Master of Business Administration – MBA Semester 4

MB0037 – International Business Management - 3 Credits

(Book ID: B0861)
Assignment Set- 1
60 Marks

Note: Each question carries 10 Marks. Answer all the questions.

Q.1 a. How has liberalizing trade helped international business? (6 marks)

The Benefits of Trade Liberalization

Policies that make an economy open to trade and investment with the rest of the
world are needed for sustained economic growth. The evidence on this is clear. No
country in recent decades has achieved economic success, in terms of substantial
increases in living standards for its people, without being open to the rest of the
world. In contrast, trade opening (along with opening to foreign direct investment)
has been an important element in the economic success of East Asia, where the
average import tariff has fallen from 30 percent to 10 percent over the past 20 years.
Opening up their economies to the global economy has been essential in enabling
many developing countries to develop competitive advantages in the manufacture of
certain products. In these countries, defined by the World Bank as the "new
globalizers," the number of people in absolute poverty declined by over 120 million
(14 percent) between 1993 and 1998.
There is considerable evidence that more outward-oriented countries tend
consistently to grow faster than ones that are inward-looking. Indeed, one finding is
that the benefits of trade liberalization can exceed the costs by more than a factor of
10. Countries that have opened their economies in recent years, including India,
Vietnam, and Uganda, have experienced faster growth and more poverty reduction.
On average, those developing countries that lowered tariffs sharply in the 1980s grew
more quickly in the 1990s than those that did not. Freeing trade frequently benefits the
poor especially. Developing countries can ill- afford the large implicit subsidies, often
channeled to narrow privileged interests that trade protection provides. Moreover, the
increased growth that results from free trade itself tends to increase the incomes of the
poor in roughly the same proportion as those of the population as a whole. New jobs are
created for unskilled workers, raising them into the middle class. Overall, inequality
among countries has been on the decline since 1990, reflecting more rapid economic
growth in developing countries, in part the result of trade liberalization. The
potentialgains from eliminating remaining trade barriers are considerable. Estimate ofthe
gains from eliminating all barriers to merchandise trade range from US$250 billion to
US$680 billion per year. About two-thirds of these gains would accrue to industrial
countries. But the amount accruing to developing countries would still be more than
twice the level of aid they currently receive. Moreover, developing countries would gain
more from global trade liberalization as a percentage of their GDP than industrial
countries, because their economies are more highly protected and because they face
higher barriers. Although there are benefits from improved access to other countries’
markets, countries benefit most from liberalizing their own markets. The main benefits
for industrial countries would come from the liberalization of their agricultural markets.
Developing countries would gain about equally from liberalization of manufacturing and
agriculture. The group of low-income countries, however, would gain most from
agricultural liberalization in industrial countries because of the greater relative
importance of agriculture in their economies.

b. What are the merits and demerits of international trade? (4 marks)

Sol.
Advantages and Disadvantages of International Trade
Advantages to consider:
•

• Enhance your domestic competitiveness

• •

• Increase sales and profits

• •

• Gain your global market share

• •

• Reduce dependence on existing markets

• •

• Exploit international trade technology

• •

• Extend sales potential of existing products

• •

• Stabilize seasonal market fluctuations

• •

• Enhance potential for expansion of your business

• •

• Sell excess production capacity

• •

• Maintain cost competitiveness in your domestic market

Disadvantages to keep in mind:

•

• You may need to wait for long-term gains

• •

• Hire staff to launch international trading

• •

• Modify your product or packaging

• •

• Develop new promotional material

• •

• Incur added administrative costs

• •

• Dedicate personnel for traveling

• •

• Wait long for payments

• •

• Apply for additional financing

• •

• Deal with special licenses and regulations

Q. 2 Discuss the impact of culture on International Business. (10 marks)

SOL - In this new millennium, few executives can afford to turn a blind eye to global
business opportunities. Japanese auto-executives monitor carefully what their
European and Korean competitors are up to in getting a bigger slice of the Chinese
auto-market. Executives of Hollywood movie studios need to weigh the appeal of an
expensive movie in Europe and Asia as much as in the US before a firm commitment.
The globalizing wind has broadened the mindsets of executives, extended the
geographical reach of firms, and nudged international business (IB) research into some
new trajectories. One such new trajectory is the concern with national culture.
Whereas traditional IB research has been concerned with economic/ legal issues and
organizational forms and structures, the importance of national culture – broadly
defined as values, beliefs, norms, and behavioural patterns of a national group – has
become increasingly important in the last two decades, largely as a result of the
classic work of Hofstede (1980). National culture has been shown to impact on major
business activities, from capital structure (Chui et al., 2002) to group performance
(Gibson, 1999). For reviews, see’ Boyacigiller and Adler’ (1991) and ‘Earley and
Gibson’ (2002).
The purpose of this Unit is to provide a state-of-the-art review of several recent
advances in culture and IB research, with an eye toward productive avenues for
future research. It is not our purpose to be comprehensive; our goal is to spotlight a
few highly promising areas for leapfrogging the field in an increasingly boundary-less
business world. We first review the issues surrounding cultural convergence and
divergence, and the processes underlying cultural changes. We then examine novel
constructs for characterizing cultures, and how to enhance the precision of cultural
models by pinpointing when the effects of culture are important. Finally, we examine
the usefulness of experimental methods, which are rarely employed in the field of
culture and IB. A schematic summary of our coverage is given in Table 2.1, which
suggests that the topics reviewed are loosely related, and that their juxtaposition in
the present paper represents our attempt to highlight their importance rather than
their coherence as elements of an integrative framework.

1 Cultural change, convergence and divergence in an era of partial globalization

An issue of considerable theoretical significance is concerned with cultural changes
and transformations taking place in different parts of the world. In fact, since the
landmark study of Haire et al. (1966) and the publication of Industrialism and
Industrial Man by Kerr et al. (1960), researchers have continued to search for
similarities in culture-specific beliefs and attitudes in various aspects of work related
attitudes and behaviours, consumption patterns, and the like. If cultures of the
various locales of the world are indeed converging (e.g., Heuer et al., 1999), IB-
related practices would indeed become increasingly similar. Standard, culture-free
business practices would eventually emerge, and inefficiencies and complexities
associated with divergent beliefs and practices in the past era would disappear. In the
following section, we review the evidence on the issue and conclude that such an
outlook pertaining to the convergence of various IB practices is overly optimistic.

2 Evolution of partial globalization

Globalization refers to a ‘growing economic interdependence among countries, as

reflected in the increased cross-border flow of three types of entities: goods and
services, capital, and know-how’ (Govindarajan and Gupta, 2001, 4). Few spoke of
‘world economy’ 25 years ago, and the prevalent term was ‘international trade’
(Drucker, 1995). However today, international trade has culminated in the emergence
of a global economy, consisting of flows of information, technology, money, and
people, and is conducted via government international organizations such as the
North American Free Trade Agreement (NAFTA) and the European Community; global
organizations such as the International Organization for Standardization (ISO);
multinational companies (MNCs); and cross – border alliances in the form of joint
ventures, international mergers, and acquisitions. These inter – relationships have
enhanced participation in the world economy, and have become a key to domestic
economic growth and prosperity (Drucker, 1995, 153).
Yet, globalization is not without its misgivings and discontents (Sassan, 1998). A vivid
image associated with the G8 summits is the fervent protests against globalization in
many parts of the world, as shown in television and reported in the popular media.
Strong opposition to globalization usually originates from developing countries that
have been hurt by the destabilizing effects of globalization, but in recent times we
have also seen heated debates in Western economies triggered by significant loss of
professional jobs as a result of off shoring to low – wage countries. Indeed, workers in
manufacturing and farming in advanced economies are becoming increasingly wary of
globalization, as their income continues to decline significantly. In parallel to the
angry protests against globalization, the flow of goods, services, and investments
across national borders has continued to fall after the rapid gains of the 1990s.
Furthermore, the creation of regional trade blocs, such as NAFTA, the European
Union, and the Association of Southeast Asian Nations, have stimulated discussions
about creating other trade zones involving countries in South Asia, Africa, and other
parts of the world. Although it is often assumed that countries belonging to the World
Trade Organization (WTO) have embraced globalization, the fact is that the world is
only partially globalized, at best (Schaeffer, 2003). Many parts of Central Asia and
Eastern Europe, including the former republics of the Soviet Union, parts of Latin
America, Africa, and parts of South Asia, have been sceptical of globalization
(Greider, 1997). In fact, less than 10% of the world’s population is fully globalized
(i.e., being active participants in the consumption of global products and services)
(Schaeffer, 2003). Therefore, it is imperative that we analyze the issues of cultural
convergence and divergence in this partially globalized world.

3 Role of multiculturalism and cultural identity

The broad ideological framework of a country, corporation, or situation is the most
important determinant of the cultural identity that people develop in a given locale
(Triandis, 1994). The ‘melting pot’ ideology suggests that each cultural group loses
some of its dominant characteristics in order to become the mainstream: this is
assimilation, or what Triandis (1994) calls subtractive multiculturalism.
In contrast, when people from a cultural group add appropriate skills and
characteristics of other groups, it may be called integration, or additive
multiculturalism. Both of these processes are essential for cultural convergence to
proceed. However, if there is a significant history of conflict between the cultural
groups, it is hard to initiate these processes, as in the case of Israelis and
Palestinians. In general, although there has been some research on the typology of
animosity against other nations (e.g., Jung et al., 2002), we do not know much about
how emotional antagonism against other cultural groups affects trade patterns and
intercultural cooperation in a business context. The issues of cultural identity and
emotional reactions to other cultural groups in an IB context constitute a significant
gap in our research effort in this area.

4 Implications of convergence and divergence issues

One message is clear: while convergence in some domains of IB activity is easily
noticeable, especially in consumer values and lifestyles, significant divergence of
cultures persists. In fact, Hofstede (2001) asserts that mental programs of people
around the world do not change rapidly, but remain rather consistent over time. His
findings indicate that cultural shifts are relative as opposed to absolute. Although
clusters of some countries in given geographical locales (e.g., Argentina, Brazil, Chile)
might indicate significant culture shifts towards embracing Anglo values, the changes
do not diminish the absolute differences between such countries and those of the
Anglo countries (i.e., US, Canada, UK). Huntington, in his ‘The Clash of Civilizations’
(1996), presents the view that there is indeed a resurgence of non-Western cultures
around the world, which could result in the redistribution of national power in the
conduct of international affairs. The attempt by the Davos group to bring about
uniform practices in various aspects of IB and work culture, thereby sustaining the
forces of globalization, is certainly worthwhile. However, our analysis suggests that
there is no guarantee that such convergence will come about easily, or without long
periods of resistance.
IB scholars need to understand that although some countries might exhibit strong
tendencies toward cultural convergence, as is found in Western countries, there are
countries that will reject globalization, not only because of its adverse economic
impacts (Greider, 1997) but also because globalization tends to introduce distortions
(in their view) in profound cultural syndromes that characterize their national
character.

Q.3. a. Explain the brief structure of WTO. (5 marks)

Sol.
Structure of World Trade Organization (WTO)
The WTO’s overriding objective is to help trade flow smoothly, freely, fairly and
predictably.
It does this by:
· Administering trade agreements
· Acting as a forum for trade negotiations
· Settling trade disputes
· Reviewing national trade policies
· Assisting developing countries in trade policy issues, through technical assistance
and training programs
· Cooperating with other international organizations

Structure
The WTO has nearly 150 members, accounting for over 97% of world trade. Around 30
others are negotiating membership.
Decisions are made by the entire membership. This is typically by consensus. A
majority vote is also possible but it has never been used in the WTO, and was
extremely rare under the WTO’s predecessor, GATT. The WTO’s agreements have
been ratified in all members’ parliaments.
The WTO’s top level decision-making body is the Ministerial Conference which meets
at least once every two years.
Below this is the General Council (normally ambassadors and heads of delegation in
Geneva, but sometimes officials sent from members’ capitals) which meets several
times a year in the Geneva headquarters. The General Council also meets as the
Trade Policy Review Body and the Dispute Settlement Body.
At the next level, the Goods Council, Services Council and Intellectual Property
(TRIPS) Council report to the General Council.
Numerous specialized committees, working groups and working parties deal with
the individual agreements and other areas such as the environment, development,
membership applications and regional trade agreements.
Secretariat
The WTO Secretariat, based in Geneva, has around 600 staff and is headed by a
director-general. Its annual budget is roughly 160 million Swiss francs. It does not
have branch offices outside Geneva. Since decisions are taken by the members
themselves, the Secretariat does not have the decision-making role that other
international bureaucracies are given with. The Secretariat’s main duties are to
supply technical support for the various councils and committees and the ministerial
conferences, to provide technical assistance for developing countries, to analyze
world trade, and to explain WTO affairs to the public and media.
The Secretariat also provides some forms of legal assistance in the dispute settlement
process and advises governments wishing to become members of the WTO.
the WTO is different from some other international organizations such
as the World Bank and International Monetary Fund. In the WTO, power is not
delegated to a board of directors or the organization’s head.
When WTO rules impose disciplines on countries’ policies, that is the outcome of
negotiations among WTO members, the rules are enforced by the members
themselves under agreed procedures that they negotiated, including the possibility of
trade sanctions. But those sanctions are imposed by member countries, and
authorized by the membership as a whole. This is quite different from other agencies
whose bureaucracies can, for example, influence a country’s policy by threatening to
withhold credit.
Reaching decisions by consensus among some 150 members can be difficult. Its main
advantage is that decisions made this way are more acceptable to all members. And
despite the difficulty, some remarkable agreements have been reached. Nevertheless,
proposals for the creation of a smaller executive body – perhaps like a board of
directors each representing different groups of countries – are heard periodically. But
for now, the WTO is a member-driven, consensus-based organization.
Highest authority: the Ministerial Conference
So, the WTO belongs to its members. The countries make their decisions through
various councils and committees, whose membership consists of all WTO members.
Topmost is the ministerial conference which has to meet at least once every two
years. The Ministerial Conference can take decisions on all matters under any of the
multilateral trade agreements.
Second level: General Council in three guises
Day-to-day work in between the ministerial conferences is handled by three bodies:
· The General Council
· The Dispute Settlement Body
· The Trade Policy Review Body
All three are in fact the same – the Agreement Establishing the WTO states they are
all the General Council, although they meet under different terms of reference.
Again, all three consist of all WTO members. They report to the Ministerial
Conference.
The General Council acts on behalf of the Ministerial Conference on all WTO affairs. It
meets as the Dispute Settlement Body and the Trade Policy Review Body to oversee
procedures for settling disputes between members and to analyze members’ trade
policies.
Third level: councils for each broad area of trade, and more back to top
Three more councils, each handling a different broad area of trade, report to the
General Council:
· The Council for Trade in Goods (Goods Council)
· The Council for Trade in Services (Services Council)
· The Council for Trade – Related Aspects of Intellectual Property Rights (TRIPS
Council)
As their names indicate, the three are responsible for the workings of the WTO
agreements dealing with their respective areas of trade. Again they consist of all WTO
members. These three also have the subsidiary bodies.

b. Highlight the drawbacks of GATT. (5 marks)

Given its provisional nature and limited field of action, the success of GATT in
promoting and securing the liberalization of much of world trade over 47 years is
incontestable. Continual reductions in tariffs alone helped spur very high rates of
world trade growth – around 8 per cent a year on average during the 1950s and 1960s.
And the momentum of trade liberalization helped ensure that trade growth
consistently out-paced production growth throughout the GATT era. The rush of new
members during the Uruguay Round demonstrated that the multilateral trading
system, as then represented by GATT, was recognized as an anchor for development
and an instrument of economic and trade reform.
The limited achievement of the Tokyo Round, outside the tariff reduction results, was
a sign of difficult times to come. GATT’s success in reducing tariffs to such a low
level, combined with a series of economic recessions in the 1970s and early 1980s,
drove governments to devise other forms of protection for sectors facing increased
overseas competition. High rates of unemployment and constant factory closures led
governments in Europe and North America to seek bilateral market-sharing
arrangements with competitors and to embark on a subsidies race to maintain their
holds on agricultural trade. Both these changes undermined the credibility and
effectiveness of GATT.
Apart from the deterioration in the trade policy environment, it also became
apparent by the early 1980s that the General Agreement was no longer as relevant to
the realities of world trade as it had been in the 1940s. For a start, world trade had
become far more complex and important than 40 years before: the globalization of
the world economy was underway, international investment was exploding and trade
in services – not covered by the rules of GATT – was of major interest to more and
more countries and, at the same time, closely tied to further increases in world
merchandise trade. In other respects, the GATT had been found wanting: for
instance, with respect to agriculture where loopholes in the multilateral system were
heavily exploited – and efforts at liberalizing agricultural trade met with little success
– and in the textiles and clothing sector where an exception to the normal disciplines
of GATT was negotiated in the form of the Multi-fibre Arrangement. Even the
institutional structure of GATT and its dispute settlement system were giving cause
for concern.
Together, these and other factors convinced GATT members that a new effort to
reinforce and extend the multilateral system should be attempted. That effort
resulted in the Uruguay Round.

Q.4. a. Give a short note on the regional economic integration. (5 marks)

Regional Economic Integration

Regional integration can take many forms, and nowhere is this more evident than in
the vastly different integration processes taking place in the regions of Europe and
East Asia. The subject of this paper is regional integration as it has developed in East
Asia with a focus on the drivers of that integration. While the paper is not intended as
a direct comparison of integration in East Asia and Europe, it will include some
comparisons between the two regions.
Integration in East Asia has progressed very slowly and is still in an early stage despite
that the process has continued for decades. In fact, it could be said that the process
began centuries ago – even as far back as the 15th century. By comparison, European
integration has progressed steadily and has gradually deepened over the last 50 years
to reach an advanced stage today with a common currency and well-developed
regional institutions. Thus, the speed of progression and the level of integration
attained in the two regions are quite dissimilar.
In addition to these differences, the drivers behind the integration process in each
region are different. In Europe, the origins of integration have been institutional in
nature, and the development of institutions has been prominent throughout the
process. Thus, regional institutions have been the driving force behind integration in
Europe. In East Asia, the development of regional institutions has also occurred;
however, progress in this area has been slow and the few existing institutions are
fairly weak and ineffective. Nevertheless, regional integration is taking place in East
Asia, but the driving force is the market rather than policy or institutions.
Corporations and the production networks they have established are driving
integration in East Asia.

b. Mention the benefits of WTO. (5 marks)

SOL- Ten Benefits of WTO

1. The system helps to keep the peace
2. The system allows disputes to be handled constructively
3. A system based on rules rather than power makes life easier for all
4. Freer trade cuts the cost of living
5. It gives consumers more choice and a broader range of qualities to choose from
6. Trade raises incomes
7. Trade stimulates economic growth and that can be good news for employment
8. The basic principles make the system economically more efficient, and they cut
costs
9. The system shields governments from narrow interests
10. The system encourages good government

Q. 5 a. Explain five-element product wave model. (7 marks)

Sol. -
The Five-Element Product Wave
As illustrated in Figure 4.5, the wave model employs design engineering, process
engineering, product marketing, production, and end-of-life activities as elements.
The first wave is associated with the "A" version of a product or service, and survives
through the traditional PLC introduction and growth phases. A second wave begins
with the "B" version, the markedly improved second model. It starts just before the
traditional life cycle maturity stage and lives until sales decline to a point at which an
EOL decision must be made.
Note that design engineering has a peak of activity level at each upgrade. Process
engineering activity shadows that of design engineering, as system changes will be
contemplated and made to facilitate the changes made in the product or service.
Product marketing also has activity level spikes that closely match engineering design
activity, lagged somewhat for product introduction. Production has one activity peak
that results from demand management and production planning through master
production scheduling.
Finally, the EOL curve peaks at each redesign. The last wave begins shortly before
original production ceases and ends when the product is no longer manufactured or
supported by the EOL Company or division. The EOL element requires that a decision
be made about the preceding version at each major redesign: continue production,
make a short-term run of spares, keep blueprints active so that parts can be made as
ordered, enter into a manufacturing and support agreement with another entity, or
discontinue production.
For the sake of parsimony, Figure 4.5 shows only a two-product model ("A" and "B"
versions). In reality, there may be hundreds of significant redesigns. The wave effect
comes from the fact that the process repeats for the successful firm, forming swells in
design engineering, process engineering, product marketing, and manufacturing
curves before the final crest at EOL activity. The five-element product wave, or FPW,
uses trigger points, rather than time, as the horizon over which the element curves vary.
Changes in magnitude, represented by the vertical axis, result from differing activity
levels within the five elements. Simple changes in levels of dollar or unit product sales, in
and of themselves, do not necessarily determine the trigger points. Rather, the varying
activity levels are a direct result of product introductions and redesigns that, from the
outset, must take into account company strategy, core capabilities, and the state of the
competitive environment. For example, a product with strong sales may be redesigned in
a preemptive strike against competitors, further distancing that product from the
competition, such as with Caterpillar’s innovative high-drive bulldozers.
That the five-element wave is grounded in reality becomes apparent when considering
the recent research that suggests product introduction cycles are being compressed.
Bayus (1994) claims that knowledge is being applied faster, resulting in increasing
levels of new product introductions. Yet since product removals are not keeping pace
with introductions, there are an increasing number of product variations on the
market. Slater (1993) observes that product life cycles are growing shorter and
shorter. Vesey (1992) reports that the strategy for the 1990s is speed to market and
discusses the pressures the market is exerting to shorten product introduction lead
times. Regardless of whether life cycles are actually being compressed or knowledge is
simply being applied faster, it is apparent that firms are increasing the speed with
which they bring their products to market. The effect of this is a compression of the
design engineering, process engineering, production, and product marketing elements
of the wave model. (The EOL curve may remain unchanged because accelerated
introductions do not necessarily affect EOL efforts.) The five-element wave clearly
shows the inefficiency of traditional "over-the-wall" systems as speed to market
increases. As the elements compress, more and more information is thrown over the
wall. Recipients find themselves with less and less time to take action. Taken to the
extreme, in-baskets, phone lines, conference rooms, desks, and floors are soon
gridlocked and littered with unanswered correspondence and things to do. Forget
quality; production itself grinds to a halt.
The solution is to maximize the advantage of the relationships within the five-
element wave and work in concurrent teams, as illustrated in Figure 6. That way,
responsibility is shared throughout the system. Members from each discipline optimize
the system. The method tears down barriers between departments and speeds the
introduction process, thus decreasing costs. The focal point becomes the customer,
rather than the task. The system is totally interactive and bound together. Each
element is connected to all of the others and is focused on the customer. (Note that
the authors have taken a great deal of artistic license here! No meaning should be
attached to the actual measure of overlap area in Figure 4.6.)
What is the recent experience with teams? There is evidence that using concurrent
design teams speeds the product to market and provides substantial savings. Boeing
expects that concurrent design will save some $4 billion in the development of its 777
airliner. Westinghouse recently suggested that concurrent engineering would
eliminate 200 duplicate processes in a project that consisted of 600 using traditional
over-the-wall approaches. Ford’s Team Taurus was able to cut a full year out of
model turnaround. In addition, design changes required after initial production began
were reduced by some 76 percent.
The strength of the five-element product wave is the fact that it illuminates critical
decision points in the life of a product or service. The interrelationships of the
elements clearly illustrate the benefit of working product introductions, design
changes, and end-of-life decisions in teams. This is particularly true in today’s rapidly
compressing environment of speeding products to market. Furthermore, the model is
flexible and may be expanded or contracted to include those functional areas
relevant to the production team. Thus, whether a given firm’s product is a service or
a manufactured good, the five-element wave is a powerful tool that can be deployed
to accelerate effective decision making in markets demanding ever-increasing levels
of speed and agility.

b. What do you mean by globalization? (3 marks)

Sol.
Economic "globalization" is a historical process, the result of human innovation and
technological progress. It refers to the increasing integration of economies around the
world, particularly through trade and financial flows. The term sometimes also refers
to the movement of people (labor) and knowledge (technology) across international
borders. There are also broader cultural, political and environmental dimensions of
globalization that are not covered here.
At its most basic, there is nothing mysterious about globalization. The term has come
into common usage since the 1980s, reflecting technological advances that have made
it easier and quicker to complete international transactions – both trade and financial
flows. It refers to an extension beyond national borders of the same market forces that
have operated for centuries at all levels of human economic activity – village
markets, urban industries, or financial centers.
Markets promote efficiency through competition and the division of labor – the
specialization that allows people and economies to focus on what they do best. Global
markets offer greater opportunity for people to tap into more and larger markets
around the world. It means that they can have access to more capital flows,
technology, cheaper imports, and larger export markets. But markets do not
necessarily ensure that the benefits of increased efficiency are shared by all.
Countries must be prepared to embrace the policies needed, and in the case of the
poorest countries may need the support of the international community as they do so.
Q. 6. Give some examples of companies doing international business and discuss
how they have they have managed their business in the international markets. (10
marks)

Sol.

A PERSPECTIVE OF THE NORTHEN ISLAND SOFTWARE COMPANIES, RAPD M–UP

Within six months of announcing it would invest $4.5 million to establish its new
software development center in Northern Ireland, IMR was up and running with more
than one-third its target staff. "The fast start-up of the Belfast facility reaffirms our
confidence to locate in Northern Ireland," said Sanan. "The success to date in building a
quality work force has surpassed our expectations and opens up new ambitions for our
interests in Northern Ireland." According to Arthur "Bro" McFerran, president of IMR (NI)
Ltd., the company is hiring 12 to 18 programmers a month in Northern Ireland and is well
on its way to meeting its staffing goal of 300 by 1999. McFerran credited Northern
Ireland’s Training & Employment Agency (T&EA) with helping place the company’s
staffing on the fast track. "The T&EA not only has helped us to identify and recruit
qualified software graduates from Northern Ireland’s universities, it is also assisting us
with a unique initiative to bring additional sources of high quality talent to the company,"
McFerran said. Innovation In Training Impressed by the number and quality of
information technology graduates from the region’s universities, IMR recognized an
untapped resource in the well-educated, versatile graduates of other fields in Northern
Ireland. Working with the T&EA, IMR developed "IMR Academy," an intensive 20-week
training program at the Belfast Institute of Further and Higher Education, to expand the
skills of qualified applicants who are not computer software graduates, but who are
equally well-educated in other Disciplines and who have demonstrated aptitude for
learning computer software programming. Tom Scott of the T&EA said IMR applicants
are assessed throughout the program and those who successfully complete the course
are awarded a National Computing Certificate and full-time employment with IMR.
Approximately 40 trainees have already participated in the program. "IMR is extremely
pleased with the T&EAs ability to design and deliver a training program customized to
our needs, and one that is delivering us an impressive pool of incremental programming
talent," McFerran said. Smart And Available "The recent software investments by IMR
and other companies provide a new opportunity for Northern Ireland’s computer
graduates," McFerrin said. Recruitment research by IMR indicates that traditionally,
nearly half of the region’s computer graduates have been forced to seek jobs outside
Northern Ireland due to the lack of available information technology positions.
Now IT graduates have the chance to find good jobs in Northern Ireland, and
graduates from other fields can take advantage of the IMR Academy training program
to get a head start on a career in the growing software sector.
McFerrin said. Recruitment research by IMR indicates that traditionally, nearly half of
the region’s computer graduates have been forced to seek jobs outside Northern
Ireland due to the lack of available information technology positions.
Competitive Advantage
Northern Ireland recently has attracted information technology – based investments
from other multinational companies such as BT, Fujitsu, Liberty Mutual Group,
Seagate Technology, STB Systems and UniComp. These companies cite Northern
Ireland’s work force and favorable cost base in their decisions to locate in the region.
"The availability of high-quality graduates combined with the region’s competitive
operating costs and attractive incentives made Northern Ireland the best possible
location for STB," said Richard W. Cooke, STB’s director of engineering operations.
With salaries and fringe costs for well trained software engineers in Northern Ireland
approximately 50 percent lower than costs for US engineers, and low employee
turnover and favorable rates for office space, the overall annual per capita
operational costs to develop high quality software can be significantly less compared
with these same costs in the United States.
Typical starting salaries for IT graduates in Northern Ireland are $22,000 to $25,000
annually. At less than three percent annually, Northern Ireland’s employee turnover
rate is a fraction of the rates typically experienced in other parts of Europe and the
United States. Annual costs per square foot for office space, exclusive of property
taxes and service charges, range from as low as $5 per square foot in some
development areas, to approximately $14 in Belfast. These costs can be as much as 50
percent lower than office space costs in other European cities.

Master of Business Administration - MBA Semester 4

 MB0037 – International Business Management - 3 Credits
(Book ID: B0861)
Assignment Set- 2
60 Marks

Note: Each question carries 10 Marks. Answer all the questions.

Q.1 Evaluate the monetary system and currency markets in international business
management. (10 marks)
Sol.
The IMF is an international organization of 185 member countries. It was established
to promote international monetary cooperation, exchange stability, and orderly
exchange arrangements; to foster economic growth and high levels of employment;
and to provide temporary financial assistance to countries to help ease balance of
payments adjustment.
The International Monetary Fund (IMF) is the intergovernmental organization that
oversees the global financial system by following the macroeconomic policies of its
member countries, in particular those with an impact on exchange rate and the
balance of payments. It is an organization formed with a stated objective of
stabilizing international exchange rates and facilitating development through the
enforcement of liberalising economic policies[1][2] on other countries as a condition for
loans, restructuring or aid.[3] It also offers highly leveraged loans, mainly to poorer
countries. Its headquarters is in Washington, D.C., United States.
Organization and purpose
IMF "Headquarters 1" in Washington, D.C. The International Monetary Fund was created
in July 1945, originally with 45members,[4] with a goal to stabilize exchange rates and
assist the reconstruction of the world's international payment system. Countries
contributed to a pool which could be borrowed from, on a temporary basis, by countries
with payment imbalances (Condon, 2007). The IMF was important when it was first
created because it helped the world stabilize the economic system. The IMF works to
improve the economies of its member countries.[5] The IMF describes itself as "an
organization of 187 countries (as of July 2010),[6][7] working to foster global monetary
cooperation, secure financial stability, facilitate international trade, promote high
employment and sustainable economic growth, and reduce poverty". With the exception
of Cuba (left in 1964),[8] Taiwan (expelled in 1980),[9] North Korea, Andorra, Monaco,
Liechtenstein, Tuvalu and Nauru, all UN member states participate directly in the IMF.
Member states are represented on a 24-member Executive Board (five Executive
Directors are appointed by the five
members with the largest quotas, nineteen Executive Directors are elected by the
remaining members), and all members appoint a Governor to the IMF's Board of
Governors.[1
Q.2 a. Mention the different entry strategies to enter international markets. (4
marks)
Sol.
Entry Strategies
Methods of entry
With rare exceptions, products just don’t emerge in foreign markets overnight – a firm
has to build up a market over time. Several strategies, which differ in aggressiveness,
risk, and the amount of control that the firm is able to maintain, are available:
· Exporting is a relatively low risk strategy in which few investments are made in the
new country. A drawback is that, because the firm makes few if any marketing
investments in the new country, market share may be below potential. Further, the
firm, by not operating in the country, learns less about the market (What do
consumers really want? Which kinds of advertising campaigns are most successful?
What are the most effective methods of distribution?) If an importer is willing to do a
good job of marketing, this arrangement may represent a "win-win" situation, but it
may be more difficult for the firm to enter on its own later if it decides that larger
profits can be made within the country.
· Licensing and franchising are also low exposure methods of entry – you allow
someone else to use your trademarks and accumulated expertise. Your partner puts
up the money and assumes the risk. Problems here involve the fact that you are
training a potential competitor and that you have little control over how the business
is operated. For example, American fast food restaurants have found that foreign
franchisees often fail to maintain American standards of cleanliness. Similarly, a
foreign manufacturer may use lower quality ingredients in manufacturing a brand
based on premium contents in the home country.
· Contract manufacturing involves having someone else manufacture products while
you take on some of the marketing efforts yourself. This saves investment, but again
you may be training a competitor.
· Direct entry strategies, where the firm either acquires a firm or builds operations
"from scratch" involve the highest exposure, but also the greatest opportunities for
profits. The firm gains more knowledge about the local market and maintains greater
control, but now has a huge investment. In some countries, the government may
expropriate assets without compensation, so direct investment entails an additional
risk. A variation involves a joint venture, where a local firm puts up some of the
money and knowledge about the local market.

b. How has E-commerce helped in international marketing? (6 marks)

Sol.
Electronic Commerce
1 Prospects for electronic commerce
Electronic commerce – usually in the form of sales, promotion, or support through the
Internet – is a hot topic at the moment, evidenced by the high market capitalization
of firms involved in this kind of business. Growth rates have been considerable over
the last two years and are expected to persist, at least to some extent, for at least
the next several years. Yet, it should be recognized that so far, sales over the
Internet account for only a small portion of sales – especially outside the U.S.
2 Obstacles to diffusion
Obstacles to the diffusion of Internet trade come both from enduring sources and
temporary roadblocks which may be overcome as consumer attitudes change and
technology is improved. Currently, Internet connections are slower than desired so
that downloading pictures and other information may take longer than consumers are
willing to wait. "Glitches" in online ordering systems may also frustrate consumers,
who are unable to place their orders at a given time or have difficulty navigating
through a malfunctioning site. The lack of non-English language sites in some areas
may also be off-putting to consumers, and registering domain names in some
countries is difficult. Further, shipping small packages across countries may be
inefficient due to high local postage rates and inefficiencies in customs processing.
Most of these obstacles may be overcome within next few years.
Other obstacles may, however, have considerably greater staying power. First, there
are legal problems, as several different countries may seek to impose their
jurisdiction on advertising and laws of product assortment and business practices.
Further, the maintenance of databases, which are essential to delivering on the
promises of e-commerce, may conflict with the privacy rules of some countries – this is
currently a hot issue of contention between the United States and the European
Union. Finally, there are issues of taxation and collection. While the Clinton
Administration has sought to get the WTO to go along with a three year tax
"moratorium" on Internet purchases much like the one observed in the U.S., strong
opposition is expected. A great attraction of e-commerce in Europe is that people
may order from other countries and thus evade local sales taxes, which can be
prohibitive (e.g., 25% in Denmark and 16% in Germany). Some firms will ship to
customers in neighbouring countries without collecting sales taxes or duties, with the
responsibility of paying falling on the consumer. Although most consumers who order
and do not arrange to pay for these taxes get away with it, fines for those caught
through random checks can be severe.
3 Locus of the site
Some firms have chosen to maintain a global site, with reference only to local sales or
support offices; others, in contrast, have unique sites for each country. In some cases,
global sites will hyperlink surfers to a country or region relevant to the site. Note that
some confusion exists since many sites outside the U.S. maintain the ".com"
designation rather than their countries’ respective suffix (e.g., ".de" for Germany,
".se" for Sweden, and ".au" for Australia). Some firms have experienced problems
getting their banks to accept credit card charges in more than one currency, and thus
it may be difficult to indicate precise prices in more than one denomination (one site
based in Britain offered its American customers to be as accurate as possible, based
on current exchange rates, although the charge could be off "by a few pennies.")
4 Lifecycle stages across the World
It has been suggested that Europe runs some five years behind the U.S. in electronic
commerce, but some sources dispute this, suggesting that lack of success among
American retailers may have other origins, such as inadequate adaptation (for
example, some British users are put off by American English). There are, however,
some factors which cause most countries run behind. Even in Europe, Internet access
penetration rates are lower than they are in the U.S., and the slower speed
associated with downloading Asian characters is discouraging. In some countries,
credit card penetration is lower, and even in European countries with high
penetration rates, consumers are reluctant to use them. Further, the fact that
consumers in most countries have to pay a per minute phone charge discourages the
essential casual and relaxed browsing common in the U.S. so long as unlimited cable
or hardwired access is not offered.

Q.3 a. Explain Bill of Lading and Letters of credit. (8 marks)

Sol.
A bill of lading (sometimes referred to as aBOL,orB/L) is a document issued by a
carrier to a shipper, acknowledging that specified goods have been received on board
as cargo forcon v eyan ce to a named place for delivery to thecon s ign ee who is usually
identified. Athorough bill of lading involves the use of at least two different modes
of transport from road, rail, air, and sea. The term derives from the verb "to lade"
which means to load a cargo onto a ship or other form of transportation.
A bill of lading can be used as a traded object. The standard short form bill of lading
is evidence of thecon t r act of carriage of goods and it serves a number of purposes:
•

It is evidence that a valid contract of carriage, or a chartering contract, exists,

and it may incorporate the full terms of the contract between the consignor
and the carrier by reference (i.e. the short form simply refers to the main
contract as an existing document, whereas the long form of a bill of lading
(connaissement intégral) issued by the carrier sets out all the terms of the
contract of carriage);
•

It is a receipt signed by the carrier confirming whether goods matching the

contract description have been received in good condition (a bill will be
described asclean if the goods have been received on board in apparent good
condition and stowed ready for transport); and
•

It is also a document of transfer, being freely transferable but not an egot iable
instrument in the legal sense, i.e. it governs all the legal aspects of physical
carriage, and, like acheque or other negotiable instrument, it may be
endorsed affecting ownership of the goods actually being carried. This matches
everyday experience in that the contract a person might make with a
commercial carrier like FedEx for mostly airway parcels, is separate from any
contract for the sale of the goods to be carried; however, it binds the carrier
to its terms, irrespectively of who the actual holder of the B/L, and owner of
the goods, may be at a specific moment.
•

A standard, commercial letter of credit is a document issued mostly by a

financial institution, used primarily in trade finance, which usually provides an
irrevocable payment undertaking.
•

The letter of credit can also be source of payment for a transaction, meaning
that redeeming the letter of credit will pay an exporter. Letters of credit are
used primarily in international trade transactions of significant value, for deals
between a supplier in one country and a customer in another. They are also
used in the land development process to ensure that approved public facilities
(streets, sidewalks, storm water ponds, etc.) will be built. The parties to a
letter of credit are usually abeneficiary who is to receive the money, the
issuing bank of whom the applicant is a client, and the advising bank of whom
the beneficiary is a client. Almost all letters of credit are irrevocable, i.e.,
cannot be amended or canceled without prior agreement of the beneficiary,
the issuing bank and the confirming bank, if any. In executing a transaction,
letters of credit incorporate functions common to giros and Traveler's cheques.
Typically, the documents a beneficiary has to present in order to receive
payment include a commercial invoice, bill of lading, and documents proving
the shipment was insured against loss or damage in transit. However, the list
and form of documents is open to imagination and negotiation and might
contain requirements to present documents issued by a neutral third party
evidencing the quality of the goods shipped, or their place of origin.

b. What is UNCITRAL and what it does? (2 marks)

SOL - The United Nations Commission on International Trade Law
(UNCITRAL) was
established by the United Nations General Assembly by its Resolution 2205 (XXI) of 17
December 1966 "to promote the progressive harmonization and unification of
international trade law.
When world trade began to expand dramatically in the 1960s, national governments
began to realize the need for a global set of standards and rules to harmonize
national and regional regulations, which until then governed

Q.4. Explain the importance of STP in international markets. (10 marks)

Sol.
The importance of STP
Segmentation is the cornerstone of marketing – almost all marketing efforts in some
way relate to decisions on who to serve or how to implement positioning through the
different parts of the marketing mix. For example, one’s distribution strategy should
consider where one’s target market is most likely to buy the product, and a
promotional strategy should consider the target’s media habits and which kinds of
messages will be most persuasive. Although it is often tempting, when observing large
markets, to try to be "all things to all people," this is a dangerous strategy because
the firm may lose its distinctive appeal to its chosen segments.
In terms of the "big picture," members of a segment should generally be as similar as
possible to each other on a relevant dimension (e.g., preference for quality vs. low
price) and as different as possible from members of other segments. That is, members
should respond in similar ways to various treatments (such as discounts or high
service) so that common campaigns can be aimed at segment members, but in order
to justify a different treatment of other segments, their members should have their
own unique response behaviour.

The importance of STP

Segmentation is the cornerstone of marketing – almost all marketing efforts in some

way relate to decisions on who to serve or how to implement positioning through the
different parts of the marketing mix. For example, one’s distribution strategy should
consider where one’s target market is most likely to buy the product, and a
promotional strategy should consider the target’s media habits and which kinds of
messages will be most persuasive. Although it is often tempting, when observing large
markets, to try to be "all things to all people," this is a dangerous strategy because
the firm may lose its distinctive appeal to its chosen segments.
In terms of the "big picture," members of a segment should generally be as similar as
possible to each other on a relevant dimension (e.g., preference for quality vs. low
price) and as different as possible from members of other segments. That is, members
should respond in similar ways to various treatments (such as discounts or high
service) so that common campaigns can be aimed at segment members, but in order
to justify a different treatment of other segments, their members should have their
own unique response behaviour.

Q. 5 a. Write a short note on branding and trademarks. (6 marks)

Sol.
Branding and trademarks
As mentioned in chapter four, it is difficult to protect a trademark or brand, unless all
countries are members of a convention. Brand "piracy" is widespread in many
developing countries. Other aspects of branding include the promotional aspects. A
family brand of products under the Zeneca (ex ICI) label or Sterling Health are likely to
be recognised worldwide, and hence enhance the "subjective" product characteristics.
Warranty Many large value agricultural products like machinery require warranties.
Unfortunately not everyone upholds them. It is common practice in Africa that if the
original equipment has not been bought through an authorized dealer in the country,
that dealer refuses to honour the warranty. This is unfortunate, because not only may
the equipment have been legitimately bought overseas; it also actually builds up
consumer resistance to the dealer. When the consumer is eventually offered with a
choice, the reticent dealer will suffer, for example, with the new dealers coming up.
Cotton Production/Marketing Interface Spinners Machines are highly flexible, that is they
can usually switch to a variety of yarn requirements. The machines are geared to high
production, are automated and are of a precision for constant quality provision. There
are strict process controls and built – n quality control. Poor raw material, especially
when contaminated with metal particles, damages opening mills, grid knives, fans and
card clothing. Previous devices employed to remove these (magnets) are becoming less
effective. The consequences are damage in the blow room and carding and danger of
fire. Quality is therefore defined as properties of the end use (clothing etc.), efficiency of
weaving and knitting and the efficient running of the spinning plant. Spinners require raw
cotton which is free of trash; dust, sugar and honey dew contamination, seed coats, bark
and foreign fibres and, will not nep the cloth. Further requirements are a certain length
(could be short, medium or long), uniformity of length, strength, fineness, maturity and a
certain elongation and colour. Suppliers In order to meet these high quality demands,
the growers have to ensure that the production, picking and ginning is of a very high
standard. Cotton grading The Liverpool Cotton exchange, for one, relied on the skills of
its experts to manually classify raw fibre purchases for its clients. It still holds the
"standards" for length, colour and trash content. As well as the demands of modem
machinery, the lack of standardised measuring and cotton classification procedures has
resulted in commercial conflict and legal disputes about the true nature of traded cotton.
Now, computer based high volume instrument listing systems of raw cotton (HVI
systems) are available. The system can handle large numbers of bales, reduce variation
in classification and the need for highly trained bate classifiers.
For cotton exporters the system offers the following advantages:
• · enhanced objectivity in classification
• · improve communication if similar systems are used by sellers or buyers
• · reduced conflict and need for arbitration
• · enhanced competitiveness against synthetic fibres
• · improved integration with modern spinning machines
• · reduced costs on training of experts and in measuring time.
The system can process 2000 bales per day and give a printout on the seven
parameters of grading. These include length and length uniformity, strength and
elongation, micronaire or fineness, leaf and colour. Manufacturers include SPINLAR
INC. of Knoxville, USA.

b. What are the features of exchange and currency markets? (4 marks)

Sol.
The exchange rate regimes adopted by countries in today’s international monetary
and financial system, and the system itself, are profoundly different from those
envisaged at the 1944 meeting at Bretton Woods establishing the IMF and the World
Bank. In the Bretton Woods system:
· exchange rates were fixed but adjustable. This system aimed both to avoid the
undue volatility thought to characterize floating exchange rates and to prevent
competitive depreciations, while permitting enough flexibility to adjust to
fundamental disequilibrium under international supervision;
· private capital flows were expected to play only a limited role in financing payments
imbalances, and widespread use of controls would prevent instability in such flows;
· temporary official financing of payments imbalances, mainly through the IMF, would
smooth the adjustment process and avoid unduly sharp correction of current account
imbalances, with their repercussions on trade flows, output, and employment.
In the current system, exchange rates among the major currencies (principally the
U.S. dollar, the euro, and Japanese yen) fluctuate in response to market forces, with
short-run volatility and occasional large medium-run swings (Figure 1). Some medium-
sized industrial countries also have market – determined floating rate regimes, while
others have adopted harder pegs, including some European countries outside the euro
area. Developing and transition economies have a wide variety of exchange rate
arrangements, with a tendency for many but by no means all countries to move
toward increased exchange rate flexibility (Figure 2).
This variety of exchange rate regimes exists in an environment with the following
characteristics:
· partly for efficiency reasons, and also because of the limited effectiveness of capital
controls, industrial countries have generally abandoned such controls and emerging
market economies have gradually moved away from them. The growth of
international capital flows and globalization of financial markets has also been
spurred by the revolution in telecommunications and information technology, which
has dramatically lowered transaction costs in financial markets and further promoted
the liberalization and deregulation of international financial transactions; · international
private capital flows finance substantial current account imbalances,
but the changes in these flows appear also sometimes to be a cause of
macroeconomic disturbances or an important channel through which they are
transmitted to the international system;
· developing and transition countries have been increasingly drawn into the
integrating world economy, in terms of both their trade in goods and services and of
financial transactions.
Lessons from the recent crises in emerging markets are that for such countries with
important linkages to global capital markets, the requirements for sustaining pegged
exchange rate regimes have become more demanding as a result of the increased
mobility of capital. Therefore, regimes that allow substantial exchange rate flexibility
are probably desirable unless the exchange rate is firmly fixed through a currency
board, unification with another currency, or the adoption of another currency as the
domestic currency (dollarization).
Flexible exchange rates among the major industrial country currencies seem likely to
remain a key feature of the system. The launch of the euro in January 1999 marked a
new phase in the evolution of the system, but the European Central Bank has a clear
mandate to focus monetary policy on the domestic objective of price stability rather
than on the exchange rate. Many medium-sized industrial countries, and developing
and transition economies, in an environment of increasing capital market integration,
may also continue to maintain market-determined floating rates, although more
countries could may adopt harder pegs over the longer term. Thus, prospects are
that:
· exchange rates among the euro, the yen, and the dollar are likely to continue to
exhibit volatility, and schemes to reduce volatility are neither likely to be adopted,
nor to be desirable as they prevent monetary policy from being devoted consistently
to domestic stabilization objectives;
· several of the transition countries of central and eastern Europe, especially those
preparing for membership in the European Union, are likely to seek to establish over
time the policy disciplines and institutional structures required to make possible the
eventual adoption of the euro.
The approach taken by the IMF continues to be to advise member countries on the
implications of adopting different exchange rate regimes, to consider the choice of
regime to be a matter for each country to decide and to provide policy advice that is
consistent with the maintenance of the chosen regime (Box 3).
Q. 6 Discuss the various International product and pricing decisions. (10 marks)
Sol.
Production decisions
In decisions on producing or providing products and services in the international
market it is essential that the production of the product or service is well planned and
coordinated, both within and with other functional area of the firm, particularly
marketing. For example, in horticulture, it is essential that any supplier or any of his
"out grower" (sub-contractor) can supply what he says he can. This is especially vital
when contracts for supply are finalized, as failure to supply could incur large
penalties. The main elements to consider are the production process itself,

specifications, culture, the physical product, packaging, labelling, branding, warranty

and service.
International Pricing In New Open-Economy Models
Recent developments in open-economy macroeconomics have progressed under the
paradigm of nominal price rigidities, where monetary disturbances are the main
source of fluctuations. Following developments in closed-economy models, new open-
economy models have combined price rigidities and market imperfections in a fully
micro founded inter-temporal general equilibrium setup. This framework has been
used extensively to study the properties of the international transmission of shocks,
as well as the welfare implications of alternative monetary and exchange rate
policies.
Imperfect competition is a key feature of the new open-economy framework. Because
agents have some degree of monopoly power instead of being price takers, this
framework allows the explicit analysis of pricing decisions. The two polar cases for
pricing decisions are producer-currency pricing and local-currency pricing. The first
case is the traditional approach, which assumes that prices are preset in the currency
of the seller. In this case, prices of imported goods change proportionally with
unexpected changes in the nominal exchange rate, and the law of one price always
holds.’ In contrast, under the assumption of local-currency pricing, prices are preset
in the buyer’s currency. Here, unexpected movements in the nominal exchange rate
do not affect the price of imported goods and lead to short-run deviations from the
law of one price.
Empirical evidence using disaggregated data suggests that international markets for
tradable goods remain highly segmented and that deviations in the law of one price
are large, persistent, and highly correlated with movements in the nominal exchange
rate, even for highly tradable goods. Moreover, there is strong evidence that the large
and persistent movements that characterize the behaviour of real exchange rates at
the aggregate level are largely accounted for by deviations in the law of one price for
tradable goods.
In this article I make use of a simplified version of a two-country model where the
two markets are segmented, allowing firms to price discriminate across countries, and
where prices are preset in the consumer’s currency. This model generates movements
in the real exchange rate in response to unexpected monetary shocks, which are a
result of the failure of the law of one price for tradable goods. I then compare this
model to a version in which prices are preset in the producer’s currency and examine
the implications of these two alternative price-setting regimes for several key issues.
The price-setting regime determines the currency of denomination of imported goods
and the extent to which changes in exchange rates affect the relative price of
imported to domestic goods and the international allocation of goods in the short run.
That is, different pricing regimes imply different roles for the exchange rate in the
international transmission of monetary disturbances. As we shall see, this assumption
has very striking implications for several important questions, namely real exchange
rate variability, the linkage between macroeconomic volatility and international
trade, and the welfare effects of alternative exchange rate regimes, among others.
While generating deviations from the law of one price that are absent from models
assuming producer-currency pricing, the assumption of local-currency pricing still
leaves important features of the data unexplained. The key role of this assumption in
the properties of open-economy models suggests that it is necessary to keep exploring
the implications of alternative pricing structures in open-economy models.
In Section 1, I review the empirical evidence on the behaviour of real exchange rates
and on international market segmentation and pricing. In Section 2, I present the
model with local-currency pricing and explore the main implications of this pricing
assumption. The final section concludes.
1 Some Evidence on Real Exchange Rates
I first review some empirical evidence on the behaviour of real exchange rates using
aggregate data. I then turn to a review of the evidence on the sources of movements
in real exchange rates.
The real exchange rate between two countries represents the relative cost of a
common reference basket of goods. For two countries, say the United States and
Japan, the real exchange rate is given by
where P^sub US^ and P^sub JP^ represent the American and Japanese price levels
(measured in terms of dollars and yen, respectively) and where e denotes the nominal
exchange rate (defined as the dollar price of one yen).
The theory of purchasing power parity (PPP) predicts that real exchange rates should
equal one, or at least show a strong tendency to quickly return to one when they
differ from this value. The fundamental building block of PPP is the law of one price:
due to arbitrage in goods markets, and absent barriers to trade, similar products
should sell in different countries for the same price (when converted in the same
currency). Large international price differentials would be only temporary, as profit-
maximizing traders would quickly drive international goods prices back in line.
Therefore, if arbitrage in goods markets ensures that the law of one price holds for a
sufficiently broad range of individual goods, then aggregate price levels (when
expressed in a common currency) should be highly correlated across countries.
Because aggregate prices are reported as indices rather than levels, most empirical
work has tested the weaker hypothesis of relative PPP, which requires only that the
real exchange rate be stable over time. Figure 1 show the log changes in the CPI-
based dollar-yen real and nominal exchange rates and the relative price level. In this
figure, which is typical for countries with floating exchange rates and
moderate
inflation, it clearly stands out that short-run deviations from PPP are large and
volatile.(Delete) In the short run, movements in the real exchange rate mimic those
in the nominal exchange rate, with no offsetting movements in the relative price
level. Not surprisingly, early empirical work based on simple tests of short-run PPP
produced strong rejections of this hypothesis for moderate inflation countries.
However; these studies did not allow for any dynamics of adjustment to PPP and
therefore did not address the validity of PPP as a medium- or long-run proposition.
The conventional explanation for the failure of short-run PPP is the presence of
nominal price rigidities. If the short-term volatility of nominal exchange rates were
due mostly to monetary and financial disturbances, then nominal price stickiness
would translate these disturbances into short-run fluctuations in the real exchange
rate. If this were true, however, we should observe a substantial convergence to PPP
in one to two years, as the adjustment of prices and wages takes place. Purchasing
power parity, therefore, would be re-established in the medium to long run.