Global Business Management

S3 MBA

Evolution and Development of International Business

Process of Evolution MNCs do not emerge overnight. Domestics firms, after expanding their operation and going through various stages of the evolution process, qualify for being called an MNC. The process of evolution takes place in three stages:
Trade Assembly or Production Integration
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Early Developments
International trade is many centuries old. In the 16th and 17th centuries, international trade was carried out by individuals seeking fortunes for themselves. The reward was often great, but the risk of the voyage was also very high. Exotic goods that were traded normally were those that were sold at a soaring prices. It was the fabulous profits that motivated some firms to operate abroad
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Cont
In the wake of Industrial Revolution in Europe, the character of international Business changed. International enterprises came to be engaged in extracting, processing and transporting raw materials for industrial plants located in the home country and also in exporting their manufactured goods back to the raw material producing countries
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Post-War Developments
By the mid 1940s, the economy of the US turned out to be the strongest American industries were well developed and needed to acquire new sources of raw material. They capture the largest share of the world market

In 1960s, many European firms too turned into multinationals and

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Cont
In 1970 only one MNC was listed among the world largest 50 companies. By the end of the decade, the number rose to six
By 1980s, the Japanese became the largest producers of automobiles- a position that was enjoyed by the USA until then
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Recent Trends
Along with rapid internationalisation of firms, world trade both intra-firm and inter-firm grew manifold. The reduction of tariff and non-tariff barriers under the aegis of GATT and now under the WTO umbrella too gave a fillip to international trade. International business has witnessed a phenomenal growth in the recent years.
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Importance of International business

Profit Advantage Growth Opportunities Domestic Market Constraints Competition Government Policies and regulations Monopoly Power Spin-offs of International Business Strategic Vision
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Theories of International Business Mercantilists Version

Mercantilists Version Mercantilism stretched over nearly three centuries, ending in the last quarter of the eighteenth century. For the Purpose of consolidation, they required gold that could best be accumulated through trade surplus. Government monopolised trade activities, provides subsidiary and other incentives for export and restricted imports
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Cont
Most European countries were colonial powers, they imported low cost raw material from that colonies and exported high cost manufactured good to the colonies. This was done in order to generate export surplus. Increasing gold holding through export augmentation and import restrictions lay at the root of the Mercantilists theory
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Cont
The later version of the mercantilists doctrine explained that trade surplus was not an over lasting phenomenon of positive trade balance led to increase in the commodity prices relative to other countries. The increase in the commodity caused a drop in the export and thereby erosion in the surolus of the trade balance.
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Classical Approach
Classical economist refuted the mercantilists notion of precious metals and Specie being the source of wealth: and thereby assumed productive efficiency to be the motivating factor being trade. There are two classical approach theories
One propounded by Adam Smith The other propounded by David Ricardo

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Theory of Absolute cost Advantage

Adam Smith was one of the forerunners of the classical school of thoughts. He propounded a theory of absolute cost advantage for International trade in 1776. He was on the opinion that productive efficiency differed among different countries because of diversity in the natural and acquired resources possessed by them.
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Cont
A particular country should specialise in producing only those goods that it is able to produce with greater efficiency or at lower cost will lead to optimal utilisation of resources in both the countries. Both countries will gain from trade in so far as both of them will get two sets of goods at the least cost.
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Cont
Adam Smith explains the concept of absolute advantage in a two-commodity two country frame work Failure of the theory The theory explains how trade helps increase the total output in the two countries. But it fails to explain whether trade will exist if any of the two countries produces both the goods at lower cost.
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Theory of Comparative cost

Davis Ricardo illustrated the Comparative cost theory of International trade in 1871. Some countries have the advantage of producing some goods at a lower cost compared to the other countries. This is due to the availability of raw materials, advanced technology, competent management practices, etc.
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Cont
Availability of these factors enhances productivity and thereby reduces the cost of production per unit. Similarly other countries have this advantage in producing other goods Example: Japan has the advantage in producing electronics at low cost, where as India has similar advantage in producing textiles.
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Cont
According to this theory the countries in the long run will tend to specialise in the business of those goods in whose business they enjoy comparative low cost advantage and import other good in which the countries have comparative cost advantage in free trade. David Ricardo used a two country, two commodity model. The conclusion of this model are.
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Cont
Business between two countries is profitable when a country produces one good at the lower cost than other country and other produces another good at a lower cost than the former country. Business between two countries is also profitable when one country produces more than one product efficiently. Both the nations can engage in business when one country specialise in the production in which it has greater efficiency in production
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Cont
Assumptions of the theory
The only element of the cost of production is labour Production is subject to the law of constant returns There are no trade barriers Trade is free from cost of transportation.

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Factor Proportion Theory

The theory explains that in a two-country, two factors and two commodity frame work different countries are endowed with varying proportions of different factors of production. Some countries have large populations and large labour resources others have abundance of capital but are short of labour resources.
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Cont
Thus a country with a large labour force will be able to produce goods at a lower cost using a labour intensive mode of production Similarly countries with a large supply of capital will specialise in goods that involve a capital intensive mode of production

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Neo Factor proportion theory

Extending Leontiefs view, some of the economist emphasise on the point that it is not only the abundance of a particular factor, but also the quality of that factor of production that influences the pattern of international trade.

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Cont
The quality is so important in their view that they analyse the trade theory in a three factor frame work instead of two factor frame work taken into account by Heckscher and others The third factor manifests the form of Human capital Skill intensity Economies of scale Research and development
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Foreign Direct Investment

Foreign direct investment (FDI) happens when a firm invests directly in facilities in a foreign country
A firm that engages in FDI becomes a multinational enterprise (MNE) Multinational = More than one country

Factors which influence FDI are related to factors that stimulate trade across national borders
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Definition
Foreign Direct Investment, or FDI, is a type of investment that involves the injection of foreign funds into an enterprise that operates in a different country of origin from the investor.

Foreign Direct Investment

Involves ownership of entity abroad for
Production Marketing/service R&D Raw materials or other resource access

Parent has direct managerial control

The degree of direct managerial control depends on the extent of ownership of the foreign entity and on other contractual terms of the FDI No managerial involvement = portfolio investment
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Forms of FDI
Purchase of existing assets Quick entry, local market know-how, local financing may be possible, eliminate competitor, buying problems New investment No local entity exists or is available for sale, local financial incentives may encourage, no inherited problems, long lead time to generation of sales or other desired outcome Participation in an international joint-venture Shared ownership with local and/or other non-local partner

Why FDI?
FDI over exporting High transportation costs, trade barriers FDI over licensing or franchising Need to retain strategic control Need to protect technological know-how Capabilities not suitable for licensing/franchising

Host Country Effects of FDI

Benefits Resource -transfer Employment Balance-of-payment (BOP) Import substitution Source of export increase Costs Adverse effects on the BOP Capital inflow followed by capital outflow + profits Production input importation Threat to national sovereignty and autonomy Loss of economic independence

Home Country Effects of FDI

Benefits
BOP current account adversely affected by inward flow of foreign earnings Positive employment effect from increased exports of raw materials / assemblies to the overseas subsidiary Repatriation of skills and know-how

Costs
BOP trade position is negatively affected (lower finished goods exports) Loss of employment to overseas market

Government Policy and FDI

Home country
Outward FDI encouragement
Risk reduction policies (financing, insurance, tax incentives)

Outward FDI restrictions

National security, BOP

Host country
Inward FDI encouragement
Investment incentives Job creation incentives

Inward FDI restrictions

Ownership extent restrictions (national security; local nationals can safeguard host countrys interests