International Management
PGCBM 43
XLRI
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Importance of international management in today’s
context
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Course objectives
1) To expose students to the principles and practices of International Business.
2) To enable students to understand the process of internationalization of business and the various forces
influencing and shaping international business.
3) To help students to analyze the experiences of companies in managing and operating international
businesses
4) To promote strategic, global business thinking among students.
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Evaluation components
i. Group project on market identification and entry 40%
ii. End term exam: 60%
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[Link] to international business, International Trade
theory,
[Link] and institutions in international business
[Link] external environment – political, legal, economic
[Link] assessment for market entry
[Link] of entry
[Link] on market assessment and modes of entry
[Link] business strategy- logic of AAA
[Link] organization of international business
[Link] functional strategies to international business
[Link] in international business
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Internatio
nal Trade
Theory
SESSION 1
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Difference between national and global business/theories
Strategizing at the national level vs strategizing at the international level
Businesses and business models
Manager’s frame of decision making
Issues that are important
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WHY IS FREE TRADE BENEFICIAL?
Free trade - 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
Trade theory shows why it is beneficial for a country to engage in
international trade even for products it is able to produce for
itself
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A tale of two nations- Ghana and South Korea
40 years ago both countries were near the same levels
of development
How were the policies of Ghana and South Korea
different?
How did the difference in policies affect the two
countries differently?
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WHY IS FREE TRADE BENEFICIAL?
International trade allows a country
to specialize in the manufacture and export of products and
services that it can produce efficiently
import products and services that can be produced more
efficiently in other countries
limits on imports may be beneficial
to producers, but not beneficial for
consumers
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WHY DO CERTAIN
PATTERNS OF TRADE EXIST?
Some patterns of trade are fairly easy to explain
it is obvious why Saudi Arabia exports oil, Ghana exports
cocoa, and Brazil exports coffee
But, why does Switzerland export chemicals, pharmaceuticals,
watches, and jewelry?
Why does Japan export automobiles, consumer electronics, and
machine tools?
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WHAT ROLE DOES
GOVERNMENT HAVE IN TRADE?
The mercantilist philosophy makes a crude case for government involvement
in promoting exports and limiting imports
Smith, Ricardo, and Heckscher-Ohlin promote unrestricted free trade
New trade theory and Porter’s theory of national competitive advantage
justify limited and selective government intervention to support the
development of certain export-oriented industries
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WHAT IS MERCANTILISM?
Mercantilism (mid-16th century) suggests that it is in a country’s
best interest to maintain a trade surplus -to export more than it
imports
advocates government intervention to achieve a surplus in the
balance of trade
Mercantilism views trade as a zero-sum game - one in which a
gain by one country results in a loss by another
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WHAT IS SMITH’S THEORY OF ABSOLUTE ADVANTAGE?
Adam Smith (1776) argued that a country has an absolute
advantage in the production of a product when it is more
efficient than any other country in producing it
countries should specialize in the production of goods for which
they have an absolute advantage and then trade these goods
for goods produced by other countries
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HOW DOES THE THEORY
OF ABSOLUTE ADVANTAGE WORK?
Assume that two countries, Ghana and South Korea,
both have 200 units of resources that could either be
used to produce rice or cocoa
In Ghana, it takes 10 units of resources to produce one
ton of cocoa and 20 units of resources to produce one
ton of rice
Ghana could produce 20 tons of cocoa and no rice, 10 tons of
rice and no cocoa, or some combination of rice and cocoa
between the two extremes
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HOW DOES THE THEORY
OF ABSOLUTE ADVANTAGE WORK?
In South Korea it takes 40 units of resources to produce one ton of cocoa and
10 resources to produce one ton of rice
South Korea could produce 5 tons of cocoa and no rice, 20 tons of rice and
no cocoa, or some combination in between
Without trade
Ghana would produce 10 tons of cocoa and 5 tons of rice
South Korea would produce 10 tons of rice and 2.5 tons of cocoa
With specialization and trade
Ghana would produce 20 tons of cocoa
South Korea would produce 20 tons of rice
Ghana could trade 6 tons of cocoa to South Korea for 6 tons of rice
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HOW DOES THE THEORY
OF ABSOLUTE ADVANTAGE WORK?
After trade
Ghana would have 14 tons of cocoa left, and 6 tons of rice
South Korea would have 14 tons of rice left and 6 tons of cocoa
If each country specializes in the production of the good in which
it has an absolute advantage and trades for the other, both
countries gain
trade is a positive sum game
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HOW DOES THE THEORY
OF ABSOLUTE ADVANTAGE WORK?
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WHAT IS RICARDO’S THEORY
OF COMPARATIVE ADVANTAGE?
David Ricardo asked what happens when one country
has an absolute advantage in the production of all
goods
The theory of comparative advantage (1817) -
countries should specialize in the production of those
goods they produce most efficiently and buy goods that
they produce less efficiently from other countries
even if this means buying goods from other countries that they could produce more efficiently
at home
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HOW DOES THE THEORY OF COMPARATIVE ADVANTAGE
WORK?
Assume Ghana is more efficient in the production of both cocoa and rice
In Ghana, it takes 10 resources to produce one ton of cocoa, and 13 1/3
resources to produce one ton of rice
So, Ghana could produce 20 tons of cocoa and no rice, 15 tons of rice and no
cocoa, or some combination of the two
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HOW DOES THE THEORY OF COMPARATIVE ADVANTAGE
WORK?
In South Korea, it takes 40 resources to produce one ton of cocoa
and 20 resources to produce one ton of rice
So, South Korea could produce 5 tons of cocoa and no rice, 10
tons of rice and no cocoa, or some combination of the two
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HOW DOES THE THEORY OF COMPARATIVE ADVANTAGE WORK?
With trade
Ghana could export 4 tons of cocoa to South Korea in exchange for 4 tons of
rice
Ghana will still have 11 tons of cocoa, and 4 additional tons of rice
South Korea still has 6 tons of rice and 4 tons of cocoa
if each country specializes in the production of the good in which it has a
comparative advantage and trades for the other, both countries gain
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HOW DOES THE THEORY OF COMPARATIVE ADVANTAGE
WORK?
Comparative advantage theory provides a strong rationale for
encouraging free trade
total output is higher
both countries benefit
Trade is a positive sum game
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HOW DOES THE THEORY OF COMPARATIVE ADVANTAGE
WORK?
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IS UNRESTRICTED FREE TRADE ALWAYS BENEFICIAL?
Unrestricted free trade is beneficial, but the gains may not be as great
as the simple model of comparative advantage would suggest
immobile resources
diminishing returns
dynamic effects and economic growth
the Samuelson critique
But, opening a country to trade could increase
a country's stock of resources as increased supplies become available from
abroad
the efficiency of resource utilization and so free up resources for other uses
economic growth
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COULD A RICH COUNTRY BE WORSE OFF WITH FREE TRADE?
Paul Samuelson - the dynamic gains from trade may not
always be beneficial
free trade may ultimately result in lower wages in the rich country
The ability to offshore services jobs that were
traditionally not internationally mobile may have the
effect of a mass inward migration into the United
States, where wages would then fall
but, protectionist measures could create a more harmful situation than free trade
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WHAT IS THE
HECKSCHER-OHLIN THEORY?
Eli Heckscher (1919) and Bertil Ohlin (1933) - comparative
advantage arises from differences in national factor endowments
the extent to which a country is endowed with resources like land,
labor, and capital
The more abundant a factor, the lower its cost
The pattern of trade is determined by factor endowments
Heckscher and Ohlin predict that countries will
export goods that make intensive use of locally abundant factors
import goods that make intensive use of factors that are locally
scarce
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DOES THE HECKSCHER-OHLIN
THEORY HOLD?
Wassily Leontief (1953) theorized that since the U.S.
was relatively abundant in capital compared to other
nations, the U.S. would be an exporter of capital
intensive goods and an importer of labor-intensive
goods.
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
trade theory, it became known as the Leontief Paradox
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The above mentioned ‘trade theories’ imply that
• Nations could benefit from trade.
• Hence some of the micro level actors- such as firms could also
benefit from this value creation.
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WHAT IS THE ‘PRODUCT LIFE CYCLE’ THEORY?
The product life-cycle theory - as products mature both the
location of sales and the optimal production location will change
affecting the flow and direction of trade
proposed by Ray Vernon in the mid-1960s
At this time most of the world’s new products were developed by U.S. firms and
sold first in the U.S.
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WHAT IS THE
PRODUCT LIFE CYCLE THEORY?
According to the product life-cycle theory
the size and wealth of the U.S. market gave U.S. firms a strong incentive to
develop new products
initially, the product would be produced and sold in the U.S.
as demand grew in other developed countries, U.S. firms would begin to
export
demand for the new product would grow in other advanced countries over
time making it worthwhile for foreign producers to begin producing for their
home markets
U.S. firms might set up production facilities in advanced countries with
growing demand, limiting exports from the U.S.
As the market in the U.S. and other advanced nations matured, the product
would become more standardized, and price would be the main competitive
weapon
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WHAT IS THE PRODUCT LIFE CYCLE THEORY?
Producers based in advanced countries where labor
costs were lower than the United States might now be
able to export to the United States
If cost pressures were intense, developing countries
would acquire a production advantage over advanced
countries
Production became concentrated in lower-cost foreign
locations, and the U.S. became an importer of the
product
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WHAT IS THE PRODUCT LIFE CYCLE THEORY?
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WHAT IS THE PRODUCT LIFE CYCLE THEORY?
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DOES THE PRODUCT LIFE
CYCLE THEORY HOLD?
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
mature industries leave the U.S. for low cost assembly locations
But, the globalization and integration of the world economy has made this theory less valid today
the theory is ethnocentric
production today is dispersed globally
products today are introduced in multiple markets simultaneously
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WHAT IS NEW TRADE THEORY?
New trade theory suggests that the ability of firms to
gain economies of scale (unit cost reductions
associated with a large scale of output) can have
important implications for international trade
Countries may specialize in the production and export
of particular products because in certain industries, the
world market can only support a limited number of
firms
new trade theory emerged in the 1980s
Paul Krugman won the Nobel prize for his work in 2008
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WHAT IS NEW TRADE THEORY?
[Link] its impact on economies of scale, trade can
increase the variety of goods available to consumers
and decrease the average cost of those goods
without trade, nations might not be able to produce those
products where economies of scale are important
with trade, markets are large enough to support the production
necessary to achieve economies of scale
so, trade is mutually beneficial because it allows for the
specialization of production, the realization of scale economies,
and the production of a greater variety of products at lower
prices
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WHAT IS NEW TRADE THEORY?
[Link] those industries when output required to attain
economies of scale represents a significant proportion
of total world demand, the global market may only be
able to support a small number of enterprises
first mover advantages - the economic and strategic advantages that accrue to early entrants
into an industry
economies of scale
first movers can gain a scale based cost advantage that later entrants find difficult to match
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WHAT ARE THE IMPLICATIONS OF
NEW TRADE THEORY FOR NATIONS?
Nations may benefit from trade even when they do not
differ in resource endowments or technology
a country may dominate in the export of a good simply
because it was lucky enough to have one or more firms among
the first to produce that good
Governments should consider strategic trade policies
that nurture and protect firms and industries where first
mover advantages and economies of scale are
important
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WHAT IS PORTER’S DIAMOND OF COMPETITIVE ADVANTAGE?
Michael Porter (1990) tried to explain why a nation
achieves international success in a particular industry
identified four attributes that promote or impede the creation of competitive advantage
[Link] endowments - a nation’s position in factors of
production necessary to compete in a given industry
can lead to competitive advantage
can be either basic (natural resources, climate, location) or
advanced (skilled labor, infrastructure, technological know-
how)
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WHAT IS PORTER’S DIAMOND OF COMPETITIVE ADVANTAGE?
[Link] conditions - the nature of home demand for
the industry’s product or service
influences the development of capabilities
sophisticated and demanding customers pressure firms to be
competitive
[Link] and supporting industries - the presence or
absence of supplier industries and related industries
that are internationally competitive
can spill over and contribute to other industries
successful industries tend to be grouped in clusters in countries
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WHAT IS PORTER’S DIAMOND OF COMPETITIVE ADVANTAGE?
[Link] strategy, structure, and rivalry - the conditions
governing how companies are created, organized, and
managed, and the nature of domestic rivalry
different management ideologies affect the development of
national competitive advantage
vigorous domestic rivalry creates pressures to innovate, to
improve quality, to reduce costs, and to invest in upgrading
advanced features
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PORTER’S DIAMOND OF COMPETITIVE ADVANTAGE
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DOES PORTER’S THEORY HOLD?
Government policy can
affect demand through product standards
influence rivalry through regulation and antitrust laws
impact the availability of highly educated workers and advanced
transportation infrastructure.
The four attributes, government policy, and chance work as
a reinforcing system, complementing each other and in
combination creating the conditions appropriate for
competitive advantage
So far, Porter’s theory has not been sufficiently tested to
know how well it holds up
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WHAT ARE THE IMPLICATIONS OF TRADE THEORY FOR MANAGERS?
[Link] implications - a firm should disperse its various
productive activities to those countries where they can be
performed most efficiently
firms that do not may be at a competitive disadvantage
[Link]-mover implications - a first-mover advantage can help a
firm dominate global trade in that product
[Link] implications - firms should work to encourage
governmental policies that support free trade
want policies that have a favorable impact on each component
of the diamond
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WHAT IS THE
BALANCE OF PAYMENTS?
A country’s balance of payments accounts keep track of
the payments to and receipts from other countries for a
particular time period
double entry bookkeeping
sum of the current account balance, the capital account and the financial account should be
zero
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WHAT IS THE
BALANCE OF PAYMENTS?
There are three main accounts
[Link] current account records transactions of goods, services, and
income, receipts and payments
current account deficit - a country imports more than it exports
current account surplus – a country exports more than it imports
[Link] capital account records one time changes in the stock of assets
[Link] financial account records transactions that involve the purchase or
sale of assets
net change in Indian assets owned abroad
foreign owned assets in India
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IS A CURRENT
ACCOUNT DEFICIT BAD?
Question: Does current account deficit in India matter?
A current account deficit implies a net debtor
so, a persistent deficit could limit future economic growth
But, even though capital is flowing out of India as
payments to foreigners, much of it flows back in as
investments in assets
Yet, suppose foreigners stop buying Indian assets and
sell their rupees for another currency?
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Free trade in Africa
What are the implications of the tripartite trade agreement?
Why are African countries more likely to trade with US or Europe
rather than with each other
If a common African market is established, what are the
implications
What are the problems in implementing this agreements
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Implications for the firm from the trade theories
• Value can be created through international trade
• Firms which are involved in it/facilitating trade can capture part of the value
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