International business means carrying of business activities beyond national boundary. Globalization makes the business environment increasingly global even for domestic firms. These activities include transactions of economic resources such as goods, capital, services comprising of technology, skilled labor, transportation, etc. They also include international production. The production may embrace either production of physical goods or provision of services like banking, financing, insurance, construction, trading, etc. Thus International business includes not only international trade of goods and services but also foreign investment and especially foreign direct investment.
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According to Sharan, international business has been playing a crucial role for countries. However, in the present-day world, it has become indispensable for any country. Its role has turned out to be more significant both at the macro- economic and micro- economic levels. No country whether developed or developing produces all commodities of its requirements. Thus, there is a need for importing those items that are not produced domestically. At the same time, a country tries to export all those items that it is able to produce over and above its domestic requirements so that its balance of payments may not worsen in the wake of imports. In a developing economy, the range of production is often limited with the result that the import requirements are bigger. On the other hand, it tries to expand its exports in order to earn scarce foreign exchanges that could in turn meet its import requirements.
It is not only international trade that has become a compulsion. The foreign direct investment is no less important. Foreign direct investment is made for different purposes. Acquiring of natural resources, recovery of large expenditure made on research and development, capturing a larger segment of the international market, earning large profits, etc. are some important motives. In the case of a developing country with weak balance of payments position, foreign direct investment is more crucial. It is in the sense that it helps obtain large foreign exchange resources, latest technology and developed managerial capabilities required for economic development programs. In other words, foreign direct investment is essential for them as it bridges their resources gap. Thus, whether it is international trade or international investment, it is an integral part of a country’s economic behavior.
At the micro- economic level, from the view point of maximizing the corporate wealth, it is in the interest of a firm to export its product to foreign market and to capture a large share of the markets abroad, especially when the domestic market is saturated. On the other hand, in order to minimize the cost and thereby to maintain competitive edge, firms like to import the inputs from least cost location. In off-shore assembly operations, the components, involving capital intensive mode of production are manufactured in a capital abundant economy for their assembly so that the firm could make use of cheap labor. The assembled product is again ship to the home country and to other markets.
Wilkins stated that when the demand of the firm product is matured in the foreign markets, it is in the interest of the firm to start production in those markets so that the transportation cost and the tariff could be avoided. The Manufacturing in a foreign location involves not only investment of capital but also the transfer of technology. The transfer of technology helps improve the firm’s competitiveness in the markets abroad and at the same time is able to recover the huge cost incurred on research and development. The firm receiving capital and technology too gets the necessary resources and improves its competitiveness. Thus, at a firm’s level too, international business has turned out to be indispensable.
International trade has been viewed as an important source of welfare gains and wealth. The deliberate trade of merchandise induces positive outline of specialization, and thus leads to a development in the international labor division. As every nation is aimed at utilizing its comparative competitive advantages and producing those goods which it can produce efficiently and effectively, there is an increase in the global output and the profit of countries in the international trade. This positive outlook of international trade is being challenged by both the insiders and outsider. The insiders of the body include the mainstream economic theorists and the outsiders are those like dependency theorists. Even with few qualifications, it has managed to survive the above critiques. As the economists have come to know about the exceptions to these rules, most of them have acknowledged the universal strength of these principles of international trade.
An intense debate has been initiated among the researchers, because of the consequences of the international trade. The capability of governments to rule in the globalize world has been commented by some of the researchers while the others have debated on the association between the economic development and the international trade. It has also been believed that any changes made in the network structure, would in one form or the other, reflect the connection between the development and the international trade.
Theories of International Trade and Investment
Trade is an important mode of international business. There are various theories of trade and investment, which explain how much and with whom a country should trade. Theories of international trade are based on two versions: Mercantilist Version and Classical Approach.
Mercantilist stretched over about three centuries ending in the last quarter of the eighteen century. It was the period when the nation-states were consolidating in Europe. For the purpose of consolidation, they required gold that could best be accumulated through trade surplus. In order to achieve trade surplus, the government monopolized the trade activities, provided subsidies and other incentives for export and restricted imports. Since the European governments were mainly the empires, they imported low-cost raw material from the colonies and exported high-cost manufactures to the colonies. They also prevented colonies from producing manufactures. All this was done in order to generate export surplus. Thus, in short, increasing gold holding through export augmentation and import restriction lay at the root of the mercantilist theory of international trade. However, the latter version of the Mercantilist Doctrine explained that trade surplus was not an everlasting phenomenon. A positive trade balance led to an increase in the commodity prices relative to other countries. The increases in commodity prices caused a drop in export and thereby erosion in the surplus of the trade balances.
The Classical Approach:
The classical economist refuted the Mercantilist notion of precious metals and spices being the source of wealth. They thought domestic production was the prime source of wealth. And so they took into account the productive efficiency as the motivating factor behind trade.
Theories of Trade:
1. Theory of Absolute cost advantage:
This theory was propounded by Adam Smith the forerunner of the classical school of thoughts in the year 1776. Theory of Absolute cost advantage lets us understand that the productive efficiency among different countries differ because of diversity in the natural and acquired resources processed by them. It also made people understand the facts like differences in the natural advantage manifests in varying climate, quality of land, availability of minerals, water and other natural resources; while the difference in acquired resources manifests in different levels of technology and skills available. By adopting this trade theory, the countries have taken the advantage of specialization and availed the low cost benefits. They have also earned huge revenues by making an optimal use of resources of both the partner countries.
This theory of Absolute cost advantage has also helped the countries in determining the ways of increasing the total output in the two countries. Thus, this theory of absolute cost advantage not only improved the trade relations among the countries but also helped in the economic development of the partner countries. The only thing, which the policy lacked, was that it was not able to explain whether trade will exist if any of the two countries produces both the goods at lower cost.
2. Theory of Competitive cost advantage:
This theory by David Ricardo focuses on the relative efficiency of the countries for producing goods rather than absolute efficiency of the countries for producing the goods. It helps the trading partners know that the country should produce only that product which it is able to produce more efficiently. This theory has made the countries develop comparative cost advantage that leads to trade and to specialization in production and thereby to increase in the total output in the two countries. The role of this theory can be well understood with the help of an example. Taking two stations where the first one represents no trade between two countries, India and Bangladesh and in the second situation where trade of articles exists between two nations of India and Bangladesh. In the first condition (No trade) the total output of two countries will be 25.65 kg.
Bangladesh5.00 kg5.00 kg
India6.25 kg5.00 kg
While, in the later case (trade exist), when both the countries will produce only that goods in which it is efficient and that too in a cost effective manner, the total output will be 30 kg.
Thus, from this we can make a clear understanding that this theory has helped the countries in successfully trading those commodities, in which they can get the benefit of cost as well as of economies of scale.
3. Factor propositions Theory:
This theory is also known as factor endowment theory. This theory was successful in the international trade, as it explained in a framework of two-countries, two-commodities, and two-factors, that different countries are endowed with varying proportions of different factors of production. This theory has helped the countries in trading in accordance with the proportion of population they hold and there by making full utilization of all the available resources. With this theory, the countries were able to make an effective decision on the techniques to be used in producing goods and the markets where these goods could be traded most profitably. This theory has also helped the countries in their overall welfare. This was possible because the countries knowing the importance of the factors of production would experience the normal prices of factors of production.
Theories of Investment:
1. McDougall-Kemp Hypothesis:
This theory was developed by McDougall and Kemp and has helped the various economies understand the flow of capital inside and outside the country. This theory, by assuming the two-country model, helps the companies decide the movement of capital from the abundant economy to one which is scarce and thus, equalizing the marginal productivity of capital between the investor and the investor country. Thus, this theory led to an improvement in the efficiency in the use of resources, which ultimately resulted to an increase in the welfare and growth of service trade between the nations. This theory, by making the investments possible in capital country, poses a temporary problem of less capital output but does not result in the fall of national income so far as the country receives returns on capital times the amount of foreign investments.
2. Industrial Organization Theory:
This theory helps the people in understanding the conditions under the oligopolistic or imperfect market situations. Market imperfection arises in the cases like intra-industry trade, when there exist product differentiation, economies of scale and government imposed market distortion. This policy, by making the companies know the above advantages, confers on them an edge over their competitors in foreign locations and thus helps compensate the additional cost of operating in an unfamiliar environment. The theory has helped the countries in identifying the superiority in the ologopolistic market, thus maximizing its profits in the country where it has no intimate knowledge of language, culture, legal system and consumer’s preferences.
3. Location-Specific Theory:
This theory in the international trade was successful because it laid emphasis on the location factors. With the help of this theory, the companies and the economies were able to identify the locations where they could easily access cheap and abundant raw material. This had further encouraged many other MNC’s to invade in the country of abundant resources.
4. Product Cycle Theory:
This theory also emphasize on the factors like why and where the foreign investment take place, which had helped the companies analyze the perfect situations and locations of trading. The originator of this theory explains the facts that the products follow a life cycle, which is divided into three stages, which are as follows: the innovation stage, the maturing product stage and the final standardized product stage. All these stages have let the companies analyze the stages of their product operations and make the companies aware of a consumer’s taste and preferences.
5. Internalization Approach:
Buckley and Casson too assume market imperfection, but imperfection, in their view, is related to the transaction cost that is involved in the intra-firm transfer of intermediate products such as knowledge of expertise. In an international firm, technology developed at one unit is passed on to other units normally free of charge. This means that the transaction cost in respect of intra-firm transfer of technology is almost zero, whereas such cost in respect of technology transfer to other firms is usually, exorbitantly high putting those firms at a disadvantageous position. It is believed that the MNC’s bypass the regular market and use internal prices to overcome the excessive transaction cost of an outside market. Thus, it is the internationalization benefit manifesting in the cost free intra-firm flow of technology or any other knowledge that motivates a firm to go international. It can be said that the view of Buckley and Casson are more or less in common with the contents of the appropriability of Magee that emphasizes on potential returns from technology criteria as a prime mover behind internationalization of firms.
6. The Eclectic Paradigm:
This theory is the combination of the major imperfect market oriented theories and the location theories. It postulates that at any given time, the stock of foreign assets owned by a multinational firm is determined by a combination of firms specific or ownership advantage, the extent of location bound endowments, and the extent to which these advantages are marketed within the various units of the firm. With this theory, the companies were able to know the various advantages available in different countries. They were ensured that the foreign investment in the intra industry will be more profitable.
7. Currency Based Approaches:
The currency based theory is normally based on imperfect foreign exchange and capital market. This theory explains that internationalization of firms can best be explained in terms of relative strengths of different currencies. Firms from strong currency countries move out to weak currency countries. In a weak currency country, the income is fraught with greater exchange risk. As a result, the income of strong country firms is capitalized at a higher rate. This hypothesis also lies in a fact that it has stood to the empirical testing. The fact is that the depreciation in the real value of currency of a country lowers the wealth of domestic resident vis-à-vis the wealth of foreign resident. As a result, it is cheaper for the foreign firms to acquire assets of domestic firms.
8. Political-economies theory:
The political-economies theory concentrates on political risk. Political stability in the host countries leads to foreign investment therein. Similarly, presence of political instability in the home country encourages investment in foreign countries. This theory also tells us that the political determinants of foreign direct investment are less well-developed than those involving economic determinants. The political factors are only additive one influencing foreign investment.
Benefits and gains of International Trade and Investment
A country opts for trade with any other country only when it expects gains from trade. These theories are very successful to explain the growth of intra-industry trade. According to these theories, we could analyze the various gains and benefits for both the host and home country.
Benefits for the Host Country: International trade and investment helps attaining a proper balance among different factors of production through the supply of scarce factors and fosters the pace of economic development. FDI brings in capital and supplements the domestic capital. This is a significant contribution where the domestic savings rate is too low match the warranted rate of investment. Foreign investors make available raw materials and improved technology. It also helps to improve the balance of payments of the host country. The inflow of the investment is credited to the capital account. At the same time, the current account improves because FDI helps to improve either imports substitution or export promotion.
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Benefits for the home country: The country gets the supply of necessary raw material, if the investors make the investment in the exploration of a particular raw material. This trade and balance of payment improves insofar as the parent company gets dividends, royalty, technical service fees and other payments. It is also because of the rising export of the parent company to subsidiary. If FDI takes place in order to develop a vertical set-up abroad, the export is quite significant. When person accompanies the investment, it results in a greater employment of the nationals. The parent company makes an access to new financial markets though abroad. Moreover, the government of the country generates revenues through taxing the dividend and other earnings of the parent company. Revenue is also earned from imposing tariff on the import of the parent company from its subsidiary abroad.
The international business takes place between the countries to fulfill their unsatisfied needs of resources, which they do not have an access to. It is a known fact that every country is not self-sufficient and wants to access those resources also, which it is lacking, that too on the cheaper rates but in sufficient quantity. There are many factors, which affect the international trading among the countries. They are not limited to the country specific governmental policies but also relate to the culture, society, GDP, resources available and also other economic factors.
From the above analysis of the international trade policies, it has been quite clear that successful international trade policies consider not only the internal market situations but also the foreign market situations. The countries and the MNC’s should take the advantages of low costs and the comparative competitive strategies. These theories have helped many companies and countries stand in the global economic scenario because of their successful and easy understandability. Deciding the allocation of resources according to the proportions of these resources in the investment countries also helps in generating profitable returns.
Thus, to sum up, we can say that considering all the factors while entering into any foreign market makes the companies generate profitable returns, thus leading to a successful organizational operations.
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