International Business

Introduction Globalization
• The term global means involving or relating to the whole world.
• Hence globalization refers to the removal of barriers between
countries leading to free movements of goods, people, resources,
capital, technology and information
• It is integration at international level of economies, culture and
technologies.
• Globalization leads to cross exchange of of ideas, philosophies and
culture thereby making the world a global village where there is
increase in competition and people can specialize in what they can do
best, leading to market efficiency.
Driving forces of globalization
• Liberalization of economies
• Rapid spread of technology
• Increase role of international organization
• Regional economic integration
• Convergence of culture
• Economic viability
• Robust transportation system
Significance of globalization
• Economic globalization
• Financial globalization
• Political globalization
• Culture globalization
Impact of globalization on international business

Positive impact of globalization

• Harmonious relations among countries
• Delight for consumers
• Increase in job opportunities
• Tapping new markets
• International systems
• Availability of capital
• Handling global issues
• Knowledge sharing
• Boom to tourism industry
Impact of globalization on international business

Negative impact of globalization

• Job loss in developed countries
• Health problems
• Competition to domestic companies
• Unethical and illegal activities
• Environmental issues
• National identify is loss
• Political risks/tension
• Growing gap between rich and poor
Concept of international business
• IB refers to exchange of goods, services and resources between
countries.
• It include commercial transactions by companies and government
across their national boundaries with multiple countries for their
growth and development.
• In simple words, it means carrying out business operations at
international level
Concept of international business
International business includes:
• Exports and imports of inputs, finished goods and services
• Investment by companies in assets (physical, financial and human) of
foreign countries
• Setting up manufacturing plants in foreign countries
• Contractual agreements such as licensing, franchising with foreign
companies
• Dealing in intellectual property rights across national boundaries
Complexities of international business
• Infrastructure problems
• Lacks of qualifies managers
• Trade barriers
• Fluctuations in exchange rate
• Corrupt government
• Cultural diversity
Internationalization stage
The term ‘internationalization’ refers to the process through which a
company goes through when it plans to expand its operation beyond the
national boundaries and tapping the worldwide market.

Stages of internationalization
1. Domestic company
2. International company
3. Multinational company
4. Transnational/global company
International orientation
These approaches or orientations was explained by Howard V.
Perlmutter in 1969 trough his EPG framework which was later modified
to EPRG framework by including one more dimension.

Ethnocentric orientation
Polycentric orientation
Regiocentric approach
Geocentric approach
Motives for international business expansion

• Increase of sale and profit

• Competitive advantage
• Product decline in domestic market
• Economies of scale
• Diversifying risks
• Saturation in domestic market
• Seeking resources
• Economic policies in foreign county
• Reaction to competitors
Modes of entry into international business
Modes of entry
Trade Related Contractual Related Investment Related

Exporting Turnkey contracting Joint venture

Counter trade Management contracting Wholly owned subsidiary

Licensing

Franchising

Leasing
Exporting
Advantages
• It is the traditional and simplest mode of entry
• It requires les capital investment compared to other methods which
require setting up of manufacturing plants in foreign country
• It helps company to take advantage of economies of scale
• It provide the option of easy exit in case of crises in foreign country
• It provide opportunity for the company to expand their business in
case of seasonal products or when their product has reached maturity
stage in domestic market
Exporting
Disadvantage
• It require knowledge of foreign trade policies of home country as well
as that of countries where the company is exporting
• it requires obtaining licenses, getting necessary approvals and
documentation
• It requires company to undertake market research to modify their
marketing strategy as per the foreign market
• Collecting payments in foreign market may turn out to be cumbersome
and risk also
Counter trade
• Counter trade is an agreement where companies exchanges goods
(wholly or partly)
• Counter trade is old as civilization and was known as barter system
• There are various forms of counter trade such as buyback, switch
trading, offset, clearing arrangement and counter purchase.
• In case of buyback the seller of machines and equipment receives
complete payment in cash. With this cash he has to buy the goods
produced from the machine and equipment supplied by him.
• In case of clear arrangement the countries involved continue doing
import and export among themselves without making any cash payment.
At the end of the decided period balance is settled in cash.
• Example of PepsiCo to operate in India has to buy tomato from India
Counter trade
Advantages
• This method is suitable for countries having shortage of cash to buy
foreign inputs or finished products
• It helps in solving problems of BOP and risk arising due to
fluctuations in foreign exchange market
• The country’s by exchanging goods only can maintain their reserves of
foreign currency
•
Counter trade
Disadvantages
• The goods so received as payment may not be useful to the seller (not
in house use) creating extra burden
• It is time consuming process as it involves lots of negotiations
• There is risk of receiving defective and inferior goods
Turnkey contracting
Advantages
• The agreement is with one contractor for both designing and
constructing the facility. Hence it is easy to coordinate
• The firm to which contract is given is specialized in their field as a
result facility constructed is of superior quality and reduce wastage of
resources
• The client doesn’t have to look into day to day working and cam
concentrate on other important areas
• As the fees of the contractor is fixed, the contactor has to bear any
additional cost
Turnkey contracting
Disadvantages
• The contractor is responsible in case the project doesn't’t meet the
client's performance standard
• The client has no or very limited control over the project. It is limited
to deciding the project specification
• From the contractors point of view, the labiality of the contracting firm
increases
• It may lead to leakage of confidential information of company to the
competitors
Management contracting
Advantages
• The contractor is responsible for managing the facility. Hence the
owner of the facility can concentrate on other business areas
• As the contractor has management experience, it will be able to
provide better quality services and thereby generate more revenue
• It is suitable mode of entry in foreign markets where foreign
investment is not allowed
• it helps the management company to establish their brand in
international market
Management contracting
Disadvantages
• The contract entered is for long duration to a high lock in period
• The client has no or very limited control over the management of the
facility
• There is a risk of leak of secret information by company to the
competitors
• The management company faces risk of their personnel in case of
adverse situation in clients country
Licensing
Advantages
• It is simple method for a licensor to expand into foreign markets
• it does not involves much capital investment as compared to other
methods
• It is less risky for the licensee as he is using rights of an established
company
• The licensor is able to generate more revenue from proprietary assets
such as technical knowhow
Licensing
Disadvantages
• There are chances that licensee may become a competitors for licensor
in the future
• The licensor doesn't’t have control over the activities of the licensee
• It require intensive research to find a suitable partner
• Mismanagement of the rights by the licensee can tarnish the reputation
of the licensor
Franchising
Advantages
• It is low cost option for franchisor to expand into foreign market. As
the outlets are owned and managed by the franchisee
• With this model the franchisor has the option to expand
simultaneously into various foreign market
• It is low risk option for franchisee as it is entering the marketing with
an established business model and brand. There is low chance of
product failure
• Franchisor helps the franchisee to establish its operation by providing
them with requisite training
Franchising
Disadvantages
• The revenue of the franchisor is limited to royalty payment
• In case strategic information is shared there may be chance of the
franchisee turning into rival
• The franchisee has to pay percentage of its revenue to franchisor
which reduces its earning
• The franchisor has less control over the activities of the franchisee .
Leasing
Advantage
• The lessee doesn't’t have to block his funds by purchasing the asset
and can easily hire by paying rent with no initial expense
• It requires less documentation as compared to getting loans from the
bank and the contract is flexible in nature
• An asset which is no longer required by the lessor can be given for
ease thus generating revenue for the lessor
• Lessor is responsible for the maintenance of the leased asset a benefit t
the lessee
Leasing
Disadvantage
• On termination of the contract the asset may have to be transferred to
the lessor. The lessee loses his right on residual value
• The lessee cannot make any changes in the asset without the prior
approval of the lessor
• The rentals are to be paid on regular basis by the lessee to the lessor
Joint venture
Advantages
• It is quicker and an easier way for setting up a new company in a foreign
country
• The domestic counterpart is aware about the local business environment
saves the foreign partner from undertaking market research
• The risk is shared by the parties involved limiting their liability
• The parties also gain knowledge from each other. Pooling of resoirces
also leads to their efficient utilization
• It gives a strategic edge to new entity. Hence it is better able to meet the
compettion
Joint venture
Disadvantages
• The partners may have different management philosophies giving rise
to conflict among them
• At times a partner can leak the confidential information of the other to
other players in the market
• As many parties are involved it ay lead to delay in decision making
pertaining to important areas
• A JV partner in future may turn rival
 Unit: 2

International business environment

Introduction
• Business is a dynamic activity, which is influenced by environment around it.
• Environment scanning refers to systematic analysis of information to determine
which factor present in the environment affect the business activities such as
marketing, production, finance, personal and how.
• The business environment can be classified into micro and macro environment.
• The micro environment includes all those factors which are specific to that firm and
can be controlled by it to an extent (e.g. intermediaries, customers, employees,
suppliers)
• The macro environment refers to those factors that influence all the firms of that
particular industry and which they cannot control (e.g. political, economic, socio
cultural, technological, ecological and legal environment.
• Beside the macro and micro the company has also to keep check on the global
environment (world bank, world trade organization, international law and regional
integration)
Macro environment
Physical environment
• Geographical location of country
• Natural resources
• Climate and topography
Ecological environment
Political environment: focuses on the roe played by the government their
ideologies and philosophies as well as well the stability of the govt.
Political Risk:
• Confiscation
• Nationalization
• Expropriation
• Remittance problem
Macro environment (Legal)
Types of legal system

• Civil law: based on roman law and is based on codes (France,

Germany china and others)
• Common law: it is also known as English law and is based on pat
precedencies. (UK, india)
• Religious law: base don religious teaching and beliefs.
Macro environment (culture)
Element of culture
• Language
• Religion
• Aesthetics
• Social group
Macro environment
Economic
• Infrastructure
• Economic and financial policies
Technological environment
Hecksher-Ohlin theory/modern theory of
international trade
• Prof E Heckscher- 1919
• Prof Bertil ohlin- 1933
• According to this theory: different countries are endowed with different factors of production
• Certain countries have higher supply of capital whereas certain countries have large supply
of labor
• Because of factor difference, the price of factors varies country to country and due to which
cost of goods varies
• Countries in which capital is relatively plentiful and labor relatively scarce will tend to
export capital-intensive products and import labor-intensive products.
• While countries in which labor is relatively plentiful and capital relatively scarce will tend to
export labor intensive products and import capital intensive products.
• “a nation will export the commodity whose production require the intensive use of the
nations relatively abundant and cheap factor and import the commodity whose production
requires the intensive use of the nation’s relatively scarce & expensive factors”.
 Assumptions
• 2*2*2
• Perfect competition in commodities and factors market
• Homogeneous production function (constant return to scale)
• Factor mobility
• Different factors supply in 2 countries. e.g.. (India (labor) and japan (capital)
• Each commodities differ in factor intensity
• Factor intensity differs between commodities but same in both countries for
each commodities
• Full employment
• Free trade
• No transportation cost
 Example
• Country A have 2000cr capital and 500L
• Country B have 500cr capital and 2000L
• Ratio of capital and labor of A is 4, i.e country A have 4 capital per labor
• Ratio of capital and labor of B is .25, i.e country B have .25 capital per labor
• Hence country A is abundant in capital than country B and country B is
abundant in labor
• So, country A will produce more capital intensive goods (like electronic
items, watches) and export to country B
• And country B will produce more labor intensive goods (cloths, shoes etc)
and export to country A.
Factor abundance
In term of factor price (price criterion)
• A country having capital relatively cheap and labor relatively dear
(costly/precious) is regarded as relatively capital-abundant
• A nation is capital abundance if the nation of capital price to the labor
price is less than another country
In terms of quantity of factor (physical criterion)
• a country relatively capital-abundant only if it possesses a greater
proportion of capital to labor as compared to other country
• A nation is capital abundance if the ratio of total amount of capital to
the total amount of labor is higher than another country
 Limitation
• Un realistic assumption
• Static in nature
• Demand condition neglected
• Leontief paradox
• Other factor neglected
• Commodity prices neglected
Superiority of H.O theory over the classical theory/ Difference between H.O
theory and the classical theory
H.O Theory Classical theory
International trade is a special case of inter-regional/inter International trade is different from domestic trade
local trade
H.O theory is based on the general equilibrium theory of Classical theory is based on the labor theory of value
value
H.O models takes two factor of production i.e. labor and Labor is the only factor of production in the classical theory
capital trade
The pattern of international trade is determined by the Ricardian theory doesn’t take note of difference in factor
difference in factor supplies supplies
H.O theory considers differences in relative productivities of The classical theory considers relative prices of goods only
labor and capital as the basis of international trade

H.O theory is based on differences in factor endowments in Ricardian theory is based on the quality of one factor only i.e.
different countries. Thus, it lays emphasis on both quantity labor
and quality of factors in determining international trade

The merits of H.O theory lies in explaining the causes of According to Sameuelson, the Ricardian theory could not
difference in comparative advantage satisfactory explain the causes of differences in competitive advantage
Cont…

H.O Theory Classical Theory

H.O theory is scientific and focuses on the basis of The classical theory demonstrate the gains from trade between
international trade. It thus relates to positive theory the two countries. Thus it is related to welfare theory

According to Harberler, the H.O theory is a location theory The classical theory regards different countries as space less
which highlights the importance of the space factor in market
international trade

The H.O theorem is explicitly based on the assumption of The classical theory is based on differences in the production
productions of the two countries of the trading countries.

The H.O models leads to complete specialization in the The trade between two countries may or may not leads to
production of one commodity by one country and that of the specialization in the classical theory
other commodity by the second country when they enter into
trade

In the H.O theory will not cease in future even if the labor In the classical theory differences in comparative costs
become equally efficient in the two countries because the between two countries are due to differences in efficiency of
basis of trade is differences in factor endowments and factor labor. Overtime, if labor in both countries becomes equally
prices efficient in both countries there’ll be no trade between them
Introduction to the Leontief Paradox:

• Leontief made use of 1947 input-output tables related to the U.S.

economy. 200 groups of industries were consolidated into 50 sectors,
of which 38 traded their products directly on the international market.
He took only two factors of production— labor and capital.
• In brief, capital-abundant countries export labor- intensive goods and
labour-abundant countries export capital-intensive goods. This reflects
what is called as ‘Leontief Paradox’ as this conclusion goes against H-
O theory. Although the United States is a capital-abundant country, yet
its specialization is found in the labor-intensive commodities.
Criticisms of Leontief Paradox:
• Inherent Bias:The writers like B.C. Swirling and Salvatore found an inherent bias in Leontief s work related
to year 1947. This year was very close to the period of Second World War (1939-45). The world economy,
completely disorganized during the war-period, had not yet been able to make proper adjustments in
production and international trade.
• Inclusion of Industries with Low Capital-Intensity: Swirling pointed out that the Leontief paradox
involved a bias because of inclusion of certain industries in case of which capital-labour ratio was low. In
view of this objection, Leontief reworked upon his data after enlarging the group of industries into 192
sectors. However, even this study confirmed that the American import- substitution industries had higher
capital-intensity than the export industries, although the capital- intensity of the former over the latter had
been reduced only to 6 percent.
• Unbalanced Trade: Learner expressed the view that Leontief paradox would fail when the country had trade
imbalance. He pointed out that the United States had a trade surplus in 1947 and there was little evidence that
exports were labour- intensive.
• Neglect of Tariffs: A serious weakness in Leontief’s analysis was that he failed to take into account the effect
of tariffs policy on the pattern of trade.
• Natural resources overlooked: Buchanan criticized leaontief for neglecting the role of natural resources
which were very important in determining trade patterns.
 Product life cycle

• 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 PLC theory, Vernon points out that each product and its manufacturing technologies
go through a continuum or cycle of evolution that consist of:
 Introduction: heavy expenditure in R&D & advertisement, No economy of scale, cost is high inevitably
at beginning, not too long period
 Growth: market pickup, decrease in average cost due increase in output
 Maturity: the scope of excess modification ends, it attracts other competitors. if patented then no much
competitors, but if provides licenses on royalty, is the time export surplus output since domestic
consumption is exceeded by its supply.
 Standardize: it’s the technology is known, time for large scale production, time is more advantageous for
labor intensive countries. Also invented country can outsource its production
The theory states that how a capital intensive commodity shifts the capital intensive to labor intensive
production within the continuum of PLC
 Criticism
• The PLC theory holds the location of production facilities that serve world markets
shifts as products move through their life cycle. Many industrial product like steel,
coal etc. or basic foodstuff like salt, sugar etc. fall outside the purview of life cycle
• The movement of production from one stage to another is not certain
• The present stage in which the product is cannot be known with certainty
• Certain products have extremely short life cycle because of rapid innovation.
Shifting production of such products from one country to another doesn’t reduce
their cost. Hence there is no benefit of shifting
• Luxury products for which cost is of little concern to the consumers aren’t covered
by the PLC
• The companies today develop products for worldwide market segments and to
introduce the new products at home and abroad simultaneously. In so doing they
choose an initial production location (that may or many not be in the innovating
country) that will minimize cost for serving markets worldwide
Theory of National Competitive Advantage

• Developed by Michael Porter

• Also called as Porter’s Diamond Model/ porter diamond theory of
national advantage
• Explains: Why a nation achieves success in the international market
and why others do not or it helps to understand the competitive
advantage that a nation possess due to certain factors available to
them.
Attributes
Factor conditions: Factor conditions are those elements that porter
believes a country’s economy can create for itself, such as large pool
of skilled labors, technological innovation, infrastructure
(communication and transportation) and capital above all
Cont…

Strategy structure and rivalry:

• A firm facing rivalry leads to it to find the ay to increase production and the
development of technological innovation.
• The competition brings prosperity to a nations domestic market
• Firms inner strategy to beat their competition, making a strong structure is the major
factor of this theory
• Competition, business structure and strategy
Related and supporting industry:
• These are the supporter in the same sector or industry that facilitates the innovation
through their support and by exchanging their ideas
• We can divided them in upstream and downstream industries, often we call them
suppliers and customers
• They can exchange their knowledge ideas by making transparency between the two
industries.
Cont…
Demand condition:
• it refers to the size and nature of the nature of the customers base of the product
that a company or industry is offering
• Customers leads the product improvement and innovation when they started
making feedbacks for the product
• Industries tries to learn their customers and makes their product more customer
oriented
• Customer choice, preference & fashion
Conclusion
• Apart from these four factors, two more factors are there that helps a industry to
make their product more competitive in the internatioal market not only in the
domestic market.
• Government policies
• Chance
• Here we can say it is the most famous theory of international trade which covers
almost all the factors
 Tariff and non-tariff barriers

Tariff:
• A tariff is a tax imposed on commodities that are traded across the
national border of a country.
• They are also referred to as import or export duties or customs duties
• Tariff are imposed to make import costlier than domestically produced
goods
Tariff and non-tariff barriers
Objectives:
• To raise governments revenue
• To protect and support domestic industries
• To conserve foreign reserves
• To make domestic prices competitive with import prices
• To reduce dependence on other countries
• To generate employment within the country
• To prevent shortages in domestic markets by imposing export tariffs
Tariff and non-tariff barriers
Types of tariffs:
Classification on the basis of imposition
Classification on the basis of purpose
Classification on the basis of source of import
Classification on the basis of retaliation
Classification on the basis of imposition:

1. Specific tariff:
• Imposed on the physical weight, measurement or unit of a commodity that is
imported/exported
• Example: agri commodities, cement, fertilizers, minerals etc.
• Specific tariff may not always bring in equity
2. Ad-Valorem tariff:
• Ad-valorem means on the value
• Levied at percentage rate of the value of the imported or exported commodities
• More equitable: more expensive goods that are consumed by the rich will
attract higher tariff, while cheaper goods consumed by low income groups will
be levied lower tariffs.
Classification on the basis of imposition:
3. Mixed tariffs:
• Expressed on either a specific or on ad valorem rate, depending on
whichever generates more revenue
4. Compound tariffs:
• It is a combination of both specific and ad valorem tariffs
• It include specific tariff on a unit of the commodity plus a percentage
of ad valorem tariffs
• Greater elasticity in revenue collection
5. Tariffs rate quotas:
• These are made up of low tariff rates on an intital quantity of import
that is within the quota limited & a very high tariffs rate on import
above that initial amount.
Classification on the basis of purpose
1. Revenue Tariffs:
• Imposed primarily to generate revenue for the govt
• Important source of revenue to the govt in developing countries
2. Protective tariffs:
• The primary objectives is to protect domestic industries by making
imports more expensive
• Higher the tariffs rate, greater is the protective effect
• If domestic demands for imported commodities is strong, then even
high rates of import tariffs may not be able to provide much protetion
to domestic industries
• High rates of protective tariffs on raw material and intermediate goods
- inflation
Classification on the basis of source of import

1. Non-discriminatory tariffs:
• Do not discriminate between the countries from where the import originates
• A single uniform rate is levied on imports of a particular commodity
• Also called as single column tariffs
2. Discriminatory tariffs:
• Tariffs rates differs according to the countries form where the import
originate
• Product form countries with whom the importing country may have on
agreement - lower tariff than tariffs imported of products originating from
other countries
• Also called as double/multiple column tariffs (general, international,
preferential)
 Classification on the basis of source of
import
3.Maximum and Minimum Tariffs:
• The minimum rates apply to products from the most favored nation (MFNs)
• The maximum rates are applied for the purpose of trade negotiation with
some countries in order to improve the tariffs imposing country’s bargaining
position in trade
4. Preferential tariffs
• Imposed on import from countries that are part of a preferential trade
agreement like free trade areas (North America free trade area NAFTA, EU)
• These rates are lower than general tariff rates imposed on import from
countries outside the FTA
Classification on the basis of Retaliation
1.Rataliatory Tariffs:
• Imposed as retaliation by a trading partner on a country that initially imposed
tariffs on import, to counter the effect of the tariffs
• Will impact the export of both the trading partners
• Trade war and harmful to international trade
2. Countervailing tariffs:
• Levied on imported goods to neutralize the effect of subsidies given to the
producers in exporting country
• Provide a level playing field between domestic producers and producers of the
same products in the exporting countries
• Usually developed countries give large subsidies to their farmers
• Developing countries impose countervailing duties
Classification on the basis of Retaliation
3. Anti Dumping Duties:
• Dumping is a practice by an exporter of selling product in a foreign
market at price lower than what is charged for the product in the
domestic market
• The practice of dumping goes against the principle of the fair trade
• It is type of protective tariff, that may be imposed by the govt on
imports that it believes are priced below that fair market price by the
exporter
• Objective: protect the interest of local producers
Effect of Tariffs

• Decrease the volume of import and export

• Loss of consumer surplus
• Protect domestic industries
• Increase the well being of producers
• Increase in the production and employment
• Encourage inefficient production
• Increase government revenue
 Non Tariff Barriers

• NTB are means of restricting import through measures other than

tariffs
Eg. Import quotas, import licenses, product standard etc
Classification of NTB
• NTBs that have direct impact on the price of the imported goods
• NTBs that influence the quantity of goods imported
Non Tariff Barriers
Import Quotas:
• Import quotas are the maximum quantity of import of commodities
that are fixed by the govt
• They limit the volume/money value of goods that a country can import
during a particular period
• They are imposed to boost domestic production and restrict imports
more effectively in reducing BOP deficit than tariffs
Type of Import Quotas
1. Tariff Quotas:
• Import of commodities upto quota limit no tariffs/low tariff
• Import in excess of the quota limit- high tariff rate
2. Unilateral quotas
• It is quota imposed on the import of a commodity without prior
negations with the concerned exporting country
• Global unilateral quota- the commodity may be imported from any
country upto the full amount of the quota limit
• Allocated unilateral quota the total quota limit is distributed among
specific exporting countries
3. Bilateral quotas:
• These quotas are fixed through negotiations between the importing
and exporting countries
• Decided through mutual consent and will not face retaliation
4. Mixing quotas:
• It makes it mandatory for producers to use certain proportion of
domestic raw material along with imported raw material and
components to produce finished product domestically
• Objective- limit the use of foreign resources
5. Import licensing
• Under this system, importer are required to obtain a license from the
govt authorities
• Used to administer and implement import quotas
• Drawback:- corruption, monopoly, shortages and price rise
 Other Non tariff Barriers
1.Domestic subsidies:
• Direct payments made by the govt to domestic producers in order to lower cost of production
and increase production
• Forms --- cash payments, low interest rates, tax concessions
• Lower price of domestic goods and helps producers to compete foreign goods
• Help to increase export
• May attract countervailing duties
2. Voluntary export restraints (VERs)
• Bilateral agreements between trading countries to limit export
• The govt of the importing country can request the govt of the exporting country to impose
restrictions on its exporters of certain specified goods in order to protect the domestic
producers in the importer country
• Decrease supply of imported goods, increase their price and encourages domestic production
3. Local content requirement
• Govt makes it mandatory for domestic producers to use some proportion of domestic raw
material - decrease in import of foreign resources
• Expressed either in term of physical or in terms of value
4. Preferential govt procurement policy:
• The govt of a country makes it mandatory for all the departments and
ministries to purchase and procure their requirement only from local
producers
5. Administrative barriers:
• Certain administrative regulations and procedures are designed in such a
way that they become a form of barriers to imports
• Legal or procedural requirement
• Least transparent and very difficult to eliminate
6.Intellectual property laws:
• Strict patent and copyrights laws---barrier to import certain type of
products
• Increasingly leased by developed countries to prevent imports from
developing countries
7. Exchange controls:
• The govt puts restrictions on the purchase and use of foreign exchange
for imports as well as for investments made by residents in foreign
countries
• Objective---preserve foreign exchange reserves
• Importers required to purchase foreign currency at higher rate of
exchange determined by the central bank
8. Product and testing standards:
• Requirement that imported goods meets a country's product and testing
standards
• Product of developing countries are often fail to meet very high product
and testing standards set by developed countries
• Example: products not complying raw material norms, use of child labor,
using sweat shops that violates workers rights etc.
 Balance of payment

• The balance of payments of a country is a systematic record of all

economic transactions between the residents of the reporting country
and residents of foreign countries during a given period of time
• Residents– all individuals, businesses, and their agencies
• A standard double entry book keeping method
• Credit- receipts and debits  payments
Purpose
• To know international economic position of a country
• Monetary and fiscal policy decisions
• Trade and BOP policies
Balance of payment structure
Trade account balance Receipts (credits) Payments (debits)
• Difference between export and Trade account
import of goods
1. Expo of goods Import of goods
• Also called as balance of visible
trade or balance of merchandise
trade
• Balance on trade A/C :- value of
exp = value of imp
• surplus on trade A/c :- value of
exp > value of imp
• Deficit on trade A/C :- value of
exp < value of imp
Current account balance Receipts (credits Payments (debits)

• Services Current account

• Investment income: developed
countries receives and developing 1. Expo of goods Import of goods
countries pay
• Transfer/ unilateral denotation ,
grants, gifts, remittances 2. Exp of services Import of services
• Surplus  strengthens the country's
international financial position 3. Rate of interest & Dividend Rate of interest & Dividend paid
• Deficit- creates payments received
problems
• Benchmark for CAD
4. Unilateral receipt Unilateral payments
Capital account balance Receipts (credits Payments (debits)
Foreign investment Capital account
• FDI MNCs own or in collaboration
with Indian company (asset creation) 5. Foreign investment Invest abroad
• FPI financial assets (share, debenture, 6. Short term borrow Short term lending
bond)
• External assistance 7. Med & long term borrow Medium & long term
• Short term borrowing to cover CAD (by
banks)
• Med & long term borrowing foreign
govt/ international institutions like IMF
(low & easy terms)
• Borrowing for smart cities, blood train.
(prefered to borrow from world bank,
Asian development bank, BRICS bank)
• IMF movement shown separately
• Financial account IMF & some
countries record FDI, FPI & foreign exp
as fin account
• Capital A/C balance balance, surplus &
deficit
Statistical discrepancy

• Transaction that have not been recorded & cannot be 8. Statistical discrepancy (errors of omissions)
entered under standard heading but must appear since full
BOP A/C must sum to zero
• Overall balance = Current A/C + Capital A/C + SD
• If above sum is +ve the overall balance is surplus
• If it is -ve the overall balance is deficit
• If current A/C –ve & Capital A/c +ve overall balance
depends on the size of each balance
Foreign exchange reserves Receipts (credits) Payments (debits)

• Hard currencies like dolar, 9. Change in reserve (+) Change in reserve (-)
pound etc, gold, SDR (special
drawing rights)
• Surplus BOP increase reserves.
It is transferred to foreign
exchange reserve, shown as
minus as the particular years
BOP A/C
• Deficit BOP decrease reserve,
foreign exchange reserves used
to meet deficit, entry in the
receipt side as positive
• Official settlement:- foreign
exchange reserves are used for
adjusting surplus/deficit in BOP
The basic balance
• Sum of the current and capital account when the two
sides of current d capital account are equal (difference
between two is zero) the basic balance is achieved
• According to Bo sodersten basic balance need not
necessarily be a happy state of affairs
• If achieved through long term borrowing  repayment
burden
• Capital out flow deficit but profit & dividend in long
term.
Equilibrium & disequilibrium

• BOP always balances in an accounting /technical sense

• The A/C must balance there can be no deficit/ surplus
• When the total debits & credits of all accounts balance we say BOP
balances
• It is achieved when overall balance is zero i.e. current account
deficit/surplus is matched by a surplus/deficit in capital account
Autonomous Flows Accommodating flows

Take place in the ordinary course of foreign trade Not undertaken for their own sake

Undertaken for their own sake (profit/ satisfaction) Free from considerations of profit

Example:- Transactions are undertaken to cover deficit or surplus

• Virtually all export and import of goods and in autonomous transactions
services
• Unilateral transfer Consists almost entirely of cash payments/ receipts
• Most long term capital movement (FDI) &
• Many short term capital movements (FPI) Example :-
• Increase or decrease in the official foreign
exchange reserve
• Borrowings

Autonomous receipts > autonomous payments = surplus

autonomous receipts < autonomous payments = deficits
Types of BOP disequilibrium
1. Short-run disequilibrium
• Prevails for a year or for few quarters
• Sudden increase in demand for foreign goods and services
• Reasons- failure of monsoon, natural calamities, political disturbance
• Can be corrected through short term borrowings or other adjustments
2. Long term disequilibrium
• Also called as chronic/persistent disequilibrium
• IMF terms such as disequilibrium as fundamental disequilibrium
• Caused by continuous excess demand for foreign exchange
Reasons
• Excess import for planned economic development (India's 5 year plan)
• continuous increase in population – increase in import for essential goods
• Domestic investments > domestic savings
• Increase in price of imports (crude oil)
• Decrease in demand for exports (technology, taste, habits etc)
• Solutions:- increase export and decrease import
3. Cyclical disequilibrium
• Economic activities are subject to business cycles
• Four phases a. boom, b. recession, c. depression, 4. recovery
• International transmission of business cycles (impact of any recession
from developed country)
• Depression cause increase unemployment, decrease income, decrease
import
• Boom causes increase employments, increase income, increase import
• It is a result of the effects of business cycles at home as well as in ther
countries
• No special measures are adopted
• Measures are primarily directed to control business cycle (monetary
and fiscal policy)
4. Structural disequilibrium
• Due to structural changes in the country in the economy affecting demand
and supply relations in commodity and factor markets (e.g. India in 1991)
Example :- a. changes in tastes, fashion, habits or income, b. demand for
raw material decreases due to tech changes.
• Structural changes in factor markets
• Changes in supply of factors of production
• Shortage/excess supply –change in production
• Change in commodity price & export
• Structural changes in developing countries
Causes of BOP disequilibrium
1. Increase in import
• Import of essential goods and services
• Development programmes:– import of capital goods, raw material &
high skilled and specialized man power unavailable/short supply,
import continues for long time
• Population growth (import of essential commodities due ti large size
of population
• Demonstration effects:- increase income & awareness of high standard
of living of foreigners induce people to imitate the foreigners,
international demonstration effect & increase propensity to import
2. Low or decline in exports
• Low income elasticity of demand:– most of the poor countries–
primarily goods export
• Discovery of substitutes:– technological & scientific improvements
decreases in raw material requirement/ content
• Protectionist trade policy:- most developed countries do not follow
free trade policy, they impose NTBs on their import
• Example: place of origin, quality requirement, dumping etc
3. cyclical transmission
• Recession/ depression in one or more developed countries may affect
rest of the world (1930 depression)
• Negative effects of trade cycle i.e. low income, low demand etc. are
transmitted from one country to another.
4. Capital flight:-
• removal of restrictions on the movement of capital- money capital
flow to those countries which yield higher returns
• Economic and political troubles/ speculation in foreign exchange
market
5. Structural adjustments
• Liberalization and more freedom to private sector
• Change in macro variables- increase imports in initial stage
6. Globalization:
• WTO and change in world economic environment
• More liberal & open atmosphere
• Increased competition & BOP problems
Measures to correct BOP disequilibrium
1. Expenditure reducing (adjusting) policies, also known as
deflationary policy.
A. Tight monetary policy:-
i. Increase in policy rates (CRR, SLR, Repo rate etc.)
ii. Decrease money supply and increase interest rate
iii. Discourage investments
B. Contractionary fiscal policy
• Decrease in government expenditure/ increase in taxes
• Decrease in domestic expenditure and decrease in import
• Decrease in price and increase exports
2. Expenditure switching policies
• BOP deficit-- devaluation/ depreciation
• BOP surplus– revaluation/ appreciation
• Devaluation refers to an official announcement through which the value of
domestic currency is reduced
• Devaluation makes exports cheaper and import costlier
• It influence the prices of only traded goods
• People switch the expenditure from domestic goods to the goods of the country
which devalued its currency
3. Direct measures:
• Tariffs
• Quotas
• Export promotion:- decrease export duty/ export subsidy and tax
concession, export promotion through exhibition, trade fair and market
research
• Import substitution: concessions to industries producing import
substitutes--> tax concession, tech assistance, subsidy and provision of
scarce input etc.
• Financial control:- exchange control:- multiple exchange rates–
different rates of exchange for the trade of different commodities and
for transaction with different countries