MODULE 1: FOUNDATIONS OF GLOBAL

BUSINESS

At the end of the module, you should be able to:

 Briefly explain why trade and foreign investment are good for society
as a whole.
 Describe the major international trade theories and how they operate.
 Evaluate trade policy, the main instruments of trade policy, and their
impact on business, consumers, and governments.
 Explain the rationale behind a country’s choice of managing trade.

TIME FRAME:
This lesson will be completed by the students at the end of week 2.

The growth trends in China and India today illustrate the impact that
international business has on blue-collar and white-collar workers in wealthy
countries (such as the United States and in Europe) as relatively low-skill factory
jobs as well as high-skill service profession jobs migrate overseas. Business has
become increasingly international in nature and has been accelerated by low-cost
communications technology. What is international business? And, how did all this
development happen?
One could trace international business to a story from fertile Mesopotamia
(present-day Iraq). In 3000 b.c., Sumerian farmers realized that the grain surplus
they produced could be used as barter for things they did not have. Therefore, the
Sumerians obtained copper from Sinai Desert traders who were located several
hundred miles to the west in order to make weapons and repel nomadic raiders.
Thus, international trade yielded to the Sumerian farmers not only a bounty of
material goods (copper and armaments for security) but also an understanding of
the culture of their neighbors and a mutual desire to sell things to other groups
rather than to annihilate them.
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Task 1: Reality Check
Visit the retail store where you purchase everyday necessities and pick
out ten items that you regularly use. Now, look at the labels and find out
how many of them come from abroad. Can you imagine what your life
would be like if we did not have international trade?

Task 2: Economic Perspective – Direction: Read the case carefully and answer the
question legibly, clearly, and concisely.

In September 2009, U.S. President Barack Obama imposed a three-year, sliding-scale tariff on tires
imported from China starting at 35 percent for the first year and decreasing to 25 percent in the final year.
Critics noted that this decision seemed hypo-critical considering that the president had accused China of
unfair trade practices. China decided to challenge the U.S. decision by deferring the matter to the World
Trade Organization’s dispute resolution branch. China retaliated by initiating an investigation regarding the
United States’ possible violation of WTO sanctions by unfairly dumping chicken feet and auto parts into
China’s market. Global concerns were raised about how a tit-for-tat trade war could lead to rapid
contraction of global trade, economic growth, and accelerating unemployment, thereby deepening the
global recession.
China has been accused of predatory trade practices on several counts, and many believed the
Chinese should be held accountable for their actions. First, the value of the Chinese currency, the yuan, has
not been market determined, but rather managed and kept artificially low (some economists claim by as
much as 15 to 20 percent), thereby providing an unfair competitive advantage for all Chinese exporters. In
addition, cheap credit, subsidized land, low-cost energy, and controlled wages add to China’s
competitiveness to the detriment of nations that practice fair trade worldwide. These actions have led China
to accumulate some $4 trillion in foreign exchange reserves in 2014 that are available for investment abroad.
Until the Obama decision, the United States had been generally unwilling to impose broad trade
sanctions on China lest they curtail buying U.S. Treasury securities that finance the United States’ large
federal deficits. If that were to happen, U.S. interest rates would need to rise, leading to rising debt service,
increasing the cost of capital to U.S. firms, and slowing economic growth in the United States. Why impose
tariffs on Chinese tires? The U.S. used a trade law against Chinese tire exports because their unfair exchange
rate could “cause or threaten to cause market disruption” in the domestic tire-manufacturing industry.
China’s share of the U.S. tire market increased from 5 percent to 17 percent over the 2004–2008 period;
during this time four U.S. tire plants were closed, and approximately 5,200 workers were laid off. In 2013,
the first full year since the 25 percent tariff on passenger and light truck tires imported from China expired, a
record 51.2 million tires were imported from China—10 percent higher than the 2008 figure of 46.5 million
units—the year before the tariff went into effect. And, three new tire plants opened in the United States
during the 2014– 2015 period because of improving economic conditions in the country. In 2010, China
imposed tariffs on certain imported chicken products from the United States including chicken feet, which
are considered a delicacy in China. China accused the United States of selling chicken parts at below market
prices. On August 2, 2013, the WTO ruled that by enacting those tariffs, China violated international trade
regulations, which was welcome news to American poultry processors.

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Questions:
1) Is China practicing fair trade? Explain in detail what China is trying to achieve and the
implications of the result for the rest of the world.
2) Why did the United States impose a “sliding-scale” tariff on China’s tires? And why only for a
three-year period? What was the net result?

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Directions: Answer the following questions below. Limit your answers to not more than
100 words.
How would you make a convincing case that open trade in goods and
services as well as free flow of foreign direct investment will enhance the
well-being of (a) consumers, (b) producers, and (c) the government of
countries? Give specific examples to prove your position.

(a) consumers

(b) producers

(c) the government of countries

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Benefits of Trade and Foreign Direct Investment
The earliest and simplest form of international business is trade, which can be defined
as the sale (exports) and purchase (imports) of goods (textiles, wine, spices,
smartphones, etc.) and services (banking, transportation, education, consulting, etc.)
across national borders. International trade benefits consumers in three major ways by
providing:
• A greater amount of choice in the availability of goods and services.
• Lower prices for goods and services consumed.
• Higher living standards.

Major Theories of International Trade

 Wealth Accumulation as a Basis for Trade Theory: Mercantilism

Mercantilism is a theory of international trade that supports the premise that a nation
could only gain from trade if it had a trade surplus, that is, more exporting than importing.

Mercantilists believed that for a nation to become wealthy, that nation must export as
much as possible and, in turn, import as little as possible. Their objective was to see that,
as a nation, the value of exports must always exceed those of imports so that the
country would have a trade surplus.

 Specialization as a Basis for Trade Theory: Absolute and Comparative Advantage

Absolute advantage the ability of one country to produce a good or service more
efficiently than another.

Comparative advantage the ability of one country that has an absolute advantage in the
production of two or more goods (or services) to produce one of them relatively more
efficiently than the other

 Factor Endowments as a Basis for Trade Theory: Heckscher–Ohlin and Factor

Price Equalization

The Heckscher–Ohlin (H–O) theory attributes the comparative advantage of a nation to

its factor endowments: land (quantity, quality, and mineral resources beneath it), labor
(quantity and skills), capital (cost), and technology (quality). By implication, a country rich
in minerals, such as Australia, would have global competitive advantage in the
production and exports of minerals, such as iron and uranium ore, and coal.

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 A related theory, factor price equalization theory, states that when factors (labor, for
example) are allowed to move freely among trading nations, efficiency further increases,
which leads to superior allocation of the production of goods and services among
countries.

The Practice of Trade Policy

 Tariffs, Preferential Duties, and Most Favored Nation Status

Tariffs are taxes on imports; they are also known as custom duties in some countries.
Like domestic taxes, import tariffs generate revenues for governments. In many
developing countries, import tariffs are a major source of government revenue. Tariffs
come in two forms: specific and ad valorem.

 Specific tariff an import tax that assigns a fixed dollar amount per physical unit.
 An ad valorem tariff describes a tax on imports levied as a constant percentage
of the monetary value of one unit of the imported good.

Preferential duties refer to low tariff rates applied to specific imports coming from certain
countries, especially from the developing world. Under this system, the same good
imported from a country outside the preferred group will be subject to a higher tariff.
Preferential duties are; therefore, geographically discriminatory as certain countries
receive different or preferential treatment.

 Nontariff Barriers

Import quotas, also known as Quantitative Restrictions (QRs), limit the amount or
number of units of products that can be imported to a country. Import quotas are
generally worse than import tariffs because when a quota is reached, that particular
good can no longer be imported or purchased. In the case of an import tariff, the price of
imports can only increase by the amount of the tariff. But under an import quota, with
high demand, the price of goods will increase to extremely high levels.

Voluntary export restraint (VER) occurs when an efficient exporting nation agrees to
temporarily limit exports of a product to another country to allow competitors in the
importing country to become more efficient within a set period of time.
Current Practice of “Managed” Trade
 Socioeconomic Rationale

In countertrade, an exporter of goods or services to another country commits to import

goods or services of corresponding value from that country. The terms of export and
import exchange are predetermined through negotiations. However, most countertrade
transactions are still paid through the banking system; relatively few are done through
outright barter (e.g., Iranian crude oil exports for imports of Chinese goods and
infrastructure services).

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 Rich, developing countries dependent upon certain nonrenewable natural resources
have generally seen their export earnings and economic growth widely fluctuate.
Commodity price changes caused by business cycles, as well as a limited number of
countries competing with one other in the same market cause this to happen. In order to
maintain stable economic growth, natural-resource-rich countries have tried to join
together to form export cartels, which could control export volume and prices.

Economists have successfully argued that at times when a country gets a “late start” in a
particular industry where it has a potential to become a world-class competitor, short-
term protection for that industry or firm may be justified. This infant industry argument
expects those economies of scale and the comparative advantage of an industry can
only be exploited by providing temporary protection.

 Geopolitical Rationale

There are several geopolitical and strategic reasons why nations practice managed
trade. The geopolitical objective is to sacrifice some economic efficiency for the greater
good of the country in terms of national security, protection of critical industries, and
international commerce.

Some countries provide protection to strategic industries that have a significant

employment impact on certain sectors of an economy—the so-called “national
champions”—when these champions are unable to compete globally.

Throughout this course pack you will be exposed to many examples of real-world companies to help
illustrate how the concepts that you are learning in each module and apply it to real business situations.

Task 3: Explore Your own case in point: Understanding the Global environment
The objective of this portfolio project is to enable you to conduct an independent analysis of a large
company (e.g., a Fortune 500 company). Select a company that you admire, a company that intrigues
you, a company that you would like to work for after graduation, or a company that you’ve always wanted
to know more about. Select a company listed in a major stock exchange like London, New York, Tokyo,
Shanghai, Hong Kong, Singapore, Bombay, Frankfurt, or Philippines so that various types of information
(financial or otherwise) are readily available.
After reading this Lesson 2 you should be prepared to find the answers to some basic questions
about your favorite company.
1) Determine whether your company is a producer of goods or services. What are the major
products and/or services provided by your company? Are those outputs sold only domestically or
are they also exported?
2) If some or all of the output is exported, how much of it is exported? To where are they exported,
and why?

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 3) Do these products and services face tariff or nontariff barriers in the target export markets?
What are the tariff rates or nontariff barriers imposed on these items?

Task 4: Develop an international Strategy for Your own Small Business:

Your Idea for Exporting
Using the data sources listed earlier, as well as other sources you may find on your own, develop
a strategy and make a convincing case for why you would like to produce a particular product or
service and export it to a target country. It is important that you identify in detail the comparative
advantage of sourcing the product or service in your home country. You should look into supply
as well as demand for your product or service. You should focus sales to one target country and
its currency. The following questions will help you define your objectives:

1) What product or service do you plan to produce at home and sell abroad? What is your
rationale and what competitive advantages do you have?

2) What foreign country do you plan to target and why? What is its demand for your product or
service?

Directions: Fill in the spaces below. (Limit your answers to be not more than 100 words)

It is important to study international business because…..

I realized that there are a lot of benefits when we engaged in global business such as…

Congratulations! You have completed the Lesson 2: The Evolution of International

Business for Module 1 of this course pack. You may now proceed to the next lesson.
Keep up the good work.

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