International Business Management

5. GENERAL AGREEMENTS ON TARIFFS AND TRADE

In the 18th and 19th century, almost all nations and nation-states believed that
protectionism is a must for the well-being of domestic economies. However, with passing
time, this idea started to change. The idea of liberalizations and thereby abolishment of
protectionist measures peaked in the middle half of the 20th century. The epitome of
liberalism took the first palpable shape as GATT, which was later replaced by the WTO.

General Agreements on Tariffs and Trade

General Agreement on Tariffs and Trade (GATT) includes some multilateral trade
agreements formed to abolish the quotas and reduce various tariffs among the
participating nations. GATT was formed by 23 countries signing the agreement at Geneva,
in 1947. It was aimed to offer an interim arrangement which could be replaced by a United
Nations agency soon.

GATT played a hero’s role in expanding the world trade in the latter half of the 20th
century. 125 nations had already become signatories to GATT when it was replaced by the
WTO in 1995.

GATT – Major Principles

GATT’s major principle was trade without discrimination. The participating nations
opened the markets impartially to every other member. According to GATT, once a nation
and its largest trade allies had agreed to reduce a tariff, that reduction automatically
became applicable to all other GATT members.

 GATT preferred protection through tariffs and by leveraging on it, GATT

systematically tried to eliminate the import quotas or other quantitative trade
restrictions.

 GATT also had homogenous customs regulations and the obligation of the
participating nations in negotiating for tariff reductions on any other nation’s
request.

 The escape clause was also in place for contracting nations to modify the
agreements when their domestic producers suffered excessive losses due to the
trade concessions.

Role of GATT in Promoting International Trade

GATT’s role was instrumental in the following aspects:

 GATT formulated standards to direct the contracting nations to take part in

international trade. As mentioned above, GATT stipulated some basic principles for
the contracting parties.

 GATT cut tariffs for the mutual benefit of an accelerated trade liberalization. There
was a palpable reduction, about 35% on average, in both Kennedy and Tokyo
Rounds.
15
 International Business Management

 GATT brought discrimination in tariff down to promote reducing other trade

barriers. GATT had regulated that the participating nations cannot increase tariffs
at will.

 GATT, in its progressive days, tried to protect the desires of the developing
countries in terms of international trade. It established some special measures,
including the tariff protection for select industries. GATT made sure that the
developing countries got a preferential treatment.

Finally, GATT was the “court of international trade.” Settling the disputes between two or
more parties was one of its primary objectives. GATT had become a legal guardian of
nations for settling trade disputes.

16
 International Business Management
6. WORLD TRADE ORGANIZATION

The World Trade Organization (WTO) is the single global international organization dealing
with the rules related to international trade. WTO’s agreements are negotiated and signed
by a majority of prominent trading nations. The agreements are ratified in the parliaments
of the contracting countries.

Reasons behind the Formation of WTO

On 1st January, 1995, the World Trade Organization replaced GATT. The reasons for GATT
being replaced by the WTO are the following.

 GATT was only a provisional arrangement. It lacked the qualities of an international

covenant, and it could not ensure the enforcement mechanisms. GATT could do
nothing in case of a bilateral trade-agreement failure. There were rules set for
enforcement by GATT, but there was no mechanism for its application.

 GATT’s jurisdiction was applicable only to product-transactions. Due to

globalization, services and technologies became a major part of international
investments and trade.

 Limitations and restriction on dispute settlement systems of GATT also made it

vulnerable to challenges. GATT required a fully positive consensus in the GATT
Council to propose the dispute to the panel. Many countries often objected in
dispute settlement cases related to discrimination.

 Moreover, GATT’s rules were not sufficiently strict and their execution was very
hard to practice. Many participating parties tried to bend the rules of GATT in their
self-interests, and GATT could not verify and inspect these issues.

 Finally, there were some influences of powerful nations in some historical

multilateral rounds. Starting from the Geneva Round till the Uruguay Round,
national sovereignty was present in the multilateral negotiation rounds.

The WTO was a natural demand of the times for a holistic development of economies.

17
 International Business Management

Role of WTO in Promoting International Trade

WTO promotes business liberalization and economic globalization. It has implemented a
substantial decline in tariff levels.

WTO members experienced an average of 40% decline in tariff rate. Agriculture industry
and textile trade expansions, security enhancement, anti-dumping and countervailing,
dispute-free investment and trade in services and intellectual properties have been the
most significant achievements of the WTO.

WTO STATISTICS

In 1999, tariff rate in developed countries dropped from 6.3% to 3.9%. Imported duty-
free manufactured goods increased from 20% to 43%, and tariffs on imported
manufactured goods reduced to 5% on average.

WTO plays a major role in promoting peace among the countries. WTO lets international
trade and investment to run smoothly. Countries also get a constructive and fair institution
for dealing with disputes over trade issues due to the presence of the WTO.

The WTO also plays a role in decreasing the cost of living. Protectionism increases the cost
of the goods. WTO lowers the trade barriers via negotiation and through its non-
discrimination policy.

Role of Developing Countries

Developing countries usually don’t have the muscle to negotiate in the international
markets and they need to follow the developed countries’ terms. WTO’s Most favored
Nation (MFN) principle, which allows market liberalization, helps the developing nation to
trade and prosper. Besides, it also supports the multilateral framework for rules and
agreement.

18
 International Business Management

Developing countries benefit from the intellectual property rules of WTO. Trade-Related
Aspects of Intellectual Property Rights (TRIPS) agreement offers a suitable policy
framework that helps to promote technology transfer and FDI flow to developing nations.

There are some preferential treatments available for the developing countries too.
Generalized System of Preferences (GSP) enables non-reciprocal preferential
treatment by developed countries.

WTO offers flexibility to developing countries to implement their TRIPS obligation,

especially those that are adopted in the Uruguay round. It helps in holistic improvement
of developing nations.

19
 International Business Management
7. GLOBAL TRADE – MAJOR CHALLENGES

Global trade and investment or broadly, globalization, is a common market condition for
all countries of the world now. However, it is not free from challenges. To be specific, there
are seven major challenges to global trade and investment the world is facing now.

Economic Warfare
Globalization has a tough challenge against polarization and conflicting issues. The world
is experiencing increased conflicts, major economic powers are seizing influence, financial
sanctions are being used as a weapon, and the Internet is breaking into pieces. Therefore,
the international flow of money, information, products and services may slow down.

Geo-politicization
Globalization is a kind of Americanization. The United States is still a dominating economy
and the hallmark of the international financial system. Moreover, information age is
promoting the democratization of information. It is paving the way for demanding more
information and the autocrats now need to care more about public opinion. The
developments of developing countries are making them more or less like America.

State Capitalism
The United States was a strong nation in the last quarter of the century. But now, state
capitalism in a modern form is gripping many nations. This is creating new segments in
the markets and destroying the uniformity expected from globalization. Now, there is
nothing predominantly American or about globalization itself.

Lack of Leadership
Globalization will continue rapidly, but the U.S led world order is getting diminished. An
inconsistent, war-ridden United States lacks the will and ability to provide global
leadership. Moreover, no other country is interested in taking its place. The West is having
its own problems, and allies are only interested in hedging their bets. Therefore, there is
no clear and definite way for globalization to progress and it is getting distorted.

Power Distribution
China, Russia, Turkey, India, and some other emerging nations are getting powerful
enough to dismantle the US led theory of globalization. But they lack synchronization and
influence. Their values and interests are not compatible. So, a regionalized world is
emerging. Americanization and globalization are neither believed to be one and the same
now nor is it preached by these power-seeking nations.

Weaker Underdogs
The regional economic powerhouses are getting more room to operate in today’s world.
Russia is intruding in its backyard, Germany is experiencing firm control over Euro zone,
and China is rapidly rising in the Asia-Pacific. These major countries are trying to

20
 International Business Management

consolidate power without caring for the smaller countries near them. It is a kind of
‘hollowing of the peripherals’ that is accelerating.

Price Fluctuations of Natural Resources

The oil monopoly is deteriorating and many clashes and terrorist incidents are tearing the
world apart. In such turmoil, the very essence of globalization is somehow getting blurred.
These time-sensitive challenges are being faced by all international and huge global
companies. While the problems don’t seem to end soon, the global companies now have
the choice to exercise their power in a global scale. They may or may not adapt to the new
trend, but their superiority and powers have definitely got a boost due to the
predominantly geopolitical crises.

21
 International Business Management
8. IB – MODERN THEORIES

There are many theories and concepts associated with international trade. When
companies want to go international, these theories and concepts can guide them to be
careful and prepared.

There are four major modern theories of international trade. To have a brief idea, please
read on.

The Heckscher and Ohlin Model

The Heckscher–Ohlin theory deals with two countries’ trade goods and services with each
other, in reference with their difference of resources. This model tells us that the
comparative advantage is actually influenced by relative abundance of production factors.
That is, the comparative advantage is dependent on the interaction between the resources
the countries have.

Moreover, this model also shows that comparative advantage also depends on production
technology (that influences relative intensity). Production technology is the process by
which various production factors are being utilized during the production cycle.

The Heckscher–Ohlin theory tells that trade offers the opportunity to each country to
specialize. A country will export the product which is most suitable to produce in exchange
for other products that are less suitable to produce. Trade benefits both the countries
involved in the exchange.

The differences and fluctuations in relative prices of products have a strong effect on the
relative income gained from the different resources. International trade also affects the
distribution of incomes.

The Samuelson and Jones Model

According to Samuelson–Jones Model, the two major reasons for which trade influences
the income distribution are as follows:

 Resources are non-transferable immediately and without incurring costs from one
industry to another.

 Industries use different factors. The change in the production portfolio of a country
will reduce the demand for some of the production factors. For other factors, it will
increase it.

There are three factors in this model: Labor (L), Capital (K), and Territory (T).

Food products are made by using territory (T) and labor (L), while manufactured goods
use capital (K) and labor (L). It is easy to see that labor (L) is a mobile factor and it can
be used in both sectors. Territory and capital are specific factors.

A country with abundant capital and a shortage of land will produce more manufactured
goods than food products, whatever may the price be. A country with territory abundance
will produce more foods.

22
 International Business Management

Other elements being constant, an increase in capital will increase the marginal
productivity from the manufactured sector. Similarly, a rise in territory will increase the
production of food and reduce manufacturing.

During bilateral trade, the countries create an integrated economy where manufactured
goods and food production is equal to the sum of the two countries’ productions. When a
nation does not trade, the production of a product will equal its consumption.

Trade gains are bigger in the export sector and smaller in the competing import sector.

The Krugman and Obsfeld Model

The Krugman–Obsfeld Model is the standard model of trade. It implies two possibilities:

 The presence of the relative global supply curve stemming from the possibilities of
production.

 The relative global demand curve arising due to the different preferences for a
selected product.

The exchange rate is obtained by the intersection between the two curves. An improved
exchange rate – other elements being constant – implies a substantial rise in the welfare
of that country.

The Michael Porter Model

Michael Porter identified four stages of development in the evolution of a country. The
dependent phases are: Factors, Investments, Innovation, and Prosperity.

Porter talked extensively on attributes related to competitive advantages which an

organization can achieve relative to its rivals which consists of Lower Cost and
Differentiation. These advantages derive from factor(s) that permit an organization to
outperform its competition, such as superior market position, skills, or resources.

In Porter's view, the strategic management of businesses should be concerned with

creating and continuing competitive advantages.

23
 International Business Management
9. GLOBAL COMPETETIVENESS

The International Institute for Management Development defines competitiveness as "a

field of economic knowledge which analyzes the facts and policies that shaped the ability
of a nation to create and maintain an environment that sustains more value creation for
its enterprises and more prosperity for its people."

The World Economic Forum defines global competitiveness as "the ability of a country to
achieve sustained high rates of growth in gross domestic product (GDP) per capita."

Factors Affecting Global Competitiveness

Business firms abide by the rules and regulations formed by the government. The
government assumes a very important role in enhancing competitiveness. Governments
must promote trade by reengineering systems and procedures. Governments should be
more responsive, reducing bureaucratic red tape.

 Physical infrastructure plays a critical role in improving the global

competitiveness of a country. This will lead to the smoother movement of people,
products, and services, facilitating faster delivery of goods and services.

 The business environment should be as such that it improves coordination

among public-sector agencies. The best methods include providing support and
incentives for R&D activities, HRD and education, encouraging innovativeness and
creativity, facilitating the improvement of industrial blocks, and productivity
enhancements of SMEs.

 High total factor productivity (TFP) is a boon for economic growth. It shows the
synergy and efficiency of both capital and HR utilization and promotes national
competitiveness.

 Productivity campaigns are important because they promote public-awareness

and provide mechanisms to use the productivity tools and techniques.

 Intensifying R&D activities that contribute to creativity, innovation, and

indigenous technological development is also an important factor.

 Improving the capacities of SMEs to become increasingly productive suppliers

and exporters makes strategic sense.

GLOBAL COMPETITIVENESS INDEX

The Global Competitiveness Reports asses the competitiveness landscape of 144

economies of the world. It provides information about the drivers of their productivity
and prosperity. The Report is the most comprehensive assessment of national
competitiveness worldwide.

To check out its 2014-15 edition, please click here.

24
 International Business Management
10. REGIONAL TRADING BLOCS

What are Regional Trading Blocs?

A regional trading bloc (RTB) is a co-operative union or group of countries within a specific
geographical boundary. RTB protects its member nations within that region from imports
from the non-members. Trading blocs are a special type of economic integration. There
are four types of trading blocs:

 Preferential Trade Area – Preferential Trade Areas (PTAs), the first step towards
making a full-fledged RTB, exist when countries of a particular geographical region
agree to decrease or eliminate tariffs on selected goods and services imported from
other members of the area.

 Free Trade Area – Free Trade Areas (FTAs) are like PTAs but in FTAs, the
participating countries agree to remove or reduce barriers to trade on all goods
coming from the participating members.

 Customs Union – A customs union has no tariff barriers between members, plus
they agree to a common (unified) external tariff against non-members. Effectively,
the members are allowed to negotiate as a single bloc with third parties, including
other trading blocs, or with the WTO.

 Common Market – A ‘common market’ is an exclusive economic integration. The

member countries trade freely all types of economic resources – not just tangible
goods. All barriers to trade in goods, services, capital, and labor are removed in
common markets. In addition to tariffs, non-tariff barriers are also diminished or
removed in common markets.

Regional Trading Blocs – Advantages

The advantages of having a Regional Trading Bloc are as follows:

 Foreign Direct Investment: Foreign direct investment (FDI) surges in TRBs and
it benefits the economies of participating nations.

 Economies of Scale: The larger markets created results in lower costs due to
mass manufacturing of products locally. These markets form economies of scale.

 Competition: Trade blocs bring manufacturers from various economies, resulting

in greater competition. The competition promotes efficiency within firms.

 Trade Effects: As tariffs are removed, the cost of imports goes down. Demand
changes and consumers become the king.

 Market Efficiency: The increased consumption, the changes in demand, and a

greater amount of products result in an efficient market.

25
 International Business Management

Regional Trading Blocs – Disadvantages

The disadvantages of having a Regional Trading Bloc are as follows:

 Regionalism: Trading blocs have bias in favor of their member countries. These
economies establish tariffs and quotas that protect intra-regional trade from
outside forces. Rather than following the World Trade Organization, regional trade
bloc countries participate in regionalism.

 Loss of Sovereignty: A trading bloc, particularly when it becomes a political

union, leads to partial loss of sovereignty of the member nations.

 Concessions: The RTB countries want to let non-member firms gain domestic
market access only after levying taxes. Countries that join a trading bloc needs to
make some concessions.

 Interdependence: The countries of a bloc become interdependent on each other.

A natural disaster, conflict, or revolution in one country may have adverse effect
on the economies of all participants.

26
 International Business Management
11. MAJOR TRADE BLOCS

There are four major trade blocs in current times that have the reputation and will to make
a significant impact on international business process.

ASEAN
Association of Southeast Asian Nations (ASEAN) was established on August 8, 1967, in
Bangkok (Thailand).

 Members: The member states are Brunei Darussalam, Cambodia, Indonesia, Laos,
Malaysia, Myanmar, Philippines, Singapore, Thailand, and Vietnam.

 Goals: The goals of ASEAN are to (a) accelerate economic growth, social progress,
and cultural development in the region and (b) promote regional peace and stability
and adhere to United Nations Charter.

 ASEAN Economic Community (AEC): The AEC is aiming to transform ASEAN

into a single entity and a production powerhouse that is highly competitive and
fully compatible with the global economy.

EU
The European Union (EU) was founded in 1951 by six neighboring states as the European
Coal and Steel Community (ECSC). Over time, it became the European Economic
Community (EEC), then the European Community (EC), and was ultimately transformed
into the European Union (EU). EU is the single regional bloc with the largest number of
member states (28).

 Members: Austria, Belgium, Bulgaria, Croatia, Cyprus, Czech Republic, Denmark,

Estonia, Finland, France, Germany, Greece, Hungary, Ireland, Italy, Latvia,
Lithuania, Luxembourg, Malta, Poland, Portugal, Romania, Slovakia, Slovenia,
Spain, Sweden, The Netherlands, and the United Kingdom.

 Goal of EU: To construct a regional free-trade association of states through the

union of political, economic, and executive connections.

MERCOSUR
Mercado Comun del Cono Sur (MERCOSUR) was established on 26 March 1991 with the
Treaty of Assunción. The major languages spoken in this region are Spanish and
Portugese.

 Members: Argentina, Brazil, Paraguay, Uruguay, and Venezuela. Bolivia is

undergoing the process of becoming a full member. Associate members include
Chile, Colombia, Ecuador, Guyana, Peru, and Suriname. There are associate
members who can do preferential trade but not allowed to have tariff benefits like
the registered members. Mexico has an observer status.

 Goals: Accelerate sustained economic development based on social justice,

environmental protection, and reduction of poverty.
27
 International Business Management

NAFTA
The North American Free Trade Agreement (NAFTA) was signed on 1 January 1994.

 Members: Canada, Mexico, and the United States of America.

 Goals: The goals of NAFTA are to (a) eliminate trade barriers among its member
states, (b) promote an environment for free trade, (c) increase investment
opportunities, and (d) protect intellectual property rights.

28
 International Business Management

Part 3: Strategic Approaches

29
 International Business Management
12. STRATEGIC COMPULSIONS

To survive in the world of cut-throat competition, companies must sell their products in
the global market. It is necessary to come up with new strategies to win more customers.
Effective strategic management requires strategic estimation, planning, application and
review/control.

The path for strategic management is activated by compulsions like modern developments
in the societal and economic theory and the recent changes in the form of business, apart
from the economic context.

Areas of Strategic Compulsions

Here is a list of some compulsions that a global business might have to face:

 E-commerce and Internet Culture – Expansion of internet and information

technology made the business move towards e-commerce. Online shopping /Selling
and Advertising are important issues. These factors compel the businesses to go
modern.

 Hyperactive Competition – Businesses now are hyper-competitive which compel

them to draw a competitive strategy that includes general competitive intelligence
to win the market share.

30
 International Business Management

 Diversification – Uncertainty and operational risks have increased in the current

global markets. Companies now need to protect themselves by diversifying their
products and operations. Businesses now are compelled to focus on more than one
business, or get specialized in one business.

 Active Pressure Groups – Contemporary pressure groups direct businesses to be

more ethical in their operations. Most of the multinationals are now spending a
good deal to address their Corporate Social Responsibility (CSR).

Standardization Vs Differentiation
Standardization and differentiation are the two sides of globalization. By standardization,
we mean to show the global representation, while differentiation looks upon local
competitiveness. The following figure depicts how standardization differs from
differentiation.

Figure: Standardization and Differentiation

Strategic Options
Strategic Options include a set of strategies that helps a company in achieving its
organizational goals. It is important to do a SWOT analysis of the internal environment
and also the external environment to get the a list of possible strategic alternatives.

A business can’t run on gut feeling and hence, strategic options are indispensable tools for
every international business manager. The following diagram shows the very basic options
to choose – whether to go global or act local while improving the business in a holistic
manner.

31
 International Business Management

Figure: Four Ways of Doing Business

Factors that Affect Strategic Options

There are many factors that need to be taken care of while choosing the best possible
strategic options. The most influential ones are the following:

 External Constraints – The survival and prosperity of a business firm is fully

dependent on interaction and communication with the elements that are intrinsic
to the business. It includes the owners, customers, suppliers, competitors,
government, and the stakeholders of the community.

 Intra-organizational Forces – The big decisions of a company are often

influenced by the power-play among various interest groups. The strategic
decision-making processes are no exception. It depends on the strategic choices
made by the lower Management and top notch strategic management people.

 Values and Preferences towards Risk – Values play a very important role, It
has been observed hat the successful managers have a more pragmatic, interactive
and dynamic progressive and achievement seeking values. The risk takers in the
high-growth less-stable markets prefer to be the pioneers or innovators. They seek
an early entry into new, untapped markets.

 Impact of Past Strategies – A strategy made earlier may affect the current
strategy too. Past strategies are the starting point of building up a new strategies

 Time Constraints – There may be deadlines to be met. There may be a period of

commitment, which would require a company to take immediate action.

 Information Constraints – The choice of a strategy depends heavily on the

availability of information. A company can deal with uncertainty and risks

32
 International Business Management

depending on the availability of information at its disposal. Lesser the amount of

information, greater the probability of risks.

 Competitor’s Risk – It is important to weigh the strategic choices the competitors

may have. A competitor who adopts a counter-strategy must be taken into account
by the management. The likelihood of a competitor’s strength to react and its
probable impact will influence the strategic choices.

33