Master of Business Administration – MBA Semester 4-SMU MB0037 – International Busine

ss Management Assignment Set- 1 & Set- 2 3 Credits (60 Marks)

Submitted by : L.V.R.SASTRY Reg No : 510910051
Master of Business Administration – MBA Semester 4 MB0037 – International Business M
anagement Assignment Set- 1
Note: Each question carries 10 Marks. Answer all the questions. Q.1 a. How has l
iberalizing trade helped international business? (6 marks) Sol. The Benefits of
Trade Liberalization Policies that make an economy open to trade and investment
with the rest of the world are needed for sustained economic growth. The evidenc
e on this is clear. No country in recent decades has achieved economic success,
in terms of substantial increases in living standards for its people, without be
ing open to the rest of the world. In contrast, trade opening (along with openin
g to foreign direct investment) has been an important element in the economic su
ccess of East Asia, where the average import tariff has fallen from 30 percent t
o 10 percent over the past 20 years. Opening up their economies to the global ec
onomy has been essential in enabling many developing countries to develop compet
itive advantages in the manufacture of certain products. In these countries, def
ined by the World Bank as the "new globalizers," the number of people in absolut
e poverty declined by over 120 million (14 percent) between 1993 and 1998. There
is considerable evidence that more outward-oriented countries tend consistently
to grow faster than ones that are inward-looking. Indeed, one finding is that t
he benefits of trade liberalization can exceed the costs by more than a factor o
f 10. Countries that have opened their economies in recent years, including Indi
a, Vietnam, and Uganda, have experienced faster growth and more poverty reductio
n. On average, those developing countries that lowered tariffs sharply in the 19
80s grew more quickly in the 1990s than those that did not. Freeing trade freque
ntly benefits the poor especially. Developing countries can ill-afford the large
implicit subsidies, often channeled to narrow privileged interests that trade p
rotection provides. Moreover, the increased growth that results from free trade
itself tends to increase the incomes of the poor in roughly the same proportion
as those of the population as a whole. New jobs are created for unskilled worker
s, raising them into the middle class. Overall, inequality among countries has b
een on the decline since 1990, reflecting more rapid economic growth in developi
ng countries, in part the result of trade liberalization. The potential gains fr
om eliminating remaining trade barriers are considerable. Estimate of the gains
from eliminating all barriers to merchandise trade range from US$250 billion to
US$680 billion per year. About two-thirds of these gains would accrue to industr
ial countries. But the amount accruing to developing countries would still be mo
re than twice the level of aid they currently receive. Moreover, developing coun
tries would gain more from global trade liberalization as a percentage of their
GDP than industrial countries, because their economies are more highly protected
and because they face higher barriers. Although there are benefits from improve
d access to other countries’ markets, countries benefit most from liberalizing the
ir own markets. The main benefits for industrial countries would come from the l
iberalization of their agricultural markets. Developing countries would gain abo
ut equally from liberalization of manufacturing and agriculture. The group of lo
w-income countries, however, would gain most from agricultural liberalization in
industrial countries because of the greater relative importance of agriculture
in their economies.
b. What are the merits and demerits of international trade? (4 marks) Sol. Advan
tages and Disadvantages of International Trade Advantages to consider: • Enhance y
our domestic competitiveness • Increase sales and profits • Gain your global market
share • Reduce dependence on existing markets • Exploit international trade technolo
gy • Extend sales potential of existing products • Stabilize seasonal market fluctua
tions • Enhance potential for expansion of your business • Sell excess production ca
pacity • Maintain cost competitiveness in your domestic market Disadvantages to ke
ep in mind: • You may need to wait for long-term gains • Hire staff to launch intern
ational trading • Modify your product or packaging • Develop new promotional materia
l • Incur added administrative costs • Dedicate personnel for traveling • Wait long fo
r payments • Apply for additional financing • Deal with special licenses and regulat
ions
Q. 2 Discuss the impact of culture on International Business. (10 marks) Sol. Th
e following can be looked as the various aspects of the cultural dichotomies.
Table 2.1: Cultural Dichotomies In this new millennium, few executives can affor
d to turn a blind eye to global business opportunities. Japanese auto-executives
monitor carefully what their European and Korean competitors are up to in getti
ng a bigger slice of the Chinese auto-market. Executives of Hollywood movie stud
ios need to weigh the appeal of an expensive movie in Europe and Asia as much as
in the US before a firm commitment. The globalizing wind has broadened the mind
sets of executives, extended the geographical reach of firms, and nudged interna
tional business (IB) research into some new trajectories. One such new trajector
y is the concern with national culture. Whereas traditional IB research has been
concerned with economic/ legal issues and organizational forms and structures,
the importance of national culture – broadly defined as values, beliefs, norms, an
d behavioural patterns of a national group – has become increasingly important in
the last two decades, largely as a result of the classic work of Hofstede (1980)
. National culture has been shown to impact on major business activities, from c
apital structure (Chui et al., 2002) to group performance (Gibson, 1999). For re
views, see’ Boyacigiller and Adler’ (1991) and ‘Earley and Gibson’ (2002). The purpose o
f this Unit is to provide a state-of-the-art review of several recent advances i
n culture and IB research, with an eye toward productive avenues for future rese
arch. It is not our purpose to be comprehensive; our goal is to spotlight a few
highly promising areas for leapfrogging the field in an increasingly boundary-le
ss business world. We first review the issues surrounding cultural convergence a
nd divergence, and the processes underlying cultural changes. We then examine no
vel constructs for characterizing cultures, and how to enhance the precision of
cultural models by pinpointing when the effects of culture are important. Finall
y, we examine the usefulness of experimental methods, which are rarely employed
in the field of culture and IB. A schematic summary of our coverage is given in
Table 2.1, which suggests that the topics reviewed are loosely related, and that
their juxtaposition in the present paper represents our attempt to highlight th
eir importance rather than their coherence as elements of an integrative framewo
rk. 1 Cultural change, convergence and divergence in an era of partial globaliza
tion An issue of considerable theoretical significance is concerned with cultura
l changes and transformations taking place in different parts of the world. In f
act, since the landmark study of Haire et al. (1966) and the publication of Indu
strialism and Industrial Man by Kerr et al. (1960), researchers have continued t
o search for similarities in culture-specific beliefs and attitudes in various a
spects of work related attitudes and behaviours, consumption patterns, and the l
ike. If cultures of the various locales of the world are indeed converging (e.g.
, Heuer et al., 1999), IBrelated practices would indeed become increasingly simi
lar. Standard, culture-free business practices would eventually emerge, and inef
ficiencies and complexities associated with divergent
beliefs and practices in the past era would disappear. In the following section,
we review the evidence on the issue and conclude that such an outlook pertainin
g to the convergence of various IB practices is overly optimistic. 2 Evolution o
f partial globalization Globalization refers to a ‘growing economic interdependenc
e among countries, as reflected in the increased cross-border flow of three type
s of entities: goods and services, capital, and knowhow’ (Govindarajan and Gupta,
2001, 4). Few spoke of ‘world economy’ 25 years ago, and the prevalent term was ‘inter
national trade’ (Drucker, 1995). However today, international trade has culminated
in the emergence of a global economy, consisting of flows of information, techn
ology, money, and people, and is conducted via government international organiza
tions such as the North American Free Trade Agreement (NAFTA) and the European C
ommunity; global organizations such as the International Organization for Standa
rdization (ISO); multinational companies (MNCs); and cross – border alliances in t
he form of joint ventures, international mergers, and acquisitions. These inter –
relationships have enhanced participation in the world economy, and have become
a key to domestic economic growth and prosperity (Drucker, 1995, 153). Yet, glob
alization is not without its misgivings and discontents (Sassan, 1998). A vivid
image associated with the G8 summits is the fervent protests against globalizati
on in many parts of the world, as shown in television and reported in the popula
r media. Strong opposition to globalization usually originates from developing c
ountries that have been hurt by the destabilizing effects of globalization, but
in recent times we have also seen heated debates in Western economies triggered
by significant loss of professional jobs as a result of off shoring to low – wage
countries. Indeed, workers in manufacturing and farming in advanced economies ar
e becoming increasingly wary of globalization, as their income continues to decl
ine significantly. In parallel to the angry protests against globalization, the
flow of goods, services, and investments across national borders has continued t
o fall after the rapid gains of the 1990s. Furthermore, the creation of regional
trade blocs, such as NAFTA, the European Union, and the Association of Southeas
t Asian Nations, have stimulated discussions about creating other trade zones in
volving countries in South Asia, Africa, and other parts of the world. Although
it is often assumed that countries belonging to the World Trade Organization (WT
O) have embraced globalization, the fact is that the world is only partially glo
balized, at best (Schaeffer, 2003). Many parts of Central Asia and Eastern Europ
e, including the former republics of the Soviet Union, parts of Latin America, A
frica, and parts of South Asia, have been sceptical of globalization (Greider, 1
997). In fact, less than 10% of the world’s population is fully globalized (i.e.,
being active participants in the consumption of global products and services) (S
chaeffer, 2003). Therefore, it is imperative that we analyze the issues of cultu
ral convergence and divergence in this partially globalized world. ‘Universal cult
ure’ often refers to the assumptions, values, and practices of people in the West
and some elites in non-Western cultures. Huntington (1996) suggested that it ori
ginates from the intellectual elites from a selected group of countries who meet
annually in the World Economic Forum in Davos, Switzerland. These individuals a
re highly educated, work with symbols and numbers, are fluent in English, are ex
tensively involved with international commitments, and travel frequently outside
their country. They share the cultural value of individualism, and believe stro
ngly in market economics and political democracy. Although those belonging to th
e Davos group control virtually all of the world’s important international institu
tions, many of the
world’s governments, and a great majority of the world’s economic and military capab
ilities, the cultural values of the Davos group are probably embraced by only a
small fraction of the six billion people of the world. Popular culture, again mo
stly Western European and American in origin, also contributes to a convergence
of consumption patterns and leisure activities around the world. However, the co
nvergence may be superficial, and have only a small influence on fundamental iss
ues such as beliefs, norms, and ideas about how individuals, groups, institution
s, and other important social agencies ought to function. In fact, Huntington (1
996, 58) noted that ‘The essence of Western civilization is the Magna Carta, not t
he Magna Mac. The fact that non-Westerners may bite into the latter has no impli
cations for their accepting the former’. This argument is obvious if we reverse th
e typical situation and put Western Europeans and Americans in the shoes of reci
pients of cultural influence. For instance, while Chinese Kung Fu dominates figh
t scenes in Hollywood movies such as Matrix Reloaded, and Chinese restaurants ab
ound in the West, it seems implausible that Americans and Europeans have espouse
d more Chinese values because of their fondness of Chinese Kung Fu and food. A m
ajor argument against cultural convergence is that traditionalism and modernity
may be unrelated (Smith and Bond, 1998). Strong traditional values, such as grou
p solidarity, interpersonal harmony, paternalism, and feminism, can co-exist wit
h modern values of individual achievement and competition. A case in point is th
e findings that Chinese in Singapore and China indeed endorsed both traditional
and modern values (Chang et al., 2003; Zhang et al., 2003). It is also conceivab
le that, just as we talk about Westernization of cultural values around the worl
d, we may also talk about Easternization of values in response to forces of mode
rnity and consumption values imposed by globalization (Marsella and Choi, 1993).
Although the argument that the world is becoming one culture seems untenable, t
here are some areas that do show signs of convergence. We explore in the followi
ng the roles of several factors that simultaneously cause cultures of the world
to either converge or diverge, in an attempt to identify several productive aven
ues for future research. 3 Role of multiculturalism and cultural identity The br
oad ideological framework of a country, corporation, or situation is the most im
portant determinant of the cultural identity that people develop in a given loca
le (Triandis, 1994). The ‘melting pot’ ideology suggests that each cultural group lo
ses some of its dominant characteristics in order to become the mainstream: this
is assimilation, or what Triandis (1994) calls subtractive multiculturalism. In
contrast, when people from a cultural group add appropriate skills and characte
ristics of other groups, it may be called integration, or additive multicultural
ism. Both of these processes are essential for cultural convergence to proceed.
However, if there is a significant history of conflict between the cultural grou
ps, it is hard to initiate these processes, as in the case of Israelis and Pales
tinians. In general, although there has been some research on the typology of an
imosity against other nations (e.g., Jung et al., 2002), we do not know much abo
ut how emotional antagonism against other cultural groups affects trade patterns
and intercultural cooperation in a business context. The issues of cultural ide
ntity and emotional reactions to other cultural groups in an IB context constitu
te a significant gap in our research effort in this area.
4 Implications of convergence and divergence issues One message is clear: while
convergence in some domains of IB activity is easily noticeable, especially in c
onsumer values and lifestyles, significant divergence of cultures persists. In f
act, Hofstede (2001) asserts that mental programs of people around the world do
not change rapidly, but remain rather consistent over time. His findings indicat
e that cultural shifts are relative as opposed to absolute. Although clusters of
some countries in given geographical locales (e.g., Argentina, Brazil, Chile) m
ight indicate significant culture shifts towards embracing Anglo values, the cha
nges do not diminish the absolute differences between such countries and those o
f the Anglo countries (i.e., US, Canada, UK). Huntington, in his ‘The Clash of Civ
ilizations’ (1996), presents the view that there is indeed a resurgence of non-Wes
tern cultures around the world, which could result in the redistribution of nati
onal power in the conduct of international affairs. The attempt by the Davos gro
up to bring about uniform practices in various aspects of IB and work culture, t
hereby sustaining the forces of globalization, is certainly worthwhile. However,
our analysis suggests that there is no guarantee that such convergence will com
e about easily, or without long periods of resistance. IB scholars need to under
stand that although some countries might exhibit strong tendencies toward cultur
al convergence, as is found in Western countries, there are countries that will
reject globalization, not only because of its adverse economic impacts (Greider,
1997) but also because globalization tends to introduce distortions (in their v
iew) in profound cultural syndromes that characterize their national character.
Furthermore, reactions to globalization may take other forms. Bhagat et al. (200
3) have recently argued that adaptation is another approach that could character
ize the tendencies of some cultures in the face of mounting pressures to globali
ze. Other approaches are rejection, creative synthesis, and innovation (Bhagat e
t al., 2003). These different approaches highlight once again the complex dynami
cs that underlie cultural convergence and divergence in a partially globalized w
orld. Also, in discussing issues of convergence and divergence, it is necessary
to recognize that the shift in values is not always from Western society to othe
rs, but can result in the change of Western cultural values as well. For example
, the emphasis on quality and teamwork in the West is partly a result of the pop
ularity of Japanese management two decades ago. Scholars of IB should recognize
that the issue of convergence and divergence in this era of partial globalizatio
n will remain as a persistent and complex issue whose direction might only be as
sessed on a region-by-region basis. It is also wise to adopt an interdisciplinar
y perspective in understanding the forces that create both convergence and diver
gence of cultures in different parts of the world. For instance, in Understandin
g Globalization, Schaeffer (2003) has provided an insightful discussion of the s
ocial consequences of political, economic and other changes, which have signific
ant implications for IB. The cause-effect relationships of globalization and its
various outcomes, especially the cultural outcomes, are not only characterized
by bi-directional arrows, but are embedded in a complex web of relationships. Ho
w these complex relationships and processes play out on the stage of IB remains
to be uncovered by IB researchers. 5 Processes of cultural changes In the previo
us section, we make the point that, through the process of globalization, cultur
es influence each other and change, but whether or not these changes will bring
about cultural convergence is yet to be seen. In this section, we delineate a ge
neral model that describes and explains the complex processes underlying cultura
l changes. As explained before, IB is both an
agent and a recipient of cultural change, and for international business to flou
rish it is important to understand its complex, reciprocal relationships with cu
ltural change. In line with the view of Hofstede (2001) that culture changes ver
y slowly, culture has been treated as a relatively stable characteristic, reflec
ting a shared knowledge structure that attenuates variability in values, behavio
ral norms, and patterns of behaviours (Erez and Earley, 1993). Cultural stabilit
y helps to reduce ambiguity, and leads to more control over expected behavioural
outcomes (Weick and Quinn, 1999; Leana and Barry, 2000). For instance, most exi
sting models of culture and work behaviour assume cultural stability and emphasi
ze the fit between a given culture and certain managerial and motivational pract
ices (Erez and Earley, 1993). High fit means high adaptation of managerial pract
ices to a given culture and, therefore, high effectiveness. The assumption of cu
ltural stability is valid as long as there are no environmental changes that pre
cipitate adaptation and cultural change. Yet, the end of the 20 th century and t
he beginning of the new millennium have been characterized by turbulent politica
l and economical changes, which instigate cultural changes. In line with this ar
gument, Lewin and Kim (2004), in their comprehensive chapter on adaptation and s
election in strategy and change, distinguished between theories driven by the un
derlying assumption that adaptation is the mechanism to cope with change, and th
eories driven by the underlying assumption of selection and the survival of the
fittest, suggesting that ineffective forms of organization disappear, and new fo
rms emerge. However, although organizational changes as a reaction to environmen
tal changes have been subjected to considerable conceptual analyses, the issue o
f cultural change at the national level has rarely been addressed. There are rel
atively few theories of culture that pertain to the dynamic aspect of culture. O
ne exception is the eco-cultural model by Berry et al. (2002), which views cultu
re as evolving adaptations to ecological and socio-political influences, and vie
ws individual psychological characteristics in a population as adaptive to their
cultural context, as well as to the broader ecological and socio-political infl
uences. Similarly, Kitayama (2002) proposes a system view to understanding the d
ynamic nature of culture, as opposed to the entity view that sees culture as a s
tatic entity. This system view suggests that each person’s psychological processes
are organized through the active effort to coordinate one’s behaviours with the p
ertinent cultural systems of practices and public meanings. Yet, concurrently, m
any aspects of the psychological systems develop rather flexibly as they are att
uned to the surrounding socio-cultural environment, and are likely to be configu
red in different ways across different socio-cultural groups. These adaptive vie
ws of culture are supported by empirical evidence. For example, Van de Vliert et
al. (1999) identified curvilinear relationships between temperature, masculinit
y and domestic political violence across 53 countries. Their findings showed tha
t masculinity and domestic violence are higher in moderately warm countries than
in countries with extreme temperatures. Inglehart and Baker (2000) examined cul
tural change as reflected by changes in basic values in three waves of the World
Values Surveys, which included 65 societies and 75% of the world’s population. Th
eir analysis showed that economic development was associated with shifts away fr
om traditional norms and values toward values that are increasingly rational, to
lerant, trusting, and participatory. However, the data also showed that the broa
d cultural heritage of a society, whether it is Protestant, Roman Catholic, Orth
odox, Confucian, or Communist, leaves an enduring imprint on traditional values
despite the forces of modernization. The process of globalization described befo
re has introduced the most significant change in IB, with its effects filtering
down to the national, organizational, group and individual levels. Reciprocally,
changes at micro-levels of culture, when shared by the members of the society,
culminate into macro level phenomena and change the macro-levels of culture. In
the absence of research models that can shed light on this complex process of cu
ltural change, Erez and Gati (2004) proposed that the general model of multi-lev
el analysis (Klein and Kozlowski, 2000) could be adopted for understanding the d
ynamics of culture and cultural change. 6 The dynamics of culture as a multi-lev
el, multi-layer construct The proposed model consists of two building blocks. On
e is a multi-level approach, viewing culture as a multi-level construct that con
sists of various levels nested within each other from the most macro-level of a
global culture, through national cultures, organizational cultures, group cultur
es, and cultural values that are represented in the self at the individual level
, as portrayed in Figure 2.1. The second is based on Schein’s (1992) model viewing
culture as a multi – layer construct consisting of the most external layer of obs
erved artefacts and behaviours, the deeper level of values, which is testable by
social consensus, and the deepest level of basic assumption, which is invisible
and taken for granted. The present model proposes that culture as a multi – layer
construct exists at all levels – from the global to the individual – and that at ea
ch level change first occurs at the most external layer of behaviour, and then,
when shared by individuals who belong to the same cultural context, it becomes a
shared value that characterizes the aggregated unit (group, organizations, or n
ations). In the model, the most macro-level is that of a global culture being cr
eated by global networks and global institutions that cross national and cultura
l borders. As exemplified by the effort of the Davos group discussed earlier, gl
obal organizational structures need to adopt common rules and procedures in orde
r to have a common ‘language’ for communicating across cultural borders (Kostova, 19
99; Kostova and Roth, 2003; Gupta and Govindarajan, 2000).
Figure 2.1: The dynamic of top-down–bottom-up processes across levels of culture.
Given the dominance of Western MNCs, the values that dominate the global context
are often based on a free market economy, democracy, acceptance and tolerance o
f diversity, respect of freedom of choice, individual rights, and openness to ch
ange (Gupta and Govindarajan, 2000). Below the global level are nested organizat
ions and networks at the national level with their local cultures varying from o
ne nation or network to another. Further down are local organizations, and altho
ugh all of them share some common values of their national culture, they vary in
their local organizational cultures, which are also shaped by the type of indus
try that they represent, the type of ownership, the values of the founders, etc.
Within each organization are sub-units and groups that share the common nationa
l and organizational culture, but that differ from each other in their unit cult
ure on the basis of the differences in their functions (e.g., R&D vs manufacturi
ng), their leaders’ values, and the professional and educational level of their me
mbers. At the bottom of this structure are individuals who through the process o
f socialization acquire the cultural values transmitted to them from higher leve
ls of culture. Individuals who
belong to the same group share the same values that differentiate them from othe
r groups and create a group – level culture through a bottom-up process of aggrega
tion of shared values. For example, employees of an R&D unit are selected into t
he unit because of their creative cognitive style and professional expertise. Th
eir leader also typically facilitates the display of these personal characterist
ics because they are crucial for developing innovative products. Thus, all membe
rs of this unit share similar core values, which differentiate them from other o
rganizational units. Groups that share similar values create the organizational
culture through a process of aggregation, and local organizations that share sim
ilar values create the national culture that is different from other national cu
ltures. Both top-down and bottom-up processes reflect the dynamic nature of cult
ure, and explain how culture at different levels is being shaped and reshaped by
changes that occur at other levels, either above it through top-down processes
or below it through bottom-up processes. Similarly, changes at each level affect
lower levels through a top-down process, and upper levels through a bottom-up p
rocess of aggregation. The changes in national cultures observed by Inglehart an
d Baker (2000) could serve as an example for top-down effects of economic growth
, enhanced by globalization, on a cultural shift from traditional values to mode
rnization. However, in line with Schein (1992), the deep basic assumptions still
reflect the traditional values shaped by the broad cultural heritage of a socie
ty. Global organizations and networks are being formed by having local-level org
anizations join the global arena. That means that there is a continuous reciproc
al process of shaping and reshaping organizations at both levels. For example, m
ultinational companies that operate in the global market develop common rules an
d cultural values that enable them to create a synergy between the various regio
ns, and different parts of the multinational company. These global rules and val
ues filter down to the local organizations that constitute the global company, a
nd, over time, they shape the local organizations. Reciprocally, having local or
ganizations join a global company may introduce changes into the global company
because of its need to function effectively across different cultural boarders.
A study by Erez-Rein et al. (2004) demonstrated how a multinational company that
acquired an Israeli company that develops and produces medical instruments chan
ged the organizational culture of the acquired company. The study identified a c
ultural gap between the two companies, with the Israeli company being higher on
the cultural dimension of innovation and lower on the cultural dimension of atte
ntion to detail and conformity to rules and standards as compared with the acqui
ring company. The latter insisted on sending the Israeli managers to intensive c
ourses in Six – Sigma, which is an advanced method of quality improvement, and a m
anagerial philosophy that encompasses all organizational functions. Upon returni
ng to their company, these managers introduced quality improvement work methods
and procedures to the local company, and caused behavioural changes, followed by
the internalization of quality – oriented values. Thus, a top-down process of tra
ining and education led to changes in work behaviour and work values. Sharing co
mmon behaviours and values by all employees of the local company then shaped the
organizational culture through bottom–up processes. The case of cultural change v
ia international acquisitions demonstrated the two building blocks of our dynami
c model of culture: the multi-level structure explains how a lower-level culture
is being shaped by top-down effects, and that the cultural layer that changes f
irst is the most external layer of behaviour. In the long run, bottom – up process
es of shared behaviours and norms shape the local organizational culture.
7 Factors that facilitate cultural change Culture itself influences the level of
resistance or acceptance of change. Harzing and Hofstede (1996) proposed that c
ertain cultural values facilitate change, whereas others hinder it. The values o
f low power distance, low uncertainty avoidance, and individualism facilitate ch
ange. Change threatens stability, and introduces uncertainty, and resistance to
change will therefore be higher in cultures of high rather than low uncertainty
avoidance (Steensma et al., 2000). Change also threatens the power structure, an
d therefore will be avoided in high power distance cultures. Finally, change bre
aks the existing harmony, which is highly valued in collectivistic cultures, and
therefore will not be easily accepted by collectivists (Levine and Norenzayan,
1999). A recent study by Erez and Gati (2004) examined the effects of three fact
ors on the change process and its outcomes: the cultural value of individualism –
collectivism; the reward structure and its congruence with the underlying cultur
al values; and the degree of ambiguity in the reward structure. The change proce
ss examined was a shift from choosing to work alone to a behavioural choice of w
orking as part of a team, and vice versa. Working alone is more prevalent in ind
ividualistic cultures, whereas working in teams dominates the collectivistic one
s. 8 Understanding when culture matters: increasing the precision of cultural mo
dels Beyond exploring new cultural constructs and the dynamic nature of culture,
we also argue for the importance of examining contingency factors that enhance
or mitigate the effect of national culture. Consider the following scenario. A s
enior human resource manager in a multinational firm is charged with implementin
g an integrative training program in several of the firm’s subsidiaries around the
globe. Over the term of her career, the manager has been educated about differe
nces in national culture and is sensitive to intercultural opportunities and cha
llenges. At the same time, she understands the strategic need to create a unifie
d global program that serves to further integrate the firm’s basic processes, crea
ting efficiencies and synergies across the remote sites. She approaches the impl
ementation with trepidation. A key challenge is to determine whether the program
should be implemented in the same manner in each subsidiary or modified accordi
ng to the local culture at each site. Put another way, in this complex circumsta
nce, does culture matter?
Q.3. a. Explain the brief structure of WTO. (5 marks) Sol. Structure of World Tr
ade Organization (WTO) The WTO’s overriding objective is to help trade flow smooth
ly, freely, fairly and predictably. It does this by: Administering trade agreeme
nts Acting as a forum for trade negotiations Settling trade disputes Reviewing n
ational trade policies Assisting developing countries in trade policy issues, th
rough technical assistance and training programs Cooperating with other internat
ional organizations Structure The WTO has nearly 150 members, accounting for ove
r 97% of world trade. Around 30 others are negotiating membership. Decisions are
made by the entire membership. This is typically by consensus. A majority vote
is also possible but it has never been used in the WTO, and was extremely rare u
nder the WTO’s predecessor, GATT. The WTO’s agreements have been ratified in all mem
bers’ parliaments. The WTO’s top level decision-making body is the Ministerial Confe
rence which meets at least once every two years. Below this is the General Counc
il (normally ambassadors and heads of delegation in Geneva, but sometimes offici
als sent from members’ capitals) which meets several times a year in the Geneva he
adquarters. The General Council also meets as the Trade Policy Review Body and t
he Dispute Settlement Body. At the next level, the Goods Council, Services Counc
il and Intellectual Property (TRIPS) Council report to the General Council. Nume
rous specialized committees, working groups and working parties deal with the in
dividual agreements and other areas such as the environment, development, member
ship applications and regional trade agreements. Secretariat The WTO Secretariat
, based in Geneva, has around 600 staff and is headed by a director-general. Its
annual budget is roughly 160 million Swiss francs. It does not have branch offi
ces outside Geneva. Since decisions are taken by the members themselves, the Sec
retariat does not have the decision-making role that other international bureauc
racies are given with. The Secretariat’s main duties are to supply technical suppo
rt for the various councils and committees and the ministerial conferences, to p
rovide technical assistance for developing countries, to analyze world trade, an
d to explain WTO affairs to the public and media. The Secretariat also provides
some forms of legal assistance in the dispute settlement process and advises gov
ernments wishing to become members of the WTO.
Figure 5.1: Structure of WTO The WTO is ‘member-driven’, with decisions taken by con
sensus among all member governments. The WTO is run by its member governments. A
ll major decisions are made by the membership as a whole, either by ministers (w
ho meet at least once every two years) or by their ambassadors or delegates (who
meet regularly in Geneva). Decisions are normally taken by consensus. In this r
espect, the WTO is different from some other international organizations such as
the World Bank and International Monetary Fund. In the WTO, power is not delega
ted to a board of directors or the organization’s head. When WTO rules impose disc
iplines on countries’ policies, that is the outcome of negotiations among WTO memb
ers, the rules are enforced by the members themselves under agreed procedures th
at they negotiated, including the possibility of trade sanctions. But those sanc
tions are imposed by member countries, and authorized by the membership as a who
le. This is quite different from other agencies whose bureaucracies can, for exa
mple, influence a country’s policy by threatening to withhold credit. Reaching dec
isions by consensus among some 150 members can be difficult. Its main advantage
is that decisions made this way are more acceptable to all members. And despite
the difficulty, some remarkable agreements have been reached. Nevertheless, prop
osals for the creation of a smaller executive body – perhaps like a board of direc
tors each representing different groups of countries – are heard periodically. But
for now, the WTO is a member-driven, consensus-based organization. Highest auth
ority: the Ministerial Conference So, the WTO belongs to its members. The countr
ies make their decisions through various councils and committees, whose membersh
ip consists of all WTO members. Topmost is the ministerial conference which has
to meet at least once every two years. The Ministerial Conference can take decis
ions on all matters under any of the multilateral trade agreements. Second level
: General Council in three guises Day-to-day work in between the ministerial con
ferences is handled by three bodies: The General Council The Dispute Settlement
Body The Trade Policy Review Body
All three are in fact the same – the Agreement Establishing the WTO states they ar
e all the General Council, although they meet under different terms of reference
. Again, all three consist of all WTO members. They report to the Ministerial Co
nference. The General Council acts on behalf of the Ministerial Conference on al
l WTO affairs. It meets as the Dispute Settlement Body and the Trade Policy Revi
ew Body to oversee procedures for settling disputes between members and to analy
ze members’ trade policies. Third level: councils for each broad area of trade, an
d more back to top Three more councils, each handling a different broad area of
trade, report to the General Council: The Council for Trade in Goods (Goods Coun
cil) The Council for Trade in Services (Services Council) The Council for Trade –
Related Aspects of Intellectual Property Rights (TRIPS Council) As their names i
ndicate, the three are responsible for the workings of the WTO agreements dealin
g with their respective areas of trade. Again they consist of all WTO members. T
hese three also have the subsidiary bodies. Six other bodies report to the Gener
al Council. The scope of their coverage is smaller, so they are “committees”. But th
ey still consist of all WTO members. They cover issues such as trade and develop
ment, the environment, regional trading arrangements, and administrative issues.
The Singapore Ministerial Conference in December 1996 decided to create new wor
king groups to look at investment and competition policy, transparency in govern
ment procurement, and trade facilitation. Two more subsidiary bodies dealing wit
h the plural-lateral agreements (which are not signed by all WTO members) keep t
he General Council informed of their activities regularly. Fourth level: down to
the nitty-gritty Each of the higher level councils has subsidiary bodies. The G
oods Council has 11 committees dealing with specific subjects (such as agricultu
re, market access, subsidies, anti-dumping measures and so on). Again, these con
sist of all member countries. Also reporting to the Goods Council is the Textile
s Monitoring Body, which consists of a chairman and 10 members acting in their p
ersonal capacities, and groups dealing with notifications (governments informing
the WTO about current and new policies or measures) and state trading enterpris
es. The Services Council’s subsidiary bodies deal with financial services, domesti
c regulations, GATS rules and specific commitments. At the General Council level
, the Dispute Settlement Body also has two subsidiaries: the dispute settlement “p
anels” of experts appointed to adjudicate on unresolved disputes, and the Appellat
e Body that deals with appeals. Heads of Delegations and other boards: the need
for informality Important breakthroughs are rarely made in formal meetings of th
ese bodies, least of all in the higher level councils. Since decisions are made
by consensus, without voting, informal consultations within the WTO play a vital
role in bringing a vastly diverse membership round to an agreement. One step aw
ay from the formal meetings is informal meetings that still include the full mem
bership, such as those of the Heads of Delegations (HOD). More difficult issues
have to be thrashed out in smaller groups. A common recent practice is for the c
hairperson of a negotiating group to attempt to forge a compromise by holding co
nsultations with delegations individually, in twos or threes, or in groups of 20
– 30 of the most interested delegations. These smaller meetings have to be handle
d sensitively. The key is to ensure that everyone is kept informed about what is
going on (the process must be “transparent”) even if they are not in a
particular consultation or meeting, and that they have an opportunity to partici
pate or provide input (it must be “inclusive”). One term has become controversial, b
ut more among some outside observers than among delegations. The “Green Room” is a p
hrase taken from the informal name of the directorgeneral’s conference room. It is
used to refer to meetings of 20 – 40 delegations, usually at the level of heads o
f delegations. These meetings can take place elsewhere, such as at Ministerial C
onferences, and can be called by the minister chairing the conference as well as
the directorgeneral. Similar smaller group consultations can be organized by th
e chairs of committees negotiating individual subjects, although the term Green
Room is not usually used for these. In the past delegations have sometimes felt
that Green Room meetings could lead to compromises being struck behind their bac
ks. So, extra efforts are made to ensure that the process is handled correctly,
with regular reports back to the full membership. The way countries now negotiat
e has helped somewhat. In order to increase their bargaining power, countries ha
ve formed coalitions. In some subjects such as agriculture virtually all countri
es are members of at least one coalition – and in many cases, several coalitions.
This means that all countries can be represented in the process if the coordinat
ors and other key players are present. The coordinators also take responsibility
for both “transparency” and “inclusiveness” by keeping their coalitions informed and by
taking the positions negotiated within their alliances. In the end, decisions h
ave to be taken by all members and by consensus. The membership as a whole would
resist attempts to impose the will of a small group. No one has been able to fi
nd an alternative way of achieving consensus on difficult issues, because it is
virtually impossible for members to change their positions voluntarily in meetin
gs of the full membership. Market access negotiations also involve small groups,
but for a completely different reason. The final outcome is a multilateral pack
age of individual countries’ commitments, but those commitments are the result of
numerous bilateral, informal bargaining sessions, which depend on individual cou
ntries’ interests. (Examples include the traditional tariff negotiations, and mark
et access talks in services.) So, informal consultations in various forms play a
vital role in allowing consensus to be reached, but they do not appear in organ
ization charts, precisely because they are informal. They are not separate from
the formal meetings, however. They are necessary for making formal decisions in
the councils and committees. Nor are the formal meetings unimportant. They are t
he forums for exchanging views, putting countries’ positions on the record, and ul
timately for confirming decisions. The art of achieving agreement among all WTO
members is to strike an appropriate balance, so that a breakthrough achieved amo
ng only a few countries can be acceptable to the rest of the membership.
b. Highlight the drawbacks of GATT. (5 marks) Sol.
Given its provisional nature and limited field of action, the success of GATT in
promoting and securing the liberalization of much of world trade over 47 years
is incontestable. Continual reductions in tariffs alone helped spur very high ra
tes of world trade growth – around 8 per cent a year on average during the 1950s a
nd 1960s. And the momentum of trade liberalization helped ensure that trade grow
th consistently out-paced production growth throughout the GATT era. The rush of
new members during the Uruguay Round demonstrated that the multilateral trading
system, as then represented by GATT, was recognized as an anchor for developmen
t and an instrument of economic and trade reform.
The limited achievement of the Tokyo Round, outside the tariff reduction results
, was a sign of difficult times to come. GATT’s success in reducing tariffs to suc
h a low level, combined with a series of economic recessions in the 1970s and ea
rly 1980s, drove governments to devise other forms of protection for sectors fac
ing increased overseas competition. High rates of unemployment and constant fact
ory closures led governments in Europe and North America to seek bilateral marke
t-sharing arrangements with competitors and to embark on a subsidies race to mai
ntain their holds on agricultural trade. Both these changes undermined the credi
bility and effectiveness of GATT. Apart from the deterioration in the trade poli
cy environment, it also became apparent by the early 1980s that the General Agre
ement was no longer as relevant to the realities of world trade as it had been i
n the 1940s. For a start, world trade had become far more complex and important
than 40 years before: the globalization of the world economy was underway, inter
national investment was exploding and trade in services – not covered by the rules
of GATT – was of major interest to more and more countries and, at the same time,
closely tied to further increases in world merchandise trade. In other respects
, the GATT had been found wanting: for instance, with respect to agriculture whe
re loopholes in the multilateral system were heavily exploited – and efforts at li
beralizing agricultural trade met with little success – and in the textiles and cl
othing sector where an exception to the normal disciplines of GATT was negotiate
d in the form of the Multi-fibre Arrangement. Even the institutional structure o
f GATT and its dispute settlement system were giving cause for concern. Together
, these and other factors convinced GATT members that a new effort to reinforce
and extend the multilateral system should be attempted. That effort resulted in
the Uruguay Round.
Q.4. a. Give a short note on the regional economic integration. (5 marks) Sol. R
egional Economic Integration Regional integration can take many forms, and nowhe
re is this more evident than in the vastly different integration processes takin
g place in the regions of Europe and East Asia. The subject of this paper is reg
ional integration as it has developed in East Asia with a focus on the drivers o
f that integration. While the paper is not intended as a direct comparison of in
tegration in East Asia and Europe, it will include some comparisons between the
two regions. Integration in East Asia has progressed very slowly and is still in
an early stage despite that the process has continued for decades. In fact, it
could be said that the process began centuries ago – even as far back as the 15th
century. By comparison, European integration has progressed steadily and has gra
dually deepened over the last 50 years to reach an advanced stage today with a c
ommon currency and well-developed regional institutions. Thus, the speed of prog
ression and the level of integration attained in the two regions are quite dissi
milar. In addition to these differences, the drivers behind the integration proc
ess in each region are different. In Europe, the origins of integration have bee
n institutional in nature, and the development of institutions has been prominen
t throughout the process. Thus, regional institutions have been the driving forc
e behind integration in Europe. In East Asia, the development of regional instit
utions has also occurred; however, progress in this area has been slow and the f
ew existing institutions are fairly weak and ineffective. Nevertheless, regional
integration is taking place in East Asia, but the driving force is the market r
ather than policy or institutions. Corporations and the production networks they
have established are driving integration in East Asia. b. Mention the benefits
of WTO. (5 marks) Sol. Ten Benefits of WTO 1. The system helps to keep the peace
2. The system allows disputes to be handled constructively 3. A system based on
rules rather than power makes life easier for all 4. Freer trade cuts the cost
of living 5. It gives consumers more choice and a broader range of qualities to
choose from 6. Trade raises incomes 7. Trade stimulates economic growth and that
can be good news for employment 8. The basic principles make the system economi
cally more efficient, and they cut costs 9. The system shields governments from
narrow interests 10. The system encourages good government
Q. 5 a. Explain five-element product wave model. (7 marks) Sol. The Five-Element
Product Wave As illustrated in Figure 4.5, the wave model employs design engine
ering, process engineering, product marketing, production, and end-of-life activ
ities as elements. The first wave is associated with the "A" version of a produc
t or service, and survives through the traditional PLC introduction and growth p
hases. A second wave begins with the "B" version, the markedly improved second m
odel. It starts just before the traditional life cycle maturity stage and lives
until sales decline to a point at which an EOL decision must be made. Note that
design engineering has a peak of activity level at each upgrade. Process enginee
ring activity shadows that of design engineering, as system changes will be cont
emplated and made to facilitate the changes made in the product or service. Prod
uct marketing also has activity level spikes that closely match engineering desi
gn activity, lagged somewhat for product introduction. Production has one activi
ty peak that results from demand management and production planning through mast
er production scheduling. Finally, the EOL curve peaks at each redesign. The las
t wave begins shortly before original production ceases and ends when the produc
t is no longer manufactured or supported by the EOL Company or division. The EOL
element requires that a decision be made about the preceding version at each ma
jor redesign: continue production, make a short-term run of spares, keep bluepri
nts active so that parts can be made as ordered, enter into a manufacturing and
support agreement with another entity, or discontinue production. For the sake o
f parsimony, Figure 4.5 shows only a two-product model ("A" and "B" versions). I
n reality, there may be hundreds of significant redesigns. The wave effect comes
from the fact that the process repeats for the successful firm, forming swells
in design engineering, process engineering, product marketing, and manufacturing
curves before the final crest at EOL activity. The five-element product wave, o
r FPW, uses trigger points, rather than time, as the horizon over which the elem
ent curves vary. Changes in magnitude, represented by the vertical axis, result
from differing activity levels within the five elements. Simple changes in level
s of dollar or unit product sales, in and of themselves, do not necessarily dete
rmine the trigger points. Rather, the varying activity levels are a direct resul
t of product introductions and redesigns that, from the outset, must take into a
ccount company strategy, core capabilities, and the state of the competitive env
ironment. For example, a product with strong sales may be redesigned in a preemp
tive strike against competitors, further distancing that product from the compet
ition, such as with Caterpillar’s innovative high-drive bulldozers. That the five-
element wave is grounded in reality becomes apparent when considering the recent
research that suggests product introduction cycles are being compressed. Bayus
(1994) claims that knowledge is being applied faster, resulting in increasing le
vels of new product introductions. Yet since product removals are not keeping pa
ce with introductions, there are an increasing number of product variations on t
he market. Slater (1993) observes that product life cycles are growing shorter a
nd shorter. Vesey (1992) reports that the strategy for the 1990s is speed to mar
ket and discusses the pressures the market is exerting to shorten product introd
uction lead times. Regardless of whether life cycles are actually being compress
ed or knowledge is simply being applied faster, it is apparent that firms are in
creasing the speed with which they bring their products to market. The effect of
this is a compression of the design engineering, process
engineering, production, and product marketing elements of the wave model. (The
EOL curve may remain unchanged because accelerated introductions do not necessar
ily affect EOL efforts.) The five-element wave clearly shows the inefficiency of
traditional "over-the-wall" systems as speed to market increases. As the elemen
ts compress, more and more information is thrown over the wall. Recipients find
themselves with less and less time to take action. Taken to the extreme, in-bask
ets, phone lines, conference rooms, desks, and floors are soon gridlocked and li
ttered with unanswered correspondence and things to do. Forget quality; producti
on itself grinds to a halt. The solution is to maximize the advantage of the rel
ationships within the five-element wave and work in concurrent teams, as illustr
ated in Figure 6. That way, responsibility is shared throughout the system. Memb
ers from each discipline optimize the system. The method tears down barriers bet
ween departments and speeds the introduction process, thus decreasing costs. The
focal point becomes the customer, rather than the task. The system is totally i
nteractive and bound together. Each element is connected to all of the others an
d is focused on the customer. (Note that the authors have taken a great deal of
artistic license here! No meaning should be attached to the actual measure of ov
erlap area in Figure 4.6.) What is the recent experience with teams? There is ev
idence that using concurrent design teams speeds the product to market and provi
des substantial savings. Boeing expects that concurrent design will save some $4
billion in the development of its 777 airliner. Westinghouse recently suggested
that concurrent engineering would eliminate 200 duplicate processes in a projec
t that consisted of 600 using traditional over-the-wall approaches. Ford’s Team Ta
urus was able to cut a full year out of model turnaround. In addition, design ch
anges required after initial production began were reduced by some 76 percent. T
he strength of the five-element product wave is the fact that it illuminates cri
tical decision points in the life of a product or service. The interrelationship
s of the elements clearly illustrate the benefit of working product introduction
s, design changes, and end-of-life decisions in teams. This is particularly true
in today’s rapidly compressing environment of speeding products to market. Furthe
rmore, the model is flexible and may be expanded or contracted to include those
functional areas relevant to the production team. Thus, whether a given firm’s pro
duct is a service or a manufactured good, the five-element wave is a powerful to
ol that can be deployed to accelerate effective decision making in markets deman
ding ever-increasing levels of speed and agility.
b. What do you mean by globalization? (3 marks) Sol.
Economic "globalization" is a historical process, the result of human innovation
and technological progress. It refers to the increasing integration of economie
s around the world, particularly through trade and financial flows. The term som
etimes also refers to the movement of people (labor) and knowledge (technology)
across international borders. There are also broader cultural, political and env
ironmental dimensions of globalization that are not covered here. At its most ba
sic, there is nothing mysterious about globalization. The term has come into com
mon usage since the 1980s, reflecting technological advances that have made it e
asier and quicker to complete international transactions – both trade and financia
l flows. It refers to an extension beyond national borders of the same market fo
rces that have operated for centuries at all levels of human economic activity – v
illage markets, urban industries, or financial centers.
Markets promote efficiency through competition and the division of labor – the spe
cialization that allows people and economies to focus on what they do best. Glob
al markets offer greater opportunity for people to tap into more and larger mark
ets around the world. It means that they can have access to more capital flows,
technology, cheaper imports, and larger export markets. But markets do not neces
sarily ensure that the benefits of increased efficiency are shared by all. Count
ries must be prepared to embrace the policies needed, and in the case of the poo
rest countries may need the support of the international community as they do so
.
Q. 6. Give some examples of companies doing international business and discuss h
ow they have they have managed their business in the international markets. (10
marks) Fall 2010 Sol. A PERSPECTIVE OF THE NORTHEN ISLAND SOFTWARE COMPANIES, RA
PD M– UP Within six months of announcing it would invest $4.5 million to establish
its new software development center in Northern Ireland, IMR was up and running
with more than one-third its target staff. "The fast start-up of the Belfast fa
cility reaffirms our confidence to locate in Northern Ireland," said Sanan. "The
success to date in building a quality work force has surpassed our expectations
and opens up new ambitions for our interests in Northern Ireland." According to
Arthur "Bro" McFerran, president of IMR (NI) Ltd., the company is hiring 12 to
18 programmers a month in Northern Ireland and is well on its way to meeting its
staffing goal of 300 by 1999. McFerran credited Northern Ireland’s Training & Emp
loyment Agency (T&EA) with helping place the company’s staffing on the fast track.
"The T&EA not only has helped us to identify and recruit qualified software gra
duates from Northern Ireland’s universities, it is also assisting us with a unique
initiative to bring additional sources of high quality talent to the company,"
McFerran said. Innovation In Training Impressed by the number and quality of inf
ormation technology graduates from the region’s universities, IMR recognized an un
tapped resource in the well-educated, versatile graduates of other fields in Nor
thern Ireland. Working with the T&EA, IMR developed "IMR Academy," an intensive
20-week training program at the Belfast Institute of Further and Higher Educatio
n, to expand the skills of qualified applicants who are not computer software gr
aduates, but who are equally welleducated in other Disciplines and who have demo
nstrated aptitude for learning computer software programming. Tom Scott of the T
&EA said IMR applicants are assessed throughout the program and those who succes
sfully complete the course are awarded a National Computing Certificate and full
-time employment with IMR. Approximately 40 trainees have already participated i
n the program. "IMR is extremely pleased with the T&EAs ability to design and de
liver a training program customized to our needs, and one that is delivering us
an impressive pool of incremental programming talent," McFerran said. Smart And
Available "The recent software investments by IMR and other companies provide a
new opportunity for Northern Ireland’s computer graduates," McFerrin said. Recruit
ment research by IMR indicates that traditionally, nearly half of the region’s com
puter graduates have been forced to seek jobs outside Northern Ireland due to th
e lack of available information technology positions. Now IT graduates have the
chance to find good jobs in Northern Ireland, and graduates from other fields ca
n take advantage of the IMR Academy training program to get a head start on a ca
reer in the growing software sector. McFerrin said. Recruitment research by IMR
indicates that traditionally, nearly half of the region’s computer graduates have
been forced to seek jobs outside Northern Ireland due to the lack of available i
nformation technology positions.
Competitive Advantage Northern Ireland recently has attracted information techno
logy – based investments from other multinational companies such as BT, Fujitsu, L
iberty Mutual Group, Seagate Technology, STB Systems and UniComp. These companie
s cite Northern Ireland’s work force and favorable cost base in their decisions to
locate in the region. "The availability of high-quality graduates combined with
the region’s competitive operating costs and attractive incentives made Northern
Ireland the best possible location for STB," said Richard W. Cooke, STB’s director
of engineering operations. With salaries and fringe costs for well trained soft
ware engineers in Northern Ireland approximately 50 percent lower than costs for
US engineers, and low employee turnover and favorable rates for office space, t
he overall annual per capita operational costs to develop high quality software
can be significantly less compared with these same costs in the United States. T
ypical starting salaries for IT graduates in Northern Ireland are $22,000 to $25
,000 annually. At less than three percent annually, Northern Ireland’s employee tu
rnover rate is a fraction of the rates typically experienced in other parts of E
urope and the United States. Annual costs per square foot for office space, excl
usive of property taxes and service charges, range from as low as $5 per square
foot in some development areas, to approximately $14 in Belfast. These costs can
be as much as 50 percent lower than office space costs in other European cities
.
Master Of Business Administration-MBA Semester 4 MB0037 – International Business M
anagement Assignment Set-2
Note: Each question carries 10 Marks. Answer all the questions. Q.1 Evaluate the
monetary system and currency markets in international business management. (10
marks) Sol. The IMF is an international organization of 185 member countries. It
was established to promote international monetary cooperation, exchange stabili
ty, and orderly exchange arrangements; to foster economic growth and high levels
of employment; and to provide temporary financial assistance to countries to he
lp ease balance of payments adjustment. The International Monetary Fund (IMF) is
the intergovernmental organization that oversees the global financial system by
following the macroeconomic policies of its member countries, in particular tho
se with an impact on exchange rate and the balance of payments. It is an organiz
ation formed with a stated objective of stabilizing international exchange rates
and facilitating development through the enforcement of liberalising economic p
olicies[1][2] on other countries as a condition for loans, restructuring or aid.
[3] It also offers highly leveraged loans, mainly to poorer countries. Its headq
uarters is in Washington, D.C., United States. Organization and purpose IMF "Hea
dquarters 1" in Washington, D.C. The International Monetary Fund was created in
July 1945, originally with 45 members, [4] with

a goal to stabilize exchange rat
es and assist the reconstruction of the world s international payment system. Co
untries contributed to a pool which could be borrowed from, on a temporary basis
, by countries with payment imbalances (Condon, 2007). The IMF was important whe
n it was first created because it helped the world stabilize the economic system
. The IMF works to improve the economies of its member countries.[5] The IMF des
cribes itself as "an organization of 187 countries (as of July 2010), [6][7] wor
king to foster global monetary cooperation, secure financial stability, facilita
te international trade, promote high employment and sustainable economic growth,
and reduce poverty". With the exception of Cuba (left in 1964),[8] Taiwan (expe
lled in 1980),[9] North Korea, Andorra, Monaco, Liechtenstein, Tuvalu and Nauru,
all UN member states participate directly in the IMF. Member states are represe
nted on a 24-member Executive Board (five Executive Directors are appointed by t
he five members with the largest quotas, nineteen Executive Directors are electe


d by the remaining members), and all members appoint a Governor to the IMF s Boa
rd of Governors.[1
Data dissemination systems In 1995, the International Monetary Fund began work o
n data dissemination standards with the view of guiding IMF member countries to
disseminate their economic and financial data to the public. The International M
onetary and Financial Committee (IMFC) endorsed the guidelines for the dissemina
tion standards and they were split into two tiers: The GDDS and the SDDS. The In
ternational Monetary Fund executive board approved the SDDS and GDDS in 1996 and
1997 respectively and subsequent amendments were published in a revised "Guide
to the General Data Dissemination System". The system is aimed primarily at stat
isticians and aims to improve many aspects of statistical systems in a country.
It is also part of the World Bank Millennium Development Goals and Poverty Reduc
tion Strategic Papers.
The IMF established a system and standard to guide members in the dissemination
to the public of their economic and financial data. Currently there are two such
systems: General Data Dissemination System (GDDS) and its superset Special Data
Dissemination System (SDDS), for those member countries having or seeking acces
s to international capital markets. The primary objective of the GDDS is to enco
urage IMF member countries to build a framework to improve data quality and incr
ease statistical capacity building. This will involve the preparation of meta da
ta describing current statistical collection practices and setting improvement p
lans. Upon building a framework, a country can evaluate statistical needs, set p
riorities in improving the timeliness, transparency, reliability and accessibili
ty of financial and economic data.
Q.2 a. Mention the different entry strategies to enter international markets. (4
marks) Sol. Entry Strategies Methods of entry With rare exceptions, products ju
st don’t emerge in foreign markets overnight – a firm has to build up a market over
time. Several strategies, which differ in aggressiveness, risk, and the amount o
f control that the firm is able to maintain, are available: Exporting is a relat
ively low risk strategy in which few investments are made in the new country. A
drawback is that, because the firm makes few if any marketing investments in the
new country, market share may be below potential. Further, the firm, by not ope
rating in the country, learns less about the market (What do consumers really wa
nt? Which kinds of advertising campaigns are most successful? What are the most
effective methods of distribution?) If an importer is willing to do a good job o
f marketing, this arrangement may represent a "win-win" situation, but it may be
more difficult for the firm to enter on its own later if it decides that larger
profits can be made within the country. Licensing and franchising are also low
exposure methods of entry – you allow someone else to use your trademarks and accu
mulated expertise. Your partner puts up the money and assumes the risk. Problems
here involve the fact that you are training a potential competitor and that you
have little control over how the business is operated. For example, American fa
st food restaurants have found that foreign franchisees often fail to maintain A
merican standards of cleanliness. Similarly, a foreign manufacturer may use lowe
r quality ingredients in manufacturing a brand based on premium contents in the
home country. Contract manufacturing involves having someone else manufacture pr
oducts while you take on some of the marketing efforts yourself. This saves inve
stment, but again you may be training a competitor. Direct entry strategies, whe
re the firm either acquires a firm or builds operations "from scratch" involve t
he highest exposure, but also the greatest opportunities for profits. The firm g
ains more knowledge about the local market and maintains greater control, but no
w has a huge investment. In some countries, the government may expropriate asset
s without compensation, so direct investment entails an additional risk. A varia
tion involves a joint venture, where a local firm puts up some of the money and
knowledge about the local market. b. How has E-commerce helped in international
marketing? (6 marks) Sol. Electronic Commerce 1 Prospects for electronic commerc
e Electronic commerce – usually in the form of sales, promotion, or support throug
h the Internet – is a hot topic at the moment, evidenced by the high market capita
lization of firms involved in this kind of business. Growth rates have been cons
iderable over the last two years and are expected to persist, at least to some e
xtent, for at least the next several years. Yet, it should be recognized that so
far, sales over the Internet account for only a small portion of sales – especial
ly outside the U.S. 2 Obstacles to diffusion
Obstacles to the diffusion of Internet trade come both from enduring sources and
temporary roadblocks which may be overcome as consumer attitudes change and tec
hnology is improved. Currently, Internet connections are slower than desired so
that downloading pictures and other information may take longer than consumers a
re willing to wait. "Glitches" in online ordering systems may also frustrate con
sumers, who are unable to place their orders at a given time or have difficulty
navigating through a malfunctioning site. The lack of non-English language sites
in some areas may also be off-putting to consumers, and registering domain name
s in some countries is difficult. Further, shipping small packages across countr
ies may be inefficient due to high local postage rates and inefficiencies in cus
toms processing. Most of these obstacles may be overcome within next few years.
Other obstacles may, however, have considerably greater staying power. First, th
ere are legal problems, as several different countries may seek to impose their
jurisdiction on advertising and laws of product assortment and business practice
s. Further, the maintenance of databases, which are essential to delivering on t
he promises of e-commerce, may conflict with the privacy rules of some countries
– this is currently a hot issue of contention between the United States and the E
uropean Union. Finally, there are issues of taxation and collection. While the C
linton Administration has sought to get the WTO to go along with a three year ta
x "moratorium" on Internet purchases much like the one observed in the U.S., str
ong opposition is expected. A great attraction of e-commerce in Europe is that p
eople may order from other countries and thus evade local sales taxes, which can
be prohibitive (e.g., 25% in Denmark and 16% in Germany). Some firms will ship
to customers in neighbouring countries without collecting sales taxes or duties,
with the responsibility of paying falling on the consumer. Although most consum
ers who order and do not arrange to pay for these taxes get away with it, fines
for those caught through random checks can be severe. 3 Locus of the site Some f
irms have chosen to maintain a global site, with reference only to local sales o
r support offices; others, in contrast, have unique sites for each country. In s
ome cases, global sites will hyperlink surfers to a country or region relevant t
o the site. Note that some confusion exists since many sites outside the U.S. ma
intain the ".com" designation rather than their countries’ respective suffix (e.g.
, ".de" for Germany, ".se" for Sweden, and ".au" for Australia). Some firms have
experienced problems getting their banks to accept credit card charges in more
than one currency, and thus it may be difficult to indicate precise prices in mo
re than one denomination (one site based in Britain offered its American custome
rs to be as accurate as possible, based on current exchange rates, although the
charge could be off "by a few pennies.") 4 Lifecycle stages across the World It
has been suggested that Europe runs some five years behind the U.S. in electroni
c commerce, but some sources dispute this, suggesting that lack of success among
American retailers may have other origins, such as inadequate adaptation (for e
xample, some British users are put off by American English). There are, however,
some factors which cause most countries run behind. Even in Europe, Internet ac
cess penetration rates are lower than they are in the U.S., and the slower speed
associated with downloading Asian characters is discouraging. In some countries
, credit card penetration is lower, and even in European countries with high pen
etration rates, consumers are reluctant to use them. Further, the fact that cons
umers in most countries have to pay a per minute phone charge discourages the es
sential casual and relaxed browsing common in the U.S. so long as unlimited cabl
e or hardwired access is not offered.
Q.3 a. Explain Bill of Lading and Letters of credit. (8 marks) Sol. A bill of la
ding (sometimes referred to as a BOL,or B/L) is a document issued by a carrier t
o a shipper, acknowledging that specified goods have been received on board as c
argo for conveyance to a named place for delivery to the consignee who is usuall
y identified. A thorough bill of lading involves the use of at least two differe
nt modes of transport from road, rail, air, and sea. The term derives from the v
erb "to lade" which means to load a cargo onto a ship or other form of transport
ation. A bill of lading can be used as a traded object. The standard short form
bill of lading is evidence of the contract of carriage of goods and it serves a
number of purposes: • It is evidence that a valid contract of carriage, or a chart
ering contract, exists, and it may incorporate the full terms of the contract be
tween the consignor and the carrier by reference (i.e. the short form simply ref
ers to the main contract as an existing document, whereas the long form of a bil
l of lading (connaissement intégral) issued by the carrier sets out all the terms
of the contract of carriage); • It is a receipt signed by the carrier confirming w
hether goods matching the contract description have been received in good condit
ion (a bill will be described as clean if the goods have been received on board
in apparent good condition and stowed ready for transport); and • It is also a doc
ument of transfer, being freely transferable but not a negotiable instrument in
the legal sense, i.e. it governs all the legal aspects of physical carriage, and
, like a cheque or other negotiable instrument, it may be endorsed affecting own
ership of the goods actually being carried. This matches everyday experience in
that the contract a person might make with a commercial carrier like FedEx for m
ostly airway parcels, is separate from any contract for the sale of the goods to
be carried; however, it binds the carrier to its terms, irrespectively of who t
he actual holder of the B/L, and owner of the goods, may be at a specific moment
. • A standard, commercial letter of credit is a document issued mostly by a finan
cial institution, used primarily in trade finance, which usually provides an irr
evocable payment undertaking. • The letter of credit can also be source of payment
for a transaction, meaning that redeeming the letter of credit will pay an expo
rter. Letters of credit are used primarily in international trade transactions o
f significant value, for deals between a supplier in one country and a customer
in another. They are also used in the land development process to ensure that ap
proved public facilities (streets, sidewalks, storm water ponds, etc.) will be b
uilt. The parties to a letter of credit are usually a beneficiary who is to rece
ive the money, the issuing bank of whom the applicant is a client, and the advis
ing bank of whom the beneficiary is a client. Almost all letters of credit are i
rrevocable, i.e., cannot be amended or canceled without prior agreement of the b
eneficiary, the issuing bank and the confirming bank, if any. In executing a tra


nsaction, letters of credit incorporate functions common to giros and Traveler s
cheques. Typically, the documents a beneficiary has to present in order to rece
ive payment include a commercial invoice, bill of lading, and documents proving
the shipment was insured against loss or damage in transit. However, the list an
d form of documents is open to imagination and negotiation
and might contain requirements to present documents issued by a neutral third pa
rty evidencing the quality of the goods shipped, or their place of origin. b. Wh
at is UNCITRAL and what it does? (2 marks) Sol. The United Nations Commission on
International Trade Law (UNCITRAL) was established by the United Nations Genera
l Assembly by its Resolution 2205 (XXI) of 17 December 1966 "to promote the prog
ressive harmonization and unification of international trade law. When world tra
de began to expand dramatically in the 1960s, national governments began to real
ize the need for a global set of standards and rules to harmonize national and r
egional regulations, which until then governed
Q.4. Explain the importance of STP in international markets. (10 marks) Sol. The
importance of STP Segmentation is the cornerstone of marketing – almost all marke
ting efforts in some way relate to decisions on who to serve or how to implement
positioning through the different parts of the marketing mix. For example, one’s
distribution strategy should consider where one’s target market is most likely to
buy the product, and a promotional strategy should consider the target’s media hab
its and which kinds of messages will be most persuasive. Although it is often te
mpting, when observing large markets, to try to be "all things to all people," t
his is a dangerous strategy because the firm may lose its distinctive appeal to
its chosen segments. In terms of the "big picture," members of a segment should
generally be as similar as possible to each other on a relevant dimension (e.g.,
preference for quality vs. low price) and as different as possible from members
of other segments. That is, members should respond in similar ways to various t
reatments (such as discounts or high service) so that common campaigns can be ai
med at segment members, but in order to justify a different treatment of other s
egments, their members should have their own unique response behaviour.
Q. 5 a. Write a short note on branding and trademarks. (6 marks) Sol. Branding a
nd trademarks As mentioned in chapter four, it is difficult to protect a tradema
rk or brand, unless all countries are members of a convention. Brand "piracy" is
widespread in many developing countries. Other aspects of branding include the
promotional aspects. A family brand of products under the Zeneca (ex ICI) label
or Sterling Health are likely to be recognised worldwide, and hence enhance the
"subjective" product characteristics. Warranty Many large value agricultural pro
ducts like machinery require warranties. Unfortunately not everyone upholds them
. It is common practice in Africa that if the original equipment has not been bo
ught through an authorized dealer in the country, that dealer refuses to honour
the warranty. This is unfortunate, because not only may the equipment have been
legitimately bought overseas; it also actually builds up consumer resistance to
the dealer. When the consumer is eventually offered with a choice, the reticent
dealer will suffer, for example, with the new dealers coming up. Cotton Producti
on/Marketing Interface Spinners Machines are highly flexible, that is they can u
sually switch to a variety of yarn requirements. The machines are geared to high
production, are automated and are of a precision for constant quality provision
. There are strict process controls and built – in quality control. Poor raw mater
ial, especially when contaminated with metal particles, damages opening mills, g
rid knives, fans and card clothing. Previous devices employed to remove these (m
agnets) are becoming less effective. The consequences are damage in the blow roo
m and carding and danger of fire. Quality is therefore defined as properties of
the end use (clothing etc.), efficiency of weaving and knitting and the efficien
t running of the spinning plant. Spinners require raw cotton which is free of tr
ash; dust, sugar and honey dew contamination, seed coats, bark and foreign fibre
s and, will not nep the cloth. Further requirements are a certain length (could
be short, medium or long), uniformity of length, strength, fineness, maturity an
d a certain elongation and colour. Suppliers In order to meet these high quality
demands, the growers have to ensure that the production, picking and ginning is
of a very high standard. Cotton grading The Liverpool Cotton exchange, for one,
relied on the skills of its experts to manually classify raw fibre purchases fo
r its clients. It still holds the "standards" for length, colour and trash conte
nt. As well as the demands of modem machinery, the lack of standardised measurin
g and cotton classification procedures has resulted in commercial conflict and l
egal disputes about the true nature of traded cotton. Now, computer based high v
olume instrument listing systems of raw cotton (HVI systems) are available. The
system can handle large numbers of bales, reduce variation in classification and
the need for highly trained bate classifiers. For cotton exporters the system o
ffers the following advantages: enhanced objectivity in classification improve c
ommunication if similar systems are used by sellers or buyers reduced conflict a
nd need for arbitration
 enhanced competitiveness against synthetic fibres improved integration with mode
rn spinning machines reduced costs on training of experts and in measuring time.
The system can process 2000 bales per day and give a printout on the seven para
meters of grading. These include length and length uniformity, strength and elon
gation, micronaire or fineness, leaf and colour. Manufacturers include SPINLAR I
NC. of Knoxville, USA. Service In agricultural machinery, processing equipment a
nd other items which are of substantial value and technology, service is a prere
quisite. In selling to many developing countries, manufacturers have found their
negotiations at stake due to the poor back-up service. Often, this is no fault
of the agent, distributor or dealer in the foreign country, but due to exchange
regulations, which make obtaining spare parts difficult. Many organisations atte
mpt to get around this by insisting that a Third World buyer purchases a percent
age of parts on order with the original items. Allied to this problem is the poo
r quality of service due to insufficient training. Good original equipment manuf
acturers will insist on training and updating as part of the agency agreement. I
n order to illustrate the above points, cotton can be used as an example. Cotton
is a major foreign exchange earner for Zimbabwe. In 1990/91, 52,000 tons were s
old overseas at a value of Zim $ 238 million. As the spinners, particularly thos
e in the export market are in a highly competitive industry, it is essential tha
t the raw material is as clean as possible. Also today’s spinning equipment is hig
hly technical and the spinner wishes to avoid costly breakdowns by all means. Pr
oduct strategies There are five major product strategies in international market
ing. Product communications extension This strategy is very low cost and merely
takes the same product and communication strategy into other markets. However it
can be risky if misjudgements are made. For example, CPC International believed
the US consumer would take to dry soups, which dominate the European market. It
did not work. Extended product – communications adaptation If the product basical
ly fits the different needs or segments of a market it may need an adjustment in
marketing communications only. Again this is a low cost strategy, but different
product functions have to be identified and a suitable communications mix devel
oped. Product adaptation – communications extension The product is adapted to fit
usage conditions but the communication stays the same. The assumption is that th
e product will serve the same function in foreign markets under different usage
conditions. Product adaptation – communications adaptation Both product and commun
ication strategies need attention to fit the peculiar need of the market. Produc
t invention This needs a totally new idea to fit the exclusive conditions of the
market. This is very much a strategy which could be ideal in a Third World situ
ation. The development costs may be high, but the advantages are also very high.
Table 9.2 summarizes the strategic alternatives with examples. The choice of st
rategy will depend on the most appropriate product/market analysis and is a func
tion of the product itself defined in terms of the function or need it serves, t
he market defined in terms of the conditions under which the product is used, th
e preferences of the
potential customers and the ability to buy the product in question, and the cost
s of adaptation and manufacture to the company considering these product – communi
cations approaches. Table 9.2 International strategic alternatives Product Commu
nications Product/ Conditions Examples strategy strategy functions of product Me
t use 1. Extension Extension Same Same Pepsi 2. Extension Adaptation Different S
ame Soups 3. Adaptation Extension Same Different Agriculture chemicals 4. Adapta
tion Adaptation Different Different Farm implements 5. Invention New Same – Tyson
turbine water pump Thailand tuna b. What are the features of exchange and curren
cy markets? (4 marks) Sol. The exchange rate regimes adopted by countries in tod
ay’s international monetary and financial system, and the system itself, are profo
undly different from those envisaged at the 1944 meeting at Bretton Woods establ
ishing the IMF and the World Bank. In the Bretton Woods system: exchange rates w
ere fixed but adjustable. This system aimed both to avoid the undue volatility t
hought to characterize floating exchange rates and to prevent competitive deprec
iations, while permitting enough flexibility to adjust to fundamental disequilib
rium under international supervision; private capital flows were expected to pla
y only a limited role in financing payments imbalances, and widespread use of co
ntrols would prevent instability in such flows; temporary official financing of
payments imbalances, mainly through the IMF, would smooth the adjustment process
and avoid unduly sharp correction of current account imbalances, with their rep
ercussions on trade flows, output, and employment. In the current system, exchan
ge rates among the major currencies (principally the U.S. dollar, the euro, and
Japanese yen) fluctuate in response to market forces, with short-run volatility
and occasional large medium-run swings (Figure 1). Some medium-sized industrial
countries also have market – determined floating rate regimes, while others have a
dopted harder pegs, including some European countries outside the euro area. Dev
eloping and transition economies have a wide variety of exchange rate arrangemen
ts, with a tendency for many but by no means all countries to move toward increa
sed exchange rate flexibility (Figure 2). This variety of exchange rate regimes
exists in an environment with the following characteristics: partly for efficien
cy reasons, and also because of the limited effectiveness of capital controls, i
ndustrial countries have generally abandoned such controls and emerging market e
conomies have gradually moved away from them. The growth of international capita
l flows and globalization of financial markets has also been spurred by the revo
lution in telecommunications and information technology, which has dramatically
lowered transaction costs in financial
markets and further promoted the liberalization and deregulation of internationa
l financial transactions; international private capital flows finance substantia
l current account imbalances, but the changes in these flows appear also sometim
es to be a cause of macroeconomic disturbances or an important channel through w
hich they are transmitted to the international system; developing and transition
countries have been increasingly drawn into the integrating world economy, in t
erms of both their trade in goods and services and of financial transactions. Le
ssons from the recent crises in emerging markets are that for such countries wit
h important linkages to global capital markets, the requirements for sustaining
pegged exchange rate regimes have become more demanding as a result of the incre
ased mobility of capital. Therefore, regimes that allow substantial exchange rat
e flexibility are probably desirable unless the exchange rate is firmly fixed th
rough a currency board, unification with another currency, or the adoption of an
other currency as the domestic currency (dollarization). Flexible exchange rates
among the major industrial country currencies seem likely to remain a key featu
re of the system. The launch of the euro in January 1999 marked a new phase in t
he evolution of the system, but the European Central Bank has a clear mandate to
focus monetary policy on the domestic objective of price stability rather than
on the exchange rate. Many medium-sized industrial countries, and developing and
transition economies, in an environment of increasing capital market integratio
n, may also continue to maintain market-determined floating rates, although more
countries could may adopt harder pegs over the longer term. Thus, prospects are
that: exchange rates among the euro, the yen, and the dollar are likely to cont
inue to exhibit volatility, and schemes to reduce volatility are neither likely
to be adopted, nor to be desirable as they prevent monetary policy from being de
voted consistently to domestic stabilization objectives; several of the transiti
on countries of central and eastern Europe, especially those preparing for membe
rship in the European Union, are likely to seek to establish over time the polic
y disciplines and institutional structures required to make possible the eventua
l adoption of the euro. The approach taken by the IMF continues to be to advise
member countries on the implications of adopting different exchange rate regimes
, to consider the choice of regime to be a matter for each country to decide and
to provide policy advice that is consistent with the maintenance of the chosen
regime (Box 3).
Q. 6 Discuss the various International product and pricing decisions. (10 marks)
Sol. Production decisions In decisions on producing or providing products and s
ervices in the international market it is essential that the production of the p
roduct or service is well planned and coordinated, both within and with other fu
nctional area of the firm, particularly marketing. For example, in horticulture,
it is essential that any supplier or any of his "out grower" (sub-contractor) c
an supply what he says he can. This is especially vital when contracts for suppl
y are finalized, as failure to supply could incur large penalties. The main elem
ents to consider are the production process itself, specifications, culture, the
physical product, packaging, labelling, branding, warranty and service. Interna
tional Pricing In New Open-Economy Models Recent developments in open-economy ma
croeconomics have progressed under the paradigm of nominal price rigidities, whe
re monetary disturbances are the main source of fluctuations. Following developm
ents in closed-economy models, new open-economy models have combined price rigid
ities and market imperfections in a fully micro founded inter-temporal general e
quilibrium setup. This framework has been used extensively to study the properti
es of the international transmission of shocks, as well as the welfare implicati
ons of alternative monetary and exchange rate policies. Imperfect competition is
a key feature of the new open-economy framework. Because agents have some degre
e of monopoly power instead of being price takers, this framework allows the exp
licit analysis of pricing decisions. The two polar cases for pricing decisions a
re producercurrency pricing and local-currency pricing. The first case is the tr
aditional approach, which assumes that prices are preset in the currency of the
seller. In this case, prices of imported goods change proportionally with unexpe
cted changes in the nominal exchange rate, and the law of one price always holds
.’ In contrast, under the assumption of local-currency pricing, prices are preset
in the buyer’s currency. Here, unexpected movements in the nominal exchange rate d
o not affect the price of imported goods and lead to short-run deviations from t
he law of one price. Empirical evidence using disaggregated data suggests that i
nternational markets for tradable goods remain highly segmented and that deviati
ons in the law of one price are large, persistent, and highly correlated with mo
vements in the nominal exchange rate, even for highly tradable goods. Moreover,
there is strong evidence that the large and persistent movements that characteri
ze the behaviour of real exchange rates at the aggregate level are largely accou
nted for by deviations in the law of one price for tradable goods. In this artic
le I make use of a simplified version of a two-country model where the two marke
ts are segmented, allowing firms to price discriminate across countries, and whe
re prices are preset in the consumer’s currency. This model generates movements in
the real exchange rate in response to unexpected monetary shocks, which are a r
esult of the failure of the law of one price for tradable goods. I then compare
this model to a version in which prices are preset in the producer’s currency and
examine the implications of these two alternative price-setting regimes for seve
ral key issues. The price-setting regime determines the currency of denomination
of imported goods and the extent to which changes in exchange rates affect the
relative price of imported to domestic goods and the international allocation of
goods in the short run. That is, different pricing regimes imply
different roles for the exchange rate in the international transmission of monet
ary disturbances. As we shall see, this assumption has very striking implication
s for several important questions, namely real exchange rate variability, the li
nkage between macroeconomic volatility and international trade, and the welfare
effects of alternative exchange rate regimes, among others. While generating dev
iations from the law of one price that are absent from models assuming producer-
currency pricing, the assumption of local-currency pricing still leaves importan
t features of the data unexplained. The key role of this assumption in the prope
rties of openeconomy models suggests that it is necessary to keep exploring the
implications of alternative pricing structures in open-economy models. In Sectio
n 1, I review the empirical evidence on the behaviour of real exchange rates and
on international market segmentation and pricing. In Section 2, I present the m
odel with localcurrency pricing and explore the main implications of this pricin
g assumption. The final section concludes. 1 Some Evidence on Real Exchange Rate
s I first review some empirical evidence on the behaviour of real exchange rates
using aggregate data. I then turn to a review of the evidence on the sources of
movements in real exchange rates. The real exchange rate between two countries
represents the relative cost of a common reference basket of goods. For two coun
tries, say the United States and Japan, the real exchange rate is given by where
P^sub US^ and P^sub JP^ represent the American and Japanese price levels (measu
red in terms of dollars and yen, respectively) and where e denotes the nominal e
xchange rate (defined as the dollar price of one yen). The theory of purchasing
power parity (PPP) predicts that real exchange rates should equal one, or at lea
st show a strong tendency to quickly return to one when they differ from this va
lue. The fundamental building block of PPP is the law of one price: due to arbit
rage in goods markets, and absent barriers to trade, similar products should sel
l in different countries for the same price (when converted in the same currency
). Large international price differentials would be only temporary, as profit-ma
ximizing traders would quickly drive international goods prices back in line. Th
erefore, if arbitrage in goods markets ensures that the law of one price holds f
or a sufficiently broad range of individual goods, then aggregate price levels (
when expressed in a common currency) should be highly correlated across countrie
s. Because aggregate prices are reported as indices rather than levels, most emp
irical work has tested the weaker hypothesis of relative PPP, which requires onl
y that the real exchange rate be stable over time. Figure 1 show the log changes
in the CPI-based dollar-yen real and nominal exchange rates and the relative pr
ice level. In this figure, which is typical for countries with floating exchange
rates and moderate inflation, it clearly stands out that short-run deviations f
rom PPP are large and volatile.(Delete) In the short run, movements in the real
exchange rate mimic those in the nominal exchange rate, with no offsetting movem
ents in the relative price level. Not surprisingly, early empirical work based o
n simple tests of short-run PPP produced strong rejections of this hypothesis fo
r moderate inflation countries. However; these studies did not allow for any dyn
amics of adjustment to PPP and therefore did not address the validity of PPP as
a medium- or long-run proposition. The conventional explanation for the failure
of short-run PPP is the presence of nominal price rigidities. If the short-term
volatility of nominal exchange rates were due mostly to monetary and financial d
isturbances, then nominal price stickiness would translate these disturbances in
to short-run fluctuations in the real exchange rate. If this were true, however,
we should observe a
substantial convergence to PPP in one to two years, as the adjustment of prices
and wages takes place. Purchasing power parity, therefore, would be re-establish
ed in the medium to long run. An extensive body of empirical literature has test
ed the hypothesis of long run PPP by looking at the mean-reverting properties of
real exchange rates. As is well known, it has proved rather difficult to find e
vidence supporting convergence of real exchange rates to PPP even in the long ru
n. Earlier empirical studies, which used only post-Bretton Woods data, found it
difficult to reject the hypothesis that bilateral real exchange rates for indust
rialized countries follow a random walk under floating exchange rates. But if PP
P deviations are very persistent, then it may be difficult to distinguish empiri
cally between a random walk model and a slow mean-reversion model for the real e
xchange rate, especially when this variable is highly volatile. As shown in Fran
kel (1986), the post-Bretton Woods period may simply be too short to reliably re
ject the random walk hypothesis. To overcome this problem of low power in tests
of the random walk hypothesis, Frankel used an extended data set (annual data fo
r the dollar-pound exchange rates from 1869 to 1984) and rejected the random wal
k model in favour of a mean-reverting model for the real exchange rate. His poin
t estimate for the rate of decay of real exchange rate deviations was 14 percent
per year, which implies a half-life of PPP deviations of 4.6 years. Other studi
es that test convergence to PPP using long-horizon data sets tend to find values
for the half-life of PPP deviations between three to five years. An alternative
way to increase the power of unit root tests is to expand the number of countri
es in the sample and to perform panel tests of convergence to PPP. Frankel and R
ose (1996), for example, use a panel set of annual data from 1948 to 1992 for 15
0 countries. They estimate halflives for PPP deviations of about four years. Oth
er studies using panel data sets report similar estimates. Interestingly, these
estimates are also similar to those obtained using long-time series data sets. I
n brief, studies using aggregate data provide strong evidence that deviations fr
om PPP are highly volatile and persistent. Consensus estimates suggest that the
speed of convergence to PPP is roughly 15 percent per year, implying a half-life
of PPP deviations of about four years. As we shall see next, a look at disaggre
gated data will provide us with a much richer analysis of the sources of PPP dev
iations. The Law of One Price: Market Segmentation and International Pricing As
I pointed out earlier, the idea underlying PPP is that the law of one price hold
s for a wide range of individual goods. It has long been recognized, however, th
at even for highly tradable goods and at different levels of aggregation, deviat
ions in the law of one price are large, persistent, and highly correlated with m
ovements in the nominal exchange rate. One possible explanation for the failure
of the law of one price is that international markets are segmented by physical
distance, like different markets within a country. Engel and Rogers (1996), howe
ver, show that both the distance and the physical border between countries are s
ignificant in explaining the variation in prices of similar goods across differe
nt U.S. and Canadian cities. They find that price dispersion is much higher for
two cities located in different countries than for two equidistant cities in the
same country. In fact, the effect of the border is estimated to be equivalent t
o a distance of 1780 miles between cities within one country. Engel and Rogers a
lso show that nominal price stickiness accounts for a large portion of the borde
r effect, suggesting that prices are sticky in the local currency and that chang
es in the exchange rate lead to deviations in the law of one price.
Not only are failures of the law of one priced significant but, as recent eviden
ce suggests, they also play a dominant role in explaining the behaviour of real
exchange rates. Engel (1999) measures the proportion of U.S. real exchange rate
movements that can be accounted for by movements in the relative prices of non-t
raded goods. Engel decomposes the CPI real exchange rate into two components: a
weighted difference of the relative price of non-traded to tradedgoods prices in
each country, and the relative price of traded goods between the countries. If
tradable, as a category, closely followed the law of one price, then all variabi
lity in the real exchange rate would be explained by movements in the first comp
onent. However, Engel finds that movements in the relative price of non-traded g
oods appear to account for almost none of the movement in U.S. real exchange rat
es, even at long time horizons. Instead, nearly all the variability can be attri
buted to movements in the relative price of tradable. This finding strongly sugg
ests that consumer markets for tradable goods are highly segmented international
ly and that movements in the international relative price of consumer tradable a
re very persistent. Moreover, given the high volatility of nominal exchange rate
s, these findings indicate that consumer prices of most goods (either imported o
r domestically produced) seem to be sticky in domestic currency terms. An altern
ative approach to studying the relationship between exchange rates and goods pri
ces is examining how firms in an industry (or country) pass through changes in e
xchange rates to export prices. Knetter (1989, 1993) measures the degree of pric
e discrimination across export destinations that is associated with exchange rat
e changes for U.S., U.K., German, and Japanese industry-level data. He finds tha
t the amount of exchange rate pass-through differs considerably depending on the
country and industry. Goldberg and Knetter (1997) provide an extensive survey o
f the literature and find that local currency prices of foreign products do not
respond fully to exchange rate changes. While the response varies by industry, o
n average exchange rate passthrough to U.S. import prices is only about 50 perce
nt after one year, mainly reflecting changes in destination-specific markups on
exports. In brief, there is strong evidence that international markets for trada
ble goods remain highly segmented and that deviations from PPP are largely accou
nted for by movements in the relative price of tradable goods across countries.
At the consumer level, exchange rate pass-through to import prices is virtually
zero (suggesting that consumer prices are sticky in domestic currency). At the p
roducer level, however, exchange rate pass-through is generally positive, but su
bstantially below one. Transaction Costs and the Adjustment of PPP and Law of On
e Price Deviations Some recent empirical tests of long-run PPP and the law of on
e price have abandoned the conventional framework, which assumes a linear autore
gressive process for the price differential. Instead, these studies have started
to look into nonlinear models of price adjustment, where the speed at which pri
ce differentials die out depends on the size of the deviation itself. This alter
native framework for the empirical analysis of price differentials is motivated
by the observation that commodity trade is not costless. Persistent deviations f
rom the law of one price are implied as an equilibrium feature of models with tr
ansaction costs, for deviations will be left uncorrected as long as they are suf
ficiently small relative to the shipping cost. The simplest econometric model th
at implements the notion of a nonlinear adjustment for price differentials assum
es that the process is well described by a random walk for small deviations (tha
t is, when deviations are within a "band of inaction") and an autoregressive pro
cess for large deviations (that is, when deviations are outside the band). Taylo
r (2001) shows that the improper use of linear models when the true model is non
linear may produce a large bias towards finding a
low speed of convergence. Intuitively, a linear model will fail to support conve
rgence to PPP if the true model is nonlinear and the process spends most of the
time in the random-walk band. Using both monthly data from the 1920s and annual
data spanning two centuries, Michael, Nobay, and Peel (1997) reject the linear a
djustment model in favour of a nonlinear model and provide strong evidence of me
an-reverting behaviour for PPP deviations for every exchange rate considered. 2
International Pricing in New Open-Economy Macroeconomic Models The common starti
ng point for most of the recent research in open-economy models with price rigid
ities is the model developed in Obstfeld and Rogoff (1995). This model explores
the international monetary transmission mechanism in a general equilibrium setup
characterized by nominal price rigidities, imperfect competition, and incomplet
e asset markets. Obstfeld and Rogoff’s model does not generate deviations from the
CPI– based purchasing power parity. This feature reflects the fact that preferenc
es are identical across countries and that all goods are freely tradable, with p
rices set in the seller’s currency. In this model, there is complete pass-through
of exchange rate changes to import prices, implying that the law of one price al
ways holds for all goods and that the real exchange rate is constant. Motivated
by the empirical evidence on the sources of real exchange rate fluctuations, sev
eral recent papers have extended Obstfeld and Rogoff’s framework in order to allow
for pricing-tomarket and deviations from the law of one price. This class of mo
dels assumes that home and foreign markets are segmented, which allows imperfect
ly competitive firms to price discriminate between home and foreign consumers. C
onsumers’ inability to arbitrage price differentials between countries is exogenou
s, possibly reflecting arbitrarily high transportation costs at the consumer lev
el. In addition to market segmentation, this class of models also assumes that p
rices are sticky in each country’s local currency. That is, firms set prices in ad
vance in the buyer’s currency, as opposed to the standard assumption that prices a
re set in the seller’s currency. I, next outline a basic model in which firms set
prices in advance in the local currency of the buyer (or pricing-to-market). The
model is then used to explore the main implications of pricingto-market.