MBA 303: INTERNATIONAL BUSINESS MANAGEMENT

Unit I: Concept of International Business: Stages of Internationalization – International economic,

political, legal, competitive, social demographic and cultural framework – International trade theories.

INTERNATIONAL BUSINESS:

International Business refers to the exchange of goods and services between two parties of different
countries.

International Business may be understood as those business transactions involve crossing of national
boundaries.

International Business is the process of focusing on the resources of the globe and objectives of the
organization on the global business opportunities and threats in order to produce/buy/sell or exchange of
goods and services worldwide.

EVOLUTION OF INTERNATIONAL BUSINESS:

The origin of International Business goes back to human civilization. Sindh civilization had
many traces of having a trade relationship with the Eastern civilization. Later the concept of

International Business – a broader concept of integration of economies goes back to 19 th century.

The first phase was took with the end of first World War in 1919. the import of raw
materials by colonial countries emperor from colonies and exporting them finished goods again to
the colonies. There is an increase in the level of international business.

But after second world war in 1945, the most of the colonial governments refused to export the
raw materials and import finished goods for the purpose of protecting the domestic companies. There
is a decrease in international business.

The consequences of World War II had made the world countries to feel the need of
international co-operation of global trade which led to the formation of various organizations like
International Monetary Fund (IMF) and International Bank for Reconstruction and
Development(IBRD), now called AS World Bank.

NATURE OF INTERNATIONAL BUSINESS:

Globalization – is an attitude of mind – it is a mindset which views the entire world as a single market
so that the corporate strategy is based on the dynamics of global business environment. The
concept of globalization has filled up the concept of International business. In fact, the term
International Business was not popular before 2 decades. International Business is come from the
word International marketing and International Marketing is come from the word International Trade.

International Trade – International Marketing:

Originally, the producers used to export their products to the nearby countries and gradually
extended the export to far-off countries. Gradually the companies extended the operations beyond
trade.

International Marketing – International Business:

The MNC’s which are producing in home country band marketing them in foreign countries,
now started locating their plants and other manufacturing facilities in foreign/ host countries.

Later they started producing in one country and marketing in other foreign countries.

A true global companies views the entire world as a single market. There is a great
renovision, given by Arvindh Mills:

• Source raw material wherever they are cheapest.

• Manufacture wherever in the world is most cost effective.
• Sell in those markets where the prices are highest.
• Raise finance globally.
• ‘forge international strategy alliance.
• To manage all these, take the best talent from all over the world. And you will have
achieved the stature of a true multinational.

FEATURES OF INTERNATIONAL BUSINESS:

1. Large Scale Operations:

In International business, all the operations are conducted on a very huge scale. Production
and marketing activities are conducted on a very large scale. It first sell its goods in the local market
and then the surplus goods are exported.

2. Integration of Economies:

International Business integrates (combines) the economies of many countries. This is

because it uses finance from one country, labour from other country and infrastructure from another
country. It designs the product in one country, produces its parts in many different countries and
assembles in another country and sells in many countries.

3. Dominated by developed countries and MNC’s

 International Business is dominated by developed countries and their multinational
companies. Europe and Japan dominate the foreign trade, this is because they have high financial
and other resources.

4. Benefits to Participating countries:

International Business gives benefits to all participating countries. However, the developed
countries get the maximum benefits, the developing countries also get benefits. They get foreign
capital and technology. They get rapid industrial development. They get more employment
opportunities.

5. Keen Competition:

International Business has to face competition in the world market. The competition is
between unequal partners. In this situation, the developed countries are in favorable position as they
produce the superior quality goods and services, but developing countries find difficulty to face
competition.

6. Special role of science and technology:

International Business gives a lot of importance to science and technology. Science and
Technology helps the business to have a large scale production. Developed countries use high
technology. International business helps them to transfer top-end technology to the developing
countries.

7. International Restrictions:

International Business faces many restrictions on the inflow and outflow of capital,
technology and goods. Many government do not allow international business to enter their
countries. They have many trade blocks, tariff barriers, foreign exchange restrictions, etc. All this is
harmful to international business.

8. Sensitive Nature:

The International Business is very sensitive in nature. Any changes in the economic policies,
technology, political environment has a huge impact. Therefore it must conduct marketing research
to find out and study these changes. They must adjust their business activities and adopt accordingly
to survive changes.

9. International Business need accurate information to make appropriate decision.

 10. International Business house need not only accurate but also timely information.

11. International Business house segments their markets based on the geographic market segment

REASONS FOR EMERGENCE OF INTERNATIONAL BUSINESS:

To achieve higher rate of profits

The basic objective of the business firm is to earn profit. The domestic markets do not
promise a higher rate of profits. Business firms search for foreign market which hold promise for
higher rate of profits. Thus the objective of profits affects and motivates the business to expand its
operations to foreign countries.

Expanding the production capacity

Domestic companies expanded their production capacities more than the demand for product
in domestic countries. In such cases, these companies are forced to sell their excessive production in
foreign developed market.

Severe competition in home country

The countries oriented towards market economies since 1960’s, experience severe
competition from other business firm in the home country. The weak companies which could not
meet the domestic countries started entering the markets of developing countries.

Limited home market

When the size of the home market is limited either due to the smaller size of the population
or due to lower purchasing power of the people or both, the companies internationalize their
operations.

Political Stability v/s Political Instability

Business firms prefer to enter the politically stable countries and are restrained from locating
their business operations in politically instable countries. In fact, business firms shift the operations
from politically instable countries to the politically stable countries.

Availability of Technology and Managerial Competency

Availability of advanced technology and competent human resource in some countries acts as
pulling factors for business firms from the home country. The developed countries due to these
reasons attract companies from developing world. In fact, American and European countries depend
on Indian Companies for software products and services through their BPO’s.
 High cost of transportation

Initially companies enter foreign countries trough their marketing operations. At this stage,
the companies realize the challenge from the domestic companies. Added to this, the ho me
companies enjoy higher rate of profit margins where as the foreign firms suffer from lower profit
margins. The major factor for this situation is the cost of transportation,

Under such conditions, the foreign companies are inclined to increase their pro fit margin by
locating their manufacturing unit in foreign countries where there is enough demand either in one
country or in a group of neighboring countries.

Nearness to Raw materials

The source of highly qualitative raw materials and bulk raw materials is a major factor for
attracting the companies from the various foreign countries. Most of the US based companies open
their manufacturing unit in Middle East countries due to the availability of petroleum. These
companies, thus, reduces the cost of transportation.

Availability of Quality HR at less cost

This is the major factor, in recent times, for software, high technology and tele-
communication companies to locate their operations in India. India is a major source for high
quality and low cost human resources unlike USA and other developed countries.

Liberalization and Globalization

Most of the countries in the globe liberalized their economies and opened their countries to
the rest of the globe. These changed policies attracted the multinational companies to extend their
operations to these countries.

To increase market share

Some of the large-scale business firms would like to enhance their market share in the global
market by expanding and intensifying their operations in various foreign countries.

To achieve higher rate of economic development

International Business helps the governments to achieve higher growth rate of the economy,
increases the total and per-capita income , GDP, industrial growth, employment and income levels.
STAGES OF INTERNATIONALIZATION:

Every company in the International Business will pass through the 5 different stages of
Internationalization. They are:

Domestic Company

International Company

Multi-National Company

Global Company

Transnational Company

Stage – 1: Domestic Company

Domestic Company limits its operations, mission and vision to the national
boundaries. This company focus its view on the domestic market opportunities, supplies and
customers. These companies analyze the national environment of the country, formulate the
strategies to exploit the opportunities offered by environment. They never think of growing
globally. They believe in saying, “ if it is not happening in home country, it is not happening”.

Stage – 2: International Company

Domestic companies which grows beyond their production capacities, think of

internationalizing their operation. Those companies which decide to exploit the opportunities
outside the domestic country are stage – 2 companies.

These companies believe that the practices the people and products of domestic
business are superior to those of other countries. The focus of these companies is domestic but
extends the wings to the foreign countries. These companies select the strategy of locating a branch
in foreign markets and extend same domestic operations into foreign markets.

Stage – 3: Multi-National Company

International companies turn into the Multi-National companies when they start
responding to the specific needs of different country market regarding product, price and promotion.
This stage is also referred as Multi-Domestic companies. These companies formulate different
strategies for different markets. They operate like a domestic market of country concerned in each
of their market.
 Stage – 4: Global Company

A global company is the one, which has either global strategy. Global Company
either produces in home country or in a single country and focuses on marketing these products
globally or produces globally and focuses on marketing these products domestically.

Stage – 5: Transnational Company

It produces, markets, invests and operates across the world. It is an integrated global
enterprise that links global resources with global markets at profits. There is no pure Transnational.

APPROACHES TO INTERNATIONAL BUSINESS:

Douglas Wind and Pelmutter advocated four approaches of International Business. They are:

➢ Ethnocentric Approach
➢ Polycentric Approach
➢ Regiocentric Approach
➢ Geocentric Approach

Ethnocentric Approach:

The domestic companies normally formulates their strategies, their product design and their
operations towards the national markets, customers and competitors. The company exports the same
products designed for domestic markets to foreign countries. Thus maintenance of domestic
approach towards International business is Ethnocentric Approach.

Polycentric Approach:
The company establishes a foreign subsidiary company and decentralizes all the operations
and delegates decision-making and policy making authority to its executives. In fact company
appoints executives and personnel who direct reports to managing Director of that company.
Company appoints key personnel from he home country and all other vacancies are filled by people
of host country.

Regiocentric Approach:

The company after operating successfully in a foreign country, thinks of exporting to

the neighboring countries of the host country. At this stage, the foreign subsidiary considers
the regional environment for formulating policies. It markets more or less the same product
design, under polycentric approach in other country of region with the different market strategy.
Geocentric Approach:
Under this approach, the entire world is just like a single country for the company. They
select the employees from entire globe and operate with a number of subsidiaries. Each
subsidiary functions as an autonomous company in formulating policies, strategies, product design,
etc,.

DIFFERENCE BETWEEN DOMESTIC AND INTERNATIONAL BUSINESS:

Basis Domestic Business International Business

Approach DB’s approach is Ethnocentric IB’s approach is either Polycentric

Operating Approach.
Db or Regiocentric
formulates the strategies, IB Approach.
formulates the strategies, product
Activities product design towards the design towards the International
national markets, customers and markets, customers and competitors.
competitors.
Geographic DB’s geographic scope is within IB’s geographic scope varies from
scope the national boundaries of the the national boundaries of 2
domestic country countries up to a maximum of the
entire globe.

Operating Operating style including Operating style can be spread to the

Style production, marketing is limited to entire globe.
the domestic country

Environment It analyses and scan the domestic It analyses and scan the relevant
environment. international environment.

Quotas Quotas imposed by various Quotas imposed by various countries

countries on import and export not on import and export significantly
influence the domestic business. influence the international business.

Tariffs Tariff rates of various countries do Tariff rates of various countries do

not affect the domestic business affect the international business.

Foreign Foreign exchange rates and their Foreign exchange rates and their
Exchange rates fluctuations do not directly and fluctuations directly and
significantly affect the domestic significantly affect the international
business. business.

Culture Mostly domestic culture of the Mostly cultures of the various

country affects the business countries affect the operations of the
operations international business.
 Export- Import Domestic business is not affected International business is affected by
procedure the procedure of the various
countries.

Human Domestic business normally International business normally

employs the people from the same employs the people from various
country countries.
Resources
Markets and Meets the needs of the domestic Meets the needs of the markets and
customers markets and customers customers of the different countries.

Transactions Business transaction with in the Business transaction between two

country. different countries.

ADVANTAGES OF INTERNATIONAL BUSINESS:

1. High Living Standard

Customers in various countries can buy more products with the same amount of money in the
International Markets. In turn, it can also enhance the living standard of the people through
enhanced purchasing power and by consuming high quality products.

2. Increased Socio-Economic Welfare

International business enhances the consumption level, and economic welfare of the trading
countries.

3. Wider Markets

International business widens the market and increases the market size. Therefore, the
companies need not depend on the demand for the product in one single country or customer’s
taste and preferences.

4. Reduced effects of Business Cycle

The stages of business cycle vary from country to country. Therefore, MNC’s shift from the
country experiencing a recession to the country experiencing the boom conditions. Thus,
international business firms can escape from the recessionary conditions.

5. Reduced Risks

Both commercial and political risks are reduced for the companies engaged in international
business due to spread in different countries.
6. Large Scale Economics

MNC due to the wider and larger markets produce larger quantities, which provide the benefit
of large-scale economies like reduced cost of production, availability of expertise, etc.

7. Potential Untapped Markets

International business provides the chance of exploring and exploiting the potential markets
which are untapped so far. These markets provides the opportunity of selling the product at a
higher price than in domestic markets.

8. Provides the opportunities for and challenge to domestic business

International Business firms provides the opportunities to the domestic companies. These
opportunities include technology, management expertise, market intelligence, etc,.

9. Division of Labour and Specialisation

International business leads to division of labour and specialization. Brazil specializes in coffee,
Kenya in tea, Japan in automobiles.

10. Economic Growth of the world

Specialisation, division of labour, enhancement of productivity, posing challenges, development

to meet them, innovations and creations to meet the competition lead to ovrall economic growth
of the world nations.

11. Optimum and proper utilization of world resources

International business provides for the flow of raw materials, natural resources and human
resources from the countries where they are in excess supply to those countries which are in
short supply or need most.

12. Cultural Transformation

International business benefits are not purely economical or commercial, they are even social
and cultural. There is a close cultural transformation and integration.

13. Knitting the world into a closely interactive Traditional Village

International business ultimately knits the global economies, societies and countries into a
closely interactive and traditional village where one is for all and all are for one.
DISADVANTAGES OF INTERNATIONAL BUSINESS:
1. Political Factors

Political instability is the major factor that discourages the spread of international business.

2. Huge Foreign Indebtedness

The developing countries with less purchasing power are lured into a debt trap due to the
operations of MNCs in these countries.

3. Exchange Instability

Currencies of countries are depreciated due to imbalances in the balance of payments, political
instability and foreign indebtedness. This, in turn, leads to instability in the exchange rates of
domestic currencies in terms of foreign currencies.

4. Entry Requirements

Domestic governments impose entry requirements to multinational.

5. Tariff Quotas and Trade Barriers

Governments of various countries impose tariffs, import and export barriers in order to protect
the domestic business. Further these barriers are imposed based on the political and diplomatic
relations between or among various governments.

6. Corruption

Corruption has become an international phenomenon. The higher rate bribes and kickbacks
discourage the foreign investors to expand their operations.

7. Bureaucratic Practices of Government

Bureaucratic attitudes and practices of government delay sanctions, grants permission and
licenses to foreign companies.

8. Technological Pirating

Copying the original technology, producing imitative products, imitating other areas of business
operations were common in Japan . this practices invariably alarms the foreign companies
against expansion.
 9. Quality maintenance

International business firms have to meticulously maintain quality of the products based on
quality norms of each country. The firms have to face severe consequences, if they fail to
conform to the country standards.

10. High Cost

Internationalizing the domestic business involves market survey, product improvement, quality up
gradation, managerial efficiency and the like. These activities need larger investments and involve
higher cost and risk. Hence, most of the business houses refrain themselves from
internationalizing their business.

INTERNATIONAL BUSINESS ENVIRONMENT:

Environment means surrounding. International business environment means the

factors/activities those surround/encircle the international business. In other words, business
environment means factors that affect or influence the MNC’s and transnational companies.

Factors that affect International Business include Social and Cultural factors (S), Technological
Factors (T), Economic Factors (E), Political/Governmental factors (P), International factors (I) and
Natural factors (N). [STEPIN]

William F. Glueck defined the term environmental analysis as, ‘ the process by which
strategists monitor the economic, governmental/legal, market/competitive, supplier/technological,
geographic and social settings to determine opportunities and threats to their firms”.

Factors of International Business Environment:

Business environmental factors are broadly divided into internal environmental factors and
external environmental factors. Internal environmental factors include human resource
management, trade unions, organization structure, financial management, marketing management
and production management management/leadership style, etc.

External environmental factors are further divided into micro and macro external
environmental factors. Micro environmental factors include competitors, customers, market
intermediaries, suppliers of raw materials, bankers and other suppliers of finance, shareholders and
other stakeholders of the business firm. External macro environmental factors include social and
cultural factors, technological factors, economic factors, political and governmental factors,
international factors and natural factors.
 1. CULTURAL ENVIRONMENT:

Culture is, “ the thought and behaviour patterns that member of a society learns through
language and other forms of symbolic interaction – their customs, habits, beliefs and values, the
common view points which bind them together as a social entity…. Cultural change gradually picking
up new ideas and dropping old ones, but many of the cultures of the past have been so persistent and
self contained that the impact of such sudden change has torn them apart, uprooting their people
psychologically.”

Characteristics:

• Culture is derived form the climatic conditions of the geographical region and economic
conditions of the country.
• It is a set of traditional beliefs and values which are transmitted and shared in a given
society.
• It is a total way of life and thinking patterns that are passed form generation to generation.
• It is norms, customs, art, values, etc.
• It prescribes the kind of behaviour considered acceptable in the society.
• It is based on social interaction and creation.
• Culture is acquires through learning but not inherited genetically.
• Culture is not immune to change. It goes on changing.

Factors influencing International Business:

1. Cultural attitude and International Business:

Dressing habits, living styles, eating habits and other consumption patterns, priority of needs
are influenced by culture. The eating habits vary widely. Similarly, dressing habits also vary from
country and county based on their culture.

2. Cultural Universal

Irrespective of the religion, race, region, caste, etc, all of us have more or less the same
needs. These common needs are referred as “Cultural Universal”. The cultural Universal enable the
businessmen to market the products in many foreign countries with modifications. Example: TV’s,
cars, vedio games.

3. Communication with languages

 Language is the basic medium of communication. There are more that 5000
spoken languages in the world. The same words in the same language may mean different
things in the different regions of the country.

4. Time and Culture

Time has different meaning in different cultures. Asian di not need appointment to
meet someone and vice-versa. But Americans, Europeans and Africans need prior
appointment to meet someone and vice-versa. In Asian Countries, particularly in India,
auspicious time is most important for the business, admission in a college, travel, etc.

5. Space and Culture

Space between one person to another person plays a significant role in

communication. But, culture determines the pace/distance between one person and another
person. Americans need more distance from a third person for privacy. This is unimportant
for Indians.

6. Culture and Agreement

The USA is very legalistic society and Americans are very specific and explicit
in their terms of agreement. The opposite is true in case of Asian countries. Asians never
pick up face to face confrontation. They keep quiet in case of disagreement.

7. Culture and Friendship

Americans develop friendship even in short time. In fact, they don’t develop deep
personal ties. Sometimes, people in the US complete the business and then develop
friendship. People in India, Japan and China firs develop friendship through several means
including eating together, presenting gifts and then transact business.

8. Culture and Negotiation

Americans are straightforward. Chinese negotiations are generally tough-minded

and well prepared and use various tactics to secure the best deal.

9. Culture and Superstition

 Superstitious beliefs like fortune telling, palm reading, dream analysis, phases of the
sun and moon, vaastu are prominent in Asian Countries and also in some African
Countries. Americans knock on wood, cross their fingers and feel uneasy when a black cat
crosses their path. Even Indians feel uneasy when a cat crosses their path.

10. Culture and Gifts

Culture attitudes concerning the presentation of gifts vary widely across the
world. In Japan and India gifts are given first, but in Europe only after a personal
relationship id developed. The international businessmen should study the customs of
the society in offering gifts.

2. SOCIAL ENVIRONMENT:

It consists of religious aspects, language, customs, traditions, tastes and preferences,

living habits, dressing habits, etc., It also influence level of consumption. Example:
The economic position of Germans and French people is more or less same, culturally
different. So study of social environment helps in deciding type of market, product, etc.

The various factors of social environment effect on international business are:

1. Religion:

Religion is one of the important social institution on influencing the business. The
religious play a vital role in normal and ethical standards in production and marketing of
goods and services. Most of the religion indicates in providing truthful and honest
information.

2. Family system:

In addition to religion, family system has impact on international business.

Example: Most of Islamic countries, women play less significant role in economy and also
in family with limited rights. But in Latin American countries, role of women is better
compared to that of Islamic countries. But women play a dominant role in European and
North American countries.

3. Behavioural factors affecting the business:

 Human behaviour affects the business include employee behaviour, consumer
behaviour and behaviour of stake holders (Holders of debentures, bonds, etc. Cultural
factors also influence the human behaviour cultural differences in various countries results
in variations in human behaviour from country to country. Business should consider
behaviour pattern of social groups in hiring, marketing and in selecting supplier of inputs
and market intermediaries.

4. Behaviour based on group membership:

Attitude towards female employment vary from country to country. Example:

Arabian countries discourage females from seeking employment. Family membership is
paramount rather than individual achievements in certain societies like India, China, etc.,

5. Motivations and Achievements:

Economic development of a country depends on motivations of people to work

hard and desired of achievement. People rank the motivational needs differently from
country to country. People from poor countries are mostly motivated by compensation
while their counter parts in rich countries are motivated by the higher order needs like more
responsibility, recognitions and other esteem needs.

6. Power Distance:

Power distance denotes the relationship between superior and sub-ordinates. People
in low power distance prefer little consultations between superior an subordinates.
Subordinates in high power distance may prefer participating in decision making among
themselves excluding the superior.

7. Individualism V/s Collectivism:

Individualism and collectivism are consequences of the culture and affects the
formation of group, productivity and marketing practices.

8. Risk taking behaviour:

Employees in countries with the highest scores of the uncertainty avoidance prefer
a system and a methodological work based on rules that are not to be deviated. Employees
in countries with the low scores of uncertainty avoidance prefer flexible organization and
flexible work.

Example: People in some countries like Norway trust most of the people and people
in some other countries like Brazil are very cautious in dealing with other.

3. TECHNOLOGICAL ENVIRONMENT:

Technology is the application of knowledge. In other words, technology has a

systematic application of scientific or other organized knowledge to a particular task.

Features:

a) Technology brings changes in the society, economy and

politics. b) Technology effects on entire globe.

c) Technology makes more technology possible.

Impact of technology on international business:

1. Investments in technology:

Advanced countries spend considerable amount on research and development for

further advancement of technology. Example: German spends 50% of research and
development budget on product innovation and remaining 50% on process innovation. But
Japanese spend 70% on process innovation and 30% on product innovation.

2. Technology and economic development:

Technology is one of the significant factor, determines the level of economic

development of a country. The differences between nation is mostly reflected by the
level of technolog y. Example: India has the vast natural resources. It remain importing the
products from other countries through exporting raw materials from itself due to its low
level of technology.

3. Technology and International competition:

 A few companies invent but many companies adopt scientific knowledge to generate
wealth by application and communication. The invention process and global
competitiveness are the two determinants of a national wealth. Example: Japan
concentrates on innovation of automobiles. But Italy concentrates on innovation of textiles
and leather.

4. Technology Transfer:

Technology and global business are interdependent. International business spread

technology from advanced countries to developing countries by establishing the
subsidiaries or establishing the subsidiaries joint ventures with the host countries and
arranging technological transfer to the company of developing countries through
technological alliances.

5. Technology and location of plants:

MNCs locate their manufacturing facilit ies based on the technology. In other
words, MNCs locate their plants with high technology in advanced countries and establish
the labour driven manufacturing facilities in developing countries in order to get the
advantages of cheap labour.

6. Scanning of Technological environment:

The level of technology is not same in all the countries. Advanced countries enjoy the
latest technology while the developing nations face he consequences of outdated
technology. Therefore, MNCs have to understand technology and analyse it before entering
foreign market.

7. Appropriate technology:

The technology that suit one country may not be suitable for other countries. As such
the countries develop appropriate technologies which suit their climatic conditions, social
cond itions, conditions of infrastructure etc., Ex: Japanese automobile industry design
different type of cars which suit the Indian roads.

8. Technology and globalization:

 The industrial revolution resulted in large scale production and the recent technological
revolutions leads to the production of high quality products at lower cost. These factor
forced the domestic company to enter the foreign countries in order to find market for
their products. Thus technology is one important cause for globalization.

9. Information technology and globalization:

The information technology redefined the global business through its development like
internet, www sites, e-mails, information super highways and on-line transactions brought
significant development to the global business.

Impact of technology on globalization:

• Technological advances have tremendously faster globalization. Technology have

been a very important facilitating factor of globalization.
• Several technological development becomes a compelling reason for
internationalization technology are substantially increasing the scale economies and
market scale required to break even.
• Global sourcing encouraged not only to trade liberalization but also by
technological developments which reduces transportation cost.
• Technology monopoly encourages internationalization because the firm can
exploit the respective demand without any competition.
• Development in telecommunication and information technologies have reduced the
barriers to time and place in doing a business. It is possible for customers and
suppliers to transact the business at any time and any part of the globe.
4. ECONOMIC ENVIRONMENT:

Economic environment refers to all those economic factors which have a bearing on
functioning of a business unit. Economic environment of various countries directly
influences the international business. In fact, international economic environment and
global business interact with each other.

The major changes include:

• Capital flow rather than trade or product flow across the globe.
• Establishment of production facilities in various countries.
 • Technological revolution link the relations between the size of the production and
level of employment.
• The macro economic factors of individual nations independently donot significantly
control the global economies.

Economic system:

Economic system is one of the important factor of economic development that

influences the international business to the greater extent. Economic system is an
organization of institutions established to satisfy human needs or wants.

There are three types of economic system viz.,

➢ Capitalistic Economic System

➢ Communistic Economic System
➢ Mixed Economic System

Capitalistic Economic System: This system provides for economic democracy and
customer choice for product or service. This system emphasizes on the philosophy of
individualism, believing in private ownership of production and distribution facilities Ex:
USA, Japan, UK.

Communistic Economic System: Under this system private properties and property rights to
income are abolished. The State owns all the factors of production and distribution but the
major limitation of this system is to reduced the individual freedom of choice ;and failed to
achieve significant economic growth.

Mixed Economic System: Under this system, major factors of production and distribution
owned, managed and controlled by the State. The purpose is to provide benefits to public
more or less on equality basis. This system, does not distribute the existing wealth
equally among people, but believes in full employment and suitable rewards for the
workers efforts. Ex: India, UK, France, Holand etc.,

Countries classified on the basis of income:

➢ Low income countries

➢ Lower middle income countries
➢ Upper middle income countries
 ➢ Higher Income countries

Low Income Countries: This country is also known as third world countries or pre
industrial countries. The characteristics includes, high birth rate, low literacy rate, political
instability an unrest, technological backwardness, underutilization of natural resources,
excessive unemployment and underemployment, and excessive dependency on imports.

Lower Middle Income Countries: These countries are known as less developed countries.
The characteristics of these countries include – early stage of industrialization, expansion
of consumer market, availability of cheap and motivated human resource, location for
production of standardized products or exporting, ex: clothing for exports.

Upper Middle Income Countries: These countries are called industrializing countries.
The characteristic of these countries are – less dependency on agriculture, high exports,
increase in literacy, formal education, rapid economic development, occupation mobility of
people from agriculture to industry and increased wage rate.

High Income Countries: These countries are known as advanced countries,

industrialized, post - industrialized or first world countries. The characteristics include –
development of information sector, emphasize on future plan, development of intellectual
technology over machine technology and it aims at building information society.

Impact of economic environment on international business:

1. Economic growth:

Business helps for the identification of peoples’ needs, wants, production o f goods and
services and supply to the people. Thus it creates for the conversion of inputs into the
outputs and enables for consumption. It leads to economic development. The high
economic growth rate of the countries providing an opportunity of expanding market
shares to international business firms, managers of the MNCs are interested in knowing
the future economic growth rate of various countries in order to select the market either to
enter or concentrate more resources to the market.
 2. Inflation:

It is the another important factor that affects the market share of the international
business firm. It affects the interest rate as the demand for money is high due to the higher
prices and it also affects the exchange rate of the domestic currency in terms of various
foreign currencies.

3. Balance of payments:

Balance of Payments position of a country is an outcome of international business and

also affects the future of the international business. Export and import trade in goods
and services affects the current accounts position and flow of capital affects capital
accounts position. The managers of MNCs should monitor the balance of payment
position of the countries.

4. Economic Transition:

The process of liberalization provided a significant opportunities to MNCs to enter

most of the countries of the world either by locating their manufacturing facilities or
expanding or both. Thus MNCs are immediate and greatest beneficiaries of L, P and G of
world economies.

5. POLITICAL ENVIRONMENT:

The influence of political environment on business is enormous. Political system

prevailing in a country promotes, decides, encourages, directs and control the business
activities of that country. PE includes factors such as characteristics and policies of
political parties, the nature of constitution and Government system and the Government
environment influencing the economic and business policies and regulation.

Concepts:

1. Political ideology:

Political ideology is the body of complex ideas, theories and object ives that
constitute a socio- political program. Political ideologies of the people in the same
country vary widely due to the variations in culture, ethic group, community groups,
 religious and the economic groups. These variations influence the people to form
different political parties. The difference in political ideologies change the national
boundaries. The IB manager should understand these ideologies of various in the countries
in order to know the possible political tensions and instabilities.

2. Democracy:

It refers to political arrangement in which the supreme power is vested in the hand of
people.

3. Political rights and Civil liberties:

It helps for evaluating the freedom of citizens. The major indicators of political
liberties include:

• conduct of elections fairly and competitively

• power and ability of the voters in casting their votes in the process of electing
• people ability in forming political parties and
groups.

The major indicators of civil liberties include:

• Degree of freedom of the press,

• Equality for all individuals under the law,
• Freedom from extreme in difference of Govt. and corruption.

Totalitaranism:

It refers to an individual freedom is completely subordinated to the power of authority of the

state or concentrated in the hands of one person or in a small groups.

Political Relations and International business:

Political friendly relationship results in the growth of bi-lateral or multi-lateral trade. Ex:
The friendly relationship between Indian companies but also the MNCs operating in
India to have a close business linkages with the USSR. Similarly the friendly relationship
between Pakistan and USA helped the Pakistan companies to have a close business linkages
with USA.
Types of Political System:

Appraisal of political system help us in having a ideas of political system and their
impact on international business. The are classified as:

Two party system: Two parties takes turn of controlling the Government under two party
system

Ex: USA and UK.

Multiparty system: In a multiparty system, there are many parties and no party is strong
to gain the control of the Government: Ex: Germany, France and India.

Single party system: In this system, only one dominant party gets the opportunity to
control the

Government even through several parties exists Ex: Egypt.

One party Dominated system: In this system, dominate party rules the Government
even though there are more than one party. Ex: USSR, Cuba.

Political Risk:

Political risk refers to risk of loss of assets earning power or managerial control, due to the
events or action that are politically motivated.

Political risk that affects the international business:

The international business firms face political risk as and when there are changes in
Government policies or changes in political parties in power. Risks are based on host
Government actions like:

Confiscation: The process of nationalization of property without compensation

is called confiscation.

Expropriation: It is the process of nationalization of a property with compensation.

Nationalisation: It is a process of shifting the ownership of private property from private

individuals to Government.
Domestication: In this, foreign business firm control and ownership in favour of
domestic investors either partly or fully.

General Instability risk: These risk are due to social, political, religious, unrest in the
host country.

Operation risk: These risk are due to imposition of controls on foreign business
operations by the host Government.

Political instability can be viewed from the corruption, social unrest, attitudes of nationals
and policies of host Government.

How to minimize the political risk?

The risk that are involved in international business cannot be avoided but it can be
minimized. It can be minimized from the following:

Stimulation of the local economy: The foreign company can stimulate the economic
development of host country by investing in their priority area. The foreign countries can
stimulate the host country economy by being export oriented.

Employment of nationals: MNCs can minimize political risk by employing, developing

and promoting the local people.

Sharing ownership: Foreign company should allow the domestic investors to invest and
share the ownership by converting the company into public limited company and ownership
can be shares through joint ventures.

De-civic minded: The MNCs in addition to doing business in foreign countries should also
be good corporate citizen. It may help the foreign countries in different ways like
constructing schools, hospitals, roads, etc.,

Political Neutrality: MNCs should not involved in political risk or disputes among the
local group of host countries from the point of view of long run
interest.
INTERNATIONAL TRADE THEORIES:

International trade becomes possible for mutual benefit to the two countries
due to the difference in opportunity costs. International trade between two countries
can benefit both countries if each country exports the goods in which it has a comparative
advantage. However, initially countries used to earn gold through international trade. A
number of theories have been developed by the international economists to explain how
does international trade takes place. These theories include:

➢ Mercantilism;
➢ Theory of Absolute Cost Advantage;
➢ Comparative cost advantage theory;
➢ Relative factor endowments/Hukscher-Owen Theory;
➢ Country similarity theory;

1. MERCHANTILISM:

Mercantilism is the oldest international trade theory that formed the foundation of
economic thought during about 1500 to 1800. According to this theory the holdings of a
country’s treasure primarily in the form of gold constituted its wealth. This theory
specifies that countries should export more than they import and receive the value of trade
surplus in the form of gold from those countries which experience trade deficits.

Governments imposed restrictions on imports and encouraged exports in order to

prevent trade deficit and experience trade surplus. Colonial powers like the British used to
trade with their colonies like India, Sri Lanka, etc., by importing the raw materials from
and exporting the finished goods to colonies. The colonies had to export less valued
goods and import more valued goods. Thus colonies were prevented from manufacturing.
This practice allowed the colonial powers to enjoy trade surplus and forced the colonies to
experience trade deficits. The theory benefited the colonial powers and caused much
discontent in the colonies. In fact, this was the background for the American Revolution.

The Mercantilism theory suggest for maintaining favourable balance of trade in the
form of import of gold for export of goods and services. But the decay of gold standard
reduced the validity of this theory. Consequently this theory was modified in Neo-
mercantilism. Neo mercantilism proposes that countries attempt to produce more than the
demand in the domestic country in order to achieve a social objective like full
employment in the domestic country or a political objective like assisting a friendly
country. This theory was attacked on the ground that the wealth of a nation is based on its
available goods and services rather than on gold. Adam Smith developed the theory of
absolute cost advantage which says that different countries can get the advantage of
international trade by producing cer4tain goods more efficiently than others. Now we shall
discuss this theory .

2. THEORY OF ABSOLUTE COST ADVANTAGE:

Adam Smith, the Scottish economist viewed that mercantilism weakens a country. He
advocated free trade among countries to increase a country’s wealth. Free trade enables a
country to provide a variety of goods and services to its people by specializing in the
production of some goods and services and importing others. Which goods should a
country produce and which goods it should import? Adam Smith a theory to answer this
question.

Adam Smith proposed Absolute Cost Advantage. Theory of International Trade

(1776) based on the principle of division of labour. According to him application of this
principle to international scenario helps the countries to specialize in the production of
those goods in which they have cost advantage over other countries.

According to Adam Smith, every country should specialize in producing those

products which it can produce at less cost than that of other countries and exchange these
products with other products produced cheaply by other countries. Trade between two
countries takes place when one country produces one product at less cost than that of the
another country and the other country has an absolute cost advantage over the first country
in producing in any other product.

Skilled Labour and Specialisation Advantage:

Countries have absolute cost advantage due to the following reasons:

• Suitability of the skills of the labour of the country in producing certain products.
 • Specialisation of labour in producing certain products leads to higher productivity
and less labour cost per unit of output.
• Economic of scale would reduce the labour cost per unit per output.

Natural Advantage:

In addition to the skilled labour and specialization advantage, countries do also have
natural advantage in producing certain products due to climatic conditions, access to certain
natural resources etc.,

Acquired Advantage:

In addition to the skilled labour and natural advantages, countries also acquire
advantages through technology and skills development. Japan acquired advantage in steel
production through the imports of both iron and coal. The reason for this success is that
Japan acquired labour saving and material saving technology. Denmark exports silver
tableware due to the ability of Danish companies in developing distinctive products.
Technologically advanced countries acquired abilities to develop substitute products for a
number of natural products.

Assumptions of the Theory:

Adam Smith proposed the absolute cost advantage theory based on the
fo llowing assumptions:

1. Trade is between two countries

2. Only two commodities are trades
3. Free trade exists between the countries
4. the only element of cost of production is labour.

Implications of Absolute Cost Advantage Theory:

This theory has the following implications:

• By trading, two countries can have more quantities of both the products.
• Living standards of the people of both the countries can be increased by trading
between the countries.
 • Inefficiency in producing certain products in some countries can be avoided.
• Global efficiency and effectiveness can be increased by trading.
• Global labour productivity and other resources productivity can be maximized.

Criticism:

• No Absolute Advantage: According to this theory, one country should be able to

produce at least one product at a comparatively low cost. But, in reality, most of the
developing countries do not have absolute advantage of producing any product at the
lowest cost. Yet they participate in international trade.
• Country size: Countries vary in size. This theory does not deal with country-
by-country differences in specialization.
• Variety of resources: Though thee are several resources like labour, technology and
natural resources, this theory deals with only labour and ignores all other resources.
• Transport cost: Though the cost of transportation plays a significant role in
international trade, this theory ignored this aspect.
• Scale Economic: Large scale economies reduces the cost of production and form
a part of the absolute advantage. But, this theory ignored that aspect also.
• Absolute Advantage for many products: Some countries may have absolute
advantage for many products. For ex., Japan, the USA, France, the UK etc. But this
theory does not deal with such situations.

3. COMPARATIVE COST ADVANTAGE THEORY:

Absolute Cost Advantage Theory fails to explain the situation when one
country has absolute cost advantage in producing many products. David Ricardo, a
British economist – expanded the Absolute Cost Advantage theory to clarify this situation
and developed the theory of Comparative Cost Advantage.

Assumptions:

▪ There exists full employment.

▪ The only element of cost of production is labour. Production is the subject to

the law of constant returns.

▪ There are no trade barriers.

 ▪ Trade is free from cost of production.

▪ Trade takes place between two countries.

▪ Only two products are traded.

▪ There are no costs of transport, etc.

Comparative cost advantage theory states that a country should produce and
export those products for which it is relatively more productive than that of other
countries and import those goods for which other countries are relatively more productive
that it is. The comparative cost advantage theory is based on relative productivity
differences and incorporates the concept of opportunity cost.

Comparative cost advantage theory also advocates that Japan should export audio tape
recorders to India and India should export pens to Japan.

Implications:

• Efficient allocation of global resources.

• Maximisation of global production at the least possible cost.
• Product prices become more or less equal among world markets.
• Demand for resources and products among world nations will be optimized.
• It is better for the countries to specialize in those products which they
relatively do better and export them.
• It is better for the countries to buy other goods from other countries who
are relatively better at pproducing them.

Comparative cost advantage theory is really an improvement over Adam Smith’s

theory of Cost Absolute advantage. This theory is not only an extension to the principles of
division of labour and specialization, but applies the opportunity cost concept. It is also
argued that lower lobour cost need not to be a source of comparative advantage.

4. RELATIVE FACTOR ENDOWMWNTS OR HECKSCHER- OHLIN THEORY:

In view of the criticism cost against comparative cost advantage theory, the question
pointed out by many of us was: How do the countries acquire comparative advantage? Eli
Heckscher and Bertil Ohlin – Swedish economists – developed the theory of relative
factor endowments – to answer this question. Factor endowments are land, capital, natural
resources, labour, climate, etc.

The observations made by these two economists include:

➢ Factor endowments vary among countries. Example: USA is rich in capital, India
is rich in labour, Saudi Arabia is rich in oil resources, etc.

➢ According to these economists, if labour is available in abundance in relation to land

and capital, in a acountry, the price of labour would be low and the price of land and
capital would be high in that country and vice- versa.

➢ These relative factor costs would lead countries to produce the products at low costs.

➢ Countries have comparative advantage based on the factors endowed and in turn the
price of the factors. Countries acquire comparative advantage in those products for
which the factors endowed by the country are used as inputs.

➢ Countries participate in international trade by exporting those products which

they can produce at low cost consequen upon abundance of factors and imp[ort the
other products which they can produce comparatively at high cost.

Land-Labour Relationship:

Countries where area of land available is less in relation to the people, go for
multistory factories and produce light-weight products.

Labour-Capital Relationship:

Countries where labour is abundant in relation to capital can be expected to export

labour- intensive products and vice-versa is true in case of capital abundant
countries. Thus, labour abundant countries acquire export competitiveness in products
requiring large amounts labour compared to capital.

Leontief Paradox:
 There are certain surprising aspects to the Labour-Capital Relationship in
international trade. Wassily Leonief observed that US exports are labour intensive
compared with US imports. But, it is assumed that the USA has abundant capital relative to
labour. Therefore, this surprise finding is known as the Leontief Paradox. This is because
of variation in labour skills. Advanced countries have higher labour skills compared to
developing countries.

Technological Complexities:

Technological advancements made it possible to produce products in different

methods. Canada produces wheat with more machines and India produces mostly with
labour. In addition, industries located different production processes in different countries
in order to reduce cost of production.

5. COUNTRY SIMILARITY THEORY

International trade takes place between two industries of two countries as discussed
earlier. But, international trade also takes place within each industry ( i.e, intra industry)
between two countries. Intra- industry trade amounts to nearly 40% of world trade.

Example: Japan exports Toyota cars to Germany whereas Germany exports BMW cars
to Japan.

Economic Similarity of Developed Countries:

Steffan Linder – a Swedish Economist explained the phenomenon of intra-industry

trade in

1961. According to Lindr, the similarities in consumer preferences in the countries that are at
the same stage of economic development provide the scope for intra-industry trade among
countries. Example: India and China are in the same stage of economic development.

According to this theory, the companies that develop new products for the domestic
market, export the products to those countries that are at the similar level of development
after meeting the needs of the domestic market.
Similarity of Location:

Countries prefer to export to the neighboring countries in order to have the

advantage of less transportation cost. Example: Finland is a major exporter to Russia due to
less transportation cost.

Cultural Similarity:

Countries prefer to export to those countries having similar culture. Example:

exports and imports among European countries.
Similarity of Political and Economical Interests:

Similar political interests, close political relations and economic interests

enable the countries to enter into agreements for exports and imports. Countries prefer to
trade with their politically friendly countries.