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International Business

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  1. International Business Wendy Jeffus Harvard Summer School

  2. Introduction • International Trade & Global Competition • Chapter 8: Regional Economic Integration • Case Study: Boeing vs. Airbus: Two Decades of Trade Disputes • Chapter 9: The Foreign Exchange Market

  3. Session II - Countries • Tier I (A) • Fernando ($11000) + 8 pennies • Tier I (B) • James ($20,500) + 1 penny • Tier II (D) • Andy ($8500) + 8 pennies • Tier II (E) • Bernadette ($5,000) + 1 penny • Tier II (F) • Andrew ($11,500) + No pennies • Tier III (H) • Ipek ($14,000) + 3 pennies • Tier III (I) • Nethra ($7000) + 1 penny

  4. 4:10 (By the clock on the wall) • Is the END of the game. Game Over!

  5. Starting Output Prices Small Triangle $500 Circle $500 Half-Moon with circle cut out $1,000 Large Triangle with Half-moon cut out $1,500 Parallelogram with Square cut out $1,500 Power Brokers’ Price List Environmental Token $500 Pencil $3,000 White Paper (2 sheets) $3,000 Labor (per person) $4,000 Compass $5,000 (sold out) Protractor $7,000 (sold out) Pencil Sharpener $8,000 Red Paper (1 full sheet) $10,000 Ruler $10,000 Scissors $12,000 The Bankers will pay you in cash for the shapes. You will need this cash to provide for the subsistence of your people (at $500 per person per year). You may also use this cash to purchase additional capital, raw materials, labor, and environmental tokens. You will be given 10 tokens at the start of each year. You can trade with other countries to get additional tokens and/or you can buy more tokens from the Power Brokers. At the end of each year, you must turn in any leftover tokens for which you will receive $500 each. 1. Meet your production quota - by paying the Chief Economist $500 for each citizen of your country. If you do not have enough money, then some of your people will starve, and DIE! 2. Protect and/or clean up your environment - by giving the Chief Economist one environmental token (penny) for each $1000 worth of shapes which you produced and sold to the bank. If you do not have enough tokens, the pollution will be so toxic that some of your people will DIE! Trade Simulation

  6. Designing Negotiation Strategies • Organizing to influence – creating, staffing, funding, and directing institutions in ways that influence the trade negotiation process. • Selecting the forum – identifying the most promising forum in which to pursue one’s objectives and then ensuring that negotiations take place there. • Shaping the agenda – adding or removing issues from the agenda, dividing the larger agenda into modules for parallel negotiations, and establishing some high-level principles to govern the process. • Building coalitions – identifying potential winning and blocking coalitions and then devising plans for building supportive coalitions and breaking or forestalling opposing ones. • Leveraging linkages – linking and de-linking issues or sets of negotiations in order to create and claim value. • Playing the frame game – crafting and promulgating a favorable framing of “the problem” and “the options” • Creating momentum – channeling the flow of the negotiations process in promising directions by establishing appropriate stages to take advantage of action forcing events.

  7. Wendy Jeffus Harvard Summer School Chapter 8: Regional Economic Integration

  8. Introduction • Trend - Regional Economic Integration • Regional Trade Agreements – • Agreements among countries in a geographic region to reduce, and ultimately remove, tariff and non-tariff barriers to the free flow of goods, services, and factors of production.

  9. Gulf Cooperation Council & EFTA sign free trade agreement • June 22, 2009 (Norway) after extensive negotiations which started in February 2006 and went on till April 2008. • Agreement covers areas such as commercial trade, exchange of services, intellectual property protection, governmental purchases, and methodology for arbitrating conflicts. In addition, the agreement seeks economic partnership through investments and the reduction of customs duties on most goods exchanged by both sides, especially agricultural goods. GCC: Bahrain Qatar Kuwait Oman Saudi Arabia United Arab Emirates European Free Trade Association: Iceland Liechtenstein Norway Switzerland,real_esta/249043

  10. Levels of Economic Integration • Free trade area • Barriers to trade are removed, but each country determines its own external trade policy • Example: European Free Trade Association (Norway, Iceland, Liechtenstein, & Switzerland) • Basically for industrial goods (i.e. heavy equipment) • Customs union • Internal barriers to trade are removed and a common external trade policy is adopted • Example: Andean Community of Nations (Bolivia, Colombia, Ecuador, & Peru) • Common external tariffs 5 – 20% • Common market • Has no barriers to trade between member countries, includes a common external trade policy, and also allows factors of production to move freely between members. • Example: MERCOSUR (Argentina, Brazil, Paraguay, & Uruguay) • Economic union • Involves the free flow of products and factors of production between member countries and the adoption of a common external trade policy, but it also requires a common currency, harmonization of members’ tax rates, and a common monetary and fiscal policy. • Example: EU (although not all members have adopted the common currency) • Political union • Occurs when a central political apparatus coordinates the economic, social, and foreign policy of the member states • Example: United States

  11. Levels of Economic Integration

  12. Case for Integration • Economic Arguments • Stimulates economic growth in member countries • Increases FDI and world production • Countries specialize in goods and services that can be efficiently produced • Creates additional gains from free trade beyond the international agreements such as GATT and WTO • Political Arguments • Economic interdependence creates incentives for political cooperation • This reduces the potential for violent confrontation • Together, the countries have more economic clout to enhance trade with other countries or trading blocs

  13. Impediments to Integration • Integration is hard to achieve and sustain • Nations may benefit but groups within countries may be hurt. • Example: (Canadian & U.S. textile workers) • Potential loss of sovereignty and control over domestic issues (especially for the “economically weaker” members)

  14. Trade Creation & Trade Diversion • Economists point out that the benefits of regional integration are determined by the extent of trade creation, as opposed to trade diversion • Trade creation occurs when high cost domestic producers are replaced by low cost producers within the free trade area. • Example: NAFTA/Mexico, EU/Poland • Trade diversion occurs when lower cost external suppliers are replaced by higher cost suppliers within the free trade area. • Example: Britain imported lamb from New Zealand, until the EU imposed the common external tariff. Now Britain imports lamb from France.

  15. Evolution of the European Union • Product of two political factors: • A desire for peace (after the devastation from WWI & WWII) • A desire for strong political & economic position on the world stage

  16. The Euro

  17. Key Dates 1951 - European Coal and Steel Community. 1957- Treaty of Rome establishes the European Community 1993 – Treaty of Maastricht established the European Union January 1, 1999 11 countries January 1, 2001 + Greece - Greek drachma (GRD) exchange rate of 340.750000 January 1, 2002 old currencies were not accepted Actually you could exchange currency for about 2 months until February 28, 2002. EU Membership Source:

  18. EU Membership Recent News: Sweden’s Agenda Image Source: (EU)

  19. Economic Gains of 1 Currency • Reduced exchange costs • Reduced currency risk • Increased price competition • Major investment and export opportunities for firms within region • Allows firms to optimize mix of resources to reduce overall costs

  20. The Single European Act • This act committed member countries to work toward the establishment of a single market by December 31, 1992 • The act was born out of: • Frustration among members of the European Community regarding the barriers to the free flow of trade and investment between member countries • A need to harmonize the wide range of technical and legal standards for doing business • Objectives: • Abolish delays and reduces costs of trade bureaucracy • “Mutual recognition” of product standards • Allow foreign low cost suppliers to compete • Lift barriers to banking and insurance competition • Remove restrictions on foreign exchange transactions and trucking

  21. Benefits: Savings from using only one currency Easy to compare prices, resulting in lower prices Forces efficiency Creates liquid pan-Europe capital market Increases range of investments for individuals and institutions As of 2009 Euro strong against the dollar. Costs: Countries lose monetary policy control European Central Bank controls policy for the “Euro zone” EU is not an “optimal currency area” Country economies are different Euro puts the economic cart before the political horse Strong Euro (2009) makes it harder for Euro zone exporters to sell their goods The Single European Act

  22. Enlargement of the European Union • To qualify for EU membership applicants must: • Privatize state assets • Deregulate markets • Restructure industries • Control inflation • Include EU laws into their own systems • Establish stable democratic governments • Respect human rights • Current Candidate Countries: Croatia, Macedonia, and Turkey. •

  23. NAFTA • The North American Free Trade Agreement (NAFTA) became law January 1, 1994 • NAFTA includes the following: • Over 10 year period: tariffs reduced (99% of goods traded) • Removal of most barriers on cross border flow of services • Removal of restrictions on FDI except in certain sectors • Mexican railway and energy • US airline and radio communications • Canadian culture • Protection of intellectual property rights • Applies national environmental standards • Establishment of commission to police violations

  24. Pros Enlarged and productive regional base Labor-intensive industries move to Mexico Mexico gets investment and employment Increased Mexican income to buy US/Canada goods Demand for goods increases jobs Consumers get lower prices Cons Loss of jobs to Mexico Mexican firms have to compete against efficient US/Canada firms Mexican firms become more efficient Environmental degradation Loss of national sovereignty The Case For & Against NAFTA

  25. NAFTA Results • Recent surveys indicate that NAFTA’s overall impact has been small but positive • From 1993 to 2004, trade between NAFTA’s partners grew by 250 percent • Canada’s trade with NAFTA partners increased from 70% to more than 80% of all Canadian foreign trade • Mexico’s trade with NAFTA partners increased from 66% to 80% of all Mexican foreign trade • All countries experienced strong productivity growth • According to some sources, the United States has lost 110,000 jobs per year due to NAFTA • Many economists dispute this figure because more than 2 million jobs a year were created in the US during the same time period

  26. Most Active Regional Trade Blocs

  27. The Andean Community • Bolivia, Colombia, Ecuador, Peru, Venezuela • Nearly failed. Rejuvenated in 1990 • Changed from FTA to customs union in 1992 • Still has many political and economic problems

  28. In the news… • July 2, 2009 - United States has decided to remove Bolivia from the Andean Trade Preference Act, a bill that allows many goods from Colombia, Bolivia, Ecuador, and Peru to enter into the United States duty free. • The idea behind the act is that providing tariff free access to the U.S. market will help convince farmers to stop growing coca in favor of another commodity. • Bolivia was removed because it is not doing enough to reduce the cultivation of coca. • The U.S. Trade Representative to Bolivia said there has been "explicit acceptance and encouragement of coca production at the highest levels of the Bolivian government." • Coca is seen as a cultural crop in Bolivia, where it is used for numerous reasons other than cocaine (such as religious ceremonies and as a mild sedative).; Image Bolivia Coca tea (google images)

  29. Mercosur • 1988: Argentina, Brazil. 1990: Paraguay, Uruguay • 1995: Agreed to move toward a full customs union • Trade quadrupled between 1990-1998 • Has significant trade diversion issues • Revival in 2003 by Brazil’s president to be modeled after EU with common currency and elected parliament • 2006: Venezuela

  30. Mercosur • Summit moved to July 24 – 25th • Political issues: • The delayed incorporation of Venezuela • The A/H1N1 virus pandemic, • Protectionism and hurdles to intra-trade • Bilateral disputes • Argentina and Uruguay paper mills • Brazil and Paraguay over the sale of power from the hemisphere’s largest operational hydroelectric complex

  31. Other Associations • Central American Common Market • 1960s: Costa Rica, El Salvador, Guatemala, Honduras, Nicaragua. • Collapsed in 1969 • CARICOM • 1973: English-speaking Caribbean countries • 1991: Failed for third time to establish common external tariff • Free Trade Area of the Americas • Two stumbling blocks include intellectual property rights and reductions in agriculture subsidies

  32. Association of Southeast Asian Nations Created in 1967 Objective to achieve free trade between member countries and achieve cooperation in their industrial Brunei, China, Indonesia, Laos, Malaysia, the Philippines, Myanmar, Singapore, Thailand, and Vietnam Progress limited by Asian financial crisis of the 90’s ASEAN Countries

  33. ‘Promote a sense of community’ 18 members 50% of world’s GNP 40% of global trade Despite slow progress, if successful, could become the world’s largest free trade area Asia Pacific Economic Cooperation Founded in 1990 to ‘promote open trade and practical economic cooperation APEC Countries

  34. African Union • The only African state that is not a member of the African Union is Morocco, which left the AU's predecessor, the Organisation of African Unity (OAU), in 1984. Source:

  35. Implications for Managers • Opportunities: • Creation of single markets • Protected markets, now open • Lower costs doing business in single market • Threats: • Differences in culture and competitive practices make realizing economies of scale difficult • More price competition • Outside firms shut out of market • EU intervention in M&A

  36. Global Peace Index

  37. Case Study • Boeing vs. Airbus: Two Decades of Trade Disputes • Present a 5-10min (timed) assessment of the case (answer case questions) • All group members must participate.

  38. Wendy Jeffus Harvard Summer School 9: The Foreign Exchange Market

  39. Definitions • Foreign exchange market • A market for converting the currency of one country into the currency of another. • Exchange rate • The rate at which one currency is converted into another • Foreign exchange risk • The risk that arises from changes in exchange rates • Spot exchange rate • Rate at which a dealer converts one currency into another currency on a particular day • Forward exchange rate • An exchange rate governing future transactions (can be used to reduce foreign exchange risk)

  40. 0 The FX Market • The following participants operate within the FX market: • Individuals (investors and tourists) • Speculators and arbitragers • Governments (central banks and treasuries) • Brokers and dealers • Businesses • Payments for exports & purchases from foreign suppliers • Foreign income (licensing, royalty payments, etc.) • Investment/Speculation/Hedging activities

  41. 0 FX Rates and Quotations • Most foreign exchange transactions involve the US dollar. • Professional dealers and brokers may state foreign exchange quotations in one of two ways: • European Terms - the exchange rate between the US dollar and Japanese yen is stated in European terms by the WSJ below ¥106/$ • American Terms - the exchange rate between US dollars and the Japanese yen can also be stated in American terms $0094/¥. FT vs. WSJ,

  42. FX Quotations • Be careful reading FX quotes, know which currency is first. ¥/$ Source:

  43. FX Market • Foreign Exchange Market (FX Market) • World’s largest financial market ($2.5 trillion average daily turnover) • Open 24 hours a day, 6 days a week • Sunday at 5pm (EST) to Friday 4:30pm (EST) Sydney & Tokyo west to Hong Kong & Singapore to Bahrain to Frankfurt, Zurich, & London to New York to Chicago to San Francisco & LA

  44. Currency Hedging • Volkswagen, Europe’s largest carmaker, reported a 95% drop in Q4’03 profits. • Two causes stood out: • The unprecedented rise in the value of the Euro against the dollar • Volkswagen’s decision to only hedge 30% of its foreign currency exposure as opposed to the 70% it had traditionally hedged. • Example: • Suppose the Jetta costs €14,000 to manufacture & ship from Germany to the U.S. where it sells for $15,000. • If the exchange rate is $1 = €1, VW earns €1,000 on the sale. • If the dollar depreciates to $1.25 = €1 (or $1 = 0.80€) the $15,000 price will only convert to €12,000. • In other words, VW would lose €2,000 on every Jetta sold!

  45. Hedging Fuel • In 2001, LUV substantially increased its hedging strategy. • In 2004, more than 80% of its fuel needs were hedged at a price of $24 a barrel. • Without this hedge, Q1’04 profit of $26M would have been a loss of $8M! • Both AMR and CAL reported losses in Q1’04! • Why didn’t these airlines hedge fuel costs? • Hedging requires credit lines or cash which has been in short supply to airlines. • The airline industry attracts executives that like to take risks. Photo Source:

  46. Exchange Rate Determination • Economic Theories of Exchange Rate Determination: • Exchange rates are determined by the demand and supply of one currency relative to the demand and supply of another • Law of One Price • Purchasing Power Parity (PPP) • Money supply and price inflation • Investor psychology and “Bandwagon” effects Note: For additional information on exchange rates see:, Exchange Rate Determination (A) and (B) under “International Finance”

  47. Law of One Price • In competitive markets, identical products sold in different countries should sell for the same price when their price is expressed in terms of the same currency. • Assumptions: • No transportation costs • No barriers to trade • Tradable goods • Example: If the euro/dollar exchange rate is 0.78EUR/USD. • A jacket selling for $50 in New York should retail for €39.24 in Paris ($50 x 0.78EUR/USD = €39.24)

  48. Example 1 • You can rent a compact car in Washington, D.C. for $31.99 • You can rent a compact car in Bangkok, Thailand for 4000.00 BHT • Therefore the exchange rate should be = 4000.00BHT/31.99USD = 125.04BHT/USD Source:

  49. PPP & The Law of One Price • The implied exchange rate based on the absolute theory of PPP is 4000.00BHT/31.99USD = 125.04BHT/USD • But the actual exchange rate today is 32.81BHT/USD. • Is the baht over or under valued vs. the dollar? • Calculate (implied – actual) / actual. • 125.04 – 32.81 / 32.81 = 281% • The baht is overvalued by 281% vs. the dollar.

  50. Example 2 • You can enjoy a chocolate lunch for $30 per person at the Langham hotel in Boston. • You can enjoy a chocolate lunch for 250 AED per person at the Burj Al Arab hotel in Dubai. • Therefore the exchange rate should be 8.33AED/USD.