of the manufacturing process.

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Mass customization

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The production of a variety of end products at a unit cost that could once be achieved only through mass production of a standardized output.

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Flexible machine cells

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Flexible manufacturing technology in which a grouping of various machine types, a common materials handler, and a centralized cell controller (computer) produce a family of products.

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Global learning

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The flow of skills and product offerings from foreign subsidiary to home country and from foreign subsidiary to foreign subsidiary. Idea that valuable knowledge does not reside just in a firm's domestic operations, it may also be found in its foreign subsidiaries

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Make-or-buy decisions

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Whether a firm should make or buy component parts

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Specialized Asset

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An asset designed to perform a specific task, whose value is significantly reduced in its next-best use.

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Just-in-time inventory

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Logistics system designed to deliver parts to a production process as they are needed, not before.

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