International Business Hill Summary chapters 6-12 PDF

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International Business: Competing in the Global Marketplace by Charles W. L. Hill Chapter 6 This chapter reviewed theories that attempt to explain the pattern of FDI between countries. This objective takes on added importance in light of the expanding volume of FDI in the world economy. As we saw early in the chapter, the volume of FDI has grown more rapidly than the volume of world trade in recent years. We also noted that any theory seeking to explain FDI must explain why firms go to the trouble of acquiring or establishing operations abroad when the alternatives of exporting and licensing are available. We reviewed a number of theories that attempt to explain horizontal and vertical FDI. With regard to horizontal FDI, it was argued that the market imperfections and location-specific advantages approaches might have the greatest explanatory power and therefore be most useful for business practice. This is not to belittle the explanations for horizontal FDI put forward by Vernon and Knickerbocker, since these theories also have value in explaining the pattern of FDI in the world economy. Still, both theories are weakened by their failure to explicitly consider the factors that drive the choice among exporting, licensing, and FDI. Finally, with regard to vertical FDI, it was argued that the strategic behavior and market imperfections approaches both have a certain amount of explanatory power. This chapter made the following points: 1. Foreign direct investment occurs when a firm invests directly in facilities to produce a product in a foreign country. It also occurs when a firm buys an existing enterprise in a foreign country. 2. Horizontal FDI is FDI in the same industry abroad as a firm operates at home. Vertical FDI is FDI in an industry abroad that provides inputs into a firm's domestic operations. 3. Any theory seeking to explain FDI must explain why firms go to the trouble of acquiring or establishing operations abroad when the alternatives of exporting and licensing are available. 4. Several factors characterized FDI trends over the past 20 years; (1) there has been a rapid increase in the total volume of FDI undertaken; (2) there has been some decline in the relative importance of the United States as a source for FDI, while several other countries, most notably Japan, have increased their share of total FDI outflows; (3) an increasing share of FDI seems to be directed at the developing nations of Asia and Eastern Europe, while the United States has become a major recipient of FDI; and (4) there has been a notable increase in the amount of FDI undertaken by firms based in developing nations. 5. High transportation costs and/or tariffs imposed on imports help explain why many firms prefer horizontal FDI or licensing over exporting. 6. Impediments to the sale of know-how explain why firms prefer horizontal FDI to licensing. These impediments arise when: (a) a firm has valuable know-how that cannot be adequately protected by a licensing contract, (b) a firm needs tight control over a foreign entity to maximize its market share and earnings in that country, and ( c) a firm's skills and know-how are not amenable to licensing. 7. Knickerbocker's theory suggests that much FDI is explained by imitative strategic behavior by rival firms in an oligopolistic industry. However, this theory does not address the issue of whether FDI is more efficient than exporting or licensing for expanding abroad. 8. Vernon's product life-cycle theory suggests that firms undertake FDI at particular stages in the life cycle of products they have pioneered. However, Vernon's theory does not address the issue of whether FDI is more efficient than exporting or licensing for expanding abroad. 9. Dunning has argued that location-specific advantages are of considerable importance in explaining the nature and direction of FDI. According to Dunning, firms undertake FDI to exploit resource endowments or assets that are location-specific. 10. Backward vertical FDI may be explained as an attempt to create barriers to entry by gaining control over the source of material inputs into the downstream stage of a production process. Forward vertical FDI may be seen as an attempt to circumvent entry barriers and gain access to a national market.

11. The market imperfections approach suggests that vertical FDI is a way of reducing a firm's exposure to the risks that arise from investments in specialized assets. 12. From a business perspective, the most useful theory is probably the market imperfections approach, because it identifies how the relative profit rates associated with horizontal FDI, exporting, and licensing vary with circumstances.

Chapter 7 This chapter examined governments' influence on firms' decisions to invest in foreign countries. By their choice of policies, both host-country and home-country governments encourage and restrict FDI. We also explored the factors that influence negotiations between a host-country government and a firm contemplating FDI. The chapter made the following points:

1. An important determinant of government policy toward FDI is political ideology. Political ideology ranges from a radical stance that is hostile to FDI to a noninterventionist, free market stance. Between the two extremes is an approach best described as pragmatic nationalism. 2. The radical view sees the MNE as an imperialist tool for exploiting host countries. According to this view, no country should allow FDI. Due to the collapse of communism, the radical view was in retreat everywhere by the end of the 1990s. 3. The free market view sees the MNE as an instrument for increasing the overall efficiency of resource utilization in the world economy. FDI can be viewed as a way of dispersing the production of goods and services to those locations around the globe where they can be produced most efficiently. This view is embraced in principle by a number of nations; in practice, however, most are pragmatic nationalists. 4. Pragmatic nationalism views FDI as having both benefits and costs. Countries adopting a pragmatic stance pursue policies designed to maximize the benefits and minimize the costs of FDI. 5. The benefits of FDI to a host country arise from resource-transfer effects, employment effects, balance-of-payments effects, and its ability to promote competition. 6. FDI can make a positive contribution to a host economy by supplying capital, technology, and management resources that would otherwise not be available. Such resource transfers can stimulate the economic growth of the host economy. 7. Employment effects arise from the direct and indirect creation of jobs by FDI. 8. Balance-of-payments effects arise from the initial capital inflow to finance FDI, from import substitution effects, and from subsequent exports by the new enterprise. 9. By increasing consumer choice, foreign direct investment can help to increase the level of competition in national markets, thereby driving down prices and increasing the economic welfare of consumers. 10. The costs of FDI to a host country include adverse effects on competition and balance of payments and a perceived loss of national sovereignty. 11. Host governments are concerned that foreign MNEs may have greater economic power than indigenous companies and that they may be able to monopolize the market. 12. Adverse effects on the balance of payments arise from the outflow of a foreign subsidiary's earnings and from the import of inputs from abroad. 13. National sovereignty concerns are raised by FDI because key decisions that affect the host country will be made by a foreign parent that may have no real commitment to the host country and the host government will have no control over them. 14. The benefits of FDI to the home (source) country include improvement in the balance of payments as a result of the inward flow of foreign earnings, positive employment effects when the foreign subsidiary creates demand for home-country exports, and benefits from a reverse resource-transfer effect. A reverse resource-transfer effect arises when the foreign subsidiary learns valuable skills abroad that can be transferred back to the home country. 15. The costs of FDI to the home country include adverse balance-of-payments effects that arise

from the initial capital outflow and from the export substitution effects of FDI. Costs also arise when FDI exports jobs abroad. 16. Home countries can adopt policies designed to both encourage and restrict FDI. Host countries try to attract FDI by offering incentives and try to restrict FDI by dictating ownership restraints and requiring that foreign MNEs meet specific performance requirements. 17. A firm considering FDI usually must negotiate the terms of the investment with the host government. The object of any negotiation 18. is to reach an agreement that benefits both parties. Negotiation inevitably involves compromise. 19. The outcome of negotiation is typically determined by the relative bargaining powers of the foreign MNE and the host government. Bargaining power depends on the value each side places on what the other has to offer, the number of comparable alternatives available to each side, and each party's time horizon. Chapter 8 This chapter pursued three main objectives: to examine the economic and political debate surrounding regional economic integration; to review the progress toward regional economic integration in Europe, the Americas, and elsewhere; and to distinguish the important implications of regional economic integration for the practice of international business. This chapter made the following points:

1. A number of levels of economic integration are possible in theory. In order of increasing integration, they include a free trade area, a customs union, a common market, an economic union, and full political union. 2. In a free trade area, barriers to trade between member countries are removed, but each country determines its own external trade policy. In a customs union, internal barriers to trade are removed and a common external trade policy is adopted. A common market is similar to a customs union, except that a common market also allows factors of production to move freely between countries. An economic union involves even closer integration, including the establishment of a common currency and the harmonization of tax rates. A political union is the logical culmination of attempts to achieve ever-closer economic integration. 3. Regional economic integration is an attempt to achieve economic gains from the free flow of trade and investment between neighboring countries. 4. Integration is not easily achieved or sustained. Although integration brings benefits to the majority, it is never without costs for the minority. Furthermore, concerns over national sovereignty often slow or stop integration attempts. 5. Regional integration will not increase economic welfare if the trade creation effects in the free trade area are outweighed by the trade diversion effects. 6. The Single European Act sought to create a true single market by abolishing administrative barriers to the free flow of trade and investment between EU countries. 7. The Maastricht Treaty aims to take the EU even further along the road to economic union by establishing a common currency. The economic gains from a common currency come from reduced exchange costs, reduced risk associated with currency fluctuations, and increased price competition within the EU. 8. Although no other attempt at regional economic integration comes close to the EU in terms of potential economic and political significance, various other attempts are being made in the world. The most notable include NAFTA in North America, the Andean Pact and MERCOSUR in Latin America, ASEAN in Southeast Asia, and (perhaps) APEC. 9. The creation of single markets in the EU and North America means that many markets that were formerly protected from foreign competition are now more open. This creates major investment and export opportunities for firms within and outside these regions. 10. The free movement of goods across borders, the harmonization of product standards, and the simplification of tax regimes make it possible for firms based in a free trade area to realize potentially enormous cost economies by centralizing production in those locations within the area where the mix of factor costs and skills is optimal. 11. The lowering of barriers to trade and investment between countries within a trade group will

probably be followed by increased price competition. Chapter 9 This chapter explained how the foreign exchange market works, examined the forces that determine exchange rates, and then discussed the implications of these factors for international business. Given that changes in exchange rates can dramatically alter the profitability of foreign trade and investment deals, this is an area of major interest to international business. This chapter made the following points:

1. One function of the foreign exchange market is to convert the currency of one country into the currency of another.

2. International businesses participate in the foreign exchange market to facilitate international trade and investment, to invest spare cash in short-term money market accounts abroad, and to engage in currency speculation. 3. A second function of the foreign exchange market is to provide insurance against foreign exchange risk. 4. The spot exchange rate is the exchange rate at which a dealer converts one currency into another currency on a particular day. 5. Foreign exchange risk can be reduced by using forward exchange rates. A forward exchange rate is an exchange rate governing future transactions. 6. Foreign exchange risk can also be reduced by engaging in currency swaps. A swap is the simultaneous purchase and sale of a given amount of foreign exchange for two different value dates. 7. The law of one price holds that in competitive markets that are free of transportation costs and barriers to trade, identical products sold in different countries must sell for the same price when their price is expressed in the same currency. 8. Purchasing power parity (PPP) theory states the price of a basket of particular goods should be roughly equivalent in each country. PPP theory predicts that the exchange rate will change if relative prices change. 9. The rate of change in countries' relative prices depends on their relative inflation rates. A country's inflation rate seems to be a function of the growth in its money supply. 10. The PPP theory of exchange rate changes yields relatively accurate predictions of long-term trends in exchange rates, but not of short-term movements. The failure of PPP theory to predict exchange rate changes more accurately may be due to the existence of transportation costs, barriers to trade and investment, and the impact of psychological factors such as bandwagon effects on market movements and short-run exchange rates. 11. Interest rates reflect expectations about inflation. In countries where inflation is expected to be high, interest rates also will be high. 12. The International Fisher Effect states that 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. 13. The most common approach to exchange rate forecasting is fundamental analysis. This relies on variables such as money supply growth, inflation rates, nominal interest rates, and balance-ofpayments positions to predict future changes in exchange rates. 14. In many countries, the ability of residents and nonresidents to convert local currency into a foreign currency is restricted by government policy. A government restricts the convertibility of its currency to protect the country's foreign exchange reserves and to halt any capital flight. 15. Particularly bothersome for international business is a policy of nonconvertibility, which prohibits residents and nonresidents from exchanging local currency for foreign currency. A policy of nonconvertibility makes it very difficult to engage in international trade and investment in the country. 16. One way of coping with the nonconvertibility problem is to engage in countertrade -- to trade goods and services for other goods and services. Chapter 10

This chapter explained the workings of the international monetary system and pointed out its implications for international business. This chapter made the following points: 1. The gold standard is a monetary standard that pegs currencies to gold and guarantees convertibility to gold. 2. It was thought that the gold standard contained an automatic mechanism that contributed to the simultaneous achievement of a balance-of-payments equilibrium by all countries. 3. The gold standard broke down during the 1930s as countries engaged in competitive devaluations. 4. The Bretton Woods system of fixed exchange rates was established in 1944. The US dollar was the central currency of this system; the value of every other currency was pegged to its value. Significant exchange rate devaluations were allowed only with the permission of the IMF. 5. The role of the IMF was to maintain order in the international monetary system ( i) to avoid a repetition of the competitive devaluations of the 1930s and (ii ) to control price inflation by imposing monetary discipline on countries. 6. To build flexibility into the system, the IMF stood ready to lend countries funds to help protect their currency on the foreign exchange market in the face of speculative pressure, and to assist countries in correcting a fundamental disequilibrium in their balance-of-payments position. 7. The fixed exchange rate system collapsed in 1973, primarily due to speculative pressure on the dollar following a rise in US inflation and a growing US balance-of-trade deficit. 8. Since 1973 the world has operated with a floating exchange rate regime, and exchange rates have become more volatile and far less predictable. Volatile exchange rate movements have helped reopen the debate over the merits of fixed and floating systems. 9. The case for a floating exchange rate regime claims: ( i) that such a system gives countries autonomy regarding their monetary policy and ( ii) that floating exchange rates facilitate smooth adjustment of trade imbalances. 10. The case for a fixed exchange rate regime claims: ( i) that the need to maintain a fixed exchange rate imposes monetary discipline on a country, ( ii) that floating exchange rate regimes are vulnerable to speculative pressure, (iii) that the uncertainty that accompanies floating exchange rates dampens the growth of international trade and investment, and (iv ) that far from correcting trade imbalances, depreciating a currency on the foreign exchange market tends to cause price inflation. 11. In today's international monetary system, some countries have adopted floating exchange rates, some have pegged their currency to another currency, such as the US dollar, and some have pegged their currency to a basket of other currencies, allowing their currency to fluctuate within a zone around the basket. 12. In the post-Bretton Woods era, the IMF has continued to play an important role in helping countries navigate their way through financial crises by lending significant capital to embattled governments and by requiring them to adopt certain macroeconomic policies. 13. There is an important debate taking place over the appropriateness of IMF-mandated macroeconomic policies. Critics charge that the IMF often imposes inappropriate conditions on developing nations that are the recipients of its loans. 14. The present managed-float system of exchange rate determination has increased the importance of currency management in international businesses. 15. The volatility of exchange rates under the present managed-float system creates both opportunities and threats. One way of responding to this volatility is for companies to build strategic flexibility by dispersing production to different locations around the globe by contracting out manufacturing (in the case of low-value-added manufacturing) and other means. Chapter 11 This chapter explained the functions and form of the global capital market and defined the implications of this for inte...