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Punjab College of Technical Education

Course Module MBA –IB (3rd Semester)

Subject: International Trade and Economics Code


: MBAIB 301
Tests: 04
Case Study: 03
Assignment: 02
Total lectures: 38

Weightage of Internal Assessment:


MSE – 15 Marks
Tests – 5 Marks
Presentation – 10 Marks
Case study – 5 Marks
Assignment- 5 Marks

Course Instructor – Deepa Kapoor

Course Objectives: The objectives of this course are to help you gain tools
that will enable you to systematically think about issues in international
economics. The course will cover two main areas in international economics:
international trade and international development.
International trade will cover: development of trade among nations;
theories of trade; policies, factor endowments, trends, and barriers to
trade.
International Development will cover basic development topics
such as: the role of free trade, foreign aid, and institutions for
economic growth and development.

S.N Topics To Be Covered Assignm Te Cas


o. ent st e
Stu
dy
1 Introduction to class about the subject-
Relevance, Topics to be covered, Requirements
of the course.
2 Theories of Trade-
Adam Smith’s The Law of Absolute Cost
Advantage
- Trade occurs between two countries if
one of them has an absolute advantage
in producing one commodity & the other
country having absolute advantage in
producing some other commodity.
Ricardo’s Comparative Cost Advantage Theory
- Trade takes place because different
countries have different advantages
(efficiency) in the production of different
specialization.
3 Opportunity - Cost Version of Comparative
Advantage Theory
Assignment 1
4 Hecksher-Ohlin Theorem (Theory and Graphical
Representation)
- Countries will export those goods that
make intensive use of those factors tat
are locally abundant, while importing
goods that make intensive use of factors
that are locally scarce.
5,6 Factor- Price Equalization Theorem (Graphical
Model)
- In terms of Physical Criterion

7 Factor- Price Equalization Theorem (Graphical


Model)
- In terms of Price Criterion
Leontief Paradox
8 National Competitive Advantage: Porter’s
Diamond Model for Trade
Four attributes of a nation shape the
environment in which local firms compete, &
these attributes promote or impede the
creation of competitive advantage
- Factor Endowment
- Demand Conditions
- Related and Supporting Industries
- Firm strategy, Structure and Rivalry
9 Case Study- Rise of Indian Software 1
Industry
10 Test 1
11 Terms of Trade - the rate at which one
country’s goods exchange against those of
another.
- Gross Barter Terms of Trade
- Net Barter Terms of Trade
- Income Terms of Trade
-
12 - Single factoral Terms of Trade
- Double Factoral Terms of Trade
- Real Cost Terms of Trade
- Utility Terms of Trade
13 Mill’s Doctrine of Reciprocal Demand
Marshall- Edgeworth Offer Curves
14 Factors Affecting terms of trade
- Shifts in the Demand for country’s
exports/ imports
- Economic growth and Terms of trade
15 Factors Affecting terms of trade
- Effect of Tariffs
- Effect of Devaluation
16 Factors Affecting terms of trade
- Change in supply on TOT
- Change in tastes of people
17 Tariff Barriers
Effect of Tariffs
- Price Effect
- The Protective Effect
- Revenue Effect
- Consumption effect
18 Effect of Tariffs
- Terms of Trade Effect
- Balance of Payment Effect
19 Effect of Tariffs
- Income Effect
Retaliation
20 Non-Tariff Barriers
Assignment 2
21,2 WTO
2 - Role of WTO
- Uruguay Round and the WTO
- Doha Round and the WTO
- India and WTO
23 Test 2
24 Trade Blocs
Levels of Economic Integration
- Free Trade Area
- Customs Union
- Common Market
- Economic Union
- Political Union
25 Trade Blocs
- NAFTA
- SAARC
26 Trade Blocs
- European Union
- ASEAN
27 Case Study 2
28 India’s Trade
- Trading Partners
- India’s Exports and Imports: Commodity
wise and Country Wise
- Balance of Trade
29 Balance of Payments
- Components of BOP
- India’s BOP position
30 BOP
- Measures to remove Disequilibrium in
Balance of payment
31 International Factor Movements
- Immigration
Entry Modes
- Exporting
- Turnkey Projects
- Licensing
- Franchising
32 Foreign Direct Investment
33 Test 3
34 Exchange Rates
- Bretton Woods
- Fixed and Flexible Exchange rate
- Exchange rate determination theories
35 Case Study 3
36,3 International Monetary Fund
7 - Evolution of IMF
- Role of IMF
38 Test 4

Suggested Readings:
International Economics By Dominick Salvatore
International Economics By D.M. Mithani
International Economics By Francis Cherunilam

Case studies (Weightage in Internals: 5 Marks)

Following case studies are attached with the course module


S.N Case Study Title Description
o.
1 The Rise of the Will help to know how different trade theories
Indian Software explain the performance of Indian software
Industry industry.
2 Martin’s Textiles Understand the impact of regional grouping
(NAFTA) on Textile company
3 Caterpillar Inc. Impact of country’s currency price rise on
company’s competitive position in world market.

Assignment (Weightage in Internals: 5 Marks)


 Select any two countries and identify Products and Industries in which
these countries have a comparative advantage as well as those in
which they have comparative disadvantage.
 Identify Tariffs and Non- Tariff Barriers in the Indian economy and its
effect on India’s trade.

Presentation (Weightage in Internals: 10 Marks)


Presentation will be taken in group of 4 students. Following are the topics to
be covered in the presentation:
- Foreign Direct Investment In India
- TRIPS and TRIMS
- Anti-Dumping Practices (with special reference to cases in India)
- Impact of Global recession on India’s Trade
- Euro Dollar Market
- India’s export
- IMF and its role
- Balance of Payments
- FDI- Comparison of India and China
- WTO and Agriculture
- WTO and Environment Policies
- Impact of NAFTA on Trade
- Impact of ASEAN on Trade

Case Study- I

The Rise of the Indian Software Industry

As a relatively poor country, India is not normally thought of as a nation that


is capable of building a major presence in a high-technology industry, such
as computer software. In a little over a decade, however, the Indian software
industry has astounded its skeptics and emerged from obscurity into an
important force in the global software industry. Between 1991-92 and 1996-
97, sales of Indian software companies grew at a compound rate of 53
percent annually. In 1991-92, the industry had sales totaling $388 million. By
1996-97 sales were around$1.8 billion. By 1997, there were over 760
software companies in India employing 160,000 software engineers, the
third-largest concentration of such talent in the world. Much of this growth
was powered by exports. In 1985, Indian software exports were worth less
than $10 million. Exports hit $1.1 billion in 1996-97 and are projected to
reach $4 billion by 2000-01. As a testament to this growth, many foreign
software companies are now investing heavily in Indian software
development operations, including Microsoft, IBM, Oracle, and Computer
Associates, the four largest US-based software houses.

Most of the growth of the Indian software industry has been based on
contract or project-based work for foreign clients. Many Indian companies,
for example, maintain applications for their clients, convert code, or migrate
software from one platform to another. Increasingly, Indian companies are
also involved in important development projects for foreign clients. For
example, TCS, India's largest software company, has an alliance with Ernst &
Young under which TCS will develop and maintain customized software for
Ernst & Young's global clients. TCS also has a development alliance with
Microsoft under which the company developed a paperless National Share
Depositary system for the Indian stock market based on Microsoft's Windows
NT operating system and SQL Server database technology. The Indian
software industry has emerged despite a poor information technology
infrastructure. The installed base of personal computers in India stood at just
1.8 million in 1997, and this in a nation of 1 billion people. Moreover, with
just 1.5 telephone lines per 100 people, India has one of the lowest
penetration rates for fixed telephone lines in Asia, if not the world. Internet
connections numbered just 45,000 in 1997, compared to 30 million in the
United States. Sales of personal computers are starting to take off; over
500,000 were expected to be sold in 1998. The rapid growth of mobile
telephones in India's main cities is to some extent compensating for the lack
of fixed telephone lines. In explaining the success of their industry, India's
software entrepreneurs point to a number of factors. Although the general
level of education i~ India is low, India's important middle class is highly
educated and its top educational institutions are world class. Also, there has
always been an emphasis on engineering in India. Another great plus from
an international perspective is that English is the working language
throughout much of middle-class India-a remnant from the days of the British
raja.

Then there is the wage rate. In America, software engineers are


increasingly scarce, and the basic salary has been driven up to one of the
highest for any occupational group in the country, with entry-level
programmers earning $70,000 per year. An entry-level programmer in
India, in contrast, starts at around $5,000 per year, which IS very low by
international standards but high by Indian standards. Still, salaries for
programmers are rising rapidly in India, but so is productivity. In 1992,
productivity was around $21,000 per software engineer. By 1996, the
figure had risen to $45,000. Many Indian firms now feel that they have
approached the 'critical mass required to realize scale economies in soft-
ware development and to achieve legitimacy in the eyes of important
global partners and clients.

Another factor playing to India's hand is that satellite communications


have removed-distance as an obstacle to doing business for foreign clients.
Since software is nothing more than a stream of zeros and ones, it can be
transported at the speed of light and negligible cost to any point in the
world. In a world of instant communications, India's geographical position
has given it a time zone advantage. Indian companies have exploited the
rapidly expanding international market for outsourced software services
including the expanding market for remote maintenance. Indian engineers
can fix software bugs, upgrade systems, or process data overnight while
their users in Western companies are asleep.

To maintain their competitive position, Indian software companies are now


investing heavily in training and leading-edge programming skills. They have
also been enthusiastic adopters of international quality standards,
particularly ISO 9000 certification. Indian companies are also starting to
make forays into the application and shrink-wrapped software business,
primarily with applications aimed at the domestic market. It may only be a
matter of time, however, before Indian companies start to compete head-to-
head with companies such as Microsoft, Oracle, PeopleSoft, and SAP in the
applications business.

Case Discussion Questions


1. To what extent does the theory of comparative advantage explain the rise
of the Indian software industry?
2. To what extent does the Heckscher-Ohlin theory explain the rise of the
Indian software industry? ,
3. Use Michael Porter's diamond to analyze the rise of the Indian software
industry. Does this analysis help explain the rise of this industry?
4. Which of the above theories-comparative advantage, Heckscher-Ohlin, or
Porter's-gives the best explanation of the rise of the Indian software
industry? Why?

Case Study –II

Martin's Textiles

August 12, 1992, was a really bad day for John Martin. That was the day
Canada, Mexico, and the United States announced an agreement in principle
to form the North American Free Trade Agreement. Under the plan, all tariffs
between the three countries would be eliminated within the next 10, to 15
years, with most being cut in 5 years. What disturbed John most was the
plan's provision that all tariffs on trade of textiles among the three countries
were to be removed within 10 years. Under the proposed agreement, Mexico
and Canada would also be allowed to ship a specific amount of clothing and
textiles from foreign materials to the United States each year, and this quota
would rise slightly over the first five years of the agreement. "My' God!"
thought John. "Now I'm going to have to decide about moving my plants to
Mexico."
John is the CEO of a New York-based textile company, Martin’s Textiles. The
company has been in the Martin family for four generations, having been
founded by his great-grandfather in 1910. Today, the company employs
1,500 people in three New York plants that produce cotton-based clothes,
primarily underwear. All production employees are union members, and the
company has a long history of good labor relations. The company has never
had a labor dispute, and John, like his father, grandfather, and great-
grandfather before him, regards the work force as part of the "Martin
family." John prides himself not only on knowing many of the employees by
name, but also on knowing a great deal about the family circumstances of
many of the longtime employees.

Over the past 20 years, the company has experienced increasingly tough
competition, both from overseas and at home. The mid-1980s were
particularly difficult. The strength of the dollar on the foreign exchange
market during that period enabled Asian producers to enter the US market
with very low prices. Since then, although the dollar has weakened against
many major currencies, the Asian producers have not raised their prices in
response to the falling dollar. In a low-skilled, labor-intensive business such
as clothing manufacture, costs are driven by wage rates and labor
productivity. Not surprisingly, most of John’s competitors in the
northeastern United States responded to the intense cost competition by
moving production south, first to states such as South Carolina and Missis-
sippi, where nonunion labor could be hired for significantly less than in the
unionized Northeast, and then to Mexico, where labor costs for textile
workers were less than $2 per hour. In contrast, wage rates are $12.50 per
hour at John's New York plant and $8 to $10 per hour at nonunion textile
plants in the south eastern United States.

The last three years have been particularly tough at Martin's Textiles.
The company has registered a small loss each year, and John knows the
company cannot go on like this. His major customers, while praising the
quality of Martin's products, have warned him that his prices are getting
too high and they may not be able to continue to do business with him.
His longtime banker has told him that he must get his labor costs down.
John agrees, but he knows of only one surefire way to do that, to move
production south..,-way south, to Mexico. He has always been reluctant to
do that, but now he seems to have little choice. He fears that in five years
the US market will be flooded with cheap imports from Asian, US, and
Mexican companies, all producing in Mexico. It looks like the only way for
Martin's Textiles to survive is to close the New York plants and move
production to Mexico. All that would be left in the United States would be
the sales force

John's mind was spinning. How could something that throws good honest
people out of work be good for the country? The politicians said it would be
good for trade, good for economic growth, and good for the three countries.
John-could not see it that way. What about Mary Morgan, who has worked for
Martin's for 30 years? She is now 54 years old. How will she and others like
her find another job? What about his moral obligation to his workers? What
about the loyalty his workers have shown his family over the years? Is this a
good way to repay it? How would he break the news to his employees, many
of whom have worked for the company 10 to 20 years? And what about the
Mexican workers, could they be as loyal and productive as his present
employees? From other US textile companies that had set up production in
Mexico he had heard stories of low productivity, poor workmanship, high
turnover, and high absenteeism. If this was true, how could he ever cope
with that? John has 'always felt that the success of Martin's Textiles is partly
due to the family atmosphere, which encourages worker loyalty, pro-
ductivity, and attention to quality, an atmosphere that has been built up over
four generations. How could he, replicate that in Mexico with a bunch of
foreign workers who speak a language that he doesn't even understand?

Case Discussion Questions

1. What are the economic costs and benefits to Martin's Textiles of


shifting production to Mexico?
2. What are the social costs and benefits to Martin's Textiles of shifting
production to Mexico?
3. Are the economic and social costs and benefits or moving production
to Mexico independent each other?
4. What seems to be the most ethical action?
5. What would you do if you were John- Martin?
Case Study- III

Caterpillar Inc.

Caterpillar Inc. (Cat) is the world's largest manufacturer of heavy


earthmoving equipment. Earthmoving equipment typically represents about
70 percent of the annual dollar sales of construction equipment worldwide.
In 1980, Cat held 53.3 percent of the global market for earthmoving
equipment. Its closest competitor was Komatsu of Japan, with 60 percent of
the Japanese market but only 15.2 percent worldwide.

In 1980, Caterpillar was widely considered one of the premier manufacturing


and exporting companies in the United States. The company had enjoyed 50
consecutive years of profits and returns on shareholders equity as high as 27
percent. In 1981, 57 percent of its sales were outside the United States, and
roughly two-thirds of these orders were filled by exports. Cat was the third
largest US exporter. Reflecting this underlying strength, Cat recorded record
pretax profits of $579 million in 1981. However, the next three years were
disastrous. Caterpillar lost a total of $1 billion and saw its market share slip
to as low as 40 percent in 1985, while Komatsu increased its share to 25
percent. Three factors, explain this startling turn of events: the higher
productivity of Komatsu, the rise in the value of the dollar, and the Third
World debt crisis

In retrospect, Komatsu had been creeping up on Cat for a long time. In the
1960s, the company had a minuscule presence outside of Japan. By 1974, it
had increased its global market share of heavy earthmoving equipment to 9
percent, and by 1980 it was over 15 percent. Part of Komatsu's growth was
due to its superior labor productivity; throughout the 1970s, it had been able
to price its machines 10 to 15 percent below Caterpillar's. However, Komatsu
lacked an extensive dealer network outside of Japan, and Cat's worldwide
dealer network and superior after-sale service and support functions were
seen as justifying a price premium for Cat machines. For these reasons,
many industry observers believed Komatsu would not increase its share
much beyond its 1980 level.

An unprecedented rise in the value of the dollar against most major world
currencies changed the picture. Between 1980 and 1987, the dollar rose an
average of 87 percent against the currencies of 10 other industrialized
countries. The dollar was driven up by strong economic growth in the United
States, which attracted heavy inflows of capital from foreign investors
seeking high returns on capital assets. High real interest rates attracted
foreign investors seeking high returns on financial assets. At the same time,
political turmoil in other parts of the world and relatively slow economic
growth in Europe helped create the view that the United States was a good
place. in which to invest. These inflows of capital increased the demand for
dollars in the foreign exchange market, which pushed the value of the dollar
upward against other currencies

The strong dollar substantially increased the dollar price of Cat's


machines. At the same time, the dollar price of Komatsu products imported
into the United States fell. Because of the shift in the relative values of the
dollar and the yen, Komatsu priced its machines as much as 40 percent
below Caterpillar's prices by 1985. In light of this enormous price difference,
many consumers chose to forgo Caterpillar's superior after-sale service and
support and bought Komatsu machines. The third factor, the Third World
debt crisis, became apparent in 1982 during the early 1970s; the nations of
OPEC quadrupled the price of oil, which resulted in a massive flow of funds
into these nations. Commercial banks borrowed this money from the OPEC
countries and lent it to the governments of many Third World nations to
finance massive construction projects which led to a global boom in demand
for heavy earthmoving equipment. Caterpillar benefited from this
development. By 1982, however, it became apparent that the commercial
banks had lent too much money to risky and unproductive investments, and
the governments of several countries (including Mexico, Brazil, and
Argentina) threatened to suspend debt payments.

As a result of these factors, Caterpillar was in deep trouble by late 1982.


The company responded quickly and between 1982 and 1985 cut costs by
more than 20 percent. This was achieved by a 40 percent reduction in work
force, the closure of nine plants, and a $1.8 billion investment in flexible
manufacturing technologies designed to boost quality and lower cost. The
company also pressed the government to lower the value of the dollar on
foreign exchange markets. By 1984, Cat was a leading voice among US
exporters trying to get the Reagan administration to intervene in the foreign
exchange market

Things began to go Caterpillar's way in early 1985~ Prompted by Cat and


other exporters, representatives of the US government met with
representatives of Japan, Germany, France, and Great Britain at the Plaza
Hotel in New York. In the resulting communiqué-known as the Plaza Accord-
the five governments acknowledged that the dollar was overvalued and
pledged to take actions that would drive down its price on the foreign
exchange market. The central bank of each country intervened in the foreign
exchange market, selling dollars and buying other currencies (including its
own). The dollar had already begun to fall in early 1985 in response to a
string of record US trade deficits. The Plaza Accord accelerated this 'trend,
and over the next three years the dollar fell back to its 1980 level.

The effect for Caterpillar was almost immediate. Like any major exporter,
Caterpillar had its own foreign exchange unit. Suspecting that an
adjustment in the dollar would come soon, Cat had increased its holdings of
foreign currencies in early 1985, using the strong dollar to purchase them.
As the dollar fell, the company was able to convert these currencies back
into dollars' for a healthy profit. In 1985, Cat had pretax profits of $32
million without foreign exchange gains of $89 million, it would have lost
money. In 1986, foreign exchange gains of $100 million accounted for
nearly two-thirds of its pretax profits of $159 million. More significant for
Cat's long-term position, the fall in the dollar against the yen and
Caterpillar's cost-cutting efforts by 1988 had helped to eradicate the 40
percent cost advantage that Komatsu had enjoyed over Caterpillar four
years earlier. After trying to hold its prices down, Komatsu had to raise its
prices that year by 18 percent, while Cat was able to hold its price increase
to 3 percent. With the terms of trade no longer handicapping Caterpillar, the
company regained some of its lost market share. By 1989, it reportedly held
47 percent of the world market for heavy earthmoving equipment, up from
a low of 40 percent three years earlier, while Komatsu's share had slipped to
below 20 percent.

Case Discussion Questions


1. To what extent is the competitive position of Caterpillar against Komatsu
dependent on the dollar/yen exchange rate? Between mid-1996 and early
1998, the dollar appreciated by over 40 percent against the yen. How do
you think this would have affected the relatively competitive position of
Caterpillar and Komatsu?

2. If you were the CEO of Caterpillar, what actions would you take now to
make sure there is no repeat of the early 1980s experience?

3. What potential impact can the actions of the IMF and World Bank have on
Caterpillar’s business? Is there anything Cat can do to influence the actions
of the IMF and World Bank?

4. As the CEO of Caterpillar, would you prefer a fixed exchange rate regime
or a continuation of the current managed-float regime? Why?