International Business

-
Edited by:
Hitesh Jhanji
international Business
Edited By
Hitesh Jhanji
Printed by
excel Books Private limiteD
A-45, Naraina, Phase-I,
New Delhi-110028
for
Lovely Professional University
Phagwara
Syllabus
International Business
Objectives: The objective of the course is to:
l Enable students build strong foundation in concepts of international trade and business
l Help students understand social, cultural and economic factors that lead to trade between countries
l Help students study various economic integrations for promoting regional trade and investments
Sr. No. Topics

1 International Business: An Overview – Evolution of International Business, Drivers of Globalization, Influences of
International Business, Stages of Internationalization, Differences between Domestic and International Business,
International Business Approaches, Advantages of International Business.
2 Theories of International Trade – Mercantilism, Theory of absolute cost advantage, Comparative cost advantage
theory, Relative factor endowment theory, Country similarity theory, Product life cycle theory.
3 International Business Environment – Social and Cultural Environment, Technological Environment, Economic
Environment, Political Environment.
4 Modes of Entering International Business – Modes of Entry, Exporting, licensing, franchising, contract
manufacturing, management contracts, turnkey projects, foreign direct investment, alliances like mergers and
acquisitions, joint ventures, Comparison of Different Modes of Entry.
5 Foreign Direct Investment – Factors Influencing FDI, Reasons for FDI, Costs and Benefits of FDI, Trends in FDI,
Foreign Direct Investment in India.
6 World Trade Organization – General Agreement on Tariffs and Trade (GATT), Establishment of World Trade
Organization, The Uruguay Round Package: Organization Structure of the WTO, WTO – The Third Pillar in the
Global Business.
7 International Financial Institutions and Liquidity – IMF, World Bank, International Development Association,
International Liquidity and SDR International Finance Cooperation.
8 Basics of International Marketing, Basics of Global HRM, Basics of International Financial Management, Basics of
International Accounting.
9 International Production and Logistics Management – Generic Strategies of the International Business, Acquisition
of Resources, Location Decisions, International Logistics Management.
10 Global Strategic Management and Business Ethics – Peculiarities of Global Strategic Management, Value Creation,
Global Strategic Management Process, Collaborative Strategies, Ethics and Global Business.
CONTENT
Unit 1: International Business An Overview 1

Hitesh Jhanji, Lovely Professional University
Unit 2: Theories of International Trade 21

Unit 3: Cultural and Social Environment 46

Neha Kholsa, Lovely Professional University
Unit 4: Technological Environment 62

Ashwani Panesar, Lovely Professional University
Unit 5: Political and Economic Environment 70

Ginni Nijhawan, Lovely Professional University
Unit 6: Modes of Entering International Business 91

Unit 7: Foreign Direct Investment 119

Pooja, Lovely Professional University
Unit 8; World Trade Organization 147

Ginni Nijhawan, Lovely Professional University
Unit 9: International Financial Institutions-I 176

Unit 10: International Financial Institutions-II 195

Unit 11: Basics of International Marketing 209

Unit 12: Basics of International HRM 224

Navneet Kaur, Lovely Professional University
Unit 13: Basics of International Accounting and Financial Management 240

Pooja, Lovely Professional University
Unit 14: International Production and Logistics Management 257

Unit 15: Global Strategic Management and Business Ethics 282

Neetu Singh, Lovely Professional University
Hitesh Jhanji, Lovely Professional University Unit 1: International Business: An Overview
unit 1: international Business: an overview notes
contents
Objectives
Introduction
1.1 Evolution of International Business
1.2 Drivers of Globalization
1.3 Influences of International Business
1.4 Stages of Internationalization
1.5 Differences between Domestic and International Business
1.6 International Business Approaches
1.7 Advantages of International Business
1.8 Summary
1.9 Keywords
1.10 Review Questions
1.11 Further Readings
objectives
After studying this unit, you should be able to:
lz Enumerate the concept of international business
lz Analyse the evolution of international business
lz Discuss the drivers of globalization
lz Describe the stages of internationalization
lz Explain the difference between domestic and international business
lz Discuss the approaches of international business
introduction
One of the most dramatic and significant world trends in the past two decades has been the
rapid, sustained growth of international business. Markets have become truly global for most
goods, many services, and especially for financial instruments of all types. World product trade
has expanded by more than 6 percent a year since 1950, which is more than 50 percent faster than
growth of output the most dramatic increase in globalization, has occurred in financial markets.
In the global forex markets, billions of dollars are transacted each day, of which more than 90
percent represent financial transactions unrelated to trade or investment. Much of this activity
takes place in the so-called Euromarkets, markets outside the country whose currency is used.
This pervasive growth in market interpenetration makes it increasingly difficult for any country
to avoid substantial external impacts on its economy. In particular massive capital flows can push
exchange rates away from levels that accurately reflect competitive relationships among nations
if national economic policies or performances diverse in short run. The rapid dissemination rate
of new technologies speeds the pace at which countries must adjust to external events. Smaller,
lovely Professional university 1

Notes more open countries, long ago gave up illusion of domestic policy autonomy. But even the largest
and most apparently self-contained economies, including the US, are now significantly affected
by the global economy. Global integration in trade, investment, and factor flows, technology, and
communication has been tying economies together.
Why then are these changes coming about, and what exactly are they? It is in practice, easier to
identify the former than interpret the latter. The reason is that during the past few decades, the
emergence of corporate empires in the world economy, based on the contemporary scientific and
technological developments, has led to globalization of production. As a result of international
production, co-operation among global productive units, the large-scale capital exports, “the
export of production” or “production abroad” has come into prominence as against commodity
export in world economy in recent years. Global corporations consider the whole of the world
their production place, as well as their market and move factors of production to wherever they
can optimally be combined. They avail fully of the revolution that has brought about instant
worldwide communication, and near instant-transformation. Their ownership is transnational;
their management is transnational. Their freely mobile management, technology and capital, the
modern agent for stepped-up economic growth, transcend individual national boundaries. They
are domestic in every place, foreign in none-a true corporate citizen of the world. The greater
interdependence among nations has already reduced economic insularity of the peoples of the
world, as well as their social and political insularity.
International business includes any type of business activity that crosses national borders. Though
a number of definitions in the business literature can be found but no simple or universally
accepted definition exists for the term international business. At one end of the definitional
spectrum, international business is defined as organization that buys and/or sells goods and
services across two or more national boundaries, even if management is located in a single
country. At the other end of the spectrum, international business is equated only with those
big enterprises, which have operating units outside their own country. In the middle are
institutional arrangements that provide for some managerial direction of economic activity taking
place abroad but stop short of controlling ownership of the business carrying on the activity.
Example: Joint ventures with locally owned business or with foreign governments.
In its traditional form of international trade and finance as well as its newest form of
multinational business operations, international business has become massive in scale
and has come to exercise a major influence over political, economic and social from many
types of comparative business studies and from knowledge of many aspects of foreign business
operations. In fact, sometimes the foreign operations and the comparative business are used as
synonymous for international business. Foreign business refers to domestic operations within a
foreign country. Comparative business focuses on similarities and differences among countries
and business systems for focuses on similarities and differences among countries and business
operations and comparative business as fields of enquiry do not have as their major point of
interest the special problems that arise when business activities cross national boundaries.
Example: The vital question of potential conflicts between the nation-state and the
multinational firm, which receives major attention is international business, is not like to be
centered or even peripheral in foreign operations and comparative business.
1.1 Evolution of International Business

The business across the borders of the countries had been carried on since times immemorial.
But, the business had been limited to the international trade until the recent past. The post-World
War II period witnessed an unexpected expansion of national companies into international
or multinational companies. The post 1990’s period has given greater fillip to international
business.
2 LOVELY PROFESSIONAL UNIVERSITY

Unit 1: International Business: An Overview
In fact, the term international business was not in existence before two decades. The term Notes
‘international business’ has emerged from the term ‘international marketing’, which, in turn,
emerged from the term ‘export marketing’.
International Trade to International Marketing: Originally, the producers used to export
their products to the nearby countries and gradually extended the exports to far-off countries.
Gradually, the companies extended the operations beyond trade.
Example: India used to export raw cotton, raw jute and iron ore during the early 1900s.
The massive industrialization in the country enabled us to export jute products, cotton garments
and steel during 1960s.
India, during 1980s could create markets for its products, in addition to mere exporting. The
export marketing efforts include creation of demand for Indian products like textiles, electronics,
leather products, tea, coffee etc., arranging for appropriate distribution channels, attractive
package, product development, pricing etc. This process is true not only with India, but also with
almost all developed and developing economies.
International Marketing to International Business: The multinational companies which were
producing the products in their home countries and marketing them in various foreign countries
before 1980s started locating their plants and other manufacturing facilities in foreign/host
countries. Later, they started producing in one foreign country and marketing in other foreign
countries.
Example: Unilever established its subsidiary company in India, i.e., Hindustan Lever
Limited (HLL), HLL produces its products in India and markets them in Bangladesh, Sri Lanka,
and Nepal etc. Thus, the scope of the international trade is expanded into international marketing
and international marketing is expanded into international business.
History of international business starts with the evolution of human civilization. The integration
and growth of economies and societies was the main reason for the first phase of international
business and globalization.
Timeline
zz 19th Century: Broader concept of the integration of economies and societies

zz 1870: Began first phase of Globalization
zz 1919: World War II: End of first phase of Globalization, Industrial revolution in UK,
Germany and the USA Sharp increase in the trade with import and export by colonial
empires
zz 1913: GDP 22.1: After 1913: Increased Trade Barriers to Protect Domestic Production
zz 1930’s: Declined Trade Ratio, GDP 9.1
zz After 1930’s: World Nations felt the need for International Cooperation in global trade and
balance of payments affairs
zz Establishment of IMF and IBRD (World Bank)
zz IMF: International Monetary Fund
zz IBRD: International Bank for Reconstruction and Development
zz 1947: 23 countries conducted negotiations in order to prevent the protectionist policies
and to revive the economies from recession aiming at establishment of World Trade
organization
LOVELY PROFESSIONAL UNIVERSITY 3

Notes zz 1947: Establishment of GATT (General Agreement on Trade and Tariffs)

zz 1980s: efforts to convert GATT into WTO
zz 1st Jan 1995: GATT was replaced by WTO (World Trade Organization)
zz Trade Liberalization
zz 1990 – 2000: The Term IB (International Business) has emerged from the term International
Marketing.
There are two Phases of the evolution of the term International Business
1. International Trade to International Marketing
2. International Marketing to International Business
zz After 1990: Rapid Internationalization ad globalization
Today: Interpreting the PESTIN factors of International Trade environment more clearly.
Did u know? After 1930’s, the world felt the need for international cooperation in global
trade, so for this reason IMF and IBRO were established.
1.2 Drivers of Globalization

We have discussed the nature of international business and the precautions that the multinational
companies should take while operating in foreign countries. The basic question of “why do the
businesses firms of a country go to other countries?” might have been in your minds. Therefore,
the answer to this question, before proceeding further:
To Achieve Higher Rate of Profits: As we have discussed in various courses/subjects like
Principles and Practice of Management, Managerial Economics and Financial Management
That the basic Objective of the business firms is to earn profits, business firms search for foreign
markets which promise for higher rate of profits. For example, Hewlett Packard earned 85.4% of
its profits from the foreign markets compared to that of domestic markets in 1994. Apple earned
US$390 million as net profit from the foreign markets and only US $310 millions as net profit
from its domestic market in 1994.
Expanding the Production Capacities Beyond the Demand of the Domestic Country: Some of
the domestic companies expanded their production capacities more than the demand for the
product in the domestic countries. These companies, in such cases, are forced to sell their excess
production in foreign developed countries. Toyota of Japan is an example.
Severe Competition in the Home Country: The countries oriented towards market economies
since 1960s had severe competition from other business firms in the home countries. The weak
companies which could not meet the competition of the strong companies in the domestic country
started entering the markets of the developing countries.
Limited Home Market: When the size of the home market is limited either due to the smaller
size of the population or due to lower purchasing power of the people or both, the companies
internationalize their operations.
Example: Most of the Japanese automobile and electronic firms entered US, Europe and
even African markets due to the smaller size of the home market. ITC entered the European
market due to the lower purchasing power of the Indians with regard to high quality cigarettes.
Similarly, the mere six million population of Switzerland is the reason for Ciba-Geigy to
internationalize its operations. In fact, this company was forced to concentrate on global market
and establish manufacturing facilities in foreign countries.

Political Stability vs. Political Instability: Political stability does not simply mean that Notes
continuation of the same party in power, but it does mean that continuation of the same policies
of the Government for a quite longer period. It is viewed that USA is a politically stable country.
Similarly, UK, France, Germany, Italy and Japan are also politically stable countries. Most of the
African countries and some of the Asian countries like Malaysia, Indonesia, Pakistan and India
are politically instable countries. In fact, business firms shift their operations from politically
instable countries into politically stable countries.
Availability of Technology and Managerial Competence: Availability of advanced technology
and managerial competence in some countries act as pulling factors business firms from home
country. Companies from the developing world are attracted by the developed countries due to
these reasons. In fact, American Companies, in recent years, depend on Japanese companies for
technology and management expertise.
The drivers of globalization can be classified into.
1. Market Drivers:
(a) Per capita income converging among industrialized nations
(b) Convergence of lifestyles and tastes
(c) Organizations beginning to behave as global consumers
(d) Increasing travel create global consumers
(e) Growth of global and regional channels
(f) Establishment of world brands
(g) Push to develop global advertising
2. Cost Drivers:
(a) Continuing push for economies of scale
(b) Accelerating technological innovation
(c) Advances in transportation
(d) Emergence of newly industrialized countries with productive capability and low
labour costs
(e) Increasing cost of product development relative to market life
3. Government Drivers:
(a) Reduction of tariff barriers
(b) Reduction of non-tariff barriers
(c) Creation of blocs
(d) Decline in role of governments as producers and consumers
(e) Privatization in previously state-dominated economies
(f) Shift to open market economies from closed communist systems in eastern Europe
4. Competitive Drivers:
(a) Continuing increases in the level of world trade
(b) Increased ownership of corporations by foreign acquirers
(c) Rise of new competitors’ intent upon becoming global competitors

Notes (d) Growth of global networks making countries interdependent in particular

industries
(e) More companies becoming globally centered rather than nationally centered
(f) Increased formation of global strategic alliances
5. Other Drivers:
(a) Revolution in information and communication
(b) Globalization of financial markets
(c) Improvements in business travel
Self Assessment
Fill in the blanks:

1. The countries oriented towards market economies since ................ had severe competition
from other business firms in the home countries.
2. ................ stability does not simply mean that continuation of the same party in power, but
it does mean that continuation of the same policies of the Government for a quite longer
period.
3. History of international business ................ with the evolution of human civilization.
4. International ................ includes any type of business activity that crosses national borders.
5. India, during ................ could create markets for its products, in addition to mere
exporting.
1.3 Influences of International Business

Because most of the countries are not as fortunate as the India in terms of market size, resources,
and opportunities, they must trade with others to survive; Hong Kong, has historically
underscored this point well, for without food and water from china proper, the British colony
would not have survived along. The countries of Europe have had similar experience, since most
European nations are relatively small in size. Without foreign markets, European firms would
not have sufficient economies of scale to allow them to be competitive with US firms. Nestle
mentions in one of its advertisements that its own country, Switzerland, lacks natural resources,
forcing it to depend on trade and adopt the geocentric perspective. International competition
may not be matter of choice when survival is at stake. However, only firms with previously
substantial market share and international experience could expand successfully.
Growth of Overseas Markets
Developing countries, in spite of economic and marketing problems, are excellent markets.
According to a report prepared for the U.S. CONGRESS by the U.S. trade representative, Latin
America and Asia/Pacific are experiencing the strongest economic growth. American markets
cannot ignore the vast potential of international markets. The world is more than four times
larger than the U.S. market. In the case of Amway corps., a privately held U.S. manufacturer of
cosmetics, soaps and vitamins, Japan represents a larger market than the India.

Sales and Profit Notes
Foreign markets constitute a larger share of the total business of many firms that have wisely
cultivated markets aboard. Many large U.S. companies have done well because of their overseas
customers. IBM and Compaq, foe ex, sell more computers aboard than at home. According to the
US dept. of commerce, foreign profits of American firms rose at a compound annual rate of 10%
between 1982 and 1991, almost twice as fast as domestic profits of the same companies.
Diversification
Demand for mast products is affected by such cyclical factors as recession and such seasonal
factors as climate. The unfortunate consequence of these variables is sales fluctuation, which
can frequently be substantial enough to cause lay offs of personnel. One way to diversify a
companies’ risk is to consider foreign markets as a solution for variable demand. Cold weather,
for instance may depress soft drink consumption. Yet not all countries enter the winter season at
the same time, and some countries are relatively warm year round. Bird, USA, inc., a Nebraska
manufacturer of go carts, and mini cars, for promotional purposes has found that global selling
has enabled the company to have year round production. It may be winter in Nebraska but
its summer in the southern hemisphere – somewhere there is a demand and that stabilizes the
business.
Inflation and Price Moderation
The benefits of export are readily self-evident. Imports can also be highly beneficial to a country
because they constitute reserve capacity for the local economy. Without imports, there is no
incentive for domestic firms to moderate their prices. The lack of imported product alternatives
forces consumers to pay more, resulting in inflation and excessive profits for local firms. This
development usually acts as prelude to workers demand for higher wages, further exacerbating
the problem of inflation.
Import quotas imposed on Japanese automobiles in the 1980’s saved 46200 US production jobs
but at a cost of $160,000 per job per year. This cost was a result of the addition of $400 to the
prices of US cars, and $1000 to the prices of Japanese imports. This windfall for Detroit resulted in
record high profits for US automakers. Not only do trade restrictions depress price competition
in the short run, but they also can adversely affect demand for year to come.
!
Caution Demand for most products is easily to be fluctuated by occurrence of any cyclical
or seasonal factors pertaining like recession or climate.
Employment
Trade restrictions, such as high tariffs caused by the 1930’s Smoot-Hawley bill, which forced
the average tariff rates across the board to climb above 60%, contributed significantly to the
great depression and have the potential to cause wide spread unemployment again. Unrestricted
trade on the other hand improves the world’s GNP and enhances employment generally for all
nations. Importing products and foreign ownership can provide benefits to a nation. According
to the institute for international economics – a private, non-profit research institute – the growth
of foreign ownership has not resulted in a loss of jobs for Americans; and foreign firms have paid
their American workers the same, as have domestic firms.

Notes Standards of Living
Trade affords countries and their citizen’s higher standards of living than other wise possible.
Without trade, product shortages force people to pay more for less, products taken for granted,
such as coffee and bananas may become unavailable overnight. Life in most countries would be
much more difficult were it not for the many strategic metals that must be imported. Trade also
makes it easier for industries to specialize and gain access to raw materials, while at the same time
fostering competition and efficiency. A diffusion of innovations across national boundaries is
useful by-products of international trade. A lack of such trade would inhibit the flow innovative
ideas.
The 1990s and the new millennium clearly indicate rapid internationalization and globalization.
The entire globe is passing at a dramatic pace through the transition period. Today the international
trader is in a position to analyze and interpret the global social, technical, economic, political and
natural environmental factors more clearly.
Conducting and managing international business operations is a crucial venture due to variations
in political, social, cultural and economic factors, from one country to another country.
Example: Most of the African consumers prefer high quality and high priced products
due to there higher ability to buy.
Therefore, the international businessman should produce and export less costly products to most
of the African countries and vice versa to most of the European and North American countries.
High priced Palmolive soaps are exported and marketed in developing countries like Ethiopia,
Pakistan, Kenya, India, Cambodia etc.
International business houses need accurate information to make an appropriate decision. Europe
was the most opportunistic market for leather goods and particularly for shoes. Bata based on the
accurate data could make appropriate decision to enter various European countries.
International business houses need not only accurate but timely information. Coca-Cola could
enter the European market based on the timely information, whereas Pepsi entered later.
Another example is the timely entrance of Indian Software companies also made timely decision
in the case of Europe.
The size of the international business should be large in order to have impact on the foreign
economies. Most of the multinational companies are significantly large in size. In fact, the capital
of some of the MNCs is more than our annual budget and GDPs of the some of the African
countries.
Most of the international business houses segment their markets based on the geographic
market segmentation. Daewoo segmented its market as North America, Europe, Africa, India
sub-continent and Pacific market.
International markets present more potentials than the domestic markets. This is due to the
fact that international markets are wide in scope, varied in consumer tastes, preferences and
purchasing abilities, size of the population etc.
Example: IBM’s sales are more in foreign countries than in USA. Similarly, Coca-Cola
sales, Procter and Gamble’s sales and Satyam Computer’s Sales are more in foreign countries
than in their respective home countries.

Self Assessment Notes
Fill in the blanks:

6. ................ diagnosis consists of managerial decisions made by analyzing the significance of
the data (opportunities and threats) of the environmental analysis.
7. International business includes any type of business activity that crosses ................ borders.
8. The ................ of the international business should be large in order to have impact on the
foreign economies.
9. International business ................ need accurate information to make an appropriate
decision.
10. ................ markets present more potentials than the domestic markets.
1.4 Stages of Internationalization

Internationalization process for a company is a complex process. The experts have discussed
various strategies that are generally adopted in the process of internationalization. The optimal
strategic attractive available to firms depend upon different levels of internationalization.
Although there are variations in how international operations evolve, some overall patterns
have been noted. Most of these patterns relate to risk minimization behaviour. In other words,
most companies view foreign operations as riskier than domestic ones because they must operate
in environments which are less familiar to them. Thus, they initially undertake international
activities reluctantly and follow practices to minimize their risks. But as they learn more about
foreign operations and experience success with them, they move to deeper foreign commitments
that now seem less risky to them.
Patterns of Expansion
The farther a company moves from the center on any axis, the deeper its international commitment
becomes. However, a company does not necessarily move at the same speed along each axis.
A slow movement along one axis may free up resources that allow faster expansion along
another.
For example, a company may lack initial capacity to own facilities wholly in multiple foreign
countries; thus it may choose either to limit its foreign capital commitment by moving slowly
along axis C in order to move rapidly along axis D (to multiple foreign countries), or vice versa.
1. Passive to Active Expansion – Path A: The impetus of strategic focus is shown on axis A in
Figure 1.1. Most new companies are established in response to observed domestic needs,
and they frequently think only of domestic opportunities until a foreign opportunity is
presented to them.
For example, companies commonly receive unsolicited export rejects because someone has
already seen or heard of their products. Often these companies have no idea of how their
products became known abroad.
But at this juncture, they must make a decision to export or not. Many decide not to because
they fear they will not be paid or they know too little about the mechanics of foreign
trade. Those that do fulfill the unsolicited export orders and then see that opportunities
are available to them abroad are apt later to seek out other markets to sell their goods.
Even large companies may move from passive to active involvement with aspects of their
business.

Notes For example, although Tokyo Disneyland was proposed by a group of Japanese businessmen,
the success of that venture led Disney to actively seek out a European location or another
park.
2. External to Internal Handling of Operations – Path B: The use of intermediaries to handle
foreign operations is common during early stage of international expansion because this
method may minimize risk of committing one’s own resources to international endeavours
and also because of reliance on another company that already knows how to operate in
foreign environments.
But if the business grows successfully, the company will usually be more willing to
handle the operations with its own staff. This is because it has learned more about foreign
operations, sees them as being less risky than at the onset, and realizes the volume of
business justifies the development of internal capabilities by hiring additional trained
personnel, for purposes such as to maintain a department to carry out foreign sales or
purchases. This evolution is shown on axis B in Figure 1.1.
Figure 1.1: The Usual Patterns of Internationalization
3. Deepening Mode of Commitment – Path C: Axis C in Figure 1.1 shows that importing or
exporting is usually the first type of foreign operation a company undertakes. At an early
stage of international involvement, importing or exporting requires the least commitment
and the least risk to the company’s resources such as capital, personnel, equipment, and
production facilities.
For example, a company could engage in exporting by using excess production capacity to
produce more goods which then would be exported. By doing this, it would limit its need
to invest more capital in additional production facilities such as plants and machinery.
Further, the engagement of only importing and exporting limits the functions with which
the company is responsible abroad.

For example, it does not have to manage a foreign work force. Notes
Companies often move into some type of foreign production after successfully building
exports to that market. Initially this foreign production is apt to minimize the use of one’s
own resources by licensing, by sharing ownership in the foreign facility, or by limiting the
amount of manufacture such as simply packaging or assembling output abroad.
Nevertheless this foreign production usually involves a greater international commitment
of the company’s resources than does exporting to importing. The greater commitment
results primarily because the company has to send qualified technicians to the foreign
country to establish and help run the new operations. Further, it must be responsible for
multifunctional activities abroad, such as sales and production. Later, companies are apt
to make an even higher commitment through foreign direct investments that involves
more than packaging and assembly. Their infusion of capital, personnel, and technology
are highest for these operations. A company typically does not abandon its early modes
of operating abroad, such as importing and exporting, when it adopts other means of
operating internationally. Rather, it usually continues them by expanding its trade to new
market or complements them with new types of business activities.
4. Geographic Diversification – Path D: When companies first move internationally, they
have one or very few foreign locations. Axis D in Figure l.1 shows that overtime, the number
of countries in which they operate increases. The initial narrow geographic expansion
parallels the low early commitment of resources abroad. It also minimizes the number of
foreign environments with which the company must be familiar.
Initially, companies tend to go to those locations that are geographically close and/or
perceived to be similar. There is also a perception of less risk because of greater familiarity
with nearby areas and because of a perception of similarity of environments because of
common languages and levels of economic development. Later, companies move to more
distant countries, including those that are perceived to have less similar environments to
those found in home country.
5. Leapfrogging of Expansion – Path E: The patterns that most companies have followed in their
international expansion are not necessarily optimal for their long range performance.
Example: The initial movement into a nearby country, like movement by a US company
into Canada, may delay entry into faster growing markets, such as some of those in Southeast
Asia. There is, however, evidence that many new companies are starting out with a global
focus.
Normally the following stages of internationalization can be followed as:

Stage 1 – Domestic Company: Domestic Company limits its operations, mission and vision
to the national political boundaries. These companies focus its view on the domestic market
opportunities, domestic suppliers, domestic financial companies, domestic customers etc. These
companies analyze the national environment of the country, formulate the strategies to exploit
the opportunities offered by the environment.
Stage 2 – International Company: These companies select the strategy of locating the branch
in the foreign market and extend the same domestic operations into foreign markets. These
companies remain ethnocentric or domestic country oriented. Normally internalization process
of most of the global companies starts with this stage of two processes. Many of the companies
follow this strategy due to limited resources and also to learn from the foreign market gradually
before becoming a global company without much risk.
Stage 3 – Multinational Company: This stage of multinational company is also referred as
multidomestic company formulates different strategies for different market, thus the orientation
shift from ethnocentric to polycentric. Under polycentric orientation the offices/branches/

Notes subsidiaries of a MNC work like a domestic company in each country where they operate with
distinct policies and strategies suitable to that country concerned.
Stage 4 – Global Company: Global company is the one which has either produces in home
country or in a single country and focuses on marketing these products globally and focuses on
marketing these products domestically.
Stage 5 – Transnational Company: Transnational company produces, market, invests and operate
across the world. It is an integrated global enterprise which links global resources with global
market at profits. There is no such pure transnational corporation.
Characteristics of a Transnational Company
This company thinks globally and acts locally. This company adopts global strategy but allow
value addition to the customer of a domestic country. The assets of a transnational company
are distributed throughout the world, independent and specialized. The R&D facilities of a
transnational company are spread in many countries.
zz Scanning or Information Acquisition: These companies scan the environmental information
regarding economic, political, social and cultural and technological environment.
These companies collect and scan the information regardless geographical and national
boundaries.
zz Vision and Aspiration are global, global markets, global customers, and grow ahead of
other global/transnational companies.
zz Geographical Scope: They analyze the global opportunities regarding the availability of
resources, customers, markets, technology, research and development etc. The scope is not
limited to certain countries in analyzing opportunities, threat and formulating strategies.
zz Adaptation: Global and Transnational companies Adapt their products, marketing
strategies and other functional strategies to the environmental factor of the market
concerned.
Example: Mercedes Benz is a super luxury car in North America, luxury in Germany and
standard taxi in Europe.
zz Extension: Some products do not require any change when they are marketed in other
countries. Their market is just extension.
Example: Transnational companies create their global brand extending the product
to the new market. Rothmans cigarette extended its products in many Europeans and African
countries.
zz HRM policy: It selects the best human resource and develops them regardless nationality,
ethnic group.
zz Purchasing: Transnational company procures world class material from the best source
across the globe.

Caselet India to Allow FDI in Food Retail
I
ndian government is considering allowing Foreign Direct Investment (FDI) in food
retail. The Ratan Tata led Investment Commission has favoured permitting FDI in food
retail, especially fresh and processed fruit and vegetables, with export commitments.
Contd...

According to Food Processing Minister Subodh Kant Sahay, “It should be done in such a way Notes
that it would boost our agriculture. Our farmers must also get benefits of economic liberalization”.
The Investment Commission, set up by the Prime Minister in 2004 to boost investments,
made recommendations to the government on both policies and procedures to facilitate
greater FDI inflows. The report said, “Foreign food retailers could help in the transmission
and adoption of better practices throughout the supply chain and could also facilitate
access to export markets.”
Agreeing with the panel’s suggestion, Mr. Sahay said “there was a need to bring market
discipline in procuring agro products from farms. FDI in food retail is the need of the
hour. It would mean use of latest technology in the sector, more yield per hectare and
optimum usage of arable land. Allowing FDI will create demand across all levels, from
raw material to finished products, and, at the same time, maintaining every level of quality
and standards.”
After permitting 51 percent FDI in single-brand retailing, allowing FDI in select food items,
fresh and processed fruit and vegetables is the next step. It would include retailing of farm
and dairy produce, marine and poultry products, besides fruit and vegetables. While 100
percent FDI is allowed in food processing, investment is restricted in retailing.
Today, barely 6 percent of fruit and vegetables produced in India are processed. The
country has targeted 20 percent processing within the next few years and is keen on
enhancing export of these items from less than 1-3 percent. The government was also
considering opening up the $330 billion retail market with adequate provisions to protect
neighbourhood stores. The commerce department is waiting for the report being prepared
by ICRIER on the impact of retail on local Kirana outlets. The study was commissioned to
the Delhi-based think-tank after the Congress party voiced its concerns over the effects of
FDI on retail in the unorganized sector.
Source: The Economic Times (ET), April 22, 2008.
1.5 Differences between Domestic and International Business

Difference between domestic trade and foreign trade and their peculiar problems. Trade, no
doubt, implies exchange of goods between persons, but there are marked differences between
domestic trade and international trade. The differences and the complications arise therein are
as follows:
1. Distance: The distance involved in export of goods in external trade is generally greater
than on the domestic trade.
2. Language differences: There are differences in the languages of the nations of the world. The
overseas traders should be very careful in preparing the publicity material in the languages
of the trading country.
3. Cultural difference: A producer should have full knowledge about the market of his
products. For exporting goods particularly a thorough research is undertaken.
4. Technical difference: In the national market the difference in the technical specification for
goods and their requirements is not wide.
5. Tariff barriers: In the national trade, there are no custom duties, exchange restrictions,
fixed quotas or other tariff barriers.
6. Documentations: In the home trade there are few documents involved in the exchange of
goods.

Notes 7. Payments: In the internal trade, the goods are exchanged in the currency unit of the country.
In case of foreign trade currencies differ widely throughout the world and those also vary
in value.
8. Transport and insurance cost: The transport and insurance costs are less in case of domestic
trade. For the exports, on the other hand the cost of transport is high and the insurance is
complicated.
Notes Global Company is the one which has either produces in home country or in a
single country and focuses on marketing these products globally and focuses on marketing
these products domestically.
Task Expenses an transport will be higher international trader or domestic trader.
1.6 International Business Approaches

In truth, we have become part of a global village and have a global economy where no organization
is insulted from the effects foreign markets and competition. Indeed, more and more firm are
reshaping themselves for international competition and discovering new ways to exploit markets
in every corner of the world. Failure to take a global perspective in one of the biggest mistakes
managers can make. Thus we start laying the foundation for our discussion by introducing and
describing the basic of international business.
An international business is one that is based primarily in a single country but acquires some
meaningful share of its resources or revenues (or both) from other countries. Sears fits this
description. Most of its stores are in the United States.
Example: The retailer earns around 90 percent of its revenues from its U. S. operation
with the remaining 10 percent coming sears stores in Canada. At the same time, however, many
of the products it sells, such as tools and clothing are made abroad from any perspective. Then
it is clear that we live in a truly global economy. Virtually all business today must be concerned
with the competitive situations they face in lands for from home and with how companies from
distant lands are competing in their homelands.
Douglas Wind and Pelmutter advocated four approaches of international business. They are:
Ethnocentric Approach: The excessive production more than the demand for the product, either
due to competition or due to change in customer preferences push the company to exports the
excessive production to the foreign countries. The company export the same product designed
for domestic market to foreign market under this approach. Thus, maintenance of domestic
approach towards international business is called ethnocentric approach.
Polycentric Approach: The company establishes a foreign subsidiary company and decentralized
all the operations and delegates decision making and policy making authority to its executives.
The executives of the subsidiary formulate the policies and strategies, design the product
based on the host country’s environment and the preferences of the local customer. Thus this
approach mostly focuses on the conditions of the host country in policy formulation, strategy
implementation and operations.
Regiocentric Approach: The foreign subsidiary considers the regional environmental for
formulating policies and strategies. It market more or less the same product designed under
polycentric approach in other countries of the region, but with different market strategies.

Geocentric Approach: Under this approach, the entire world is just like a single country for Notes
the company. They select the employees from the entire globe and operate with the number
of subsidiaries. Each subsidiary functions like an independent and autonomous company in
formulating policies, strategies, product design, human resource policies, operations etc.
1.7 Advantages of International Business

1. To achieve higher rate of profits:
Expanding the production capacities beyond the demand of the domestic country
Severe competition in the home country
Limited home market
2. Political stability vs. political instability:
Availability of technology and competent
Human resource
High cost of transportation
Nearness to raw materials
Availability of quality human resources at low cost
Liberalization and globalization
3. To increase market share:
To achieve higher rate of economic development
Tariffs and import quotas
4. High living standards:
Increased socio-economic welfare
Wider market
Reduced effects of business cycles
Reduced risks Large-scale economies
5. Potential untapped markets:
Provides the opportunity for and challenge to domestic business
Division of labour and specialization
Economic growth of the world
Optimum and proper utilization of world resources
Cultural transformation
Knitting the world into a closely interactive traditional village.
Notes The foreign subsidiary considers the regional environmental for formulating
policies and strategies.

Notes
Did u know? Generally all MNCs divide their markets according to geography. For example,
Daewoo has divided its market as Europe, Africa, India, etc.
!
Caution Avoid ignorance towards a global perspective to the a good manager.

Case Study Mayer & Company’s Global Success
T
his is one game that India has permanently lost to its arch-rival Pakistan—
manufacturing and exporting sports goods. Historically, when India and Pakistan
were one before 1947, Sialkot, now in Pakistan, used to be the world’s largest
production centre for badminton, hockey, football, volleyball, basketball, and cricket
equipment. After the creation of Pakistan, Jalandhar became the second centre after
Hindus in the trade migrated to India. Soon, Jalandhar overtook Sialkot and till the early
1980s it remained so. However, when the face of the trade began to change in the 1980s
and import of quality leather and manufacturing equipment became a necessity for quality
production, Pakistan wrested the initiative as India clung to its policies of discouraging
imports through high duties and restrictions. As it was, the availability of labour and skills
was a common factor in both Sialkot and Jalandhar, but with Sialkot having the advantage
of easier entry, most of the world’s top sports manufacturers and procurers developed an
association with local industry in Sialkot that continues even today.
Ten years later in the early 1990s, when Manmohan Singh liberalized the norms for
importing equipment and raw material required for producing sports goods, it was too
late as majority of the global majors had already shifted base to Sialkot. In 1961, the late
Narinder Mayor started the first large-scale sports goods manufacturing unit, Mayor &
Company, thereby laying the foundation of an organized industry. Even today, more than
70 per cent of the industry functions in an unorganized manner. Starting with soccer balls,
Mayor expanded to produce inflatable balls like volleyballs, basketballs, and rugby balls.
Today, his two sons Rajan and Rajesh have built it up into five companies engaged in a
wide array of businesses, though sports goods remain the group’s core business. While
the parent trading company, Mayor & Company, remains the leading revenue-earner to
the tune of ` 55 crore annually out of a total group turnover of ` 85 crore-plus, Mayor’s
second venture, the Indo-Australian Mayor International Limited, is spinning another
` 15 crores. Mayor International is a 100 per cent Export-oriented Unit (EOU) exclusively
manufacturing and exporting golf and tennis balls.
The product portfolio of the company comprises the following:
Inflatable Balls
l Soccer balls and footballs (Professional, Indoor, Match and Training, leisure toy)
l Volley balls, rugby balls (Volley balls and Beach Volley Balls)
l Australian rugby, hand balls (English League, Union and touch); (Australian rules,
Australian Rugby League balls with laces).
Boxing Equipment
l Boxing and punching balls (Boxing and Punching balls, Head Gear, Gloves, Punching
Mitts and Kits, Punching Bags & Bag Sets)
Contd...

l Gloves Notes
l Goal keeper’s gloves (Football/Soccer)
l Boxing gloves.
Cricket Equipment
l Worldwide distributor for Spading Cricket Bats, Balls and Protective equipment.
Hockey Equipment
l Worldwide distributor for Spading Hockey Sticks, Balls and Protective equipment.
Based in Delhi, Rajan Mayor, 41, is the CMD of the group, which also comprises an IT
division working on B2B and B2C solutions; Voyageur World Travels in the tourism
sector; a houseware exports division specializing in stainless steel kitchenware, ceramics,
and textiles; and a high school. Younger brother Rajesh, 34, is the Executive Director and
looks after all the divisions operating in Jalandhar, Technical director Katz Nowaskowaski
divides his time equally between India and Australia, where he looks after the group’s
interests. “While inflatable balls are our prime competence in our core business, we are
presently focusing on golf balls, for which we are the sole producers in South Asia. Out of
a total ` 300 crore of sports goods business generated in domestic market, most of which is
supplied by the unorganized players, golf balls constitute a miniscule amount and therefore
we came up with a 100 per cent EOU for producing golf balls. Later, the same facility was
utilized with little moderation for tennis balls too,” says Nowaskowaski.
Clarifying that the sports good industry in India only includes playing equipment and not
apparels or shoes, D K Mittal, chairman of the Sports Goods Export Promotion Council
and joint secretary in the Ministry of Commerce, has certified Mayor Group as the number
one exporter since 1993 till date, barring 1996. However, SGEPC secretary Tarun Dewan
points out that being the number one exporter does not mean that Mayor is the number one
brand being exported. “Actually we have tie-ups with Dunlop, Arnold Palmer, and Fila for
manufacturing golf balls. For footballs and volleyballs we have associations with Adidas,
Mitre, Puma, Umbro, and Dunlop. We manufacture soccer World Cup and European
Cup replicas for Adidas, which is a huge market. Only 400 balls used for actual play in
the World Cup are manufactured in Europe and that too only for sentimental reasons,
otherwise we are capable of delivering products of the same, if not better quality. Now
since we manufacture balls for them, we cannot antagonize them by producing balls of
similar quality with our own brand name. Secondly, I agree that competing with such big
giants in the world market in terms of branding is a task that is well beyond our reach at
the moment. However, we are trying to brand ourselves in the domestic market and that is
one of the prime focus areas in the coming year,” says Rajan.
Coca-Cola, Unilever, McDonald’s, American Airlines, Disney club, and other such big
brands come up with huge orders at times for golf balls with their logos for promotional
schemes. However, there is no mention of the producing country since these companies
do not want to show that balls they deliver in the US are being produced in Asia, “Not
only is our quality good enough; labour in India is cheap enough to churn out a much less
expensive product in the end. Yet, the main threat to our industry comes from countries
like Taiwan and China, who have already cornered a chunk of world markets in tennis,
badminton, and squash rackets. This is primarily because of two reasons—slow responses
to our needs in tune with the market requirements from the government and lack of
infrastructure. And most importantly, tags ‘Made in China’ or ‘Made in Taiwan’ are more
acceptable in the West than ‘Made in India’ or ‘Made in Pakistan’. One of the mottos of the
Mayor group has been to make ‘Made in India’ an acceptable label in the West. For that we
stress quality, timely delivery, and competent rates. Yet, a lot depends on perception value,
which in our case is sadly on the negative side, much owing to our government’s stance
Contd...

Notes over the years. Things might be improving, but the pace is very slow and as our economy
drifts towards a free market scenario supinely, it might just prove to be too little too late in
the end,” says Rajesh.
Today, Mayor Group is sitting pretty as its competitors; Soccer International Sakay Trades,
Savi, Wasan, Cosco, Nivia, and Spartan are only trying to catch up in the inflatable’s
category. With 1.2 million dozen golf balls, Mayor is way ahead of its competitors. The
company is planning to enhance its manufacturing capacity to 1.5 million dozen golf balls
next fiscal. With approval from the world’s two top golf associations – the US PGA and
RNA of Scotland, demand for its product is not a problem, the company’s senior marketing
officials point out. With the markets in Mayor’s current export destinations – Europe, North
America, Australia, and New Zealand – all set to expand in the coming years after the
present slump, Mayor wants to expand its sports goods business that caters to 60 per cent
of its overall exports. Though 40 per cent of exports come from house ware manufactured
in Delhi and Mumbai, with export centres in the same countries for its sports goods, just
about maintaining this business at its present state, and concentrating entirely on sports
goods is what the Mayors are intent on. With nearly 2000 skilled workforce; quality
certification from ISO 9001:2000 and ISO 14001: 2004; and having spread to more than 40
countries, Mayor and Company is obviously sitting pretty.
Questions
1. What routes of globalization has the Mayor group chosen to go global? What other
routes could it have taken?
2. What impediments are coming in the Mayor group’s way of becoming a major and
active player in international business?
3. Why is ‘Made in India’ not liked in foreign markets? What can be done to change the
perception?
Source: International Business Management by Raj
Self Assessment
Match the following:

11. Path A (a) Deepening mode of commitment
12. Path B (b) Leapfrogging of Expansion
13. Path C (c) Geographic diversification
14. Path D (d) Passive to active expansion
15. Path E (e) External to internal handling of operations
1.8 Summary
This unit attempts to give an overview of the functions in as simple manner as possible.
zz International business is all commercial transactions – private and governmental –
between two or more countries. Private companies undertake such transactions for profits;
Government may or may not do the same. These transactions include sales, investments
and transportation.
zz Study of international business has become important because (i) it comprises a large and
growing portion of the world’s total business, (ii) All companies are affected by global
events and competition whether large or small since most sell output to and secures raw
materials and supplies from foreign countries. Many companies also compete against
products and services that come from outside India.

zz The company’s external environment conditions such as physical, societal and competitive Notes
affects the business functions such as marketing, manufacturing and supply chain
management are carried out.
zz When a company operates internationally, foreign conditions are added to domestic ones
making the external environment more diverse and complex.
zz This pervasive growth in market interpenetration makes it increasingly difficult for any
country to avoid substantial external impacts on its economy.
zz In particular massive capital flows can push exchange rates away from levels that
accurately reflect competitive relationships among nations if national economic policies or
performances diverse in short run.
zz The rapid dissemination rate of new technologies speeds the pace at which countries
must adjust to external events. Smaller, more open countries, long ago gave up illusion
of domestic policy autonomy. But even the largest and most apparently self-contained
economies, including the US, are now significantly affected by the global economy.
zz Global integration in trade, investment, and factor flows, technology, and communication
has been tying economies together.
1.9 Keywords
Ethnocentric Approach: Maintenance of domestic approach towards international business.
Foreign Direct Investment: A foreign direct investment is one that gives the investor a controlling
interest in a foreign company.
Geocentric Approach: Under this approach, the entire world is just like a single country for the
company.
International Business: Any firm that engages in international trade or investment.
Merchandise Export: Tangible products sent out of a country.
Polycentric Approach: This approach mostly focuses on the conditions of the host country in
policy formulation, strategy implementation and operations.
Regiocentric Approach: It market more or less the same product designed under polycentric
approach in other countries of the region, but with different market strategies.

1. Describe the concept of international business and explain its analysis.
2. What is the importance of international business?
3. Distinguish between the domestic trade and foreign trade.
4. Why companies engage in international business?
5. What are the reasons for phenomenon international growth in recent years?
6. Describe the evolution of international business.
7. Explain the drivers of globalization.
8. Describe the stages of internationalization.
9. Discuss the approaches of international business.
10. Highlight the advantages of international business.

Notes Answers: Self Assessment
1. 1960 2. Political
3. Starts 4. Business
5. 1980s 6. Environmental
7. National 8. Size
9. Houses 10. International
11. (d) 12. (e)
13. (a) 14. (c)
15. (b)
Books C.B. Gupta, Business Environment.

Charles W.L. Hill, International Business Competing in the Global Marketplace,
4th Edition, Tata McGraw Hill, Publishing Company Limited.
Cherunillam Francis, International Business, Text and Cases, 3rd Edition,
Prentice-Hall of India Private Limited.
M. Kapagam, Environmental Economics.
Philip R. Cateora, International Marketing.
Francis Cherunillam, Global Business Environment.
Online links http://crab.rutgers.edu/~sambhary/International%20Bussiness%20

Environment/notes/Introduction%20to%20International%20Business.pdf
http://www.dallariva.org/csumba/mba602/Ch_01_Introd._to_International_.
pdf
http://www.newagepublishers.com/samplechapter/001319.pdf
www.faculty.haas.berkeley.edu/brchen/ba178_080408_long.ppt

Hitesh Jhanji, Lovely Professional University Unit 2: Theories of International Trade
unit 2: theories of international trade notes
contents
Objectives
Introduction
2.1 Theories of International Trade – Mercantilism
2.2 Theory of Absolute Cost Advantage
2.3 Comparative Cost Advantage Theory
2.4 Relative Factor Endowment Theory
2.4.1 Explanation of the Theory
2.4.2 Concept of Relative Factor Endowment
2.5 Country Similarity Theory
2.6 Product Life Cycle Theory
2.6.1 Stages of Product Life Cycle
2.6.2 Trade Implications of the Product Cycle Theory
2.6.3 Limitations of Product Life Cycle Theory
2.7 Summary
2.8 Keywords
objectives
lz Examine theories that explain why they are beneficial for a country to engage in international
trade
lz Describe the comparative advantage theory
lz Explain the product life cycle theory
lz Discuss the relative factor endowment theory
introduction
The fundamental question that arises at this juncture is why should the business firms of one
country go to another country, when the industries of that country also produce goods and market
them? What is the basis for international business? A number of theories have been developed to
explain the basis of international business.
2.1 theories of international trade – mercantilism

Mercantilists maintained that the way a nation became rich and powerful was to export more
than it imported. The resulting export surplus would then be settled by an inflow of bullion or
precious metals, primarily gold and silver. Thus, the Government had to do all in its power to
stimulate the nation’s exports and discourage and restrict imports (particularly the import of
luxury consumption of goods).
lovely Professional university 21

Notes The principle assertion of Mercantilism was that ‘a nation’s wealth and prosperity reflects in
its stock of precious metals such as, gold and silver’, as at that time gold and silver, were the
currency of trading nations. The basic tenet of Mercantilism is to maintain a trade balance where
exports are greater than imports. Consistent with this belief, the Mercantilist doctrine advocated
the government intervention. It means that their policy was to maximize exports and minimize
imports. It means that imports were to be restricted, by means of tariff and quotas, whereas,
exports were to be restricted by subsidies.
Criticism
1. The theory viewed trade as a zero sum game, a gain by one results in a loss by another. Adam
Smith and David Ricardo showed the short-sightedness of the approach and demonstrated
that trade is a positive sum game or a situation where all the countries benefit.
2. Mercantilists measured the wealth of a nation by the stock of precious metals it possessed.
In contrast, today we measure the wealth of a nation by its stock of human man-made and
natural resources, available for producing goods and services. The greater the stock of
useful resources, the greater is the flow of goods and services to satisfy human wants and
increase the standard of living of the nation.
2.2 Theory of Absolute Cost Advantage

According to Adam Smith, trade between two nations is based on absolute advantage. When one
nation is more efficient than (or has an absolute advantage over) another in the production of one
commodity but is less efficient than (or has an absolute disadvantage with respect to) the other
nations in producing a second commodity than both the nation can gain by each specializing in
the production of the commodity of its absolute advantage and exchanging part of its output
with the other nation for the commodity of its absolute disadvantage. By this process resources
are utilized in the more efficient way and the output of both commodities will rise. According to
Smith, “whether advantage which one country has over another by natural or acquired, is in this respect
of no consequence”.
Assumption
Adam Smith believed that all nations would gain from free trade and strongly advocated a policy
of laissez faire (i.e. As little government interference with the economic system as possible) To
illustrate, let there be two countries A and B having absolute differences in costs in producing a
commodity each, X and Y respectively, at an absolute lower cost of production than the other.
The absolute cost differences are given below:
Country Commodity X Commodity Y

A 10 5
B 5 10
From the above, Country A can produce 10X or 5Y with one unit of labour and country B can
produce 5X or 10Y with one unit of labour.
In the above case, country A has an absolute advantage in the production of X (For 10X is greater
than 5X) and country B has an absolute advantage in the production of Y (for 10Y is greater than
5Y). This can be expressed as
(10X of A)/ (5X of B) >1> (5Y of A)/ (10Y of B).
Trade between two countries will benefit both if A specializes in the production of X and B in the
production of Y as is shown below:

Unit 2: Theories of International Trade
Commodity → Production before trade Production after trade Gains from trade Notes
Country (1) (2) (2 – 1)
↓
X Y X Y X Y
A 10 5 20 -- +10 -5
B 5 10 -- 20 -5 + 10
Total production 15 15 20 20 +5 +5
The above reveals that before trade both countries produce only 15 units each of the two
commodities by applying one labour unit on each commodity. If A were to specialize in producing
commodity X and use both units of labour on its total production will be 20 units of X. Similarly,
if B were to specialize in the production of Y above, its total production will be 20 units of Y. The
combined gain to both countries from trade will be 5 units each of X and Y.
Pitfalls
1. The theory is vague and lack clarity.

2. According to this theory, every country should be able to produce certain products at
low cost compared to other countries and should produce certain other products at
comparatively high costs than other countries. International trade takes place only under
such conditions. But in reality, most of the developing countries do not have absolute
advantage of producing at the lowest cost any commodity, yet they participate in the
international business. Thus Smith’s analysis is weak and unrealistic.
Case: Absolute Cost Difference
According to Adam Smith, the Father of Economics, the basis of international trade was absolute
cost advantage. There may be a case where a commodity can be produced by two countries,
but the cost of producing the commodity in one country is absolutely lower than the cost of
producing it in the other country. In such a case, the commodity will be produced in that country
where the cost of production is the lowest. This is explained as follows. Suppose:
In India, 10 days of labour can produce 100 units of cotton, or
In India, 10 days of labour can produce 50 units of jute.
In Pakistan, 10 days of labour can produce 50 units of cotton, or
In Pakistan, 10 days of labour can produce 100 units of jute.
In this case, in India the same number of labour days, can produce either 100 units of cotton or
50 units of jute. The cost-ratio between cotton and jute is, 100:50 or 1 unit of cotton = 1/2 unit of
jute. Similarly, in Pakistan, the cost-ratio is, 50:100 or 1/2 unit of cotton = 1 unit of jute or 1 unit
of cotton = 2 units of jute.
Absolute cost differences arise, when each of the two countries can produce the commodity, at
an absolutely lower production cost, than the other. In above example, India has an absolute
advantage over Pakistan, in the production of cotton and Pakistan has a similar absolute
advantage over India, in the production of jute. India’s superiority in the production of cotton is
seen by the fact that:
100 units of cotton in India 50 units of jute in India

>
50 units of cotton in Pakistan 100 units of jute in Pakistan

Notes Now, if both India and Pakistan, form a part of only one country, each part will specialize in only
one commodity, viz., India in the production of cotton and Pakistan in the production of jute.
Division of labour between the two regions must lead to an increase in the total output. This is
what exactly happens, when international trade takes place between these two countries. India
will specialize in the production of cotton, export part of its output to Pakistan, as against import
of jute. India will be prepared to enter into trade, so long, as it can secure more than 1/2 unit of
jute for one unit of cotton (this is the cost ratio within India). Pakistan on the other hand, will
be prepared to give, as much as 2 units of jute, for one unit of cotton. Hence, trade between the
two countries will be very beneficial at any rate between 1/2 to 2 units of jute, for one unit of
cotton. International trade will, therefore, definitely take place under conditions of an absolute
difference in cost. But the trade between the two countries will not be for a long period or on a
permanent basis.
Nowadays, there is a very small trade on this basis. This situation is explained in Figure 2.1.
Figure 2.1: Case of Absolute Cost Difference
PRODUCTION - POSSIBILITY CURVE
A
1.0
COTTON
0.5 PAKISTAN
INDIA
B C
0 X
0.5 1.0 1.5 2.0
JUTE
In Figure 2.1, the production-possibility curves for India and Pakistan are prepared on the basis
of 1 unit of cotton = 1/2 unit of jute and 1 unit of cotton = 2 units of jute, respectively. The line
AB explains the position of India, where the distance along Y-axis i.e., OA (cotton) is double the
distance along X axis, i.e., OB (jute). Similarly, line AC indicates the position of Pakistan, where
the distance along Y-axis i.e., OA (cotton) is half the distance along X-axis i.e., OC (jute). BC is the
amount of pure surplus, which can be distributed between the two countries, in case trade takes
place. Any rate of exchange between B and C, will be beneficial to both the countries.
2.3 Comparative Cost Advantage Theory

According to the Comparative Cost Theory, countries in the long run will tend to specialize in the
business (production and marketing) of those goods in whose business they enjoy comparative
low cost advantage and import other goods in which the countries have comparative cost
disadvantage, if free trade is allowed. This specialization helps in the mutual advantage of the
countries participating in international business.
David Ricardo illustrated the Comparative Cost Theory in 1817. He used two countries,
two-commodity model. The conclusions of his model are:

1. Trade between two countries is profitable when a country produces one good at a lower Notes
cost than another country and that other country produces another good at a lower cost
than the former country.
2. Trade between two countries is also profitable when one country produces more than one
product efficiently, but when it produces one of these products comparatively at greater
efficiency than the other product.
3. Both the nations can engage in international trade when one country specializes in
production in which it has greater efficiency than the other.
Assumption of the Theory
The following are the assumptions of the comparative cost advantage theory:
1. There are only two countries.
2. They produce the same two commodities.
3. There are similar tastes in both countries.
4. The only element of cost of production is labour.
5. The supply of labour is unchanged.
6. All units of labour is homogenous.
7. Prices of two commodities are determined by labour cost i.e. the no. of labour units employed
to produce each.
8. Production is the subject to the law of constant returns.
9. Technological knowledge is unchanged.
10. Trade barriers between the two countries takes place on the basis of the barter system.
11. Factors of production are perfectly mobile within each country but are perfectly immobile
between countries.
12. There is free trade between the two countries, there being no trade barriers or restrictions in
the movement of commodities.
13. Trade is free from cost of transportation.
14. All factors of production are fully employed in both the countries.
15. The international market is perfect so that the exchange ration for the two commodities is
the same.
Notes David Ricardo illustrated the Comparative Cost Theory in 1817.
Task Give and explain any example of the above mentioned theory.
Explanation of the Theory
Suppose the production of a unit of wine in England requires 120 men for a year, while a unit
of cloth requires 100 men for the same period. On the other hand, the production of the same
quantities of wine and cloth in Portugal requires 80 and 90 men respectively. Thus England

Notes uses more labour than Portugal in producing both wine and cloth. Hence Portugal possesses an
absolute advantage in both wine and cloth. Amongst the two Portugal’s greater advantage is
production of wine and exporting to England. Since the cost of production of wine 80/120 men
is less than the cost of production of cloth 90/100 men. On the other hand, it is England’s interest
to specialize in the production of cloth in which it has least comparative disadvantage. Since the
cost of production of cloth in England is less (100/90 men) as compared with wine (120/80 men).
Thus trade is beneficial for both the countries.
Derivatives of the Theory
The advantages desired from this theory are:

1. Efficient allocation of global resources.
2. Maximization of global production at the least possible cost.
3. Product prices become more or less equal among world markets.
4. Demand for resources and products among world nations will be optimized.
Case: Comparative Cost Difference
There may be a second case, where two countries can produce two commodities. The factors of
production may be so distributed that one country may produce both the commodities at a lower
cost than the other country, but the greater advantage lies in the production of any one commodity
instead of two. There is, therefore, a need for specialization. This is explained below.
Suppose:
In India, 10 days of labour can produce 100 units of cotton or
In India, 10 days of labour can produce 100 units of jute.
In Pakistan, 10 days of labour can produce 40 units of cotton or
In Pakistan, 10 days of labour can produce 80 units of jute.
In this example, the internal cost-ratio between cotton and jute in India is 100:100 or 1 unit of
cotton = 1 unit of jute.
Similarly, the internal cost-ratio in Pakistan, between cotton and jute is 40:80 or 1 unit of
cotton = 2 units of jute.
Comparative cost difference implies that, one of the two countries has an absolute advantage in
the production of one commodity, than in the production of the other. In our example, India has
an absolute advantage in the production of both the goods, since it can produce both, cotton and
jute at a lower cost, as compared to Pakistan. But India’s advantage is comparatively greater in
the production of cotton, than in jute:
100 units of cotton in India 100 units of jute in India
>
40 units of cotton in Pakistan 80 units of jute in Pakistan
On the other hand, Pakistan has cost disadvantages in the production of both the goods, but its
comparative cost disadvantage is less in the production of jute, than in cotton. To express the
idea differently, Pakistan has a comparative cost advantage in the same production of jute, than
in cotton:
80 units of jute in Pakistan 40 units of cotton in Pakistan
>
100 units of jute in India 100 units of cotton in India

International trade will be beneficial to both the countries, if each of them specializes in the Notes
production of that commodity, in which it has comparative cost advantage. India, therefore, will
be prepared to specialize in cotton and export part of it, so long as it can get more than one unit
of jute for 1 unit of cotton. Pakistan, on the other hand, will specialize in jute, provided it can
secure 1 unit of cotton for 2 units of jute. Any rate between 1 to 2 units of jute for 1 unit of cotton,
will benefit both the countries. Under such conditions, international trade is beneficial and hence,
possible between the two countries. The principle of comparative advantage is explained in
Figure 2.2.
Figure 2.2: Case of Comparative Cost Difference
PRODUCTION - POSSIBILITY CURVE
A
1
COTTON
PAKISTAN
INDIA
B C
0 X
1 2
JUTE
In the figure, the line AB, represents the production-possibility curve for India and is based on
the cost-ratio of 1 unit of cotton = 1 unit of jute. Line AC, explains the production-possibility
curve for Pakistan and is based on the internal cost-ratio of l unit of cotton = 2 unit of jute. BC, is
a pure economic surplus, which is to be shared by the two countries through trade. Any rate of
exchange between B and C will be beneficial to the two countries.
Criticisms of the Theory
For a very long time, the classical theory of comparative cost, as formulated by Ricardo and
refined by Mill et. al., held an undisputed say. It was considered to be the most appropriate
explanation of the basis of international trade. Prof. Samuelson, expressing the elegance of this
theory writes that, “If theories, like girls, could win beauty contests, the comparative advantage
would certainly rate high in that, it is an elegantly logical structure.” But in spite of its popularity,
the theory has been put to a severe critical examination by some modern economists, like, Bertil
Ohlin and Frank Graham. Ohlin describes the theory as clumsy and dangerous, i.e. unduly
cumbersome and unreal. Moreover, it has been founded on an unrealistic assumption and has,
therefore, been vigorously attacked as under:
1. Assumption of labour cost is no longer valid: The most forthright attack against the theory
is, because of its assumption of labour costs. The assumption of labour theory of value
on which it is based, has been long discarded. In actual practice all costs, nowadays, are
measured in terms of money. Therefore, with the collapse of this major support, the theory
falls flat.
Here, it may be pointed out in support of the theory that it will be unjust to condemn
it, merely on account of this assumption. Ricardo had expressed the theory in terms of

Notes labour costs because of the prevailing belief in the labour theory of value. However, even
if the assumption of labour cost is discarded and cost differences are translated in terms of
money, the basic contents of the theory will still be valid.
2. Labor is not the only factor: Another objection against the comparative cost theory is that
it regards labour as the only factor of production. In the modern enterprise, factors like
‘capital’ and ‘entrepreneur’ assume greater importance as compared to labour. On this
account also, to restrict the cost of production only to labour cost is highly unrealistic and
makes the theory ineffective.
3. Assumption of constant cost not valid: The classical theory is based on the unrealistic
assumption of constant costs in real life. However, after a certain stage, every production
is subject to increasing costs or diminishing returns. Thus, additional quantities, beyond
this stage, can be produced only at a higher cost. As a result of this, with every increase
in production, the cost-ratios in the two countries may be so altered that they may finally
come to represent equal differences, rather than the comparative differences. The law of
increasing costs, thus, implies another limitation of the theory of comparative cost.
4. Too much emphasis on supply side: Prof. Ohlin criticizes the theory on account of its
complete neglect of the demand conditions. He regards the theory as “nothing more than
abbreviated account of the conditions of supply.” Because of their assumption of constant
costs, classical economist explained the cost difference on the basis of supply conditions
only. But, as we have seen above that costs do not remain constant; they do change with
changes in output, which in turn is influenced by the level of demand.
5. Static theory: The theory is static in the sense that it assumes so many things as given
and unalterable. Assumptions like ‘full employment’ and ‘fixed and constant supply of
factors of production’ are far from reality. In the real world, everything is changing and
changeable. The theory, therefore, does not fit into the dynamic nature of the present-day
world.
6. Assumption of perfect mobility of factors within a country and their perfect immobility
between the countries is not valid: Ohlin regards this assumption as dangerous and
misleading. If the factors are mobile within a country, then why are there differences in
wages in different occupations and differences in rates of interest in different regions? He
regards the classical doctrine of comparative costs as a clumsy tool of analysis. Ohlin rejects
the classical assumption of the immobility of factors of production between countries, as
the basis of international trade. For him, immobility of factors is not a special feature of
international trade, but is also prevalent within the different regions of the same country.
7. Assumption of perfect competition is unrealistic: Like other theories of classical economists,
the comparative cost theory is also based on the assumption of perfect competition but it
has been amply proved by modern economists that perfect competition exists nowhere.
What we actually have is some sort of imperfect competition.
8. Absence of transport costs: The theory assumes transport costs to be absent. Actually,
however, transport costs do make a difference in the direction and volume of international
trade. There are several branches of production in which transport costs are even higher
than production costs. A particular commodity cannot enter into international trade, unless
the difference in production costs between the two countries is higher than the costs of
transporting it from one country to another. Transport costs are, thus, too important to be
ignored. For example, sometime back Germany was one of the leading exporters of coal
and yet some of the near-by German ports found it more economical to import coal from
Britain. Here, comparative advantage was outweighed by transport costs.
9. Based on two countries – two commodities model: The theory has also been criticized on the
ground that it takes into consideration only two countries having only two commodities to
exchange. In actual practice, trade is multilateral, involving many countries. This, however,

is not a very damaging criticism. Even if this assumption is removed, it will not make a Notes
material change in the basic contents of the theory.
10. Comparative advantage and specialization: Professor Graham points out that the theory
loses its ground, when we find that comparative advantages will never lead to complete
specialization on the part of two countries, which enter into international trade. This may
happen when one country is big and another small. The small country will be in a position
to specialize fully as, “it can dispose off its surplus, to the other country. But the bigger
country cannot have such complete specialization because:
(a) It will not be able to meet all its requirements fully from the foreign country; and
(b) If it will fully specialize in a particular production, its surplus output will be of
such a large magnitude that it will not be entirely absorbed by the importing small
country.
Self Assessment
Choose the appropriate answers:

1. If the cost of production of items A and B in France and Germany are as given below, which
statement will hold well?
Germany France
A 15 20
B 12 24
(a) France will import A and B from Germany
(b) France will import A from Germany
(c) France will import B from Germany
(d) Germany will import A from France
(e) France will export A to Germany and import B from Germany
2. If we know that American agriculture is the most efficient in the world, we may say that:
(a) If America is also more efficient in the production of all other goods, there could be
no gain from trade
(b) It would never pay Americans to import food
(c) It would always pay Americans to import food
(d) America might or might not be a food importer
(e) America clearly never exports food
3. The assumption made by the theory of comparative advantages is:
(a) Full employment
(b) Mobility of labour within the country
(c) Constant returns to scale
(d) All of the above
(e) Both (a) and (b) above

Notes Fill in the blanks:

4. ............... maintained that the way a nation became rich and powerful was to export more
than it imported.
5. According to ..............., trade between two nations is based on absolute advantage.
2.4 Relative Factor Endowment Theory

Two Swedish economists Eli Heckscher and Bertil Ohlin developed the factor proportion theory
of international trade, also known as the modern theory of international trade. Modern Theory of
International Trade was propounded by Heckscher in an article published in 1919. It was further
improved upon by his student Bertil Ohlin in a research paper published in 1924 and later in his
book “International and Inter-regional Trade” published in 1933. This theory does not contradict
Comparative Cost Theory of International Trade, rather supports it. According to Comparative
Cost Theory, international trade takes place because of difference in comparative costs. But
it throws little light on the factors accounting for the difference in comparative costs. On the
contrary, modern theory of international trade reveals the causes responsible for difference in
the international trade.
Statement of the Theory
According to this theory, there is difference in factor endowments among different countries
of the world. For instance, certain countries have comparatively large supply of labour while
in others the supply of capital is relatively large. Because of difference in factor endowments
there is difference in the prices of the factors. Difference in the prices of the factors depends
on their relative scarcity or abundance. Owing to difference in the prices of the factors, there is
difference in the costs of the goods. Hence, this theory states that the main cause of difference in
comparative costs is the difference in factor endowment. Thus, international, trade takes place
because of diversity in factor endowments and hence difference in prices. Each country will
export that commodity in the production of which such factor is used whose supply is relatively
abundant and price is relatively cheaper. On the other hand, it will import that commodity in the
production of which that factor is used whose supply is relatively scarce and price is relatively
dearer. According to this theory, conditions of supply alone determine the pattern of international
trade. BO Sodersten, writes that
“Some countries have much capital, others have much labour. The theory now says that countries that are
rich in capital will export capital intensive goods and countries that have much labour will export labour
intensive goods”.
Definitions
In the words of Salvatore, “The Heckscher-Ohlin Theory states that difference in relative factor
endowments and factor prices between nations is the most important cause of trade. This theory predicts
that each nation will export the commodity in the production of which a great deal of relatively abundant
and cheap factor is used and import the commodity in the production of which a great deal of its relatively
scarce and expensive factor is used. The theory also predicts that trade will lead to the reduction in the
difference in factor prices between nations. “
According to Ohlin, “Immediate cause of inter-regional trade is always that goods can be bought cheaper
in terms of money than they can be produced at home and here is the case of international trade.”

Assumptions of the Theory Notes
Some of the assumptions of the theory are discussed below:

1. This theory relates to two countries, two commodities and two factors. It is therefore called
2 × 2 × 2 model.
2. There is same production function for each commodity in two countries.
3. Factors are mobile within the country but immobile between two countries.
4. There is perfect competition in all markets. As a result (i) all factors are fully employed, (ii)
factors get their reward in accordance with their marginal productivity, (iii) prices of the
commodities are equal to their marginal productivity.
5. No restriction is imposed on the exchange of goods, i.e., free trade exists between two
countries.
6. Consumers’ tastes and preferences are identical in two countries.
7. Technique of production employed in two countries is the same.
8. There is lack of transport costs.
9. Factor endowments are different in two countries.
10. Goods can be classified on the basis of factor intensity, such as, capital intensive goods and
labour intensive goods, etc.
11. Production function of all goods is homogeneous of the first degree. It means that output
will be doubled if all factors of production are doubled.
Did u know? Swedish economists Eli Heckscher and Bertil Ohlin developed “Factor
proportion theory of International Trade” in year 1919.
2.4.1 Explanation of the Theory
According to Ohlin “International Trade is but a special case of inter-regional trade.” Different regions
have different factor endowments, i.e., some regions have abundance of labour but scarcity of
capital while other regions have abundance of capital but scarcity of labour. Different goods have
different production functions, i.e., factors are combined in different proportions to produce
different commodities. Some goods are produced by employing relatively large proportion of
labour and relatively small proportion of capital. Still other goods are produced by employing
relatively small proportion of labour and relatively large proportion of capital. In this way,
each region is suitable for the production of those goods for whose production it has relatively
abundant supply of the required factors. A region is not suitable for the production of those
goods for whose, production it has relatively scarce or zero supply of the essential factors. Hence,
different regions have different capacity to produce different commodities. Difference in factor
endowments is, therefore, the main cause of international trade along with inter-regional trade.
According to Ohlin, “Immediate cause of inter-regional trade is always that goods can be bought
cheaper in terms of money than they can be produced at home and here is the case of international trade.”
Heckscher in his article, “The effect of Foreign Trade on the Distribution of Income” published in
1919 had supported the classical theory of comparative costs and maintained that international
trade took place because of differences in comparative costs. But classical theory did not explain
why there was difference in comparative costs. Answering to this question, Heckscher cites the
following causes for difference in comparative costs:
1. Difference in factor endowments
2. Difference in factor intensities

Notes According to Heckscher-Ohlin Theory of International Trade, the immediate cause of international
trade is the difference in relative commodity prices. The cause of difference in the relative prices of
the goods is the difference in the amount of factor endowments, like capital and labour, between
the two countries. As a result, there is difference in the relative demand and supply of factors.
These differences cause difference in the prices of the factors. It is due to difference in factor
prices that difference in the relative prices of the commodities takes place and it is this difference
that constitutes the main cause of international trade.
Goods, which require scarce factors on a large-scale are imported because their domestic prices
are high. On the contrary, goods, which require abundant factors on a large scale, are exported
as their domestic prices are low. For instance, if capital is abundant in USA, it will be relatively
cheap. Hence, USA will export those goods which are capital intensive. On the contrary, if labour
is abundant in India, it will be relatively cheap. Hence, India will export those goods which are
labour intensive.
Notes International trade takes place because of diversity in factor endowments and
hence difference in prices.
2.4.2 Concept of Relative Factor Endowment
Abundance or scarcity of factors of Heckscher-Ohlin theory has been explained on the basis of
two criterions:
Price Criterion of Relative Factor Endowment
Price criterion of factor endowment means that a country where capital is relatively cheap and
labour relatively dear will be called capital abundant country, even if the quantity of capital in
that country is relatively less. On the contrary, if capital is relatively dear and labour relatively
cheap, such a country will be called capital scarce country, even if the quantity of capital in such
a country is relatively more. In other words, the criterion of factor abundance or factor scarcity
is not the quantum of the factor but its price. On the basis of price criterion, international trade
theory can be explained with the help of an example.
Example:
Diagrammatic Explanation
Let us take USA and India as two trading countries. It is assumed that USA is a capital intensive
country and India is a labour intensive country, i.e., capital is cheaper in USA in relation to
labour; and labour is cheaper in India in relation to capital. This can be expressed in terms of the
following equation:
USA India
PK < PK
PL PL
Here, PK: price of capital; PL : price of labour; < : less than
Both the countries are producing watches and shirts. While the production of watches is capital
intensive, the production of shirts is labour intensive. According to Heckscher-Ohlin theory,
India should specialise in the production of shirts and USA should specialise in the production
of watches. This is illustrated in Figure 2.3.

In this figure, labour is shown on the X-axis, and capital is shown on the Y-axis. WW is isoquant* Notes
showing production of 100 watches, and SS, is the isoquant showing production of 100 shirts.
AB and CD are Isocost** lines for USA. These are parallel straight lines, which means their slope
is same and, (since slope shows price ratio) these isocost lines are showing the same price ratio.
These isocost lines are inclined towards OY-axis, showing that in USA, capital is cheaper in
relation to labour. Likewise ZT and Z1T1 are isocost lines for India. These are inclined toward
OX-axis, showing that, in India, labour is cheaper in relation to capital. These lines are also
parallel and showing the same price ratio.
Figure 2.3: Price Criterion of Relative Factor Endowment
Thus,
OZ OZ 1
=
OT OT1
Isoquants WW and SS are intersecting each other only at point E. This implies that there is no
reversal of factor intensity. Or that in both USA and India, production of watches is capital
intensive, and production of shirts is labour intensive. This conclusion is based on the assumption
of Heckscher-Ohlin theory that both in USA and India, production function of watches or of
shirts is similar.
The diagram shows that, in case of USA, isocost line CD and isoproduct curve WW for watches
are tangent at point H. So that, for USA Production Cost for 100 Watches = OF Capital + ON
Labour
As regards the production of shirts, we find isocost line AB and isoproduct curve SS are tangent
at point J. So that for USA,
Production Cost of 100 shirts = OF Capital + ON1 Labour.
* An Isoproduct curve is a curve that shows different possible combinations of two factors of production, like capital and
labour, yielding the same amount of output.
** An Isocost line is that line which shows the various combinations of factors which can be obtained at the same cost. It is
also called budget line. It shows what possible combinations of factors a firm can obtain at the same cost. Isocost line also
shows cost-ratio of the factors.

Notes In USA, capital cost of production of watches or of shirts is equal to OF, but labour cost of shirts
is ON1. While labour cost of watches is ON.
Implying that labour cost of shirts is more by NN1 (ON1– ON = NN1) units of labour.
Thus, USA can produce watches at relative lesser cost, compared to the production of shirts.
In case of India, isocost line ZT and isoproduct curve WW for watches are tangent at point R.
So that, for India,
Product Cost of 100 Watches = ON Capital + OX Labour
Likewise isocost line Z1T1 and isoproduct curve SS for shirts are tangent at point EI. So, that,
Product Cost of 100
Shirts = OT Capital + OX Labour
Thus, in India, labour cost of watches and shirts = OX but capital cost of shirts is less than the
capital cost of watches by NT capital (ON – OT = NT). This suggests that India can produce shirts
at lesser cost compared to watches. Therefore, India should specialize in the production of shirts
and export the same.
It is thus, suggested that because capital is relatively cheaper in USA and because labour is
relatively cheaper in India, USA should specialize in the production of capital-intensive goods
i.e., watches and India should specialize in the production of labour-intensive goods i.e., shirts.
USA will export watches to India, while India will export shirts to USA.
Physical Criterion of Relative Factor Endowment
Physical criterion of factor abundance or scarcity means that if in a country capital ratio is greater
than labour as against another country, then it will be called capital intensive country. Likewise,
if in a country labour ratio is greater than capital as against another country, then it will be called
labour intensive country. In other words, basis of this criterion is the physical quantity of the
factors. On the basis of this criterion, international trade can be explained with the help of the
following example.
Example:
Example: According to Heckscher-Ohlin whether two countries, say USA and India, are capital
intensive or labour intensive depends on the fulfilment of the following condition:
Ku > Ki
Lu Li
(Here Ku = Quantity of Capital in USA; Lu = Quantity of Labour in USA; Ki = Quantity of Capital

in India; Li = Quantity of Labour in India)
USA will produce capital intensive and India, labour intensive goods. It is illustrated in the
following figure. GG1 is the production possibility curve of USA and II1 is the production
possibility curve of India.
Labour intensive production, i.e., shirts, is shown on OX-axis and capital intensive production,
i.e. watches, is shown on OY-axis. If both the countries produce both the goods in the same ratio,
then they will produce along OR-ray. USA will produce at point E of its production possibility
curve GG1 and India will produce at point F of its production possibility curve II1. It is evident
from this figure that at point E, the slope of production possibility curve of USA is steeper and
at point F while the slope of production possibility curve of India is flatter. It is clear from the
fact that P1P1 price line of USA is steeper than P2P2 price line of India. It proves that watches are
cheaper in USA and shirts are cheaper in India. USA should produce more of capital intensive

goods viz., watches. It may however, be noted that the above analysis does not clarify whether Notes
USA will export watches and India shirts. Answer to this question depends on the demand for
these goods. If the domestic demand of USA for watches is less than the supply, then alone it will
export watches, otherwise not. Likewise, India too will export shirts only if domestic demand for
shirts is less than the supply.
Y
P1
G
P2
WATCHES
I E
O G1 I1 P1 P2 X
SHIRTS
Did u know? It was Eli Heckscher who proved that international trade take place because
of difference of costs in different countries.
Self Assessment
Fill in the blanks:
6. Price criterion of factor ................ means that a country where capital is relatively cheap and
labor relatively dear will be called capital abundant country.
7. ................ criterion of factor abundance or scarcity means that if in a country capital ratio
is greater than labour as against another country, then it will be called capital intensive
country.
8. ................, which require scarce factors on a large-scale, are imported because their domestic
prices are high.
9. If in a country labour ratio is greater than ................ as against another country, then it will
be called labour intensive country.
10. If capital is relatively dear and labour relatively cheap, such a country will be called capital
................ country.
2.5 Country Similarity Theory

This theory was developed by Staffan B. Linder, a Swedish economist, on the basis of his
observation of the pattern of international trade since 1970s. According to this theory, developed
countries trade more with other developed countries. About ¾ of total world exports is among
the developed countries.
This fact, by itself, is an indictment of Heckscher-Ohlin’s factor endowment theory. According
to the H-O theorem, the incentive to trade is greatest among nations of radically different
factor endowments. This means that trade would take place in larger part between developed
manufacturing countries and developing countries producing primary products (i.e., natural
resource commodities such as oil and petroleum) and labour-intensive products.

Notes Basic Tenets of the Theory
This theory has three main tenets:

1. Difference in factor endowments: It explains trade in natural resource-intensive products
and that a country’s manufactured exports are determined by internal demands.
2. Preference similarity boosts trade between the two industrialized countries: Linder also
contends that the more similar the demand preference for manufactured goods in two
countries (e.g., the United States and United Kingdom), the more intensive is the potential
trade in manufacturers between them. If two countries have the same or similar demand
structures, then their consumers and investors will demand the same goods with similar
degrees of quality and sophistication, a phenomenon known as preference similarity. This
similarity boosts trade between the two industrialized countries.
3. Average per capita income is the most important determinant of the demand structure:
To explain the determinants of the demand structure. Linder argues that average per
capita income is the most important one. Countries with high per capita income will
demand high quality luxury consumer goods and sophisticated capital goods; while low
per capita income countries will demand low quality necessity consumer goods and less
sophisticated capital goods. Consequently, a rich country that has a comparative advantage
in the production of high-quality, advanced goods will find its big export markets in other
affluent countries where people demand such products.
Staffan B. Linder divided international trade into two different categories: primary products
and manufactured goods. Linder asserts that differences in factor endowments explain trade in
natural resource-intensive products but not in manufactured goods. He argues that the range
of a country’s manufactured exports is determined by internal demands. International trade in
manufactured goods takes place largely among developed nations because nations will only
export those goods they manufacture at home and will manufacture at home only those goods
for which there is a strong domestic demand.

Caselet International Finance Facility: The Global Marshall Plan?
M
ore than one billion people (i.e., one sixth of the world’s population) live in
extreme poverty with lack of water, proper nutrition, basic healthcare and the
welfare services needed to survive. This is in spite of the fact that various loans
and grants have been extended to alleviate poverty. On September 8, 2000, 152 Heads
of State attending the UN’s Millennium Summit unanimously adopted Millennium
Development Goals (MDGs) taking a collective responsibility to uphold the principles of
human dignity, equality and equity at a global level. But the implementation of the goals
was hampered due to the shortage of funds. To finance the MDGs, Gordon Brown, the
UK’s Chancellor of the Exchequer, proposed the setting up of an International Finance
Facility, which would aim to increase worldwide aid funding from $50 billion to $100
billion, by issuing bonds that were backed by aid pledges made by donor countries, in the
international capital markets.
Source: http://www.ibscdc.org/Case_Studies/International%20Trade%20and%20Finance/ITF0027.htm
2.6 Product Life Cycle Theory

Raymond Vernon initially proposed the product life cycle theory in the mid-1960s.Vernon argued
that the wealth and size of the US market gave us firms a strong incentive to develop cost-saving

process innovations. Vernon further argued that most new products were initially produced in Notes
America. Apparently, the pioneering firms believed it was better to keep production facilities
close to the market and to the firm’s centre of decision-making, given the uncertainty and risks
inherent in introducing new products. Also the demand for most new products to be raised on
non-price factors. Consequently, firms can charge relatively high prices for new products, which
obviate the need to look for low-cost production sites in other countries.
Vernon went on to argue that early in the life cycle of a typical new product, while demand is
starting to grow rapidly in the United States, demand in other advanced countries is limited to
high-income groups. The limited initial demand in other advanced countries does not make it
worthwhile for firms in those countries to start producing the new product, but it does necessitate
some exports from the United States to those countries.
Overtime demand for the new product starts to grow in other advanced countries (e.g. Great
Britain, France, Germany and Japan). It becomes profitable for foreign producers to begin
producing for their home markets. In addition, US firms might set up production facilities in
those advanced countries where demand is growing.
If cost pressures become intense, the process might not stop there. The cycle by which the United
States lost its advantage to other advanced countries might be repeated once mare, as developing
countries (e.g. Thailand) begin to acquire a production advantage over advanced countries. Thus
the focus of global production initially switches from the United States to other advanced nations
and then from those nations to developing countries.
The consequence of these trends is that over the time the United States switches from being
exporter of the producer to an importer of the product as production becomes concentrated in
lower-cost foreign locations and then developing countries.
2.6.1 Stages of Product Life Cycle
There are three stages of the product cycle.
Stage 1: The New Product
Innovation requires highly skilled labour and large quantities of capital for research and
development. The product will normally be most effectively designed and initially manufactured
near the parent firm and therefore in a highly industrialized market due to the need for proximity,
information and communication other than the many different skilled-labour components
required.
In the development stage, the product is non-standardized. The production process requires a
high degree of flexibility (meaning continued use of highly skilled labour). Costs of production
are therefore quite high. The innovator at this stage is a monopolist and therefore enjoys all of
the benefits of monopoly power, including the high profit margins required to repay the high
development costs and expensive production process. Price elasticity of demand at this stage is
low; high-income consumers buy it regardless of cost.
Stage 2: The Maturing Product
As production expands, its process becomes increasingly standardized. The need for flexibility
in design and manufacturing decline, and therefore, the demand for highly skilled labour also
decline. The innovating country increases its sales to other countries. Competitors with slight
variations develop, putting downward pressure on prices and profit margins. Production costs
are an increasing concern.

Notes As competitors increase their pressures on price, the innovating firm faces critical decisions on
how to maintain market share. Vernon argues that the firm faces a critical decision at this stage,
either to lose market share to foreign-based manufacturers using cheaper labour or to maintain
its market share by exploiting the comparative advantages of factor costs by investing in other
countries. This is one of the first theoretical explanations of how trade and investment become
increasingly intertwined.
Stage 3: The Standardized Product
In this final stage, the product is completely standardized in its manufacture. Thus, with access
to capital in world capital markets, the country of production is simply the one with the cheapest
unskilled labour. Profit margins are thin and competition is fierce. The product has largely run
its course in terms of profitability for the innovating firm.
The country of comparative advantage therefore, shifts as the technology of the product’s
manufacture matures. The same product shifts in its production location. The country producing
the product during that stage enjoys the benefits of net trade surpluses. But such advantages are
fleeting, according to Vernon. As knowledge and technology continually change, so does the
comparative advantage of the producer country.
2.6.2 Trade Implications of the Product Cycle Theory

Product cycle theory shows how specific products were first produced and exported from one
country but, through product and competitive evolution, shifted their location of production and
export to other countries overtime. Figure 2.4 illustrates the trade patterns that Vernon visualized
as resulting from the maturing stages of a specific product cycle. As the product and the market
for the product mature and change, the countries of its production and export shift.
The product is initially designed and manufactured in the United States. In its early stages
(from time t0 to t1), the United States is the only country producing and consuming the product.
Production is highly capital-intensive and skilled-labour intensive at this time. At time t1, the
United States starts exporting the product to other advanced countries. These countries possess
the resources to purchase the product in its still. New Product Stage, in which it is relatively
high priced. These other advanced countries also commence their own production at time t1 but
continue to be net importers. A few exports, however, do find their way to the less developed
countries at this time as well.
As the product moves into the second stage, the Maturing Product Stage, production capability
expands rapidly in the other advanced countries. Competitive variations (products) begin to
appear as the basic technology of the product becomes more widely known, and the need for
skilled labour in its production declines. These countries eventually also become net exporters
of the product near the end of the stage (time t3). At time t2, the Less Developed Countries begin
their own production, although they continue to be net importers. Meanwhile, the lower cost of
production from these growing competitors turns the United States into a net importer by time
t4. The competitive advantage for production and export is clearly shifting across countries at
this time.
The third and final stage, the Standardized Product Stage, sees the comparative advantage of
production and exports shifting to the less developed countries. The product is now a relatively
mass-produced product that can be made with increasingly less-skilled labour. The United States
continues to reduce domestic production and increase imports. The other advanced countries
continue to produce and export, although exports remain at peak as the less developed countries
expand production and become net exporters themselves. The product has run its course or life
cycle in reaching time t5.

Figure 2.4: Trade Patterns and Product Cycle Theory

Notes
United States
Consumption
Imports
Exports
Production
t0 t1 t2 t3 t4 t5 Time
Other Advanced Countries
Production
Exports
Consumption
Imports
Less Developed Countries
Production
Exports
Consumption
Imports
New Product Maturing Product Standardized Product
Historically, the product life cycle theory provides an accurate explanation of international trade
patterns. Consider photocopiers; the product was developed in the early 1960s by Xerox in the
United States and sold initially to US users. Xerox exported photocopiers from the United States,
primarily to Japan and the advanced countries of Western Europe. As demand began to grow in
those countries, Xerox entered in to joint ventures to set up production in Japan (Fuji-Xerox) and
Great Britain (Rank Xerox). In addition, once Xerox’s patents on the photocopier process expired,
other foreign competitors began to enter the market (e.g., Canon in Japan, Olivetti in Italy). As a
consequence, exports from the United States declined, and US users began to buy some of their
photocopiers from lower-cost foreign sources, particularly from Japan. More recently, Japanese
companies have found that their own country is too expensive to manufacture photocopiers, so
they have begun to switch production to developing countries such as Singapore and Thailand.
As a result, initially the United States and now several other advanced countries have switched

Notes from being exporters of photocopiers to being importers. This evolution in the pattern of
international trade in photocopiers is consistent with the predictions of the product life cycle
theory. The theory clearly explains the migration of mature industries out of the United States to
low-cost assembly locations.
!
Caution Technological changes can affect the degree of comparative advantage for a
country and its production of a certain product.
2.6.3 Limitations of Product Life Cycle Theory
This theory has been criticized because of the following weaknesses:

1. Applicable on technology-based products: The technology-based products normally
experience the changes in production process as they grow and mature. Other products
such as resource-based (minerals) or services which employ capital in the form of human
capital are not easily characterized by the stages of maturity.
2. Most new products are not developed and introduced in the United States: Although
it may be true that from 1945 to 1975, most new products were introduced in US, there
have always been important exceptions. In recent years, it has been noted that many new
products are now introduced in Japan, US and the advanced European nations (laptops,
computers, compact disks and electronic cameras).
It is thus evident from above that Vernon theory may be useful for explaining the pattern of
international trade during the brief period of American global dominance; its relevance, however,
in the modern world is limited.
Notes Most new products are not developed and introduced in the United States.
Did u know? Product life cycle theory clearly shows that mature industries always relocate
to low-cost assembly locations.
Self Assessment
State whether the following statements are true or false:

11. As ................. expands, its process becomes increasingly standardized.
12. ................. initially proposed the product life cycle theory in the mid-1960s.
13. To explain the determinants of the demand structure, ................. argues that average per
capita income is the most important one.
14. The ................. products normally experience the changes in production process as they
grow and mature.
15. Staffan B. Linder divided international trade into two different categories: .................
products and ................. goods.

Notes

Case Study The Indian Cashew Processing Industry
E
ven though the cashew tree grows fruit, it is best known for its nuts. India is the
world’s largest producer, processor and exporter of cashew. In 2000, India accounted
for 65 percent of the $208 million in total global exports. The fruit of the tree (known
as the cashew apple), however, drew the earliest attention. The Tupi Indians of Brazil, first
harvested the cashew apple in the wild. They later introduced it to the early Portuguese
traders, who, in turn, propagated the tree in other tropical countries. But attempts to grow
the tree on the plantations proved unsuccessful, because it was vulnerable to insects in the
close quarters of plantations. Instead, some of the abandoned plantation trees propagated
new trees in the wild forests of India, East Africa, Indonesia and South-East Asia.
Two other factors inhibited the early harvest of the cashew nut. Firstly, cashew fruit
matures before the nut and the fruit will be kept only about 24 hours, after harvesting the
nut. So, the fruit is usually discarded in the pursuit of the nut, which, if dried, can last a
year or longer. Secondly, the processing of cashew nuts is tedious and time-consuming.
In the 1920s, however, India developed a cashew-processing industry in response to the
growing demand for cashew nuts among Indian consumers.
The processing required much manual dexterity and low wage rates, because the nut is
contained beneath layers of shell and thin skin. To remove the shell, the workers must place
the nut in an open fire for a few minutes and then tap it (while still hot), with a wooden
hammer. If the nut breaks from the tapping, its value decreases considerably. Once the
workers remove the shell, they place the nut in an oven for up to 10 hours, after which
they remove the skin by hand, while the nut is still warm, without the use of fingernails
or any sharp objects that can mark or break the surface. The workers then sort the nuts
into 33 grades, based mainly on size and wholeness. The highest grades sell for several
times the price of the lowest grades, which are sold almost entirely to the confectionery
industry. India maintained a virtual monopoly on cashew processing, until the mid-1970s.
This monopoly was due to three factors:
1. India was the largest producer of cashews.
2. Early demand occurred largely in India, meaning that any other country would have
to incur added transport charges to reach the Indian market.
3. Most importantly, the Indian workers were particularly adept at the process
technology.
Through the years, other factors threatened India’s prominence as a cashew producer.
Firstly, a shortage developed, when the demand for the nuts grew in the United States and
the United Kingdom. Secondly, because the nuts were ill-suited for plantation growth,
India could not produce enough and thus turned to East Africa, especially Mozambique,
Tanzania and Kenya, for supplies. Those countries were experiencing high unemployment
and were at first eager to sell the raw nuts, which grew in the wild. But by the 1950s,
they began to realize that they could bypass India, by processing the raw nuts themselves.
Cashew-processing methods were well known and did not require the East Africans to
invest in expensive machinery. So there was no technological obstacle. Mozambique became
the world’s largest cashew grower by the mid-1970s and processed cashews became the
country’s leading export. However, because the Indian labour force worked on making
handicrafts at home as children, by the time they were employed in cashew processing,
they could perform delicate hand operations efficiently. Without such training, the East
Africans were at a fatal disadvantage. Further, the Mozambique government neglected
Contd...

Notes reinvestments in the state-owned processing plants and many of the trees became diseased
and too old to be productive. By the 21st century, Mozambique was no longer a major
player in the industry.
Although the Africans’ inability to compete, granted a reprieve to the Indian industry, it put
it on notice, that it was vulnerable to supply cut-offs. The Indian Council for Agricultural
Research, the International Society for Horticultural Sciences, and the Indian Society
for Plantation Crops, expanded their efforts to increase India’s production of raw nuts.
Concomitantly, three different companies developed mechanical equipment to replace
hand processing. They sold equipment to East African countries and Brazil in the 1970s.
These countries reduced their exports of raw nuts to India to maintain supplies for their
own processing.
Three factors have kept India’s hand-processing industry afloat:
1. The machinery breaks many cashew nuts, so Indian processors have had an
advantage in the sale of higher-grade nuts. At any time, however, newer machinery
might solve the breakage problem, again threatening the approximately 200 Indian
processors and their 300,000 employees. Moreover, there is an increased competition
for the lower-grade output.
2. Indian processors have been able to obtain increased supplies of raw nuts, partially as
a result of the increased Indian production. Pesticide technology now makes cashew
tree plantations feasible, increasing the number of trees per acre. Nevertheless,
about 97 per cent of nuts come from trees in the wild. Indian experimentation in
hybridization, vegetative propagation and grafting and budding techniques, promises
to increase the output per tree to five times what it was in the wild. Further, India has
been increasing its imports of raw nuts substantially, primarily from Tanzania.
3. India uses fewer fertilizers than Brazil, the biggest export competitor and the lack of
fertilizer apparently gives, Indian nuts, a better flavour.
Because its exports consist of a higher portion of higher-grade nuts and because of the flavour
differences, Indian exports sell for a premium in comparison with those of competitors, for
example, about 15 percent more than nuts from Brazil. However, yields are usually higher
in Brazil, and Brazilian processors pay only between 30 and 36 percent of the price, the
Indian processors pay for raw nuts. Further, because of differences in domestic demand,
India typically exports about 50 percent of the raw kernels that it processes, whereas, Brazil
exports about 85 percent. In the mid-1990s, Brazil suffered crop problems, which enabled
India to gain an increase in the global export share of processed cashew kernels.
During the 1990s, India depended heavily on imported raw nuts from Vietnam. However,
Vietnam has since, become a competitor by processing its own nuts and by importing
nuts to process from other countries. The Vietnamese government is spending heavily to
introduce high-tech strains into production in order to improve both quantity and quality.
Vietnamese exports are of high quality and so the country’s exporters are not only targeting
India’s largest export market, the United States, but also emerging markets such as China,
Saudi Arabia and Russia. If Vietnam’s growth in exports continues at the same rate, it will
surpass India as the largest exporter by 2010.
There is potential for an excess supply of cashew nuts, which might result from plantation
techniques and improved technology in India and elsewhere. To find outlets for a possible
nut glut, the All-India Coordinated Spices and Cashew Nut Improvement Project has
focused its efforts on increasing nut sales in small markets and on finding new markets for
products from the cashew tree. For example, experimentation is going on to harvest both
the fruit and the nut. The fruit is also being studied for commercial use in candy, jams,
chutney, juice, carbonated beverages, syrup, wine and vinegar. Another area of research
Contd...

is in the use of cashew nutshell liquid (oil), which was once discarded as a waste product. Notes
It is now used extensively in industrial production of friction dusts, for formulation in
brake linings and clutch facings. However, the extraction of cashew nutshell liquid has
been too costly, to make the product fully competitive with some other types of oils. There
is also a potential for short-term cashew shortages, such as that occurred in 1999, because
of unfavourable climatic conditions. This has led India to try to increase its production and
its foreign supplies.
Questions
1. What trade theories help to explain where the cashew tree products have been
produced historically?
2. What factors threaten India’s future competitive position in cashew nut
production?
3. If you were an Indian cashew processor, what alternatives might you consider to
maintain future competitiveness?
Source: John D. Daniels, Lee H. Radebaugh & Daniel P. Sullivan, “International Business”, 11th ed., Pearson Education,
p.217-219.
2.7 Summary
zz This unit has reviewed a number of theories that explain why it is beneficial for a country
to engage in international trade and has explained the pattern of international trade that
we observe in the world economy.
zz We have seen how the theories of Smith, Ricardo, and Heckscher-Ohlin all make strong
cases for unrestricted free trade.
zz In contrast, the mercantilist doctrine and, to a lesser extent, the new trade theory can be
interpreted to support government intervention to prevent exports through subsidies and
to limit imports through tariffs and quotas.
zz In explaining the pattern of international trade, we have seen that with the exception of
mercantilism, which is silent on this issue, the different theories offer largely complementary
explanations.
zz Although no one theory may explain the apparent pattern of international trade, taken
together, the theory of comparative advantage, the Heckscher-Ohlin theory and Porter’s
theory of national competitive advantage tells us that productivity differences are
important.
zz Heckscher-Ohlin tells us that factor endowments matter; the product life cycle theory tells
us that where a new product is introduced is important; the new trade theory tells us that
increasing returns to specialization and first-mover advantages matter; and Porter tells
us that all these factors may be important insofar as they impact the four components of
national demand.
2.8 Keywords
Absolute Advantage: A country has an absolute advantage in the production of a product when
it is more efficient than any other country at producing it.
Comparative Advantage: The theory that countries should specialize in the production of goods
and services they can produce more efficiently. A country is said to have a comparative advantage
in the production of such goods and services.

Notes Factor Endowments: A country is endowed with resources such as land, labour and capital.
Isocost Line: It is that line which shows the various combinations of factors which can be obtained
at the same cost. It is also called budget line. It shows what possible combinations of factors a firm
can obtain at the same cost. Isocost line also shows cost-ratio of the factors.
Isoproduct Curve: It is a curve that shows different possible combinations of two factors of
production, like capital and labour, yielding the same amount of output.
Physical Criterion of Factor Abundance or Scarcity: It means that if in a country capital ratio is
greater than labour as against another country, then it will be called capital intensive country.

1. “Mercantilism is a bankrupt theory that has no place in the modern world.” Discuss.
2. Drawing on the theory of comparative advantage to support your arguments, outline the
case for free trade.
3. What are the potential costs of adopting a free trade regime? Do you think governments
should do anything to reduce these costs?
4. “If theories, like girls, could win beauty contests, the comparative cost theory would
certainly rate high in that, it is an elegant logical structure”. Discuss.
5. Critically explain comparative advantage theory of international trade.
6. Explain the comparative cost theory of international trade. What are its assumptions and
limitations?
7. What are the main drawbacks of comparative cost theory of Ricardo? How can this
drawback be removed?
8. Explain the modifications in the Ricardian Comparative Advantage Theory.
9. “The difference of factor endowments among the nations is the basis of international trade.”
Explain.
10. Product life cycle theory has always been a very “attractive theory” to many students.
What do you think are reasons for it?
11. Many trade theorists argue that the primary contribution of Michael Porter has been to
re-popularize old ideas, in new and more applicable ways. To what degree do you think
Porter’s ideas are new or old?
12. Discuss Income-Preference Similarity theory. What are the basic tenets of the theory?
Answers: Self Assessment
1. (e) 2. (d)
3. (d) 4. Mercantilists
5. Adam Smith 6. Endowment
7. Physical 8. Goods
9. Capital 10. Scarce
11. Production 12. Raymond Vernon
13. Linder 14. Technology-based
15. Primary manufacturing

2.10 Further Readings Notes
Books Cherunillam Francis, International Business, Text and Cases 3rd, Edition, Prentice-
Hall of India Private Limited
Charles W.L. Hill, International Business Competing in the Global Marketplace,
4th Edition, Tata McGraw Hill, Publishing Company Limited
Salvatore, Dominick, International Economics, John Wiley and Sons, New York,
Chapter 2 and 3.
Online links http://www.uwf.edu/rsjoland/WEB%20POSTED%20FILES/6%20International

%20Trade%20Theory%20A%202%2004.pdf

International Business Neha Kholsa, Lovely Professional University
notes unit 3: cultural and social environment
contents
Objectives
Introduction
3.1 Cultural Environment
3.1.1 Values and Norms
3.1.2 Culture, Society and the Nation-State
3.1.3 Determinants of Culture
3.1.4 Social Structure
3.1.5 Language
3.1.6 Education
3.1.7 Demand Conditions
3.1.8 Language and Culture in India’s Foreign Policy
3.1.9 Religion and Religious Groups
3.1.10 Language and Linguistic Groups
3.1.11 Attitudes and Values
3.1.12 Socio-cultural Factors and International Marketing
3.2 Summary
3.3 Keywords
objectives
lz Describe the concept of culture
lz Analyse the linguistic and culture
lz Explain the various approaches of culture
introduction
The word culture, from the Latin colo, -ere, with its root meaning “to cultivate”, generally refers
to patterns of human activity and the symbolic structures that give such activity significance
Culture consists of specific learned norms based on attitudes, values, and beliefs, all of which
exist in every society. Culture cannot easily be isolated from such factors as economic and
political conditions.
Much has been written on the subject of culture and its consequences. Whilst on the surface
most countries of the world demonstrate cultural similarities, there are many differences, hidden
below the surface. One can talk about “the West”, but Italians and English, both belonging to
the so called “West”, are very different in outlook when one looks below the surface. The task of
46 lovely Professional university

Unit 3: Cultural and Social Environment
the global marketer is to find the similarities and differences in culture and account for these in Notes
designing and developing marketing plans. Failure to do so can be disastrous.
Terpstran (1987) has defined culture as follows:
“The integrated sum total of learned behavioural traits that are manifest and shared by members of
society”.
Culture, therefore, according to this definition, is not transmitted genealogically. It is not, also
innate, but learned. Facets of culture are interrelated and it is shared by members of a group who
define the boundaries. Often different cultures exist side by side within countries, especially in
Africa. It is not uncommon to have a European culture, alongside an indigenous culture, say, for
example, Shona, in Zimbabwe. Culture also reveals itself in many ways and in preferences for
colours, styles, religion, family ties and so on. The colour red is very popular in the west, but not
popular in Islamic countries, where sober colours like black are preferred.
Much argument in the study of culture has revolved around the “standardisation” versus
“adaptation” question. In the search for standardisation certain “universals” can be identified.
Murdock (1954) suggested a list, including age grading, religious rituals and athletic sport. Levitt
(1982) suggested that traditional differences in task and doing business were breaking down and
this meant that standardisation rather than adaption is becoming increasingly prevalent.
Culture, alongside economic factors, is probably one of the most important environmental
variables to consider in global marketing. Culture is very often hidden from view and can be
easily overlooked. Similarly, the need to overcome cultural myopia is paramount.
3.1 Cultural Environment

When doing business abroad, a company first should determine whether a usual business practice
in a foreign country differs from its home-country experience. Understanding the cultures of
groups of people is useful because business employs, sells to, buys from, is regulated by, and is
owned by people.
3.1.1 Values and Norms

Values form the bedrock of a culture. They provide the context within which a society’s norms
are established and justified. They may include a society’s attitudes toward such concepts as
individual freedom, democracy, truth, justice, honesty, loyalty, social obligations, collective
responsibility, the role of women, love, sex, marriage, and so on. Values are not just abstract
concepts; they are invested with considerable emotional significance. People argue, fight, and
even die over values such as freedom. Values also often are reflected in the political and economic
systems of a society.
Norms are the social rules that govern people’s actions toward one another. Norms can be divided
further into two major categories: folkways and mores. Folkways are the routine conventions of
everyday life. Generally, folkways are action of little moral significance. Rather, folkways are
social conventions concerning things such as the appropriate dress code in a particular situation,
good social manners, eating with the correct utensils, neighbourly behaviour and the like. While
folkways define the way the people are expected to behave, violation of folkways is not normally
a serious matter. People who violate folkways may be though of as eccentric or ill-mannered, but
they are not usually considered to be evil or bad. In many countries foreigners may initially be
excused for violating folkways.
Mores are norms that are seen as central to the functioning of a society and to its social life.
They have much greater significance than folkways. Accordingly, violating, mores can bring
serious retribution. Mores include certain factors as indictments against theft, adultery, incest,
and cannibalism. In many societies, certain mores have been enacted into law. Thus, all advanced
societies have laws against theft, incest and cannibalism. However, there are also many differences
between cultures as to what is perceived as mores.

Notes 3.1.2 Culture, Society and the Nation-State
We have defined a society as a group of people that share a common set of values and norms, that
is, people who are bound together by a common culture. However, there is not a strict one-to-one
correspondence between a society and a nation-state. Nation-states are political creations. They
may contain a single culture or several cultures.
At the other end of the scale, we can speak of cultures that embrace several nations.
3.1.3 Determinants of Culture
The values and norms of a culture do not emerge fully formed. They are the evolutionary product
of a number of factors, including the prevailing political and economic philosophy, the social
structure of a society and the dominant religion, language and education (see Figure 3.1).
We will discuss the influence of social structure, religion, language, and education. While factors
such as social structure and religion clearly influence the values and norms of a society, the
values and norms of a society can influence social structure and religion.
Figure 3.1: Determinants of Culture
Religion
Social Structure Political

Philosophy
Culture Norms
and Value
Systems
Language Economic
Education Philosophy
3.1.4 Social Structure
A society’s “social structure” refers to its basic social organizations. Two dimensions are
particularly important when explaining differences between cultures. The first is the degree
to which the basic unit of social organization is the individual, while groups tend to figure
much larger in many other societies. The second dimension is the degree to which a society is
stratified into classes or castes. Some societies are characterized by a relatively high degree of
social stratification and relatively low mobility between strata (e.g. Indian) while other societies
are characterized by a low degree of social stratification and high mobility between strata (e.g.
American).
Individuals and Groups
A group is an association of two or more individuals who have a shred sense of identity and who
interact with each other in structured ways on the basis of a common set of expectations about
each other’s behaviour. Human social life is group life. Individuals are involved in families, work
groups, social groups, recreation groups and so on. However, while groups are found in all
societies, societies differ according to the degree to which the group is viewed as the primary
means of social organization. In some societies, individual attributes and achievements are

viewed as being more important than group membership, while in other societies the reverse is Notes
true.
Individual
Individualism is more than just an abstract political philosophy but is the basic building block of
social organization. This is reflected not just in the political and economic organization of society
but also in the way people perceive themselves and relate to each other in social and business
settings. The value systems of many Western societies, for example, emphasize individual
achievements. The social standing of individuals is not so much a function of whom they work
for, as of their individual performance in whatever work setting they choose.
Individualism also finds expression in a high degree of managerial mobility between companies,
and this not always a good thing. One positive aspect of high managerial mobility is that executives
are exposed to different ways of doing business. The ability to compare business practices helps.
The emphasis on individualism may also make it difficult to build teams within an organization
to perform collective tasks.
Group
In contrast to the Western emphasis on the individual, the group is the primary unit of social
organization in many other societies. In Japan, the social status of an individual is determined
as much by the standing of the group to which he or she belongs as by his or her individual
performance.
The primacy of the value of group identification also discourages managers and workers from
moving from company to company. Lifetime employment in a particular company is the norm
in certain sectors of the Japanese economy.
Social Stratification
All societies are stratified on a hierarchical basis into social categories-that is, into social strata.
These strata are typically defined on the basis of characteristics such as family background,
occupation, and income. Individuals are born into a particular stratum and they become a
member of the social category to which their parents belong. Individuals born into a stratum
toward the top of the social hierarchy tend to have better life chances such as better education,
better health, a better standard of living and better work opportunities, than individuals born
into a stratum towards the bottom of the hierarchy. Although all societies are stratified to some
degree they differ in two related ways that are of interest to business organization. First, they
differ from each other with regard to the degree of mobility between social strata and second,
they differ with regard to the significance attached to the social strata in business contexts.
Social Mobility
The term ‘social mobility’ refers to the extent to which individuals can move out of the strata
into which they are born. Social mobility varies significantly from society to society. The most
rigid system of stratification is the caste system. A caste system is a closed system of stratification
in which social position is determined by the family into which a person is born and change in
position is usually not possible during an individual’s lifetime. Often a caste position carries with
it a specific occupation like shoemakers, butchers etc. These occupations are embedded in the
caste and passed down through the family to succeeding generations. Although the number of
societies with caste system has diminished rapidly during the 20th century, one partial example

Notes still remains. India has four main castes and several thousand sub-castes. Even though the caste
system was officially abolished in 1949 it is still a powerful force in rural Indian society where
occupation and marital opportunities are still partly related to caste.
While many societies have class systems, social mobility within a class system varies from society
to society.
Significance Attached to the Social Strata in Business Contexts
From a business prescriptive the stratification of a society is significant if it affects the operation
of business organizations. In American society, the high degree of social mobility and extreme
emphasis on individualism limits the impact of class background on business operations. The
same is true in Japan where most of the population perceives itself to be middle class. In a country
such as Great Britain, however, the relative lack of class mobility and the differences between
classes have resulted in the emergence of class consciousness. Class consciousness refers to a
condition where people tend to perceive themselves in terms of their class background and this
shapes their relationships with members of other classes.
Religious and Ethical Systems
Religion may be defined as a system of shared beliefs and rituals that are concerned with the
realm of the sacred. Ethical systems refer to a set of moral principles, or values, that are used to
guide and shape behaviour. Most of the world’s ethical systems are the product of religions. Thus
we talk about Christian ethics and Islamic ethics.
The relationship between religion, ethics and society is subtle, complex and profound. Among
thousands of religions in the world today, four dominate Christianity, Islam, Hinduism and
Buddhism. Perhaps the most important business implications of religion centre on the context to
which different in religions shape attitudes toward work and entrepreneurship and the degree to
which religious ethics affect the costs of doing business in a country.
Did u know? From business point of view, society stratification is very significant in the
success of any business.
3.1.5 Language
One way in which countries differ is the means of communication i.e. the language-spoken and
the unspoken. Language is one of the defining characteristic of a culture.
Spoken Language
Other than communication language also structures the way we perceive the world, its certain
features. For example the English language has one word for snow; the language of the Inuit
(Eskimos) lacks a general term for it. Instead the different forms of snow is so important in their
lives they have 24 words that describe different types of snow (e.g. powder snow, falling snow,
wet snow, drifting snow).
Because language shapes the way perceive the world, it also helps define culture. In countries
where there are more than one language, one also often finds more than one culture. Canada has
an English-speaking culture and a French-speaking culture Tensions between the two run quite
high, with a substantial proportion of the French-speaking minority demanding independence
from a Canada “dominated by English speakers”. The same phenomenon can be observed in
many countries.

Notes
Notes The primacy of the value of group identification also discourages managers
and workers from moving from company to company.
Unspoken Language
Unspoken language refers to non-verbal communication. We all communicate with each other
by a host of nonverbal cues. The raising of eyebrows, for example, is a sign of recognition in most
cultures, while a smile is a sign of joy. Many nonverbal cues, however are culturally bound. A
failure to understand the nonverbal cues of another culture can lead to a failure of communication.
For example, making a circle with a thumb and the forefinger is a friendly gesture in the United
States, but it is a vulgar sexual invitation in Greece and Turkey.
Another aspect of non-verbal communication is personal space, which is the comfortable amount
of distance between you and someone you are talking to. In the United States, the customary
distance apart adopted by parties in a business discussion is five to eight feet. In Latin America it
is three to five feet. Consequently, many North American unconsciously feel that Latin Americans
are invading their personal space and can be seen backing away from them during a conversation.
In turn, the Latin American may interpret such backing away as aloofness. The result can be a
regrettable lack of rapport between two business people from different cultures.
3.1.6 Education
Formal education plays a key role in a society. It is the medium through which individuals learn
many of the language, conceptual and mathematical skills that are indispensable in a modern
society. Formal education also supplements the family’s role in socializing the young into the
values and norms of a society. Values and norms are taught both directly and indirectly. Schools
generally teach basic facts about the social and political nature of a society. They also focus on
the fundamental obligations of citizenship. Cultural norms are also taught indirectly at school.
Respect for others, obedience to authority, honesty, neatness, being on time, and so on, are all
part of the “hidden curriculum” of schools. The use of grading system also teaches children the
value of personal achievement and occupation.
From an international business perspective, one important aspect of education is its role as a
determinant of national competitive advantage. The availability of a pool of skilled and educated
workers seems to be a major determinant of the likely economic success of a country.
The general education level of a country is also a good index of the kind of products that might
sell in a country and the type of promotional material that should be used.
3.1.7 Demand Conditions
Composition of home demand, the size and pattern of growth of home demand.
1. Gross National Product (GNP): Broadest measure of economic activity which is defined
as the market value of final goods and services newly produced by domestic factors of
demand.
Notes The production by domestic factors could take place at home or abroad.

Notes 2. Gross Domestic Product: Measures the value of production that occurs within a country’s
borders without regard to whether the production is done by domestic or foreign factors of
production.
3. Per Capita GNP: Low-income ($725 or less), Mozambique ($80)
Middle-income ($726-$8,955) Colombia ((2,140) High-Income ($8,956 or more)
Example: Luxemburg (45,360)

Japan (40,940)
U.S. (28,020)
Low- and middle-income countries is where the vast majority of the world’s population
lives
North-South Dialogue
4. Relative Importance of High-income Countries: They represent only 21% of the number
of economies and 15.2% of the population, but they generate 79.5% of the world’s GNP.
5. Relative Importance of Middle-income Countries: They represent 28.1% of the world’s
population, 15.6% of its GNP, and represent 48.3% of the total countries.
6. Relative Importance of Low-income Countries: Account for 30.6% of the number of
economies in the world, 56.7% of the population, but only 4.9% of the GNP.
7. Purchasing Power Parity (PPP): The basic idea is to identify the number of units of a
country’s currency required to buy the same amounts of goods and services in the domestic
economy as one dollar would buy in the U.S. Thus, even though per capita GNP is the
primary measure of wealth in a country, purchasing power GNP is an alternative way
to measure wealth that is more indicative of the purchasing power of a country’s
currency.
8. Structure of Production: Percentage of GDP generated by agriculture, industry,
manufacturing, and services.
The key is to note that as income rises, the percentage of GDP devoted to agriculture
falls, and the percentage devoted to services rises.
Other Indicators
Quality of Life: Life expectancy, educational standards, individual purchasing power, health,
sanitation, and treatment of women are some factors indicating quality of life.
Social and cultural aspects of a society form its very nature. As “culture” is the essence of a
society, this unit will concentrate on a discussion of it only. Of all the so called “environmental
uncontrollables”, culture, or at least the study of it, is one of the most difficult to comprehend,
take account of and harness to advantage. This is particularly so when the product or service is
“culture bound”. Such products and services include those which are generally indigenous by
nature and/or of relatively small value and very common. This is particularly true of foodstuffs.
Sadza in Zimbabwe, a staple food made from maize meal, would not go down well in Beverley
Hills, California. Neither would Middle Eastern sheep’s eyes menus. Products of a more technical
nature, like computers, on the other hand, have a universal appeal.
!
Caution Culture is a broad phenomenon which tends to affect the position of any products
or services prevailing in the market.

However there is plenty of evidence to suggest that, with shrinking communications and with Notes
more people than ever travelling, even the most culture bound product or service can, and is,
finding a world market niche. So even the infamous Veldschoen footwear of the South African
pioneers has found its way into most corners of the world.
Self Assessment
State whether the following statements are true or false:

1. The emphasis on individualism may make it easy to build teams within an organization to
perform collective tasks.
2. The primacy of the value of group identification also encourages managers and workers
from moving from company to company.
3. The integrated sum total of unlearned behavioral traits that are manifest and shared by
members of society.
4. Formal education does not play a key role in a society.
5. Religion may be defined as a system of shared beliefs and rituals that are concerned with
the realm of the sacred.
6. Because language shapes the way perceive the world, it also helps define culture.
7. One way in which countries differ is the means of communication i.e. the language-spoken
and the unspoken.
3.1.8 Language and Culture in India’s Foreign Policy
Indian Struggle for Recognition
As an independent political nation, India was still very young, when it assumed the leadership of
the newly emerging Afro-Asian nations. The leadership slipped from its hands, when its rhetoric
of peace did not match with its own performance, both domestic and international; its foreign
policy failed to perceive the changes taking place in the economic front all over the world. The
policy became a list of clichés. Smaller and less prosperous nations, with equally tradition-bound
societies, soon reaped great advantages by focusing more on the economic content in their policy
than on high sounding moralistic declarations. India came to realize only much later that without
a sound economic base of its own, its pretensions to leadership will be just what these were—
mere pretensions.
To recapture the imagination of the West, India’s foreign policy became more and more a cultural
policy, with greater interest shown in the cultivation of the protest academics, protest politicians,
and moralistic philosophers. It made an alignment with the emerging New Age performers in the
sphere of religions and personal life styles, much to India’s detriment, and to the dismay of the
ever-increasing ranks of the conservatives in the West.
The shift in the geopolitical balance, which began with the growing rift between the Soviet Union
and China, and the entry of China as a major international power caused the most crucial and
disadvantageous turn in India’s foreign policy. India’s preoccupation with its geographical
integrity (deeply impressed in the collective consciousness of India by the partition of British
India into Republic of India and Pakistan) came to haunt and guide Indian foreign policy. The
elitist Indian politician, brought up in the Fabian tradition, easily identified the utmost national
interest of preserving India’s geographical integrity with his bias for socialism, which easily
led to India being the leading supporter of the Soviet Union. India was soon perceived to be
mouthing what Soviet Union wanted it to say. Americans began to see that India was rather
simply sanctimonious.

Notes From the state of being ignored by the US and its allies, in 1980s, India became an orphan in early
1990s. The death of Rajiv Gandhi and the consequent weakening of the Nehru legacy coincided
with the fall of the Soviet Union. India’s preoccupation with preserving its geographical integrity,
with brokering world peace and with the celebration of egalitarian ideals and protest thought had
not led her anywhere. In fact, she is presently facing the hardest of all challenges from within,
from Kashmir. However, people at large have always been behind the leadership in fostering,
preserving, and moulding the geographical integrity of the nation. This was not necessarily a
product of the foreign policy.
At long last, along with fear and despair, India seems to be waking up to face the reality and to
make amends through a foreign turn, a turn which while retaining some clichés yet, is willing to
break new grounds. The evidence for it is seen in the sweeping changes in its economic policies. Its
tilt towards the West, especially towards the India, is more pronounced. And this has infuriated
the leftists and hard-core nationalists within the country.
Did u know? Indian foreign and business policies were always inclined towards Soviet
Union and with its fall, India had a big lacuna to fulfill.
Similarity of Political Institutions: No Guarantee for Recognition
Since its independence in 1947 from Britain, India has tried to follow a foreign policy which
it considered would be truly characteristic of its independence, a policy which would bestow
upon it the status of a big power and preserve its geographic integrity, even as this policy would
lead to an equitable world both for the common man and the poor nations. India offers an
excellent example of how poor nations, full of ambitions and pretensions to leadership, wanted
to manipulate the world around them in their terms by assuming moralistic positions and how
these failed miserably in a world of power politics. India was soon seen to be a staunch apologist
for former Soviet Union. Whereas China with its communist label still intact was and is able to
sail smoothly with the nations of the democratic West, India continues to be at a disadvantage,
proving the point that similarity in the nature of political systems does not necessarily guarantee
success in foreign relations. India is trying to make amends for its “faults” of the past through
a sweeping and dramatic economic turn in its foreign policy content. Will this foreign turn in
economics result also in a real change in the rest of its foreign policy?
Since the advent of the NDA Government in India, there are discernible changes taking place in
Indian foreign policy. Yet one also continues to notice the inflexible and cliché-ridden policies as
in the past.
Nehru’s Idealism and British Legacy as Elements of Indian Foreign Policy
The foreign policy of independent India has been influenced more by Nehru’s idealism and
thinking than by practical ends in the past. The resolutions and declarations of the Congress
leadership in general, and Jawaharlal Nehru in particular, have shaped the contours of Indian
foreign policy. However, the elements of the Indian foreign policy are not totally original. Just
as the Indian Constitution owes several of its essential features to the succeeding proposals
of the British India Government, the current foreign policy, in its various manifestations and
demands, takes its cues from the stated and unstated foreign policy declarations of the British
India government.
Did u know? During the period of British domination, India’s relations with its neighbours
were ultimately determined by the needs of British imperialism.

Territorial Integrity Notes
A Desire to have a grand Indian nation motivated some of the declarations of the Indian National
Congress as regards its foreign policy. For example, whereas in 1885 the Indian National
Congress opposed the annexation of Upper Burma with British India, in late 1920s it opposed
the de-annexation of Burma from British India. By this time the foreign policy ideas of the Indian
National Congress, the vanguard of Indian freedom struggle, looked towards a greater Indian
nationhood.
3.1.9 Religion and Religious Groups
The role of religion in India’s foreign policy cannot be exaggerated. Hindus claim to be the most
tolerant of all religious groups. But this claim has been continuously shattered, resulting in certain
adverse reactions among various nations. Secondly, India has to come to grapple with the fact
that Hinduism is more or less a single nation religion, whereas Islam, Christianity and Buddhism
are religions practiced and encouraged in many and diverse nations. The view the practitioners
of other religions hold regarding Hinduism and Hindus certainly influences the foreign policy
of these nations towards India. India’s insistence on its secular credentials may be appreciated
in the academic circles all over the world, but India continues to be a Hindu-majority nation, a
Hindu nation, in the minds of lay Christians, Muslims, and Buddhists all over the world. The
foreign policy formulations of other nations do not fail to recognize that India is a Hindu nation,
despite India’s claims to the contrary. Not only the fundamentalist turn in Islamic countries but
also the conservative orientations in the Christian West look at the alliance between the New Age
Movements and Hinduism with great suspicion.
Religion and Cultural as Vehicles of Foreign Policy
Culture has been a great tool and strength of India’s foreign policy right from its independence
in 1947. However, this culture policy has never touched the hearts of the ordinary men and
women in other nations. Only a small number of people in the western societies (who could
be extra ordinary people, but without much impact on foreign policy administrators in those
nations) found Indian culture attractive. More often than not, culture was seen closely associated
with religion, and other social systems such as marriage and eating habits, and this association
has brought adverse notices in the minds of the vast majority of people in other nations. India’s
culture policy was aimed at the people of Hindu diaspora on the one hand, and at the academically
oriented and protest minded fringes of other nations, on the other. The policy was successful in
revitalizing the cultural moorings of the diaspora, but it did not derive any benefit from the
latter. Even the traditionally friendly southeast Asian Buddhist nations (a friendship based on an
appreciation of and admiration for the Hindu roots of Buddhism) soon preferred an economic
orientation in their relations. Culture and religion still remain a great possibility, if India could
establish a much better image for its internal affairs and economic capability. It is often forgotten
that Hinduism and Buddhism are two distinct religions and that the Buddhist masses in the
Buddhist nations may look at the Hindus and Hinduism entirely from a different angle.
Notes Culture has been a great tool and strength of India’s foreign policy right from
its independence in 1947.
Task Determine the approximate of languages spoken and studied in India.

Notes 3.1.10 Language and Linguistic Groups
The domestic language policy of India is geared towards a progressive shrinking of the use
of English, a great beneficial legacy left by the British. In tandem with its religion and culture
postures, the Indian foreign policy tried to promote the study of Indian languages abroad. This
was a direct emulation of the British, French, German and Soviet policies. Once again there
was some success, but this success was limited to the fringes of Western societies. On the other
hand, the domestic language policy in support of a national language has been incorporated
as an element of India’s foreign policy in its attempt to include Hindi as one of the UN official
languages, and to strengthen the ethnic identity of the Indian diaspora.
Again and again, India exhibits a burning desire to seek acceptance and recognition as a great
power, but its claims are expressed through weak and misplaced instruments. The ancient
nature of a civilization, expressed through continuity in religion, culture and language, does not
bestow upon any nation great power. Past achievements are no guarantee for the future status
of preeminence. And yet India can still exploit the growing desire among ordinary Indians to
learn and master English to its advantage in the free market world. Thus the role of language in
its foreign policy is not diminished, but it needs to be carefully worked out, especially with the
changes towards a free market economy.
Linguistic Groups
Religion provides the best insight into a society’s behavior and helps answer the question why
people behave rather than how they behave.
A survey in the early 1980s revealed the following religious groupings (see Table 3.1).
Table 3.1: Religious Groupings
Groups Million
Animism 300
Buddhism 280
Christianity 1500
Hinduism 600
Islam 800
Shinto 120
Religion can affect marketing in a number of ways:

1. Religious holidays - Ramadan cannot get access to consumers as shops are closed.
2. Consumption patterns - fish for Catholics on Friday;
3. Economic role of women – Islam;
4. Caste systems - difficulty in getting to different costs for segmentation/niche marketing;
5. Joint and extended families - Hinduism and organizational structures;
6. Institution of the church - Iran and its effect on advertising, “Western” images;
7. Market segments - Malaysia - Malay, Chinese and Indian cultures making market
segmentation;
8. Sensitivity is needed to be alert to religious differences.

Notes
!
Caution Though India is all set to welcome and utilise the power of English language since a
longtime. It had not taken a set back in promoting the study of Indian languages abroad.
3.1.11 Attitudes and Values
Values often have a religious foundation, and attitudes relate to economic activities. It is essential
to ascertain attitudes towards marketing activities which lead to wealth or material gain, for
example, in Buddhist society these may not be relevant.
Also “change” may not be needed, or even wanted, and it may be better to relate products to
traditional values rather than just new ones. Many African societies are risk averse, therefore,
entrepreneurialism may not always be relevant. Attitudes are always precursors of human
behaviour and so it is essential that research is done carefully on these.
Self Assessment
Fill in the blanks:

8. The word culture, derived from the Latin color, with its root meaning ................... .
9. Material culture refers to tools, artifacts and ................... .
10. ................... refer to the ideas in a culture concerning beauty and good taste as expressed
in the arts – music, art, drama and dancing and the particular appreciation of colour and
form.
11. ................... often have a religious foundation, and attitudes relate to economic activities.
12. The role of religion in India’s foreign policy cannot be ................... .
13. ................... claim to be the most tolerant of all religious groups.
14. ................... has been a great tool and strength of India’s foreign policy right from its
independence in 1947.
15. The domestic language policy of India is geared towards a progressive shrinking of the use
of ................... .
3.1.12 Socio-cultural Factors and International Marketing
Multinational corporations operate in different host countries around the world and, in doing
so, they have to deal with a wide variety of political, economic, geographical, technological
and marketing situations. Moreover, each host country has its own society and culture which is
different in many important ways from almost every other society or culture, although there are
some commonalities. Though society and culture do not appear to be a part of marketing situations,
yet they are actually key elements in showing how marketing activities will be conducted, what
goods will be produced, and through what means they will be sold to establishing industrial and
management patterns and determining the success or failure of a local subsidiary or affiliate.
Society and culture influence every aspect of overseas business of an MNC and successful MNC
operations – whether it is marketing, finance, production, or personnel – have to be acutely aware
of the predominant attitudes, feelings and opinions in the local environment. Differences in
values and attitudes between the management and the parent offices and expatriate managers at
the subsidiary or affiliate level and local managers and employees can lead to serious operational
and functional problems, which arise not because there are individual problems, but because of
the important differences between societies and cultures. Society and culture often mould general

Notes attitudes towards fundamentals of life such as time, money, productivity and achievement, all of
which can differ widely across countries and lead to situations of differing expectations between
the management in the home office and local employees of subsidiaries and affiliates.
While some socio-cultural differences are obvious, others are relatively subtle, though equally
important. It is often difficult for an international manager to catch on these subtle differences if
he or she has not lived or worked in cultures other than that of the home country.
MNCs have realised, sometimes through costly blunders, that socio-cultural factors are vital
ingredients that make up the overall business environment and that it is essential to appreciate
these differences and how they influence the business before an attempt is made to set up an
operation in a host country.
Notes Society and culture influence every aspect of overseas business of an MNC
and successful MNC operations – whether it is marketing, finance, production, or person-
nel – have to be acutely aware of the predominant attitudes, feelings and opinions in the
local environment.

Case Study Seventh Heaven
I
f there is one thing William H. Pinckney, Managing Director and CEO, Amway India,
has mastered during his seven year stay in India, it’s the art of breaking the coconut
in one go. He has had enough practice at the opening of every new branch office and
during the annual Diwali puja in office, which is an Indian tradition followed religiously
at Amway.
From wearing a kurta pyjama, to eating local food, Pinckney has taken to India and things
Indian. Even his office has shades of Indian influences, including a bronze Ganesh statue.
“My wife and I had always talked about an adventure and to us, India was the ultimate
adventure,” says Pinckney.
The Pinckney affair with 1ndia started in late 1997, when Amway sent them for a typical
look-see, to decide whether they could contemplate living here for some two-odd years.
They spent a week in Delhi just ‘getting a feel for living in the capital city’. “Before I came
here, I had heard a lot of stories, and none of them were good.” What didn’t help matters,
was the number of vaccinations he had to take before coming to India. “I had never had
as many shots in my life before,” says the only expatriate on the rolls of ` 600-crore Indian
operations of Amway.
Cleanliness and health were two issues; the Pinckney’s were concerned about. But, to their
immense relief, it turned out to be far better. “We have not taken any malaria pills in the last
five years.” People were the first thing Pinckney noticed on his arrival to India. “In Sydney,
you don’t find people on the roads, just outside the city. Here, they are everywhere.”
What has impressed him most about Indians, is the level of education, dedication and
commitment, which he says, is ‘the best and the highest in the world’.
Professionally, the HR aspect of working in India has been most interesting, ‘a learning
curve’ for him. “Coming out of the West, one was used to giving direct feedback. But in
India, you have to be very careful about that. Constructive criticism has to be applied very
carefully.”
Contd...

Another interesting observation he made, was regarding performance appraisal. “People Notes
here equate hard work with high performance. Just because you spent as many hours, it
does not make you a high achiever.” Pinckney himself works almost every Saturday, if he
is in town and dislikes taking work home to his lovely house, in the plush Sainik Farms
locality, in the outskirts of Delhi. While both husband and wife tend to stay in more, dining
out with friends is one of the few entertainment options available in India. He has got more
Indian friends than expats, mostly people he met through business, like Kanwar Bhutani
of Tupperware.
Both, however, try to find time to play golf at the ITC Golf Course in Gurgaon. It’s a game
Mrs. Pinckney took up in India, since she found free time on her hands, for the first time
in her life. A certified chartered accountant, Mrs. Pinckney used to run her own business
in Australia. Some of that time has been used to learn to cook typical Indian food, butter
chicken, aloo palak, rogan josh and dal makhani. It’s no wonder then that half their meals
are Indian. They’ve adjusted to the spice factor in Indian food. What was hot when they
first came is nothing compared to hot today. “When we travel abroad, we really miss the
spices.”
After all this time in India, they still find it striking that irrespective of which part of the
country they are in, there’s a positive spirit about the people of India. People have hope,
optimism and are generally happy. The respect Indians have for their culture and beliefs is
another factor that the Pinckney’s appreciate.
“Family ties are much stronger here, as is, respect for elders and their wisdom for instance,
girls in our office who talk and dress in a Western way, have no problems accepting
arranged marriages”, says Pinckney.
Pinckney’s gave a grand Indian reception after their daughter’s Australian wedding,
including traditional attire for the bride and groom. “Yet another occasion to break a
coconut, Mr. Pinckney?” we wonder.
Questions
1. How could William H. Pinckney acculturate himself in India?
2. What lessons can Pinckney convey to similar expatriates?
3.2 Summary
zz Culture is a complex whole that includes knowledge beliefs, art, morals, law, customs and
other capabilities acquired by people as members of society.
zz Values and norms are the central components of a culture. Values are abstract ideals about
what a society beliefs to be good, right and desirable. Norms are social rules and guide
lines that prescribe appropriate behavior in particular situations.
zz Values and norms are influenced by political and economical philosophy, social structure,
religion, language and education.
zz The social structure of a society refers to a basic social organization. Two main dimensions
along with social structures defer are the individual – group dimension and the stratification
dimension.
zz In some societies the individual is the basic building block of social organization. These
societies emphasize individual achievements above all else. In other societies the group is
a building block of social organizations. These societies emphasize group membership and
group achievements above all else.

Notes zz All societies are stratified into different classes. Class conscious societies are characterized
by low social mobility and high degree of stratification. Less class conscious societies are
characterized by high social mobility and low degree of stratification.
zz Religion may be defined as a system of shared beliefs and rituals that is concerned with
the realm of the scared. Ethical systems refers to a set of moral principals or values that are
used to guide and shape behaviour. The world’s major religions are Christianity, Islam,
Hinduism and Buddhism.
zz Language is one defining characteristic of a culture. It has both the spoken and an unspoken
dimension.
zz Formal education the medium through which the individual learns skills and are socialized
into the values and the norms of a society. Education plays an important role in the
determination of national competitive advantage.
zz Geert Hofstede studied how culture relates to values in the work place. Hofstede
summarized four dimensions – power distance, uncertainty avoidance, individualism
versus collectivism and masculinity versus femininity.
zz Culture is not a constant; it evolves over time. Economic progress and globalization seem
to be two important engines of cultural change.
zz To develop cross-cultural literacy, international businesses need to employ host-country
nationals, build a cadre of cosmopolitan executives, and guard against the dangers of
ethnocentric behaviour.
zz The value systems and norms of a country can affect the costs of doing business in that
country.
zz Although many ethical principles are universal, some are culturally bounded. What is not
ethical in one country might be common in another. International business need to adhere
to a consistent set of ethics derived from a high moral code.
3.3 Keywords
Class Consciousness: A tendency for individuals to perceive themselves in terms of their class
background.
Class System: A system of social stratification in which social status is determined by the family
into which a person is born and by subsequent socio-economic achievements. Mobility between
classes is possible.
Collectivism: An emphasis on collective goals as opposed to individual goals.
Confucian Dynamism is an acceptance of the legitimacy of hierarchy and the valuing of
perseverance and thrift, all without undue emphasis on tradition and social obligations which
could impede business initiative.
Cross-cultural Literacy: Understanding how the culture of a country affects the way business is
practiced.
Culture: The complex whole that includes knowledge, belief, art, morals, law, custom, and other
capabilities acquired by a person as a member of society.
Human Heartedness: Openhearted patience, courtesy and kindness.
Individualism: An emphasis on the importance of guaranteeing individual freedom and
self-expression.
Integration: Degree of tolerance, harmony and friendship a society endorses, at the expense of
competitiveness: it has a “broadly integrative, socially stabilizing emphasis”.

3.4 Review Questions Notes
1. Describe the main elements of culture.

2. List the major approaches to the study of culture and show their relevance in international
marketing citing examples.
3. How does Hofstede’s approach to cultural differences aid the international marketer? Do
you think his approach is reasonable and valid?
4. What is the relation between socio-cultural factors and international marketing?
5. How are culture, society and the nation state interrelated?
6. Write a short note on the determinants of culture.
7. Explain the role of language and culture in India’s foreign policy.
8. “Language is one of the defining characteristic of a culture.” Comment.
9. Describe ‘in brief’ the composition and conditions of home demand.
10. Write a short note on religion and religious groups.
Answers: Self Assessment
1. True 2. False
3. False 4. False
5. True 6. True
7. True 8. to cultivate
9. technology 10. Aesthetics
11. Values 12. Exaggerated
13. Hindus 14. Culture
15. English
Books C.B. Gupta, Business Environment.

Francis Cherunillam, Global Business Environment.
M. Kapagam, Environmental Economics.
Philip R. Cateora, International Marketing.
Online links www.prenhall.com/behindthebook/0131738607/.../Ch.%205%20revised.pdf

faculty.tamucc.edu/.../Ch%203-5%20Internatioanl%20 Cultural%20
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Sr. No. Topics

Unit 1: International Business An Overview 1

Unit 2: Theories of International Trade 21

Unit 3: Cultural and Social Environment 46

Unit 4: Technological Environment 62

Unit 5: Political and Economic Environment 70

Unit 6: Modes of Entering International Business 91

Unit 7: Foreign Direct Investment 119

Unit 8; World Trade Organization 147

Unit 9: International Financial Institutions-I 176

Unit 10: International Financial Institutions-II 195

Unit 11: Basics of International Marketing 209

Unit 12: Basics of International HRM 224

Unit 13: Basics of International Accounting and Financial Management 240

Unit 14: International Production and Logistics Management 257

Unit 15: Global Strategic Management and Business Ethics 282

unit 1: international Business: an overview notes

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1.1 Evolution of International Business

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zz 19th Century: Broader concept of the integration of economies and societies

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Notes zz 1947: Establishment of GATT (General Agreement on Trade and Tariffs)

1.2 Drivers of Globalization

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Notes (d) Growth of global networks making countries interdependent in particular

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1.3 Influences of International Business

Growth of Overseas Markets

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Sales and Profit Notes

Inflation and Price Moderation

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Notes Standards of Living

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Self Assessment Notes

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1.4 Stages of Internationalization

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Figure 1.1: The Usual Patterns of Internationalization

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Normally the following stages of internationalization can be followed as:

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Characteristics of a Transnational Company

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1.5 Differences between Domestic and International Business

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Task Expenses an transport will be higher international trader or domestic trader.

1.6 International Business Approaches

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1.7 Advantages of International Business

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Match the following:

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1.10 Review Questions