CHAPTER 4: ETHICAL BEHAVIOR AND ITS IMPORTANCE IN INTERNATIONAL BUSINESS

Ethical behavior is essential for successful business in today’s global marketplace. Ethical behavior is
about doing the right things for the company, the employees, the community, the government, and the
natural environment. It requires companies to act in ways that all stakeholders consider honest and fair.

COMPONENTS OF ETHICAL BEHAVIOR

Global business leaders define ethical behavior in terms of four key components:

1. Ethics are moral principles and values that govern the behavior of people, firms, and governments,
regarding right and wrong.
2. Corporate social responsibility (CSR) refers to operating a business in a manner that meets or exceeds
the ethical, legal, and commercial expectations of customers, shareholders, employees, and the
communities where the firm does business.
3. Sustainability means meeting humanity’s needs today without harming the ability of future
generations to meet their needs.
4. Corporate governance is the system of procedures and processes by which corporations are managed,
directed, and controlled. Corporate governance provides the means through which the organization’s
directors and managers undertake ethical behavior, corporate social responsibility, and sustainability.

VALUE OF ETHICAL BEHAVIOR

1. It is simply the right thing to do.

2. It is often prescribed within laws and regulations. Violating laws and regulations has obvious legal
consequences.
3. Customers, governments, and the news media demand ethical behavior. Firms that commit ethical
blunders attract unwanted attention from opinion leaders.
4. Ethical behavior is good business, leading to enhanced corporate image and selling prospects. The firm
with a reputation for high ethical standards gains advantages in hiring, motivating employees, partnering,
and dealing with foreign governments. Firms that behave unethically run the risk of criminal or civil
prosecution, damage to their own reputations, harm to employee morale and recruitment efforts, and
exposure to blackmailers or other unscrupulous parties. For all these reasons, companies need to
incorporate ethical considerations into their international activities.

Examples of Unethical Behavior

Firms may:
1. Falsify or misrepresent contracts or financial statements.
2. Pay or accept bribes, kickbacks, or inappropriate gifts.
3. Tolerate sweatshop conditions or otherwise abuse employees.
4. Undertake false advertising and other deceptive marketing practices.
5. Engage in pricing that is deceptive, discriminatory, or predatory.
6. Deceive or abuse intermediaries in international channels.
7. Engage in activities that harm the natural environment.

Relativism and Normativism

Relativism is the belief that ethical truths are not absolute but differ from group to group. According to
this perspective, a good rule is, “when in Rome, do as the Romans do”. Thus, a Japanese multinational
firm adhering to the position that bribery is wrong might nevertheless pay bribes in countries where the
practice is customary and culturally acceptable. Relativists opt for passive acceptance of the values,
behaviors, and practices that prevail in each of the countries where they do business.
Normativism is the belief that ethical behavioral standards are universal, and firms and individuals should
seek to uphold them consistently around the world. According to this view, managers of the Japanese
multinational firm who believe bribery is wrong will enforce this standard everywhere in the world.

ETHICAL CHALLENGES IN INTERNATIONAL BUSINESS

Companies encounter ethical challenges in a range of international activities. Ethical challenges include
corruption, bribery, unethical management practices, harmful global sourcing, illicit products and
marketing, and intellectual property infringement.

Corruption is an extreme form of unethical behavior. It is the practice of obtaining power, personal gain,
or influence through illegitimate means and usually occurs at others’ expense. Corruption influences our
political, social, and economic environments. It diminishes trust in public institutions, undermines the rule
of law, and challenges democratic principles. It stunts economic development by discouraging foreign
direct investment and hurts small businesses that lack the means to pay up.

How is corruption encountered in international business? Mainly in the following ways:

1. Bribery occurs when a person offers or gives another person a gift, cash, or favor to act dishonestly in
exchange for personal gain.
2. Embezzlement is the theft or misuse of funds typically placed in one’s care or belonging to one’s
employer.
3. Fraud involves wrongfully deceiving a person or other party to give up assets or cash.
4. Extortion and blackmail involve threats of harm against another person or party unless payment is
received or some other demand is met. Threats can include physical harm, false imprisonment, exposure
of an individual’s secrets or past, or other harmful outcomes.
5. Money laundering is the concealment of the origins of funds obtained through illegal means, typically
by transferring the funds illicitly through banks or other legitimate businesses.

Unethical Management Practices

Unethical management practices are a significant factor at the level of individual firms, especially in
countries that lack adequate regulation and professional standards. A corporate culture that advocates
profit over sustainability and human welfare can lead to employee abuse, harmful procedures, and other
unsustainable practices. The recent global financial crisis resulted in part because top management in
banks and financial firms neglected to devise safeguards against making bad loans or offering high-risk
securities. Lax management standards also give rise to dishonest accounting practices, in which
companies provide deceptive information to investors, customers, and government authorities.

Harmful Global Sourcing

Global sourcing is the procurement of products or services from suppliers located abroad. In a typical
scenario, the focal firm buys parts and components from foreign companies that manufacture such goods,
or the firm may establish its own factories abroad. However, global sourcing raises concerns about
ensuring human rights and protecting the environment. Some companies operate illicit sweatshop
factories in which employees are children or work long hours for very low wages, often in harsh
conditions. Suppliers might operate factories that generate much pollution. The use of third-party
suppliers is challenging for firms such as Nike and Philips with thousands of partners that operate in a
range of cultures and belief systems
worldwide.

Illicit Products and Marketing

Firms might market defective or harmful products or engage in unethical marketing practices. Flawed
products or packaging can lead to disastrous outcomes for public health and safety or for natural
environments. For example, millions of electronic products from cell phones to computers are discarded
every year. Products that could be recycled instead end up in landfills. Excessive product packaging
generates pollution and consumes energy and natural resources. Excessive use of plastic packaging is
wasteful and, because plastic does not easily decompose, the amount of plastic waste is steadily
increasing
on land and in the oceans.

Intellectual Property Infringement

Intellectual property refers to ideas or works that individuals or firms create and includes a variety of
proprietary, intangible assets: discoveries and inventions; artistic, musical, and literary works; and words,
phrases, symbols, and designs. Illicit use of intellectual property is common worldwide, typically through
outright theft or illegal copying. Trademarks, copyrights, and patents are examples of intellectual property
rights.

Piracy and counterfeiting hurt the world economy in various ways, especially regarding:

1. International trade – exports of legitimate products must compete with trade in counterfeit goods.
2. Direct investment – firms avoid investing in countries known for widespread intellectual property
violations.
3. Company performance – piracy and counterfeiting undermine the sales, profits, and strategies of firms
that produce legitimate products. Business costs rise because the brand value of pirated goods can fall
over time and companies must invest more to market their products and combat illicit competitors.
4. Innovation – companies avoid doing research and development in countries beset by illegal copying
of intellectual property.
5. Tax revenues – pirates usually don’t pay taxes, which, together with reduced legitimate business
activity, hurts government tax revenues.
6. Criminal activity – piracy and counterfeiting often encourage, or are supported by, organized crime.
7. The natural environment – intellectual property violators disregard environmental standards when
producing illicit goods.
8. National prosperity and well-being – in the long run, widespread piracy and counterfeiting harm job

CORPORATE SOCIAL RESPONSIBILITY

Corporate social responsibility (CSR) refers to operating a business in a manner that meets or exceeds the
ethical, legal, and commercial expectations of customers, shareholders, employees, and the communities
where the firm does business. Companies that practice CSR aim to do more for the betterment of others
than is required by laws, regulations, or special interest groups . Sometimes called corporate citizenship,
CSR emphasizes the development of shared value for both shareholders and stakeholders, creating a
double-win scenario.

Settings of Corporate Social Responsibility

Adhering to CSR principles implies a proactive approach to ethical behavior in which firms not only seek to
maximize profits but also to benefit society and the environment. Examples of CSR values include:

1. Avoiding human rights abuses.

2. Upholding the right to join or form labor unions.
3. Eliminating child labor.
4. Avoiding workplace discrimination.
5. Protecting the natural environment.
6. Guarding against corruption.
7. Undertaking philanthropic efforts.

Sustainability
Sustainability implies the development and execution of company practices that avoid harming the ability
of future generations to meet their needs. It is endorsed by economic development experts,
environmentalists, and human rights activists. The sustainable firm carries out value chain activities in
ways
that protect and preserve economic, social, and natural environments.

1. Beneficial agricultural practices. The appropriate use of crop rotation and adverse, even ruinous,
natural
pesticides improve the quality of crops grown and preserves land for use by future farmers.
2. Water conservation. Clean water is an increasingly scarce resource worldwide. Companies that depend
heavily on water, seek ways to recycle used water and minimize waste.
3. Air quality protection. Industrial practices to reduce air pollution improve life quality and enhance
competitive advantages.
4. Reduced energy and fuel consumption. Efforts to support the natural environment include regulation
of fossil fuel usage and government incentives to use renewable energy sources.
5. Increased use of solar and wind energy. Cost-effective solar and wind energy can contribute
enormously to reducing dependence on nonrenewable and polluting power sources.
6. Improved work processes. Modifying work processes to improve sustainability reduces corporate costs
and supports the natural environment.

Sustainable Business Simultaneously Pursues Three Types of Interests

1. Economic interests refer to the firm’s economic impact on the localities where it does business.
Management considers the effect of the firm’s activities on such local concerns as job creation, wages, tax
flows, disadvantaged communities, public works, and other areas where the firm can contribute positively
to local economic interests.
2. Social interests refer to how the firm performs relative to societies and social justice, often termed
social impact. The firm with a strong social interest optimizes work conditions and diversity in hiring. It
avoids using sweatshops, child labor, and other practices that harm workers. Instead, the sustainable firm
provides safe work environments, health insurance, retirement benefits, and educational opportunities
for employees.
3. Environmental interests refer to the extent of the firm’s contribution to preserving environmental
quality, commonly known as environmental impact. This concept refers to reducing the effect of the
firm’s value-chain activities on the natural environment. The sustainable firm0 maximizes its use of
recycled or renewable raw materials and environmentally friendly energy. It minimizes pollutants, designs
production lines to use water and energy efficiently, and constantly seeks ways to reduce waste. Many
firms establish a green purchasing policy, through which they procure inputs that support environmental
interests.

Ethical Standard Approaches for Corporate Governance

1. A Global Consensus
Incorporating ethics, CSR, and sustainability into global operations is a path to long-term superior
performance. International organizations such as the United Nations, the World Bank, and the
International Monetary Fund have launched programs to combat international corruption. The
Organization for Economic Cooperation and Development (OECD) has developed an anti-bribery
agreement, which was signed by its 30 member nations (essentially, all the advanced economies) plus
several Latin American countries.
2. Going Deep, Wide, and Local
Ultimately, pursuing a culture of ethical behavior requires the firm to go deep, wide, and local. Going
deep means institutionalizing appropriate behavior in the organization’s culture so it becomes part and
parcel of strategy. Going wide implies a continuous effort to understand how CSR and sustainability affect
every aspect of the firm’s operations worldwide. Going local goes hand in hand with globalization. It
requires the firm to examine its global operations to identify and improve specific local issues that affect
customers, competitive position, reputation, and any other dimension that affects the firm’s operations
worldwide.
3. Benefits of Corporate Governance
Corporate governance that ensures ethical practices, CSR, and sustainability provides numerous benefits
to the firm. These benefits include:
1. Increased employee commitment.
2. Increased customer loyalty and sales.
3. Improved reputation and brand image.
4. Reduced likelihood of government intervention.
5. Reduced business costs.
6. Improved financial performance.

A FRAMEWORK FOR MAKING ETHICAL DECISIONS

Scholars suggest that managers follow a systematic approach to resolving ethical dilemmas. Presents a
five-step framework for arriving at ethical decisions that will help you arrive at appropriate solutions to
ethical dilemmas. The steps in the framework follow:

1. Identify the problem. The first step is to acknowledge the presence of an ethical problem.
2. Examine the facts. Determine the nature and dimensions of the situation
3. Create alternatives. Identify potential courses of action and evaluate each. Finally, evaluate each
proposed action to assess its consistency with accepted ethical standards, using the approaches described
earlier:
- Utilitarian—which action results in the most good and least harm?- Rights—which action respects the
rights of everyone involved?- Fairness—which action treats people most fairly? Common good—which
action contributes most to the overall quality of life of the people affected?
- Virtue—which action embodies the character strengths you value?
4. Implement the course of action. Put the chosen plan into action. This implies making new rules,
processes, or procedures and putting these into effect. Implementation is critical because it determines
the success or failure of the chosen action. Managers need to be particularly diligent at this stage to
ensure that the action is carried out according to plan.
5. Evaluate results. After the decision is implemented, management will need to evaluate it to see how
effective it was.

CHAPTER 5 - THEORIES OF INTERNATIONAL TRADE AND INVESTMENT

Comparative advantage describes superior features of a nation that provide unique benefits in global
competition. These features typically are derived from either natural endowments or deliberate national
policies. Also known as country-specific advantage, comparative advantage includes inherited resources,
such as labor, climate, arable land, and petroleum reserves, such as those enjoyed by countries in the
Middle East.

Competitive advantage refers to assets and capabilities of a company that are difficult for competitors
to imitate. Such advantages help the firm enter and succeed in foreign markets. These capabilities take
various forms such as specific knowledge, competencies, innovativeness, superior strategies, or close
relationships with suppliers. Competitive advantage is also known as firm- specific advantage.

WHY DO NATIONS TRADE?

Trade enables countries to use their national resources more efficiently through specialization and thus
enables industries and workers to be more productive. Without international trade, most nations would
be unable to feed, clothe, and house their citizens at current levels. Even resource-rich countries such as
the United States would suffer greatly without trade. Some types of food would become unavailable or
very expensive. Coffee and sugar would be luxury items. Petroleum-based energy sources would dwindle.
CLASSICAL THEORIES
Six classical perspectives help explain the underlying rationale for trade among nations.

Mercantilism. The earliest explanations of international business emerged with the rise of European
nation–states in the 1500s. During this era, gold and silver were the most important sources of wealth,
and nations sought to amass as much of these treasures as possible. Nations typically received payment
for exports in gold, but although exports increased nations’ gold stock, imports reduced it because they
paid for imports with their gold. Exports were seen as good and imports as bad. Because the nation’s
power and strength increase as its wealth increases, mercantilism argues that national prosperity results
from a positive balance of trade achieved by maximizing exports and minimizing or even impeding
imports.

Absolute Advantage Principle. Have you ever thought about why your iPhone or iPad is not assembled
in the United States even though it is designed in California? If you answer it is because labor cost is lower
in China, you already know something about the absolute advantage principle. Because countries differ in
national endowments (e.g., land, labor, technological capabilities), they are better off to specialize in the
production of certain products and services and import others.

Comparative Advantage Principle. In his 1817 book, The Principles of Political Economy and Taxation,
British political economist David Ricardo explained why it is beneficial for two countries to trade even
though one of them may have an absolute advantage in the production of all products. Ricardo
demonstrated that what matters is not the absolute cost of production, but rather the relative efficiency
with which the two countries can produce the products. Thus, the comparative advantage principle states
that it will be beneficial for two countries to trade with each other as long as one is relatively more
efficient at producing goods or services needed by the other. The principle of comparative advantage is
the foundational logic for free trade among nations today.

Factor Proportions Theory. A significant contribution to explaining international trade was developed in
the 1920s. Two Swedish economists, Eli Heckscher and his student, Bertil Ohlin, proposed the factor
proportions theory, sometimes called the factor endowments theory.

International Product Life Cycle Theory. In a 1966 article, Raymond Vernon sought to explain
international trade based on the evolutionary process that occurs in the development and diffusion of
products to markets around the world. In his International Product Life Cycle (IPLC) Theory, Vernon
observed that each product and its manufacturing technologies go through three stages of evolution:
introduction, maturity, and standardization.

New Trade Theory. In the 1970s, economists, including Paul Krugman, observed that trade was growing
fastest among industrialized countries with similar factors of production. In some new industries, there
appeared to be no clear comparative advantage. The solution to this puzzle became known as the new
trade theory. It argues that increasing returns to scale, especially economies of scale, are important for
superior international performance in industries that succeed best as their production volume increases.

Determinants of National Competitiveness

As part of his explanation in The Competitive Advantage of Nations, Michael Porter described several
factors that give rise to competitive advantage at both the company and national levels. Named the
Porter Diamond Model, it comprises four major elements, viz:

1. Demand conditions refer to the nature of home-market demand for specific products and services. The
presence of demanding customers pressures firms to innovate faster and produce better products. For
example, the United States has a large population of prosperous senior citizens who suffer from various
health problems. These conditions have created an enormous market for quality medical equipment and
cutting-edge pharmaceutical medications.
2. Firm strategy, structure, and rivalry refer to the nature of domestic rivalry and conditions in a nation
that determines how firms are created, organized, and managed. Vigorous competitive rivalry puts these
firms under continual pressure to innovate and improve. They compete not only for market share but also
for human talent, technical leadership, and superior product quality. The presence of strong competitors
in a nation helps to create and maintain national competitive advantage. Japan has one of the world’s
most competitive consumer electronics industries, with major players such as Hitachi, Nintendo, Sony,
and Toshiba producing semiconductors, computers, video games, and liquid crystal displays. Intense
rivalry has pushed firms like Sony to a leading position in the industry worldwide and has enabled Japan to
emerge as a leader in consumer electronics.
3. Factor conditions describe the nation’s resources such as labor, natural resources and advanced factors
such as capital, technology, entrepreneurship, advanced work force skills, and know-how. Each nation has
a relative abundance of certain factor endowments. This helps determine the nature of its national
competitive advantage. For example, Germany’s abundance of workers with strong engineering skills has
propelled the country to commanding heights in the global engineering and design industries.
4. Related and supporting industries refer to the presence of clusters of suppliers, competitors, and
skilledworkforce. An industrial cluster refers to a concentration of businesses, suppliers, and supporting
firms in the same industry located at a particular geographic location.

National Industrial Policy

A national industrial policy is a proactive economic development plan a government launches to build or
strengthen a particular industry, often implemented in collaboration with the private sector. Usually,
governments design such policies to support high value-adding industries, those that yield higher
corporate profits, better wages, and tax revenues. Historically, governments favored traditional industries,
including automobiles, shipbuilding, and heavy machinery all with long value chains that produce
enormous added value.

WHY AND HOW DO FIRMS INTERNATIONALIZE?

Internationalization takes place in incremental stages over a long period. Initially and without much
analysis or planning, firms begin exporting, the simplest foreign market entry strategy. As they become
more knowledgeable, firms gradually progress to foreign direct investment (FDI), the most complex entry
strategy. The relatively slow nature of internationalization often results from managers’ uncertainty and
uneasiness about how to proceed. They lack information about foreign markets and experience with
cross- border transactions. The progression from exporting to FDI coincides with increasing levels of both
risk and control.

HOW CAN INTERNATIONALIZING FIRMS GAIN AND SUSTAIN COMPETITIVE ADVANTAGE?

Since the 1950s, such MNEs as Nestlé, Unilever, Sony, Coca-Cola, and Caterpillar have all expanded
abroad on a massive scale. Such MNEs have helped shape international patterns of trade, investment, and
technology flows. Over time, the aggregate activities of these firms became a key driving force of
globalization and ongoing integration of world economies.

FDI-Based Explanations. Most explanations of international business have emphasized FDI, the
preferred entry strategy of MNEs. These large, resource- rich companies conduct business through
networks of production facilities, marketing subsidiaries, regional headquarters, and other operations
around the world. FDI stock refers to the total value of assets that MNEs invest abroad.

1. Monopolistic Advantage Theory. Monopolistic advantage refers to resources or capabilities a company

holds that few other firms have. Monopolistic advantage theory suggests that firms that use FDI as an
internationalization strategy must own or control certain resources and capabilities not easily available to
competitors. This gives them a degree of monopoly power over local firms in foreign markets. This
monopolistic advantage should be specific to the MNE itself, such as a proprietary technology or a brand
name, rather than to the locations where it does business.

2. Internalization Theory. Internalization theory explains the process by which firms acquire and retain
one or more value-chain activities inside the firm. Internalizing value-chain activities (instead of
outsourcing them to external suppliers) reduces the disadvantages of dealing with outside partners for
performing arms-length activities such as exporting and licensing. Internalization also gives the firm
greater control over its foreign operations.

3. Dunning’s Eclectic Paradigm. Professor John Dunning proposed the eclectic paradigm as a framework
to explain the extent and pattern of the value chain operations that companies should own abroad. He
drew from various theories, including comparative advantage, factor proportions, monopolistic
advantage, and internalization theory. The eclectic paradigm is often viewed as the most comprehensive
of FDI theories.

The eclectic paradigm specifies three conditions that determine whether a company will internationalize
through FDI:

1. Ownership-specific advantages. An MNE should hold knowledge, skills, capabilities, key relationships,
and other advantages that it owns and that allow it to compete effectively in foreign markets. To ensure
international success, the firm’s competitive advantage must be substantial enough to offset the costs
that it incurs in establishing and operating foreign operations. It should also be specific to its own
organization and not readily transferable to other firms.
2. Location-specific advantages. The second condition that determines whether a firm will
internationalize by FDI is the presence of location-specific advantages. These are the comparative
advantages available in individual foreign countries that may be translated into firm competitive
advantages. These may include natural resources, skilled labor, low-cost labor, or inexpensive capital.
3. Internalization advantages. The third condition that determines FDI- based internationalization is the
presence of internalization advantages. The firm gains these benefits from internalizing foreign-based
manufacturing, distribution, or other value chain activities. When profitable, the firm will transfer its
ownership-specific advantages across national borders within its own organization rather than dissipating
them to independent, foreign entities. The FDI decision depends on which is the best option—
internalization versus using external partners and whether they are licensees, distributors, or suppliers.
Internalization advantages include the ability to control how the firm’s products are produced or
marketed, greater control of its proprietary knowledge, and greater buyer certainty about product value.