Global. Markets 9/2/2015. Chapter 3: Doing Business in. Buying products from another country (and bringing them here).

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1 Chapter 3: Doing Business in Global Markets Buying products from another country (and bringing them here). Oil, natural gas, cars & trucks, car parts, potash, gold, wood Money Selling products to another country (and sending them there.) Money Cars, trucks, car parts, oil, natural gas, aircraft 1

2 The total value of a nation s exports compared to its imports measured over a particular period. page 64 A better definition: A country s exports minus its imports. When exports are greater than imports, the balance of trade will be positive. This is called a trade surplus. Balance of Trade = Net Exports (NX) Net Exports = Exports Imports NX = X - M A country s exports minus its imports. Trade Surplus - When balance of trade (NX) is a positive number. Also known as a favorable balance of trade. Trade Deficit - When the balance of trade (NX) is a negative number. Also known as an unfavorable balance of trade. 2

3 Try to sell more goods to other countries than you buy from them. Why is that a good idea? 1. Because if you import more than you export, you will have to make up the difference by either: a. borrowing, or b. selling some of your assets to foreigners, and you can t keep doing either of those forever. Why is that a good idea? 2. Because if you borrow so much that lenders don t believe you ll pay them back, they ll start charging you higher interest to compensate for the risk of default. 3. Because if you can t afford to roll over your existing loans and/or don t have enough attractive assets to sell to close the gap, your currency will weaken. Why is that a good idea? 4. Conversely, if your net exports are positive, you can use the excess foreign currency you end up with to buy foreign assets or make loans (collecting interest on those loans,) and/or your currency may strengthen. 3

4 Imports: $2.4 trillion Exports: $1.6 trillion Net Exports: $1.6 trillion -$2.4 trillion -$0.8 trillion Our trading partners ask: Can we eat these dollars? Will they keep us warm? Then conclude: We got cheated! We ll loan you the money or you can sell us some assets. Unless the assets you still own keep magically becoming more valuable every year, as both American real estate and shares of stock in Google, Apple, and Tesla have somehow done! Eventually you will run out of assets to sell. And/or eventually, your loan will become so large, your lenders will doubt you will ever pay it back. Then the interest rate on rolling over your loan will skyrocket. 4

5 If lenders will lend to you, then you have a choice: pay now or pay later for consumption? Greece chose to consume now and pay later. Now they re having to pay that back with interest, and their businesses are still not competitive in the world marketplace, so how are they going to pay it back? If you borrow from international lenders and spend the money on machines, tools, buildings, roads, and education for your workers (investment), the story can have a happy ending. Your investments increase your labor productivity, and you use the extra GDP to pay back the loans without decreasing consumption. But if you spend the money on consumption and government services, there will be a day of reckoning. Spend more on investment and education, and less on consumption, retirement, and government programs. Become price competitive on everything you plan to export by requiring workers to work both hard and smart, adopting the best management methods, and using the best product designs and manufacturing techniques. 5

6 Global trade enables nations to specialize in producing what they are best at. Making extra amounts of those things and trading the excess for what they re not as good at making turns out to be cheaper than making everything yourself! Comparative Advantage Theory was invented in 1817, but it is still true today. States that a country should sell to other countries those products that it produces relatively more effectively and efficiently, and buy from other countries those products that it produces relatively less effectively or efficiently. But it s really just governments getting out of the way and letting companies decide who to buy from. The movement of goods and services among nations without political or economic barriers. No import tariffs No import quotas or embargos No other restrictive standards that discriminate against imports 6

7 Trade has gotten a lot freer, has increased, and has helped push world standards of living higher. Few propositions command as much consensus among professional economists as that open world trade increases economic growth and raises living standards. - Harvard economics professor N. Gregory Mankiw Though it creates winners and losers, the broad consensus among economists is that free trade produces a large and unambiguous net gain for society. In a 2006 survey of American economists, 87.5% agreed that the U.S. should eliminate all remaining import tariffs and other barriers to trade, and 90.1% disagreed with the suggestion that the U.S. should restrict employers from outsourcing work to foreign countries. 7

8 Arguments against: Loss of American jobs, downward pressure on American wages, environmental, animal rights, and worker safety concerns. PROS 1. Consumers benefit from lower prices. 2. Increased exports will produce more U.S. jobs. 3. There will be upward pressure on wages in some U.S. occupational categories. 4. The specialization made possible by free global trade boosts world living standards. CONS 1. Some U.S. workers will lose their jobs. They may need to get retrained and change careers. 2. There will be downward pressure on wages in some U.S. occupational categories. Data indicates this effect is dominating over the upward pressure on wages in other occupational categories. 8

9 A global strategy in which a firm (the licensor) allows a foreign company (the licensee) to produce its product in exchange for a fee (a royalty.) Oriental Land Company The rights to use the characters, the ride designs and names, etc. The Disney Company Royalties, management fees and consulting fees The oldest, and still one of the most popular strategies Costs include: shipment, insurance, import tariffs. Risks include: damage in transit, difficulty collecting payment. Export Assistance Centers 9

10 Joint Venture: A new company jointly-owned by two or more existing companies. 10

11 CFM International is a joint venture between U.S. company General Electric and French company Snecma to manufacture aircraft engines. General Electric and Snecma are the parent companies. CFM International is the joint venture. If no new legal entity is created, it s not a joint venture! Strategic Alliance: Any contract between two or more companies binding each to help the other in specific ways that does not create a new jointly-owned legal entity. Philips and Salesforce.com Announce a Strategic Alliance to Deliver Cloud-based Healthcare Information Technology (June 2014) In a move to accelerate the transformation of the healthcare industry, Royal Philips and salesforce.com announced a strategic alliance to deliver an open, cloud-based healthcare platform. 11

12 The buying (or building) of tangible property and/or businesses in foreign nations. Includes, but is not limited to, foreign subsidiaries The parent company is located in the home country. The foreign sub is located in the host country. Pepsico Japan is a Japanese company wholly owned by Pepsico, a U.S. company. It manufactures and sells a wide variety of beverages and snacks in Japan. 12

13 Counter-intuitive fact: U.S.- based exporters are helped when the dollar weakens and hurt when the dollar strengthens # planes sold to Europe Avg. Price in Euros Revenue in Euros (millions) 7,998 7,998 Exchange rate.719 /$.778 /$ Revenue in Dollars (millions) $11,123 $10, # planes sold to Europe Avg. Price in Euros Revenue in Euros (millions) 7,998 7,998 Exchange rate.778 /$.753 /$ Revenue in Dollars (millions) $10,280 $10,622 13

14 Dollar Goes Up Dollar Weakens Importers Exporters Helped Hurt Hurt Helped Prohibits U.S. companies, their employees or agents from making questionable or dubious payments to foreign officials to secure business contracts. Penalties in the 22 month period from Jan to October 2013 alone totalled over $740 million! Ralph Lauren, Eli Lilly, Tyco, Oracle, and Pfizer were among the companies penalized. The use of government regulations to limit the import of goods and services. Tariff: A tax imposed on imports. Protective tariff: A tariff designed to protect domestic businesses from cheap imports. 14

15 An 8%-30% tariff on imported steel materials such as steel plates, bars, tubes, rods, and wire Imposed March 2002 and lifted December 2003 Designed to protect profits and jobs at U.S. steelmakers such as Nucor and United States Steel. Nippon Steel of Japan, ArcelorMittal of Belgium, and a number of Chinese steel makers were beating them on price. A tariff designed solely to raise revenue for the government How can you tell if it s a protective tariff or a revenue tariff? 1. Look at the preamble to the bill or executive order that imposed the tariff, or 2. Notice whether there are any domestic firms to protect or not. Import Quota: A limit on the number of products in certain categories that a nation can import. Example: In 1981, sensing that the U.S. Congress was about to impose import quotas on the importation of cars and trucks from Japan, the Japanese government pre-empted that development by implementing voluntary export restraints, starting at 1.68 million units per year. 15

16 Embargo: A complete ban on the import or export of a certain product, or the stopping of all trade with a particular country. Example: The U.K. placed an embargo in the importation of beef from Argentina in 1969 after a disastrous outbreak of foot-and-mouth disease in its herds believed to have been caused by Argentinian imports. Nontariff barriers: Restrictive standards that detail how a product must be made, packaged, or sold in a country intended to favor domestic producers. Examples: 1. Denmark requires butter to be sold in cubes, and does not permit it to be sold in tubs. 2. South Korea excludes most U.S. cars by saying the engines are too large. In 1948, 23 nations signed the General Agreement on Tariffs and Trade (GATT). This established a framework through which these nations could agree to mutual reductions in their import tariffs. Over the next several decades, many more nations signed on to this trade treaty. By 1986, 124 nations were signatories. 16

17 In 1986, the GATT signatories began to negotiate the Uruguay Round of amendments to the GATT; and by 1994, these amendments had been approved. These amendments: 1. Lowered tariffs between member nations by an additional 38 percent, and 2. Established the World Trade Organization Can be used to mean either: 1. The judicial body in Geneva Switzerland established in 1986 that decides trade disputes between GATT signatories, or 2. The 152 signatories to the latest version of the GATT. Also called a trading bloc, is a regional group of countries that have: 1. A common set of external tariffs 2. No internal tariffs, and 3. The coordination of laws to facilitate exchange between the member countries. Example: The European Union, or EU. 17

18 A slightly different kind of agreement from a common market. Adopts just one of the three elements of a common market: No internal tariffs Example: The North American Free Trade Agreement between the United States, Canada, and Mexico 18