Business Explain: Multinational Business

Multinational Business

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Describe the different types of regional economic integration and give an example of each type.

Answer:

a. Free trade area (FTA): The goal of a free trade area is to abolish all tariffs among member countries. Free trade agreements usually begin modestly by eliminating tariffs on goods that already have low tariffs, and there is usually an implementation period over which all tariffs are eliminated on all products. In addition, each member country maintains its own external tariffs against non-FTA countries. Examples: the North American Free Trade Agreement, the Association of South East Asian Nations

b. Customs union: In addition to eliminating internal tariffs, member countries levy a common external tariff on goods being imported from nonmembers. Example: MERCOSUR

c. Common market: A common market has all the elements of a customs union, plus it allows free mobility of production factors such as labor and capital. Example: the European Union

Explain the static effects and dynamic effects of economic integration. What is the difference between trade creation and trade diversion resulting from economic integration?

Answer: Static effects are the shifting of resources from inefficient to efficient companies as trade barriers fall. Dynamic effects are the overall growth in the market and the impact on a company of expanding production and achieving greater economies of scale. Static effects may develop when either of two conditions occurs:

a. Trade creation: Production shifts to more efficient producers for reasons of comparative advantage, allowing consumers access to more goods at a lower price than would have been possible without integration.

b. Trade diversion: Trade shifts to countries in the group at the expense of trade with countries not in the group, even though the nonmember company might be more efficient in the absence of trade barriers.

Dynamic effects of integration occur when trade barriers come down and the size of the market increases, allowing companies to achieve economies of scale.

What are the functions of the European Commission, the European Parliament, the Council, and the European Court of Justice?

Answer:

a. The European Commission provides the European Union's political leadership and direction. The commission is composed of commissioners nominated by each member government and approved by the European Parliament. It drafts laws that it submits to the European Parliament and Council of the EU.

b. The three major responsibilities of the European Parliament are: legislative power, control over the budget, and supervision of executive decisions. The commission presents community legislation to the parliament. Parliament may approve legislation, amend it, or reject it outright. Parliament also approves the EU's budget each year and monitors spending.

c. The Council is composed of the ministers of the member countries. The Council passes laws and makes and enacts major policies. It works closely with the Commission and Parliament in adopting policies.

d. The European Court of Justice ensures consistent interpretation and application of EU treaties. Member states, community institutions, or individuals and companies may bring cases to the court. The Court of Justice is an appeals court for individuals, firms, and organizations fined by the commission for infringing treaty law. The Court of Justice is relevant to MNEs because it deals mostly with economic matters.

What are the rules of origin and regional content provisions of NAFTA?

Answer: Because NAFTA is a free trade agreement and not a customs union, each country sets its own tariffs for the rest of the world. Rules of origin ensure that only goods that have been the subject of substantial economic activity within the free trade area are eligible for the more liberal tariff conditions created by NAFTA. According to regional content rules, at least 50 percent of the net cost of most products must come from the NAFTA region. The exceptions are 55 percent for footwear, 62.5 percent for passenger automobiles and light trucks and the engines and transmissions for such vehicles, and 60 percent for other vehicles and automotive parts.

What has been the impact of NAFTA on trade and employment in NAFTA nations?

Answer: Trade and investment among the NAFTA members has increased significantly since the agreement was signed in 1994. The U.S. is the largest trade partner of Canada and Mexico, and both countries are among the most important exporters and importers for the U.S. Due to lower wages in Mexico, a lot of FDI has poured into Mexico, potentially displacing jobs in the United States. U.S. firms have come under criticism for taking advantage of cheaper wages and lax environmental standards. In addition, the agreement has not stopped the flow of illegal immigrants from Mexico to the U.S.

Identify and briefly compare the major regional trading groups in Latin America, Asia, and Africa.

Answer:

a. The major trade group in South America is MERCOSUR. In 1991, Brazil, Argentina, Paraguay, and Uruguay established MERCOSUR. MERCOSUR is significant because of its size; it generates 75 percent of South America's GNP. Another major group in South America is the Andean Group (CAN), which is composed of Bolivia, Colombia, Ecuador, and Peru. There are three major regional trading groups in Central America and the Caribbean: the Central American Common Market, the Central American Free Trade Agreement-Dominican Republic (which includes the United States), and the Caribbean Community and Common Market (CARICOM). These groups are hampered by their small markets and dependence on the United States for trade.

b. In Asia, the key group is the Association of South East Asian Nations (ASEAN), which was organized in 1967 and comprises Brunei, Cambodia, Indonesia, Laos, Malaysia, Myanmar, the Philippines, Singapore, Thailand, and Vietnam. It is promoting cooperation in many areas, including industry and trade. In 1993, the ASEAN countries formed the ASEAN Free Trade Area (AFTA) to deal with the specific intrazonal trade issues.

c. The Asia Pacific Economic Cooperation (APEC) is massive since it includes every country that borders the Pacific Ocean. In spite of the size of APEC, it does not engage in treaties like the other trade agreements, so it has potential but not much teeth.

d. Africa is divided into many different trading groups based on geographic proximity and links to former colonial powers. Most groups are hampered by poverty, small market size, and dependence on former colonial powers. The African Union is modeled loosely on the EU, but that type of integration will likely be very difficult.

Are commodity agreements effective? Why or why not?

Answer: Commodity agreements used to be influential in helping to stabilize commodity prices, but now they are more involved in disseminating information and promoting research. OPEC is an example of an effective producers' cartel that operates on quotas to try to stabilize prices. In general, very little can be done outside of market forces to influence price.

Why is geography important to most regional trade agreements? Provide examples of RTAs to illustrate your answer.

Answer: There are a number of reasons why geography matters in the case of RTAs. Neighboring countries often, though not always, share a common history, language, culture, and currency. Unless the countries are at war with each other, they usually have already developed trading ties. Close proximity reduces transportation costs, thereby making traded products cheaper in general. Armenia has RTAs in force with Kazakhstan, Moldova, the Russian Federation, Turkmenistan, and Ukraine. India has a number of trade agreements with most of the countries in its region. Germany, a member of the European Union, exports 62.9 percent of its merchandise exports to other EU members and imports 58.3 percent from them. Switzerland, which is not a member of the EU but which has a trade agreement with the EU, exports 59.7 percent of its merchandise exports to EU countries and imports 78 percent from them. NAFTA includes Canada, the United States, and Mexico.

In a brief essay, explain the roles of the World Trade Organization and the United Nations in international trade.

Answer: The World Trade Organization (WTO) replaced GATT in 1995 as a continuing means of trade negotiations that aspires to foster the principle of trade without discrimination and to provide a better means of mediating trade disputes and of enforcing agreements. The United Nations is composed of representatives of most of the countries in the world and influences international trade and development in a number of significant ways. The UN family of organizations is too large to list, but it includes the WTO, the International Monetary Fund, and the World Bank. If the UN performs its responsibilities, it should improve the environment in which MNEs operate around the world, reducing risk and providing greater opportunities.

What is the difference between a free trade agreement and a customs union? Provide examples of each in your answer.

Answer: The goal of an FTA is to abolish all tariffs between member countries. It usually begins modestly by eliminating tariffs on goods that already have low tariffs, and there is usually an implementation period during which all tariffs are eliminated on all products. Moreover, each member country maintains its own external tariffs against non-FTA countries. NAFTA is an example of a free trade agreement. The EU is considered a customs union by the WTO. In addition to eliminating internal tariffs, member countries levy a common external tariff on goods being imported from nonmembers. For example, the EU removed internal tariffs from 1959 to 1967, when it established a common external tariff. Now it negotiates as one region in the WTO rather than as separate countries. Customs unions account for less than 10 percent of the RTAs identified by the WTO.

What are the disadvantages of import restrictions in regards to creating domestic employment opportunities?

Answer: One problem with restricting imports in order to create jobs is that other countries might retaliate with their own restrictions. New import restrictions by a major country have usually brought quick retaliation, sometimes causing more job losses than gains in industries protected by the new restrictions. Even if no country retaliates, the restricting country will gain jobs one place and lose them somewhere else, such as in import-handling jobs. Imports may also help create jobs in other industries, and these industries may form pressure groups against protectionism.

Explain the rationale for and problems with making the infant-industry argument work as intended.

Answer: The infant-industry argument holds that a government should guarantee an emerging industry a large share of the domestic market until it becomes efficient enough to compete against imports. Developing countries still use this argument to support their protectionist policies. The infant-industry argument is based on the logic that although the initial output costs for an industry in a given country may be so high as to make it noncompetitive in world markets; over time the costs will decrease to a level sufficient to achieve efficient production. The cost reductions may occur for two reasons: As companies gain economies of scale and employees become more efficient through experience, total unit costs drop to competitive levels.

Although it is reasonable to expect costs to decrease over time, they may not go down enough, which poses two problems for protecting an industry. First, governments have difficulty identifying those industries that have a high probability of success. If infant-industry protection goes to an industry that does not reduce costs enough to make it competitive against imports, chances are its owners, workers, and suppliers will constitute a formidable pressure group that may prevent the importation of a cheaper competitive product. Second, even if policymakers can ascertain which industries are likely to succeed, it does not necessarily mean that companies in those industries should receive governmental assistance. Entrepreneurs may incur the costs and reap the benefits instead. For the infant-industry argument to be fully viable, future benefits should exceed early costs.

Why do developing countries sometimes impose import restrictions to increase their levels of industrialization?

Answer: Countries with a large manufacturing base generally have higher per capita incomes than do countries without such a base. Moreover, a number of countries, such as the United States and Japan, developed an industrial base while largely preventing competition from foreign-based production. Many developing countries use protection to increase their level of industrialization because of industrial countries' economic success and experience. Specifically, they believe:

a. Surplus workers can more easily increase manufacturing output than they can increase agricultural output.
b. Inflows of foreign investment in the industrial area will promote growth.
c. Prices and sales of traditional agricultural products and raw materials fluctuate too much, harming economies that depend on too few of them.
d. Markets and prices for industrial products will grow faster than those for agricultural products.

What is the difference between import substitution policies and export-led development policies? What are the potential effects of each?

Answer: Developing countries promote industrialization by restricting imports in order to encourage local production for local consumption goods which they formerly imported. This is known as import substitution. If the protected industries do not become efficient, consumers may have to support them by paying higher prices or higher taxes. In contrast to import substitution, some countries have achieved rapid economic growth by promoting export industries, an approach known as export-led development. These countries try to develop industries for which export markets should logically exist. Industrialization may result initially in import substitution, yet export-led development of the same products may be feasible later.

Many companies and industries argue that they should have the same access to foreign markets as foreign industries and companies have to their markets. In a short essay, discuss this issue of "comparable access," or "fairness."

Answer: From an economic standpoint, comparable access argues that in industries in which increased production will greatly decrease cost, either from scale economies or learning effects, producers that lack equal access to a competitor's market will have a disadvantage in gaining enough sales to be cost-competitive. The argument for equal access also is presented as one of fairness. There are at least two arguments against this fairness doctrine. First, there are advantages of freer trade, even if imposed unilaterally. Restrictions may deny one's own consumers lower prices. Second, governments would find it cumbersome and expensive to negotiate separate agreements for each of the many thousands of different products and services that might be traded.

What are common reasons that governments enact export restrictions? What are the possible negative consequences of such restrictions?

Answer: A country may limit exports of a product that is in short supply worldwide in order to favor domestic consumers. Typically, greater supply drops local prices beneath those in the intentionally undersupplied world markets. However, this discourages domestic producers from increasing output and encourages them to smuggle output to sell abroad. It also encourages foreign producers to develop substitutes or production of their own. Countries also fear that foreign producers will price their exports so artificially low that they drive domestic producers out of business, after which they charge monopoly prices. However, competition among foreign producers limits their ability to charge exorbitant prices. The ability to price low abroad may result from high domestic prices due to a lack of competition at home or from home country governmental subsidies.

What is dumping? What are the possible effects of dumping on a country's economy?

Answer: When companies export below cost or below their home country price, this is called dumping. Most countries prohibit imports of dumped products, but enforcement usually occurs only if the imported product disrupts domestic production. If there is no domestic production, then the only host country effect is a low price to its consumers. Companies may dump because they cannot otherwise build a market abroad. They can afford to dump if the competitive landscape allows them to charge high domestic prices or if their home country government subsidizes them. They may also incur short-term losses abroad if they believe they can recoup those losses after eliminating competitors in the market. Home country consumers or taxpayers seldom realize that they are, in effect, paying so that foreign consumers have low prices. A company believing it is competing against dumped products may ask its government to restrict the imports.

Briefly discuss the four non economic rationales for governmental intervention in the free movement of trade: maintaining essential industries, preventing shipments to unfriendly countries, maintaining or extending spheres of influence, and preserving national identity.

Answer:

a. Maintenance of essential industries (especially defense): A major consideration behind governmental action on trade is the protection of essential domestic industries during peacetime so that a country is not dependent on foreign sources of supply during war. This is called the essential-industry argument. This argument for protection has much appeal in rallying support for import barriers. However, in times of real crisis or military emergency, almost any product could be essential. Because of the high cost of protecting an inefficient industry or a higher-cost domestic substitute, the essential-industry argument should not be accepted without a careful evaluation of costs, real needs, and alternatives. Once an industry becomes protected, that protection is difficult to terminate because protected companies and their employees support politicians who will support their protection from imports.

b. Prevention of shipments to unfriendly countries: Groups concerned about security often use defense arguments to prevent exports, even to friendly countries, of strategic goods that might fall into the hands of potential enemies or that might be in short supply domestically. Export constraints may be valid if the exporting country assumes there will be no retaliation that prevents it from securing even more essential goods from the potential importing country. Trade controls on nondefense goods also may be used as a weapon of foreign policy to try to prevent another country from easily meeting its economic and political objectives.

c. Maintenance or extension of spheres of influence: Governments frequently give aid and credits to, and encourage imports from, countries that join a political alliance or vote a certain way within international bodies. A country's trade restrictions may also coerce governments to follow certain political actions or punish companies whose governments do not follow the actions.

d. Conservation of activities that help preserve a national identity: Countries are held together partially through a common sense of identity that sets their citizens apart from other nationalities. To protect this "separateness," countries limit foreign products and services in certain sectors, particularly the media.

Describe and compare the different types of tariffs (duties).

Answer: A tariff, or duty, the most common type of trade control, is a tax that a government levies on a good shipped internationally. If collected by the exporting country, it is known as an export tariff; if collected by a country through which the goods have passed, it is a transit tariff; if collected by the importing country, it is an import tariff. The import tariff is by far the most common. Import tariffs primarily serve as a means of raising the price of imported goods so that domestically produced goods will gain a relative price advantage.

A tariff may be protective even though there is no domestic production in direct competition. Tariffs also serve as a source of governmental revenue. Import tariffs are of little importance to large industrial countries, but are a major source of revenue in many developing countries. Transit tariffs were once a major source of revenue for countries, but they have been nearly abolished through governmental treaties. A government may assess a tariff on a per-unit basis, in which case it is a specific duty. It may assess a tariff as a percentage of the value of the item, in which case it is an ad valorem duty. If it assesses both specific and an ad valorem duty on the same product, the combination is a compound duty. A specific duty is easy for customs officials who collect duties to assess because they do not need to determine a good's value on which to calculate a percentage tax. Because an ad valorem tariff is based on the total value of the product, meaning the raw materials and the processing combined, developing countries argue that the effective tariff on the manufactured portion turns out to be higher than the published tariff rate.

In a short essay, list and discuss the nontariff barriers that relate to direct price influences: subsidies, aid and loans, customs valuations, and other direct price influences.

Answer:

a. Subsidies: Countries sometimes make direct payments (called subsidies) to domestic companies to reduce their costs or compensate them for losses incurred from selling abroad.

b. Aid and loans: Governments also give aid and loans to other countries. If the recipient is required to spend the funds in the donor country, some products can compete abroad that might otherwise be noncompetitive.

c. Customs valuation: Most countries have agreed on a procedure for assessing values when their customs agents levy tariffs, but customs must ascertain whether the invoice correctly identifies the product, its price, and its origin.

d. Other direct price influences: Countries frequently use other means to affect prices, including special fees, requirements that customs deposits be placed in advance of shipment, and minimum price levels at which goods can be sold after they have customs clearance.