Basic Factors and Ideas in International Business

Date: 2015-10-07; view: 760.

Most countries realize the advantages of world trade. Countries have developed their economies, increased production of goods, and met market demands through increased world trade. The interdependence among trading nations has provided increased business opportunities.

International trade develops because certain countries are able to pro­duce some goods more efficiently than other countries. They exchange goods to satisfy their needs and wants. Efficient production may be the result of several factors. A certain climate in a particular country may allow that country to grow agricultural products in abundance. For instance, the climates in the United States and Canada are suitable for production of large amounts of wheat. Natural resources such as oil or coal are abundant in other countries. Countries with a large pool of unskilled laborers are able to produce products which are labor inten­sive (requiring a lot of labor) more cheaply than countries with highly paid, skilled labor forces. Another factor is geographical location. Countries like Singapore and Panama engage in (deal in) banking and trading because they are located on world trade routes.

The Scottish economist, Adam Smith (1723-1790), theorized (believed) that in a free market countries produce whatever they can most efficiently grow or manufacture, or what is of the greatest advantage to them. In other words, if they can make more money growing cotton than making cloth, they grow cotton and export it. Then they import cloth from a country that makes cloth more efficiently than it grows cotton. In an uncon­trolled free market trade situation, there is international specialization (division of labor) which results in the most efficient production of goods. Therefore, competition guarantees that countries import products which are most efficiently manufactured abroad (in other countries) and export products which are most efficiently produced domestically (at home). Price is determined by the supply side of the market (quantity available for sale). Smith's theory was a theory of absolute advantage. The English economist, David Ricardo (1772-1823), refined Smith's theory to one of comparative advantage. He theorized that an exporting country does not have to be the most efficient producer of the product; it only has to be more efficient than the country which imports the product. Mutually beneficial trade (a basis for trade which benefits both countries) arises when one country has a comparative advantage.

There are several reasons why governments try to control the imports and exports of a country. One reason is that a country enjoys an advantage if it exports more than it imports. Wealth accrues to the exporting country. Some countries have special programs to encourage exports. They may be programs that provide marketing information, establish trade missions, subsidize exports, and provide tax benefits or incentives (reduce taxes). Government subsidies (financial support) allow companies to sell products cheaply. Sometimes these subsidized companies export their products and sell them cheaply overseas (in foreign countries). This practice is known as dumping. Dumping is selling on a foreign market at a price below the cost of production.

On the other hand, governments impose taxes and quotas to restrict (limit) imports of certain products. For example, to protect Japanese farmers, Japan limits the amount of produce that can be imported. Sometimes governments want to protect a domestic industry because that industry provides employment for the population. Not only the industries, but also the labor unions encourage the government to enact (establish) protectionist controls.

Protectionist measures (laws/controls) are in the form of duties (taxes) which eliminate the comparative advantage, or quotas which restrict the import of the product altogether. There are two forms of import tariffs (taxes): specific and ad valorem. A specific tariff is a certain amount of tax for each unit of the product, for example $500 for each automobile. An ad valorem tariff is based on the value of the product, for example 5% of its value. Thus, under an ad valorem tax a Rolls Royce imported to the United States would be taxed more than a Datsun. The imposition (levying) of the ad valorem tax depends upon first determining the value of the product. The United States uses the free on board (FOB) method, which is the cost of the product as it leaves the exporting country. European countries have adopted the cost insurance freight (CIF) method, which adds the value of place utility to the cost of the product. A tariff increases the price of the item, raises revenue for the government, and controls consumption through market forces. A quota has a different effect on the market because it limits the number of items imported. While under a quota there may be a higher price because of a limited supply, under a tariff it is the tax that creates a higher price: the supply is not limited.

In order to import and export products, there needs to be a system of international monetary exchange. While a few products like oil are always priced in dollars, most products must be paid for with the legal tender (currency) of the producing country. International trade involves the ex­change of one currency for another. Most currencies are now exchanged on a floating (variable) rate basis. There are no official exchange rates. The rates fluctuate (change) according to market forces. If large amounts of a country's currency are being exchanged, the exchange rate may vary greatly because demand, and therefore, the price of a currency is either rising or falling. Sometimes these great fluctuations in value threaten economic stability; then central banks change market forces by purchasing a foreign currency to support its price and maintain stability.

The amount of money that goes in and out of a country is referred to as the balance of payments. If a country is exporting more than it imports, it is receiving foreign currency and has a balance of trade surplus. If it is importing more than it exports, it is sending money out of the country and has a balance of trade deficit. Continued surpluses or deficits change the demand for the currency of a country and cause its value to float either upward or downward.

The comparative advantage which exporting countries enjoy sometimes changes. If transportation costs increase or currency exchange rates change, it may become cheaper to produce the product in the market country, especially if large amounts of exports are involved.

Exporting companies sometimes set up subsidiaries (branch companies) in the market countries. The larger company is referred to as the parent company. Some countries have laws restricting the foreign ownership of factories or other production facilities, while others encourage foreign investment. A large company that sets up production facilities in several different countries is referred to as a multinational. Multinational corporations develop a global (world wide) philosophy of management, marketing, and production. They choose to operate in those countries that afford (provide) them comparative advantages.