International Trade CHAPTER 12

Ricardo’s classic example of this concept is demonstrated in Table 12.1, which illustrates the allocation of labor time in England and Portugal, two l...

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International Trade and Investment

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ince World War II, most national economies around the world have become more integrated than ever as they have become more specialized within a global division of labor. Technological breakthroughs in transportation and communications, the decline in protectionism, and the growth of transnational corporations have contributed to this process. International business includes the international transmission of goods, services, information, and capital. Increasingly large numbers of companies invest in foreign countries to acquire raw materials, to penetrate markets, and to exploit cheap labor. The expansion of production overseas has been matched by a parallel, symbiotic expansion of services. International trade is expanding, and its composition and patterns are changing. But in many respects, it is now less significant than the international movement of capital. The late twentieth century marked a watershed in the world economy. First, industrialized countries experienced a slowdown in their economic growth rates, in part due to the petroshocks of the 1970s and the ensuing deindustrialization. Increases in oil prices reduced real income in the advanced countries and dealt a particularly harsh blow to the oil-importing Third World countries. These oil shocks left a permanent imprint on the structure of global finance, trade, and investment. Second, competitive rivalry among industrialized countries increased significantly as they developed their productive capacities in different sectors and sought foreign revenues via exports. Third, global financial markets underwent a profound series of alterations (Chapter 8). In 1973, the old Bretton-Woods monetary arrangement, which involved fixed monetary exchange rates and the convertibility of the U.S. dollar into gold, collapsed and was replaced by a system of fluctuating exchange rates, in which supply and demand dictated relative values of currencies. This change had serious effects on the relative prices of imports and exports worldwide. A global electronic network allowed vast sums of money to be traded internationally, creating an almost seamless financial market around the planet. The World Trade Organization became a permanent body for the regulation of barriers to trade. The fourth structural change was massive geopolitical realignments. Japan and other East Asian newly industrialized countries (NICs) enjoyed rapid industrial growth. China grew rapidly to become the world’s second-largest economy. The Soviet bloc collapsed, sending waves of turmoil throughout central Asia and Eastern Europe. And Europe pursued a relentless strategy of economic unity through the European Union, a path followed to some extent in North America under the North American Free Trade Agreement. This chapter examines the concepts and patterns that underlie the expanding world of international business. First, it reviews the major theories of trade, including classical comparative advantage and competitive advantage. Second, it discusses international capital markets, including exchange rates and foreign direct investment (FDI). It focuses on the role played by multinational corporations. Then the chapter considers major obstacles to trade, particularly tariffs, quotas, and nontariff barriers. Finally, it examines ways in which protectionism has declined, including the roles of trade organizations such as the General Agreement on Trade and Tariffs (now the World Trade Organization) and regional trade agreements such as the European Union and the North American Free Trade Agreement.

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INTERNATIONAL TRADE Trade among countries has long been central to capitalism and a major factor in linking various parts of the world together. World trade has jumped from $2 trillion annually in 1980 to over $11 trillion today. Why are so many countries, large and small, rich and poor, deeply involved in international trade (Figure 12.1)? One answer lies in the unequal distribution of productive resources among countries (i.e., uneven spatial development), which can be offset to some extent by trade. However, whether a country can export successfully depends not only on its resources but also on the 313

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FIGURE 12.1 World growth in exports by value, 1965–2005. Even though world exports have grown steadily over the time period represented here, the growth of world trade is under some question now. The global financial crisis of 2008–2010 has left an unprecedented degree of unemployed workers and underused factories in its aftermath. At the same time, across the rich world, the supply of workers is about to slow, while the number of pensioners rises. In Western Europe the working age population will shrink by 0.5% a year going forward, while in Japan the rate of shrinkage will be about 1.0% per year. America’s aging population demography is more favorable, but growth in its working-age population will eventually slow down to a third of its post–World War II average. The world is expanding at 4% in the second decade of the twenty-first century, but growth of the United States is less than 3% per annum, and growth of Europe is less than 2%—so low that there will be little, if any, reduction in the 40 million unemployed in these two major economic blocs. Clearly, most European countries waited too long to overhaul their welfare states. The added costs of global recession have now forced them to do the politically undesirable: chop social spending and raise taxes, leading to further production slowdowns. The United States must now deal with the same issues.

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opportunity, ability, and effort of producers to trade and the capacity of local producers to compete abroad. Production factors—labor, capital, technology, human capital and skills, entrepreneurship, and land containing raw materials—vary enormously from country to country. Some countries have populations large enough to support industrial complexes and domestic markets; others do not. One country is home to workers adept at running modern machinery; another abounds with scientists and engineers specializing in research-intensive products; yet a third has huge pools of unskilled workers. The imbalance in natural and human-made resources accounts for much of the international interchange of production factors and the products and services that the factors can be used to produce. There may be numerous reasons why countries cannot use their productive factors to best advantage, including inflation, exchange rates, labor conditions, governmental policies, and laws. Other countries are hobbled by the legacy of colonialism, drought, or political violence. Inflation, which is an increase in the general level of the prices of goods and services, can be detrimental to a country’s ability to compete domestically or internationally. Exchange rates, the prices of currencies in foreign exchange markets, can also influence competitiveness. For example, if a currency is overvalued in relation to other

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currencies, local producers may find it difficult not only to compete with foreign imports but also to export successfully. In addition, recurring labor disputes that interrupt production can create obstacles for exporters. Governments can encourage or discourage their export sectors through trade policies, currency manipulation, and the allocation of public resources to infrastructure or education. Finally, the competitiveness of exporters is affected by labor laws, tax laws, and patent laws. Trade by Barter and Money For much of human existence, trade was primarily conducted on a barter basis, the direct exchange of goods or services for other goods or services. Barter still occurs within some traditional markets in underdeveloped countries and is of importance to some countries internationally. Russia and eastern European countries use barter to trade among themselves and with underdeveloped countries. Major oil-exporting countries such as Iran and Nigeria barter oil and gas for manufactured goods. Despite its widespread use, particularly by governments that have turned toward economic protectionism, barter is a cumbersome way of conducting international exchange. Even within a country, consumers would find it difficult to

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barter goods or services to satisfy all their daily needs. In fact, more time would be devoted to exchange than to production. Money greatly simplifies exchange and trade within and among countries, although it does present problems such as those associated with exchange rates.

COMPARATIVE ADVANTAGE One of the hallmarks of capitalism is its tendency to generate uneven economic landscapes, that is, great differences in the types of economic activity from place to place as well as in the standards of living and life chances that those activities create. Different regions have long specialized in the production of different types of goods and services. In Europe during the Industrial Revolution, for example, Britain became a major producer of textiles, ships, and iron; France produced silks and wine; Spain, Portugal, and Greece generated citrus, wine, and olive oil; Germany, by the end of the nineteenth century, was a major exporter of heavy manufactured goods and chemicals; Czechs were selling glass and linens; Scandinavia sold furs and timber; and Iceland and Canada exported cod to the growing middle classes. Similarly, within the United States different places acquired advantages in some goods and not others: The Northeast dominated light industry, particularly textiles; the Manufacturing Belt became the center of heavy industry; Appalachia developed a large coal industry to feed the furnaces of the industrial core; the South grew crops such as cotton and tobacco; the Midwest became the agricultural behemoth of the world; the Rocky Mountains sold coal and copper; and the Pacific Northwest was incorporated into the national division of labor based on the expanding timber and lumber industry. When regions or countries specialize in the production and export of some goods or services, they enjoy a comparative advantage. This notion was first introduced by the famous nineteenth-century economist David Ricardo (Figure 12.2), a contemporary of Thomas Malthus and one of most famous figures in the history of economics. Like all classical political economists, he held to the labor theory of value (the value of goods reflects the amount of socially necessary labor time that goes into their production) and thus ignored demand, and so labor productivity was the central element of his model of trade. Ricardo concluded that nations will specialize in the production of a commodity that they can produce using the least labor, compared to other nations. Ricardo’s classic example of this concept is demonstrated in Table 12.1, which illustrates the allocation of labor time in England and Portugal, two long-time allies and trading partners, before and after they specialized and thus traded. In the first table, which depicts the labor hours per unit of wine or cloth that England and Portugal must each dedicate to the production of one unit of each good, it is evident that Portugal has an absolute advantage in both goods (i.e., it can produce both of them with fewer labor hours

FIGURE 12.2 David Ricardo (1772–1823) was one of the most influential figures in the history of economic thought. By spatializing Adam Smith’s notion of comparative advantage, he laid the theoretical foundations for the analysis of international trade and regional development.

than can England). If Portugal is more efficient in both goods, does it make sense for Portugal to trade? The answer is yes, because even the most efficient producer benefits from trade. Ricardo’s analysis examined what happens when each country allocates its resources to the good it can produce most efficiently compared to its trading partners (i.e., when it acquires a comparative advantage). Thus, in the second table, England produces only cloth (two units at 100 hours each) and Portugal produces only wine (two units at 80 hours each). In the process of specializing, that

TABLE 12.1 Ricardian Example of Comparative Advantage Before Specialization (labor hours/unit) Wine Cloth Total England 120 100 220 Portugal 80 90 170 units 2 2 390 After Specialization (labor hours/unit) Wine Cloth Total England 0 200 200 Portugal 160 0 160 units 2 2 360

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is, of producing for a market that consists of both economies together rather than either alone, each country frees up some resources that would otherwise have been dedicated to the inefficient production of a good in which it did not have a comparative advantage. England saves 20 labor hours, Portugal saves 10, and the combined trading system thus saves 30, which can be reallocated toward investment (the original model is static and says nothing about change over time). The Ricardian model—the simplest of many, more complex notions of comparative advantage—has important implications for economic geography. First, it shows how powerfully trade and exchange shape local production systems. It demonstrates that trade allocates resources to the most efficient (i.e., profitable) ends at minimum cost. The only costs of free trade are borne by inefficient producers, in this case, English wine growers and Portuguese textile producers (or today, U.S. auto and textile producers). Second, Ricardian notions of comparative advantage reveal that specialization reduces the total costs of production; thus, trade improves efficiency even without reallocating resources. Productivity arises from many sources, including technological change (which is absent in this model), but an increasingly specialized division of labor has long been central to capitalism’s growth and success. For this reason, the vast majority of economists favor free trade as beneficial to all parties concerned. Third, the Ricardian model points out that large markets allow more specialization than do small ones; thus, the combined market of England and Portugal allows more specialization than either could achieve alone. Adam Smith, the great political economist of the eighteenth century, noted the same thing when he stated that the “division of labor is governed by size of the market.” In this case, when the market expanded from one country to two, it allowed firms to specialize and become more efficient in the process. Large markets allow firms to develop economies of scale (Chapter 5) and become more efficient. Small economies, with limited domestic markets, thus tend to be inefficient ones.

Transport Costs and Comparative Advantage Clearly, just as there is no specialization without trade, there can be no trade without transportation. Goods must be moved across space from producer to consumer, and these transport costs must ultimately be borne by those who consume the goods. To the degree that transport costs affect the delivered price of commodities, they also influence consumers’ willingness to buy them and thus the competitiveness of the regions that export them. If transport costs are low, their impacts on the division of labor will be low. However, sometimes, particularly for heavy and bulky goods, transportation costs may increase the market prices of exports/imports prohibitively, as demonstrated in Figure 12.3. In the two regions here, A and B, the supply for the good is identical but the demand differs greatly. Producers in A can sell their good in region B for a high price, and thus earn a higher rate of profit. Unfortunately, the market price plus transport costs (MP ⫹ TC) of the imported goods in region B exceed the domestic production price in region A; in other words, the transport costs make the exports too expensive to ship across regions. Throughout the history of capitalism, declines in transport costs have made it progressively easier for regions to realize their comparative advantage; thus, lower transport costs have contributed to lower production costs and higher standards of living. For example, New Zealand became a major producer of lamb following the introduction of refrigerated shipping in the late nineteenth century. Similarly, the Pacific Northwest began to export vast quantities of wood and paper to the cities of the Midwest and East Coast following the completion of the transcontinental rail lines in the 1890s. Heckscher-Ohlin Trade Theory David Ricardo’s two-country, two-product theory of comparative advantage can be expanded by considering several countries and commodities and by taking into account several production factors. The multifactor approach to

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FIGURE 12.3 The influence of transport costs on comparative advantage. When the costs of shipping exports become greater than the differential in market prices between two countries, trade is inhibited. However, declining transport costs have steadily allowed for comparative advantages to flourish worldwide.

Chapter 12 • International Trade and Investment

trade theory derives from work by two Swedish economists, Eli Heckscher and Bertil Ohlin. The Heckscher-Ohlin theory takes the view that a country should specialize in producing those goods that demand the least from its scarce production factors and that it should export its specialties in order to obtain the goods that it is ill equipped to make. Unlike the original Ricardian model, the theory includes demand and allows for the production of more than one good. Typically, in this formulation, specialization of production will be incomplete, that is, countries may continue to produce some of a good even if they do not enjoy complete superiority in the costs of production. The Heckscher-Ohlin theory argues not only that trade results in gains but also that wage rates will tend to equalize as the trade pattern develops. The reasoning behind this factor-price equalization, as it came to be called, is as follows: If a country specializes in a labor-intensive good, its abundance of labor diminishes, the marginal productivity of labor rises, and wages increase. Conversely, in a different country specializing in capital-intensive goods, labor becomes less scarce, the marginal productivity of labor falls, and wages also fall. Inadequacies of Trade Theories Trade theories are based on restrictive assumptions that limit their validity. They generally ignore such considerations as scale economies and transportation costs. Scale economies improve the ability of a country to compete even in the face of higher factor costs. Trade theories assume perfect knowledge of international trading opportunities, an active interest in trading, and a rapid response by managers when opportunities arise. However, corporate executives are often ignorant of trading opportunities. Even if they are aware, they may fear the complexities of international trade. Other inadequacies of trade theories include the assumptions of homogeneous products, perfect competition, the immobility of production factors, and freedom from governmental interference. But products are not homogeneous; oligopolies exist in many industries; and production factors such as capital, technology, management, and labor are mobile. Governments interfere with trade; they can raise formidable barriers to the movement of goods and services, as well as labor, and affect interest, inflation, and exchange rates, which in turn affect the prices of imports and exports. The most important shortcoming of trade theories, however, is their failure to adequately account for the role of multinational corporations. In these corporations, trading decisions are made on the microeconomic level by managers, not by governments. Multinational corporations also operate from a multinational perspective rather than from a national perspective. When international trade occurs between different affiliates of the same company, it is referred to as intracorporate trade. Special considerations, such as tax incentives or no competition from other affiliates of the same company, can often play a pivotal role in a company’s international decisions.

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Fairness of Free Trade Free trade is best from the standpoint of efficiency, but is it fair given the existence of unequal exchange between developed and developing countries? This question is raised by world-systems theorists such as Wallerstein, for whom free trade was a weapon wielded by rich countries to pry open the markets of poor ones (Chapter 14). Their argument is that an artificial division of labor has made it difficult for developing countries to earn export revenues from free trade. The British were instrumental in creating an unfair global division of labor in the eighteenth and nineteenth centuries. Implicit in the argument in favor of free trade was the notion that what was good for Britain was good for the world. But free trade was established within a framework of inequality among countries. Britain found free trade and competition agreeable only after becoming established as the world’s most technically advanced industrial nation; prior to that period, Britain (and later, the United States) used protectionism extensively. For example, Britain levied high tariffs against textile imports from its colony India. Having gained a large initial advantage over other countries, Britain then threw open its markets to the rest of the world in 1849. Other countries were pressured to do the same. The pattern of specialization that resulted was obvious. Britain concentrated on producing manufactured goods, such as vehicles, engines, machine tools, paper, and textile yarns and fabrics, and exporting them in exchange for a variety of primary products such as furs, wines, silks, and bulk imports such as timber, grains, fruit, and meat. In this way, uneven spatial development was fostered and perpetuated. Although many countries gained from the application of this artificial division of labor, none gained more than Britain. The only way other countries could break out of this division of labor was by interfering with free trade. The United States was highly protectionist in the nineteenth century, and tariffs on imports were a major source of federal government revenues prior to the adoption of the income tax. Germany, France, Japan and other countries with embryonic industries did the same. The original division of labor changed little until after World War II, when a new global structure began to evolve. The basic trend was export-led industrialization, concentrated in a few countries. For the best-off poor countries, industrial growth is geared to the needs of the old imperial powers. Thus, the growth of manufacturing in the Third World, under multinational corporate auspices, is not a portent of its emancipation from an unfair division of labor. Worsening Terms of Trade A deterioration in the terms of trade—the prices received for exports relative to the prices paid for imports— exemplifies the problem for less developed countries of unequal exchange. By and large, less developed countries export raw materials and semiprocessed goods—agricultural commodities, lumber, fish, and minerals. Primary commodities account for about 70% and 47%, respectively, of

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the total exports of low- and middle-income countries (excluding China and India). The proceeds from these exports are needed to pay for imports of manufactured goods, which are vital for continuing industrialization and technological progress. Shifts in the relative prices of commodities and goods can therefore change the purchasing power of the exports of less developed countries dramatically. The situation is exacerbated because many of these low- and middle-income countries are dependent on a

single commodity for much of their revenues, which leaves them vulnerable to oscillations in the price of that good (Table 12.2). In the late twentieth century, less developed countries experienced a worsening in their terms of trade caused by a decline in the prices of primary commodities and an increase in the prices of manufactured goods. Globally, there are numerous producers of primary sector goods in competition with one another, and productivity gains in

TABLE 12.2 Single-Commodity-Dependent Countries Product’s Percentage of Total Export Earnings 40% to 59% Agriculture and Fishing Benin (cotton) Burkina Faso (cotton) Burma (lumber, opiuma) Chad (cotton) Cocos (Keeling) Islands (copra) Comoros (spices) El Salvador (coffee) Equatorial Guinea (cocoa, lumber) Finland (wood products) Ghana (cocoa) Grenada (spices) Honduras (bananas) Iceland (seafood) Kiribati (copra, seafood) Mali (cotton) Mauritania (seafood) Nicaragua (seafood) Sudan (cotton) Crude Oil and Petroleum Products Congo Ecuador Syria Yemen

Metals and Minerals Central African Republic (diamond) Chile (copper) Jamaica (aluminum) Liberia (iron ore) Mauritania (iron ore) Togo (phosphates) a

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Although impossible to quantify, Myanmar’s opium exports may exceed 40% of total exports.

Chapter 12 • International Trade and Investment

this sector have increased the supply much more than the demand, leading to falling prices, which is good for consumers but bad for exporters. Maintenance of trade deficits was possible only because the less developed countries had access to external sources of finance. The economies of many less developed countries are characterized by structural rigidity. They cannot alter the composition of exports rapidly in response to changing relative prices. Thus, if their commodity export prices decrease, they have no alternative but to accept declines in their terms of trade (Figure 12.4). Another factor that may lead to worsening terms of trade is technological advances in developed countries. Advanced technology enables industrial economies to (1) reduce the primary content of final products; (2) produce high-quality finished products from less valuable or lowerquality primary products; and (3) produce substitutes for existing primary products (e.g., synthetic rubber for naturally grown rubber). These developments are irreversible. The demand for many primary products may be inelastic for price decreases, but in the long run it may be very elastic for price increases. A rise in the price of a raw material is an incentive for industrial research geared to economizing on the commodity, or substituting something else for it, or producing it in the importing country.

COMPETITIVE ADVANTAGE The traditional theory of comparative advantage is very simplistic and unrealistic. Ricardo never gave an adequate account of why regions specialize in some goods and not others, instead offering a picture that is static with respect to time, overemphasizes labor productivity and does not explain its variations, ignores consumption as well as the role of economies of scale and agglomeration, says nothing about the nature of competition, and is silent concerning the impacts of public policy. Some of these

issues have been addressed by neoclassical models in successively more sophisticated and complex models of comparative advantage. A different model, advocated by Michael Porter, is called the theory of competitive advantage. Unlike the Ricardian model, which was useful for understanding the simpler economies of the early Industrial Revolution, Porter’s model focuses on the social creation of innovation in a knowledge-based economy. Porter begins by dismissing two commonly held myths about the source of national competitiveness, cheap labor and abundant natural resources. Is cheap labor central to economic success? Cheap labor is, on a worldwide scale, virtually ubiquitous. Countries that have succeeded in competing internationally, such as Germany or Japan, have done so with labor costs well above those of their competitors. Why? Because their labor is productive and well educated and because their economies endow workers with sufficient capital. In contrast, countries with the cheapest labor, say most of Africa, have done poorly in the global economy. Nor are abundant natural resources necessary for economic success. Japan, for example, has done well despite having virtually no resources, and many developing countries with resources are trapped in low-wage economies that export raw materials. In a global economy, flows of oil, minerals, and foodstuffs are available anywhere. What, then, does determine economic success? The key, in Porter’s formulation, is productivity growth: Over the long run, rising productivity creates wealth for everyone, if not equally. Productivity growth in turn is a reflection of many factors, including the education and skills of the labor force, available capital and technology, government policies and infrastructure, and the presence of scale economies (as discussed earlier). In the context of global markets, all firms can maximize scale economies. Porter emphasizes that competitive advantage, unlike the Ricardian view, is dynamic and changes over time. The goal of

FIGURE 12.4 The worsening terms of trade for ores, minerals, and nonferrous metals, 1980–2008. Many underdeveloped countries cannot alter the composition of exports rapidly in response to changing relative prices.

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national development strategies is to move into highvalue-added, high-profit, high-wage industries as rapidly as possible. Such goods have high multiplier effects and do the most to trigger rounds of growth. To accomplish this goal, firms and countries should seek to sell high-quality goods at premium prices in differentiated markets. Quality is a key variable here; countries often acquire reputations for producing high- or low-quality goods, earning (or not earning) brand loyalty as a result. Finland is well known for its production of cell phones, for example, just as Japan is well regarded for its automobiles. When moving into high-value-added goods, nations should seek to automate low-wage, low-skill functions and retain knowledgeintensive ones. Porter argues that although the global economy is increasingly seamless, competitive advantage is created in highly localized contexts (i.e., within individual metropolitan areas). Globalization does not eliminate the importance of a home base. Thus, countries that succeed internationally do so because a few regions within them move into cuttingedge products and processes. For example, the propulsive regions of the U.S. economy include Silicon Valley, Boston’s Route 128, and New York City’s financial and producer services firms; in Europe, they are Italy’s Emilia-Romagna, that continent’s largest high-technology region, as well as Germany’s Baden-Wurtenburg, Denmark’s Jutland peninsula, and the Cambridge region of the United Kingdom; in Japan, the government has actively constructed a series of technopolises toward this end. The overall determinants of competitive advantage include the following: 1. Skilled labor, good educational systems, and adequate technical training. 2. Agglomeration economies, including pools of expertise, webs of formal and informal interactions, trust, linkages, strategic alliances, trade associations, integrated networks of suppliers and ancillary services. 3. A culture that rewards innovation: adaptation, experimentation, risk tolerance, and entrepreneurship; this includes heavy levels of corporate and public research and development and the continual upgrading of capital and skills. Corporations must engage in ongoing and organizational learning, anticipating changes in markets and demand; rigid corporate bureaucracies, like public ones, lead to complacency and short planning horizons. 4. Competitive markets at home; uncompetitive markets (i.e., private or public monopolies) exhibit little innovation. In the world economy today, increasingly sophisticated buyers spur a constant upgrading in the quality of output. 5. Adequate financing and venture capital. 6. Public policies that encourage productivity growth, including subsidized research, export promotion, improved educational systems; and an up-to-date infrastructure (i.e., airports, telecommunications).

The theory of competitive advantage concludes that four attributes of a nation combine to increase or decrease its global competitive advantage and world trade: (1) factor conditions; (2) demand conditions; (3) supporting industries; and (4) firm strategy, structure, and competition. Factor conditions include land, labor, capital, technology, and entrepreneurial skill: 1. Human Resources The quantity, skill, educational level, productivity, and cost of labor. 2. Physical Resources Raw materials and their costs, location, access, and transport costs. 3. Capital Resources All aspects of the money supply and availability to finance the industry and trade from a particular country, including the amount of investment capital available; the savings rate; the health of money markets and banking in the host country; government policies that affect interest and exchange rates and the money supply; levels of indebtedness; trade deficits; public and international debt; and so forth. 4. Knowledge-Based Resources Research, development, the scientific and technical community within the country, its achievements and levels of understanding, and the likelihood for future technological support and innovation. 5. Infrastructure All public services available to develop the conditions necessary for producing the goods and services that provide a country with a competitive advantage. Included are transportation systems, communications and information systems, housing, cultural and social institutions, education, welfare, retirement, pensions, and national policies on health care and child care. These five factors are identified in current international and economic circles as the keys to the competitive advantage of a nation in the foreseeable future. Demand conditions are the market conditions in a country that aid the production processes in achieving better products, cheaper products, scale economies, and higher standards in terms of quality, service, and durability. Demand conditions cause firms to become innovative and therefore to produce products that will sell not only in the domestic market but also in the world market. To be competitive internationally, firms require access to networks of other firms specialized in different tasks in the economy. For example, large financial institutions require law firms, marketers, and advertisers. Often large companies use management consultants or similar business services, subcontracting tasks that require heavy investments in human capital. Access to these industries, which generally provide expertise, is often done through face-to-face contact. Firm strategy, structure, and competition relates to the conditions under which firms originate, grow, and mature. For example, because stockholders demand U.S. companies to show short-term profits, U.S. corporate performance

Chapter 12 • International Trade and Investment

may be less successful than it would be if it were judged over a much longer time period, as is Japanese and German corporate performance. State support of corporate strategy and performance is important. For example, a country can regulate taxes and incentives so that investment by a firm is high or low. In addition, competition within a country can impose demands on company performance; new business formations often pressure existing firms to improve products and lower prices and thus increase competitiveness.

INTERNATIONAL MONEY AND CAPITAL MARKETS In addition to trade, capital markets, or long-term financial markets, form another component of the international financial system. Stock exchanges, futures exchanges, and tax havens have proliferated. American, European, and Asian multinational corporations take advantage of tax-haven countries, countries where taxes on foreignsource income or capital gains are low or nonexistent (see Chapter 8). The global expansion of the financial system has three components: the internationalization of (1) currencies, (2) banking, and (3) capital markets. International currency markets developed with the establishment of floating exchange rates in 1973 and with the growth in private international liquidity, mostly in the form of eurocurrencies. Capital movements take two major forms. The first type involves lending and borrowing money. Lenders and borrowers may be in either the private or the public sector. The public sector includes governments or international institutions such as the World Bank and agencies of the United Nations. The second type of capital movement involves investments in the equity of companies. If a longterm investment does not involve managerial control of a foreign company, it is called portfolio investment. If the investment is sufficient to obtain managerial control, it is called direct investment. Multinational corporations are the epitome of direct investors. Monetary capital is the result of historical development. Unlike a natural resource like iron ore, it must be accumulated with time as a result of the willingness of a society to defer consumption. Low-income countries have low capacities to generate investment capital; all the capital that they do generate is usually employed domestically. Developed countries have much greater capacities for generating investment capital. They provide most of the world’s private-sector capital, although a few fast-growing countries such as the NICs are also capital exporters. Optimally, financial markets should produce an efficient distribution of money and capital throughout the world. However, there are many barriers to optimal distribution. Personal preferences of investors, practices of investment banking houses, and governmental intervention and controls confine money and capital movements to well-worn paths. They flow to some areas and not to others, even though the need in neglected areas may be greater.

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International Banking Paralleling the internationalization of domestic currency is the internationalization of banking (Chapter 8). International banks have existed for centuries; for example, banking houses founded by the Medici and the Rothschilds helped to finance companies, governments, voyages of discovery, and colonial operations. The banks of the great colonial powers—Britain and France—have long been established overseas. American, Japanese, and other European banks went international much later. Major American banks moved into international banking in the 1960s, and the Japanese banks and their European counterparts in the 1970s. Banks were enticed into international banking because of the explosion in foreign investment by industrial corporations in the 1950s and 1960s. The banks of different countries “followed the flag” of their domestic customers abroad. Once established overseas, many found international banking highly profitable. From their original focus on serving their domestic customers’ international activities, banks evolved to service foreign customers as well, including foreign governments. Euromarkets Eurocurrencies are bank deposits that are not subject to domestic banking legislation. With relatively few exceptions, they are held in outside countries, “offshore” from the country in which they serve as legal tender. They have accommodated a large part of the growth of world trade since the late 1960s. The eurocurrency market is attractive because it provides funds to borrowers with few conditions; it also offers investors higher interest rates than can be found in comparable domestic markets. At first, euromarkets involved U.S. dollars deposited in Europe; hence, they were called eurodollar markets. Although the dollar still represents about 80% of all eurocurrencies, other currencies, such as the deutsche mark and yen, are also vehicles of international transactions. Therefore, eurocurrencies is preferred to the less accurate term eurodollar. However, even eurocurrencies is a misnomer. Only 50% of the market is in Europe, the major center of which is London. Other eurocenters have developed in the Bahamas, Panama, Singapore, and Bahrain.

EXCHANGE RATES AND INTERNATIONAL TRADE In international trade, the buyer country must swap its currency for the currency of the exporting country. If a retail chain in the United States wants to buy televisions, video camcorders, or DVD players from Japanese firms, the buyer must convert U.S. dollars to Japanese yen in order to satisfy the terms of the purchase. As is the case with most international transactions—exports and imports— the seller receives payment in the currency of its own country, not in the currency of the purchasing country. The value of a currency compared with that of another country is called the exchange rate, that is, the amount

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of one currency required to purchase one unit of foreign money. Exchange rates are never stable but fluctuate constantly over time, with important impacts on the prices of imports and exports. For example, the U.S. dollar strengthened abroad during the 1990s as a result of economic stagnation abroad and currency devaluation by European governments. However, the dollar declined during the 2000s as the U.S. government hoped it would improve its trade deficits. To illustrate this notion in more detail, Figure 12.5 shows the changing relationship between the Mexican peso and the U.S. dollar as the peso was devalued. The demand curve, D, shows dollars sloping downward to the right. U.S. citizens will demand more Mexican pesos if they can be purchased with fewer dollars. Point P0 suggests that fewer pesos can be purchased with a dollar, whereas point P1 suggests that many more pesos are available per dollar. The demand for Mexican pesos in the United States is based on the amount of goods and services that a U.S. citizen wants to purchase in Mexico. A lower exchange rate for the peso makes Mexican goods less expensive to Americans. In Figure 12.5, the supply of pesos is upward-sloping to the right, which means that as the number of dollars increases per 10,000 pesos, more pesos are offered in the marketplace. Mexican residents desire more goods from the United States when the dollar exchange rate (price) for the peso is high. The more dollars per 10,000 pesos, the relatively cheaper American products are for Mexicans. Therefore, Mexican residents will demand more dollars with which to purchase American goods and will consequently supply more pesos to foreign exchange markets when the exchange rate for the peso increases. The equilibrium position is reached when supply and demand conditions for foreign exchange is based on supply and demand of international goods produced in Mexico demanded by Americans and American goods demanded by Mexicans.

Dollars per Thousand Pesos

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FIGURE 12.5 Determining the exchange rate of the U.S. dollar and the Mexican peso.

Line S2 represents devaluation of the peso because of economic restructuring in Mexico. This restructuring effectively reduced the number of dollars per 10,000 pesos on the international market. The result was that fewer American products could be purchased for the same amount of pesos because American goods and services became relatively more expensive. Cross-border purchases by Mexican border residents decreased dramatically, as did the international flow of goods and services from America to Mexico. At the same time, the quantity of pesos available to Americans increased from Q0 to Q1. American purchasers poured into border communities and increased their travel to the main tourist destinations within Mexico. The international flow of goods from Mexico to the United States increased because Mexican goods and services were relatively less expensive. When the dollar appreciates in foreign exchange markets relative to other currencies, it can buy more foreign currency and, therefore, more goods and services from other countries (Figure 12.5). As a result, American retailers import more goods to the United States. At the same time, the appreciated U.S. dollar means more costly American goods and therefore less demand for them. Exports from America decline under these circumstances. Thus, a strong dollar, which means that the dollar can buy more units of foreign currency, is not always desirable for U.S. trade. Conversely, when the dollar depreciates and is “weak,” it can buy fewer units of foreign currency and therefore fewer goods and services. Imports usually decline under these circumstances. Why Exchange Rates Fluctuate Exchange rates fluctuate for five reasons. First, as countries become wealthier, they typically import more goods from abroad. The result is that the increased demand for foreign currency raises the exchange rate of their currencies and decreases the value of the home country’s internationally. A second factor is the inflation rate of a nation. If the inflation rate of one nation increases faster than that of its trading partners, the currency of the nation with high inflation will depreciate compared with the currency of its trading-partner nations. Consequently, the products of the trading-partner nations will be more attractive to consumers in the country with high inflation. For example, when the U.S. inflation rate increases, the demand for Canadian dollars increases as investors seek a currency that will not lose its value so quickly. This demand raises the U.S. dollar price of both the Canadian dollar and Canada’s exports to the United States. At the same time, Canadians demand fewer of the comparatively higherpriced U.S. goods. Third, domestic demand is a factor in determining exchange rates. Real income growth and the relative price levels between countries affect domestic demand. However, domestic demand also depends on consumer tastes and preferences. Americans will pay higher prices for specialty items and technologically advanced foreign

Chapter 12 • International Trade and Investment

323

TABLE 12.3 Trade in the U.S. Economy, 1960–2008 1960

Exports Imports Net exports

$ Billions 23.3 22.3 4.7

1975 % of GDP 4.9 4.4 .9

$ Billions 136.3 122.7 13.6

goods such as electronic consumer products from Asia, French wines and perfumes, German automobiles, and Italian shoes than for comparable domestic products. An increase in the demand for foreign goods decreases domestic demand and causes the dollar to depreciate. Fourth, a country’s currency may appreciate on foreign exchange markets if its domestic interest rates rise and provide a higher yield to foreign investors. Foreign investors increase their demand for dollars in order to purchase companies overseas and thus supply more of their currency in exchange for the target country’s currency. When domestic interest rates are low compared to rates of return in other nations, they do not attract foreign investors. Conversely, as interest rates rise, a country’s currency becomes more attractive to investors elsewhere. Fifth, currency speculation affects exchange rates worldwide. Speculation is a prime cause of the “bubbles” that have affected finance-dominated capitalism for the past several decades. Speculation is often driven by expectations of future events, such as hopes that prices in a market will rise or fears of political disasters, which encourage individuals to sell the currency of that country to buy foreign currencies. If all people reacted in the same manner to such events, the market would be driven down for that currency against the dollar, and the anticipated depreciation would actually occur.

2000 % of GDP 8.6 7.7 0.8

$ Billions 937 1,048 -111

2008 % of of GDP 11.6 12.9 1.3

$ Billions 1826 2522 –696

% of of GDP 12.0 17.0 4.7

U.S. TRADE DEFICITS Because the United States is by far the world’s largest national economy, its trade situation deserves a closer look. The United States enjoyed a trade surplus throughout most of its history. Starting in the 1970s, however, the volume of its imports began to exceed the volume of exports (Table 12.3). The merchandise trade deficit was $25 billion in 1980, but by 2009, it had jumped to $850 billion. There are several causes of this trade deficit: an overvalued dollar, which makes imports cheap and exports expensive, and American consumers’ voracious demand for imported goods, often fueled by consumer debt (Chapter 11). As Figure 12.6 shows, the international value of the U.S. dollar has changed widely over time. Increases in the value of the dollar mean that U.S. currency and products are relatively expensive to foreign nations, whereas foreign goods are less expensive to Americans. The U.S. dollar peaked in value internationally in 1985, which increased the amount of foreign imports and decreased the amount of its exports. Since 1985, the value of the dollar has fallen steadily. While the U.S. demand for imported goods remains strong, its exports have not kept pace, leading to severe trade deficits of $800 billion annually (Figure 12.7). In short, Americans import significantly more products from other countries than they export to them. Many households and

International Value of the Dollar

Index, March 1973 = 1.0 1.60 1.50 1.40 1.30 1.20 1.10 1.00 .90 .80 .70 1973 1975 1977 1979 1981 1983 1985 1987 1989 1991 1993 1995 1997 1999 2001 2003 2005 2007 2009 1974 1976 1978 1980 1982 1984 1986 1988 1990 1992 1994 1996 1998 2000 2002 2004 2006 2008 FIGURE 12.6 International value of the dollar, 1973–2009. The value of the dollar against other currencies exerts a significant influence over the prices of U.S. exports and imports. The dollar’s value is determined by many things, including rates of inflation and interest between trading partners, speculative flows in currency markets, and government policy. The cheaper the dollar, the more foreign countries can afford to buy U.S. imports, thus improving job growth in America.

The World Economy: Geography, Business, Development

FIGURE 12.7 The U.S. merchandise trade deficit, 1960–2008. Because imports have exceeded exports, the United States regularly runs a deficit of more than $800 billion annually. Several factors account for this trade deficit. The first is that the United States is a rich country and can afford to import more than it exports. But the relatively high cost of labor in America makes American products more expensive outside its borders. Another factor is that some countries, such as China, undervalue their currency, leading to export-led economic growth. China's underpricing of exports and overpricing of imports hurts trading countries, from Brazil to India.

3000 2500

Billions of U.S. Dollars

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Exports Imports Trade Balance

2000 1500 1000 500 0 -500

corporations finance these purchases through debt, as do many corporations and the federal government. Results of the U.S. Trade Deficit The U.S. deficit has had several results: First, an increase in the volume of imports pushes prices of domestically produced goods down as they compete with cheap imports. This is good for consumers but not good for producers, who see their profit margins fall. For example, U.S. automobile manufacturers, steel manufacturers, and textile producers have been seriously affected by the trade deficit. The United States is a large net debtor instead of a creditor nation, owing foreign governments more than they owe it. Foreign debt includes federal government debt held by foreigners (largely Asians and West Europeans), primarily in the form of Treasury Department securities, as well as private debt issued by corporations. The total U.S. foreign debt was roughly $14 trillion in 2009 (about 90% of gross domestic product [GDP]), making the United States by far the largest debtor nation in the world. In other words, American consumers have been subsidized because more goods and services flowed into the country than flowed out of the country. The reverse is true for its lenders, including particularly Japan and China. The United States has been living above its means, and its consumers have received an economic boost, but this situation is not likely to be tenable in the long run. Large federal budget deficits and huge balance of trade deficits have led to the so-called selling of America to foreign investors. Foreign investors now own 26% of America’s total domestic assets.

CAPITAL FLOWS AND FOREIGN DIRECT INVESTMENT Closely related to trade flows is the flow of capital, including foreign direct investment (FDI). Given the massive scale of FDI today, understanding the rationale for such investments is important.

2008

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Three strategic profit motives drive a firm’s decision to operate abroad. One motive for many direct investments is to obtain natural or human resources. Resource seekers look for raw materials or low-cost labor that is also sufficiently productive. A second motive is to penetrate markets. The third goal is to increase operating efficiency. These three motives are not mutually exclusive. Some segments of a transnational corporation’s operations may be aimed at obtaining raw materials, whereas other segments may be aimed at penetrating markets for the products made from the raw materials. Automobile producers such as Ford, for example, rely on a global network of parts suppliers (Figure 12.8). These operations may also result in some production and market efficiencies. There may be strong motivations for a firm to internationalize, but there are also compelling constraints. Prominent among these are the uncertainties of investing or operating in a foreign environment. Consumers’ incomes, tastes, and preferences vary from country to country. Japanese consumers, for example, are wary of foreign products, at least those that are not name brands. Cultural differences in business ethics and protocol complicate the task of conducting business in two or more languages. Added to these barriers are differences in laws, taxation, and governmental restrictions. World Investment by Transnational Corporations Transnational corporations (TNCs) are the leading sources of foreign investment in the world and one of the most prominent dimensions of globalization. TNCs have a long history stretching to the dawn of capitalism in the sixteenth century, when their roots were laid down in the chartered monopolies like the British East India Company that played a crucial role in European colonialism (Chapter 2). In the twentieth century, the numbers of TNCs grew exponentially (Figure 12.9), as did their economic and political

Chapter 12 • International Trade and Investment United Kingdom Carburetor, rocker arm, clutch, ignition, exhaust, oil pump, distributor, cylinder bolt, cylinder head, flywheel ring gear, heater, speedometer, battery, rear wheel spindle, intake manifold, fuel tank, switches, lamps, front disc, steering wheel, steering column, glass, weatherstrips, locks

Netherlands

Belgium

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Hose clamps, cylinder bolt, exhaust down pipes, pressings, hardware

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Germany

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Tires, paints, hardware

Tires, tubes, seat pads, brakes, trim

325

Locks, pistons, exhaust, ignition, switches, front disc, distributor, weatherstrips, rocker arm, speedometer, fuel tank, cylinder bolt, cylinder head gasket, front wheel knuckles, rear wheel spindle, transmission cases, clutch cases, clutch, steering column, battery, glass Norway Exhaust flanges, tires

France Alternator, cylinder head, master cylinder, brakes, underbody coating, weatherstrips, clutch release bearings, steering shaft and joints, seat pads and frames, transmission cases, clutch cases, tires, suspension bushes, ventilation units, heater, hose clamps, sealers, hardware Spain United States EGR valves, wheel nuts, hydraulic tappet, glass

Austria Tires, radiator and heater hoses

Wiring harness, radiator and heater hoses, fork clutch release, air filter, battery, mirrors

Italy

Switzerland

Cylinder head, carburetor, glass, lamps, defroster grills

Underbody coating, speedometer gears

Japan Starter, alternator, cone and roller bearings, windscreen washer pump

Note: Final assembly takes place in Halewood (U.K.) and Saarlouis (Germany).

FIGURE 12.8 The international car: the component network for the Ford Focus (Europe).

significance. Today, they generate trillions of dollars in flows of cross-border financial assets and FDI (Figure 12.10). So rapid has their growth been in the late twentieth and early twenty-first century that the total values of their assets, sales, and exports is an order of magnitude larger than it was in the early 1980s (Figure 12.11). Most TNCs and FDI originate in economically developed countries, which have the surplus capital to invest abroad. Despite common impressions that TNCs always invest in developing countries where labor costs are lower, the reality is that most FDI is concentrated in the devel-

Investment by Foreign Multinationals in the United States

60,000 50,000 40,000 30,000 20,000 2010

Number of Transnational Corporations

70,000

10,000

oped world (Figure 12.12). American firms lead the world in FDI, but their share of the total is slipping. The rate of increase has been most rapid for companies from Western Europe; however, some developing countries have also increased their outflow of FDI, such as Brazil, Singapore, South Korea, and Taiwan. Investment in the developing world has focused mainly on a handful of countries— particularly China (Figure 12.13). Availability of natural resources, recent economic growth, and political and economic stability were among the factors that attracted foreign investment to less developed countries.

0 1700 1750 1800 1850 1900 1950 2000 FIGURE 12.9 The history of transnational corporations extends to the dawn of the age of colonial expansion, but their numbers multiplied rapidly throughout the twentieth century.

Foreign firms invest in the United States, and in other developed economies, to gain access to its domestic markets and to avoid protectionist measures (Figure 12.14). For example, cars produced by Japanese transplants in the United States are exempt from quotas. FDI in the United States grew rapidly from 1970, when it was a skimpy $13 billion, to 2008, when it amounted to $1.6 trillion. In fact, it increased more rapidly than did U.S. foreign investment overseas. The popularity of investing in the United States was a result of the economic and political stability of the country and the relatively inexpensive dollar in world markets. Trade deficits and FDI are closely linked. The U.S. trade deficit led to the outflow of American dollars into

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Global Money Flows, Total Cross-border Financial Assets 100

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80

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FIGURE 12.10 Global money flows and foreign direct investment by transnational corporations have grown exponentially. To remain competitive in the global economy, transnational corporations carefully review their production costs to identify fabrication stages that can be performed by low-paid, low-skilled workers in developing countries. Hence, the substitute transportation cost for lower wage costs. Operations that require more skilled workers or better quality control remain in the host country.

foreign hands. This money allowed foreign governments and corporations to buy American real estate and factories. Ironically, many foreign firms that sell to U.S. markets found it cheaper to produce goods from plants that they own and operate in the United States. As a result, foreign investment in the United States increased sharply. Because of cultural affinities and the lack of language barriers, the United Kingdom is still the lead FDI investor in America (but not if one includes purchases of federal government debt, in which case China and Japan are the leaders). FDI

in the United States is mainly in manufacturing, chemicals, electrical machinery, electronics, pharmaceuticals, and services. The geography of FDI in the United States varies by investor country. Originally, European countries invested in the Middle Atlantic and Great Lakes states of the north central United States. Canadian investment has been the strongest, not unexpectedly, along the border states from the western north central region through New England, including the South Atlantic states. But the Pacific region

Chapter 12 • International Trade and Investment

FIGURE 12.11 Compared to the early 1980s, the foreign assets, sales, and exports of the world’s transnational corporations have jumped significantly. Transnational corporations select lowwage countries for work through the process known as outsourcing. Here, the host company either runs a subsidiary in the developing country or turns over much of the production to independent manufacturers that operate in the low-cost country. Outsourcing contrasts with the more traditional approach of manufacturing in which a company controls all phases of the manufacturing process, usually in the original country. This latter approach, used by Henry Ford and many others later, is called vertical integration.

Value of Transnational Foreign Assets

Sales of Transnational Foreign Assets

1982 2005

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0

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50

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of the United States leads overall in FDI, primarily because of recent heavy investment by the Japanese and other East Asian countries (Figure 12.15). Effects of Foreign Direct Investment

great potential for aiding the economic development process (Figures 12.16 and 12.17). In this view, the TNC is an efficient social, economic, and political institution that accomplishes the following tasks for the less developed nations:

Is widespread FDI desirable? Should the operations of multinationals be controlled? There is no unanimity of opinion, particularly when investment in less developed countries is the issue. There are two opposing attitudes regarding the presence of multinationals in less developed countries. Some argue that multinational firms offer

80°

FLOW OF FOREIGN-DIRECT-INVESTMENT

160° 140° 120° 100°

80°

60°

1. Raising, investing, and reallocating capital 2. Creating and managing organizations 3. Innovating, adopting, perfecting, and transferring technology 4. Distributing product, performing maintenance, marketing, and selling 40°

20°



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ARCTIC

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100° 120° 140° 160°

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Largest Host Economies Other Host Economies Transnational Corporation Investor Economies

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FIGURE 12.12 Global flows of foreign direct investment. Multinationals’ foreign direct investment originates, for the most part, in the United States, Japan, the United Kingdom, Germany, and France. These transnational corporations have invested most of their resources in other developed countries. In addition, U.S. multinational corporations are more likely than the Japanese or Europeans to invest in Latin America. European multinational corporations are more likely to invest in Eastern Europe and the Middle East, while Japanese transnationals are more likely to invest resources in East Asia.

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8. Facilitating the creation of vertical organizations or vertical arrangements that allow for the progression of goods from one stage of production to another 9. Finally, providing both a market and a mechanism for satellite services and industries that can stimulate local development

FIGURE 12.13 Foreign direct investment by U.S. firms in the Pacific includes the ubiquitous McDonald’s.

5. Furnishing local elites with suitable career choices 6. Educating and upgrading both blue-collar and whitecollar labor 7. Serving as a source of local savings and taxes and in supplying skilled graduates to the local economy

FIGURE 12.14 Foreign direct investment (FDI) in the United States by source area, 2007. FDI in the United States is defined by the U.S. Bureau of the Census as all U.S. companies in which foreign interest or ownership is 10% or more. Countries with higher production costs than the United States look at the attraction of low-cost labor and huge markets as an incentive to operate in America. High-cost countries, such as Japan, the United Kingdom, the Netherlands, and Germany, account for 70% of the FDI in the United States.

Other scholars argue that multinational corporations are counterproductive to development (Chapter 14). Foreign firms can bankrupt local producers, who may be small or undercapitalized, and establish local monopolies. Transnationals that use extensive networks of foreign suppliers have few local linkages and low employment multipliers (Chapter 5). They may not improve the host country’s balance of payments because of heavy repatriations of profits; indeed, some countries attempt to restrict repatriation of profits to keep the benefits of investment at home. Although the balance-of-payments problem could be avoided in part if multinational firms reinvested more of their profits in the host country, it is uncertain that the national interest would be served. Reinvestment increases foreign control of the economy and the denationalization of local industry. Some argue that the multinational firm is an assault on political sovereignty, with its demands for government subsidies, training programs, and tax breaks. This latter issue is particularly important given the long history of TNC involvement in the politics of developing countries, ranging from bribes to helping military officers overthrow democratically elected governments. Moreover, the transnational system internationalizes the tendency to unequal development and to unequal income. To be sure, multinationals are imperfect organs of development in developing countries, and their potential for the exploitation of poor countries is tremendous. There is, therefore, an inherent tension between the multinational’s desire to integrate its activities on a global basis and the host country’s desire to integrate an affiliate with its national economy. Maximizing corporate profits does not necessarily maximize national economic objectives.

Foreign Direct Investment in U.S. 2007 Japan United Kingdom Netherlands Canada Germany France Switzerland Sweden Belgium-Luxembourg Italy Other Europe Other Areas 0

11.1% 19.6% 10% 10.2% 9.7% 8.1% 7.4% 1.5% 7.3% 0.7% 6.4% 8% 10

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Chapter 12 • International Trade and Investment

329

FIGURE 12.15 Foreign direct investment (FDI) in the United States, 2005. The value of FDI during this period has quadrupled. The top four states accounted for more than a third of the total FDI, and California, Texas, and New York led all states. A large influx of foreign direct investment has brought prosperity to the Rust Belt states of Michigan, Illinois, Indiana, and Ohio, with extensions into Kentucky and Tennessee.

Foreign Direct Investment in U.S. California Texas New York Illinois Michigan New Jersey Ohio Indiana Pennsylvania Alaska Louisiana State

Florida Kentucky North Carolina Georgia South Carolina Massachusetts Tennessee Washington Alabama Virginia Minnesota Arizona Hawaii West Virginia 0

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FIGURE 12.16 Foreign direct investment. Ford Motor Company headquarters in Britain. Ford is a true multinational corporation, with 330,000 employees scattered in 30 countries throughout the world. Although accused of exploiting local labor in developing countries, Ford and other multinationals have helped to stimulate economies and, therefore, provide foreign sources of revenue.

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FIGURE 12.17 U.S. Ford plant in Europe. General Motors and the Japanese manufacturers of automobiles produce two-thirds to ninetenths of their products in their home countries. The Ford Motor Company produces two-thirds of its more than 5 million manufactured vehicles abroad. Ford has been one of the most prolific of the American multinational corporations. The 1960s saw the most rapid expansion of American multinational investment, with over 300 new subsidiaries being set up annually by American companies in foreign countries. The advantage American firms saw in multinational expansion was the rapid development of postwar markets for their goods in Europe, Japan, and throughout the world. By establishing manufacturing plants in those foreign countries, companies could reduce expensive transportation costs for finished products as well as import duties. Another major factor, sometimes overlooked, is transfer pricing. Japan and European countries have higher rates of corporate taxation than does America. Shrewd multinationals can invoice their subsidiaries in these foreign countries in such a way as to show low profits in high-tax countries and therefore shelter their income.

The impacts of TNCs depend on both the characteristics and bargaining power of the corporation and the host country. Both the larger and wealthier of the less developed countries and of the TNCs have more bargaining leverage. A consumer-products manufacturing corporation will accept more controls to gain access to a country with a large market. Manufacturing industries with advanced and dynamic technologies are more difficult to control than firms involved in raw materials. Similarly, the degree of host-country control varies across industries and states. Host governments’ policies can range from open hostility to open encouragement. Corporations prefer to invest in countries that follow an outward-oriented, export-led development strategy, impose few controls, offer incentives, and appreciate the employment, skills, exports, and import substitutes that foreign investment can bring, an outlook exemplified by the NICs.

BARRIERS TO INTERNATIONAL TRADE AND INVESTMENT Like trade, international flows of the production factors can help to reduce imbalances in the distribution of natural resources. Whereas trade offsets differences in factor endowments, factor movements reduce these differences. International trade and flows of factors would occur more commonly if barriers did not exist. The main barriers relate to management, distance, and government.

Management Barriers Trade and investment expansion can be reduced by a number of managerial characteristics. These include lack of awareness of opportunities, lack of skills, fear, and inertia. Firms may have the potential to expand but fail to do so because they are satisficers—they settle for less than the optimal outcome. Until the economic crisis of the 1970s, many U.S. firms paid little attention to foreign markets; they were satisfied with the large domestic market. Firms may also have the will to go international but may lack knowledge of potential markets. The burden of recognizing export opportunities rarely falls solely on the managers of individual companies, however. Most national and local governments are actively involved in increasing international awareness and in promoting exports. Firms may have the potential and will to go international and an awareness of the opportunities, but they may be thwarted by the complexity of international business and ignorance of foreign cultures. Governments and universities can aid companies by providing education. Knowledge of intermodal rate structures, freight forwarders, shipping conferences, and customs brokers (firms that contract to bring other companies’ imported goods through local customs) is vital for the conduct of international business. Just as necessary is knowledge of foreign cultures. In the past, for example, U.S. firms could not penetrate the Japanese market, partly because of a failure to appreciate Japanese culture.

Chapter 12 • International Trade and Investment

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FIGURE 12.18 U.S. average tariff rates, 1820–2000. Historically, prior to the inception of the General Agreement on Tariffs and Trades (GATT) in 1947, U.S. tariff rates had been high. They reached a peak in the mid-1930s, with the Smoot-Hawley tariff, designed to protect U.S. markets from foreign goods, precipitating a trade war with Europe. Today, the United States has the lowest barriers to trade in the world, although on occasion American administrations will impose tariffs for political gain.

Uruguay Round begins (1986)

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No country permits a completely free flow of trade across its borders. Governments have erected barriers to achieve objectives regarding trade relationships and indigenous economic development. Trade barriers include tariffs— schedules of taxes or duties levied on products as they cross national borders—and nontariff barriers—quotas, subsidies, licenses, and other restrictions on imports and exports. These kinds of obstacles (apart from political bloc prohibitions) are the most pervasive barriers to trade. Free-market enthusiasts advocate free trade because it promotes the increased economic efficiency and productivity that results from international specialization. They argue that trade, a substitute for factor flows, benefits each participating nation and that deviation from free trade will inhibit production. It follows, then, that protectionism adversely affects the welfare of the majority. Protectionism drives up the costs of imports, and products that compete with them, thus adding to inflation, and invites retaliation on the part of trading partners. What are some of the major arguments in favor of protectionism? One of the most common is that it saves jobs by keeping cheap foreign imports out. This argument is often put forward by industries having difficulty competing internationally and contradicts the principle of comparative advantage: By purchasing cheap imports, consumers have more money to spend on other things. Conversely, protectionism takes the money away from consumers that generates jobs in consumer-oriented sectors and transfers it to inefficient industries that can’t compete internationally. Each job “saved” in a declining, protected sector comes at enormous expense to the public in the form of more expensive goods. Thus, protectionism does not generate jobs, it redistributes them, imposing costs on large numbers of people for the benefit of a few. Typically, beleaguered producers are well organized politically while consumer groups are not. A second argument is that protectionism is necessary to reduce dependence on foreign supplies of critical goods

necessary for national defense. This line of thought led, for example, to the formation of the Strategic Petroleum Reserve, large salt domes in Louisiana and Texas where the federal government stores significant amounts of oil in case of a national emergency. However, deeming what goods are, and are not, essential for national defense is often arbitrary: cardboard boxes? Styrofoam? Moreover, it is more efficient to store such goods than to use tariffs to keep foreign suppliers at bay. Still another argument is that tariffs can be used to protect an infant industry that is less efficient than a well-established industry in another country. The infantindustry argument was invoked to justify protectionist policies in nineteenth- and twentieth-century America and nineteenth-century Germany. It was also used to justify the protectionism of the less developed countries in the 1960s. Although these arguments have some merit, free marketers recommend other approaches to attain desired goals. For example, they suggest that if grounds exist for protecting an infant industry until it has grown large enough to take advantage of scale economies, this could be accomplished through providing a subsidy rather than through a protective tariff. In each case, protectionism provides a politically appealing argument that caters to troubled industries and regions, but it is a poor economic argument. Despite long-standing pleas for free trade and low tariffs, throughout the history of the United States tariff rates have been unquestionably high (Figure 12.18). In the nineteenth century, tariffs were the federal government’s primary source of income, until the adoption of the federal income tax in 1913. The Compromise Tariff of 1833 and the Smoot-Hawley Tariff of 1930 made 70% of imports subject to tariffs. The reasons for tariffs are clear. Highpowered, politically savvy lobbyists hired by special-interest groups that stand to gain economically from tariffs and quotas press the government for protection. The public, which must then absorb these tariffs and quotas as a surcharge on all imported products, is politically uninformed and not well represented in Washington, DC. In 1947, however, the United States and 25 other nations signed the

Tokyo Round (1979)

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General Agreement on Tariffs and Trade (GATT). GATT established multinational reductions of tariffs and import quotas and now has more than 110 signatories. The Uruguay Round of tariff negotiations (1986–1994) once again reduced tariffs, so U.S. tariff rates currently average approximately 5% on dutiable imports. Tariffs, Quotas, and Nontariff Barriers Tariffs are the most visible of all trade barriers, and they can be levied on a product when it is exported, imported, or in transit through a country. The tariff structure established by the developed countries in the post–World War II period works to the detriment of underdeveloped countries. The underdeveloped countries encounter low tariffs on traditional primary commodities, higher tariffs on semimanufactured products, and still higher tariffs on manufactures. These higher rates are, of course, intended to encourage firms in industrial countries to import raw materials and process them at home. They also discourage the development of processing industries in the developing world. In recent years, the relative importance of tariff barriers has decreased, whereas nontariff barriers have gained significance. The simplest form of nontariff barrier is the quota—a quantitative limit on the volume of trade permitted. A prominent example of a product group subject to import quotas in developed countries is textiles and clothing. Since the early 1970s, these have been subject to quotas under successive Multifibre Arrangements (MFAs), which have created a worldwide system of managed trade in textiles and clothing in which the quotas severely curtail underdeveloped-country exports. Another common nontariff barrier is the export-restraint agreement. Governments increasingly coerce other governments to accept “voluntary” export-restraint agreements by which the government of an exporting country is induced to limit the volume or value of exports to the importing country. Other nontariff barriers include discretionary licensing standards; labeling and certificate-of-origin regulations; overly detailed health and safety regulations, especially on foodstuffs, aimed at discouraging imports; and packaging requirements. Increasingly, loose, or break-bulk, cargo is unacceptable to mechanized transportation handlers in developed countries. These are only a few of the hundreds of nontariff barriers devised by governments. The evidence indicates that these barriers in developed countries are higher for exports from developing countries than they are for exports from rich, developed countries. Effects of Tariffs and Quotas The economic effect of tariffs and quotas in the host country is the development and expansion of inefficient industries that do not have comparative advantages. At the world level, tariffs and quotas penalize industries that are relatively efficient and that do have comparative advantages. The result is less international trade and higher costs for consumers.

Figure 12.19 shows the economic effects of a protective tariff and an import quota. Let’s first deal with the case of a protective tariff. Line Dd represents domestic demand in, for example, the United States for cassette players, whereas line Sd is the domestic supply. (Disregard the Sd⫹ Quota line for now.) The domestic equilibrium position is at price P3 and quantity Q3. Now assume that the U.S. market for CD players is open to world trade. The world price is lower than the domestic price because, compared with Japan, Malaysia, or Taiwan, the United States has the comparative disadvantage of high labor costs. The world equilibrium price is P1. At this price, Americans will consume the quantity Q5 at point N. With the low price, the domestic supply is only Q1 at point P, with the quantity Q1 – Q5 supplied by foreign imports. Next, let’s say that the United States imposes a tariff on the import of CD players. This tariff raises the price from P1 to P2. The equilibrium price and quantity are now P2, Q4, respectively, at point Q. The first reaction will be a decline in quantity demanded by American consumers, from Q5 to Q4, as they back up their demand curve toward the higher price. American consumers are hurt by the tariff because they can buy fewer goods at a higher price. While the consumers move back up the demand curve to point Q, domestic producers, with a higher price opportunity, increase their production and move up their supply curve from point P to point R. Domestic production has increased from Q1 to Q2. Consequently, we can understand why domestic producers send lobbyists to Washington, DC, to secure tariffs that give the producers a relative advantage in the market. The increased tariff reduces the number of East Asian imports from Q1 – Q5 to Q2 – Q4. The U.S. government, not the East Asian supplier, receives the tariff monies, P1 – P2. At the same time, the market shrinks because of reduced demand and domestic supply increases. The shaded area represents the amount of tariff revenue paid to the U.S. government. This revenue is an economic transfer from the consumers of the country to the government.

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The result of levying a tariff is reduced world trade and reduced efficiency in the international economic system, which hurts foreign suppliers, aids domestic producers, and costs the consumer. The indirect effect is that the supplying countries have a smaller market in America and thus earn fewer dollars with which to exchange or invest in American resources. As FDI decreases, trade deficits may increase. Next, let us consider the effects of levying an import quota. The difference between a tariff and an import quota is that a tariff yields extra revenue to the host government, whereas a quota produces revenue for foreign suppliers. Imagine that the United States subjects a foreign nation to an import quota, rather than imposing a tariff (see Figure 12.19). The import quota in this case is Q2 – Q4. The quantity Q2 – Q4 is the number of CD players that foreign producers are allowed to supply. Note that for easy comparison this example limits the quota to the exact amount of imported goods in our tariff example. The quota establishes a new supply curve, Sd ⫹ Quota, with an equilibrium position at point Q. The new supply of CD players is the result of domestic supply, plus a constant amount, Q2 – Q4, which is supplied by importers. The chief economic outcomes are the same as with the tariff example. The price is P2 rather than P1, and domestic consumption is reduced from Q5 to Q4. The American manufacturers enjoy a higher price for their goods, P2 rather than P1, and increased sales, Q2 rather than Q1. But the main difference is that the shaded box, paid by the domestic consumer on imports of Q2 – Q4, is not paid to the U.S. government. Instead, the extra revenue in the shaded box is paid to the foreign supplier. That is, no tariff exists, and consequently, the foreign supplier keeps all the revenue in the box Q2 – Q4 – Q – R. The result is that for local consumers, and their government, a tariff produces a better revenue situation than a quota does. Tariff money can be used to lower the overall tax rate and provide social services and infrastructure for the population as a whole. However, either case is detrimental to international trade and economic efficiency and takes away from the comparative advantages of supplying nations. Government Stimulants to Trade Not only do governments attempt to control trade, they also attempt to stimulate trade. Examples of governmental assistance in promoting exports include market research, provision of information about export opportunities to exporters, international trade shows, trade-promotion offices in foreign countries, and free-trade zones, areas where imported goods can be processed for reexport without payment of duties. Advocates of free trade believe that government intervention to promote trade is yet another obstacle to free trade and is a form of subsidy to politically influential corporations. In their view, gains from trade should result from economic efficiencies, not from government support.

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REDUCTIONS OF TRADE BARRIERS There have been several efforts to eliminate some of the trade barriers that were erected in the past. GATT and the Uruguay Round were two of these efforts. In addition, the United States continues to try to penetrate Japan’s closed markets. General Agreement on Tariffs and Trade The most notable reduction of trade barriers was a multilateral effort known as GATT, which was put into operation in 1947. When 23 countries signed the agreement, they thought they were putting in place one part of a future World Trade Organization (WTO), an organization that would have wide powers to police the trading charter and regulate international competition in such areas as restrictive business practices, investments, commodities, and employment. It was to be the third in the triad of Bretton-Woods institutions charged with overseeing the postwar economic order— along with the International Monetary Fund (IMF) and the World Bank. But the draft charter of the WTO was never ratified by the U.S. Congress and GATT remained a treaty without an organization. More than 100 member countries administer GATT through a process of negotiation and consensus. This has resulted in a substantial reduction of tariffs. However, GATT’s rules proved inadequate to cope with new forms of nontariff barriers, such as export-restraint agreements. Also, services, which now account for about 30% of world trade, were not covered by GATT at all. GATT was also of little help to developing countries with limited trading power. Since the 1970s, the liberal trading order that GATT helped to uphold has been steadily challenged by renewed protectionist threats, especially in the guise of nontariff barriers. Between 1981 and 1990, the proportion of imports to North America and the European Union (EU) that were affected by nontariff barriers increased by more than 20%. Trade between developed and underdeveloped countries is also increasingly affected by nontariff barriers; roughly 20% of less developed countries’ exports are covered by such measures. In the coming years, pressure on governments in developed countries to protect domestic jobs through trade barriers is likely to mount. The problem with GATT agreements arose from European and U.S. opposition to reducing and phasing out agricultural subsidies (a problem that has reoccurred under the World Trade Organization that was finally established in 1995). The EU wanted to maintain export subsidies, which are government payments that reduce the prices of goods to buyers abroad. Another type of subsidy, the domestic farm subsidy, constitutes direct payments to farmers according to their production levels in order to subsidize their output, a massive form of state intervention in agriculture (Chapter 6). The result is increased domestic food output, which unfairly competes with the agricultural products of less developed countries on the world market, and often bankrupts small farmers throughout the world. Both types of subsidies are

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artificial barriers that reduce prices on the world market and provide advantages to local farmers. In 1993, the Uruguay Round of GATT negotiations reconvened in an attempt to further resolve trade disagreements. Because most of the industrialized world was in the midst of an economic slowdown or an outright recession in 1992, there was much interest in the international trade measures of GATT to be discussed at Uruguay. The United States was attempting to pry open foreign markets, especially those considered to be unfair traders. Finally, in Geneva in 1993, 117 nations agreed to reduce worldwide tariffs, lower subsidies, and eliminate other barriers to trade. In reducing worldwide protectionism, the GATT nations have chosen to improve resource allocation, which will eventually increase trade and employment and raise wages and standards of living. The United States obtained most of what it sought: the opening of agricultural markets, cuts in industrial tariffs, intellectual property rights, and the opening of markets to the world’s service industries. There were both losers and gainers. America’s heavy equipment manufacturers, toy makers, and beer brewers were joyful, but the pharmaceutical industry, Hollywood film makers, and textile manufacturers were not pleased.

trade sanctions by all members of the WTO, meaning that a country gives up part of its sovereignty to this multilateral world organization. Moreover, a country’s power to control flows across its borders is to some extent lost. For some countries that do not abide by international trade agreements, this is a scary proposition. Under the WTO, quantitative limits on imports have become illegal. For example, Japanese and Korean import restrictions on U.S. rice, peanuts, dairy products, and sugar are now banned. Perhaps the most important aspect of the WTO to the United States is intellectual property rights, because it has a strong competitive advantage in this area. All signatories of the WTO are required to protect patents, copyrights, trade secrets, and trademarks. This measure is designed to end the wholesale pirating of computer programs, videocassettes, musical recordings, books, and prescription drugs widely practiced in some developing countries (e.g., China). The WTO calls for free trade in financial services, shipping, and audiovisual products—movies, television programs, and musical recordings. The WTO also prohibits members from requiring in products a certain proportion of content manufactured within their borders. This practice was widely employed as a device to limit the use of imported parts and components and, thus, to bolster local employment. The WTO has been criticized for its failure to establish production standards that address environmental concerns. Goods can be part of international trade without meeting the production standards of other countries, but many signatories have argued that the environmental standards under which a good has been produced should be a consideration. Others argue that globalization, as represented by the WTO, is dominated by large corporations, which are secretive and undemocratic. Labor unions are

World Trade Organization In 1995, the last round of GATT established a permanent World Trade Organization (WTO), to which most of the world’s countries now belong (Figure 12.20). Until the WTO was enacted, countries that had trade conflicts had to resolve their own problems. The WTO provides thirdparty arbitration to settle disagreements between nations over trade. The judgments are enforced through retaliatory 80°

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concerned about the exploitative conditions in sweatshops and the downward pressure on wages that globalization has created. Others protest the austerity programs of the IMF (Chapter 14). For these reasons, and others, WTO and similar meetings have attracted globalization protestors (Figure 12.21), including the notable “Battle in Seattle” that occurred in 1999 and subsequent demonstrations at meetings of ministers of the Group of Eight (G-8). Government Barriers to Flows of Production Factors Although not as complex as trade barriers, obstacles to the free flow of capital, labor, and technology constrain international managerial freedom. Exchange controls and capital controls are the main barriers that interfere with the movement of money and capital across national borders. Exchange controls, which restrict free dealings in foreign exchange, include multiple exchange rates and rationing. In multiple-exchange-rate systems, rates vary for different kinds of transactions. For example, a particular commodity may be granted an unfavorable rate. Foreign exchange may also be rationed on a priority basis or on a first-come, first-served basis. Thus, exchange rates are political tools bearing little relationship to economic reality. Capital controls are restrictions on the movement of money or capital across national borders. They are typically designed to discourage the outflow of funds. All countries regulate immigration, but the movement of workers from poorer to richer countries was the dominant pattern during the long postwar boom. When the boom ended, jobs moved to the workers. One reason for this change was tighter immigration laws in the advanced industrial countries. These laws strengthened the position of domestic labor and resulted in a growth in managed trade and a decline in managed migration. Technology, which is highly mobile, can be transferred in many ways: equipment export, scientific and managerial training, books and journals, personal visits, and the licensing of patents. Political and military considerations regulate

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the export of technology. Although these controls are not yet terribly onerous, demands for more stringent controls are on the increase. Labor unions in advanced industrial countries are one source of demand for control. The unions attribute domestic job loss to the export of high technology. Multinational Economic Organizations As nations turn inward to concentrate on problems of economic growth and stability, we are witnessing a resurgence of protectionism. But also in evidence is a strong, simultaneous countermovement toward international interdependence. Scores of multinational organizations have sprung up that for the most part are loosely connected leagues entailing little or no surrender of sovereignty on the part of member nations. Some of these international organizations are global in scale, the most inclusive being the United Nations (UN), with 191 member nations accounting for more than 99% of humankind. Much of the UN’s work is accomplished through approximately two dozen specialized agencies, such as the World Health Organization (WHO) and the International Labor Organization (ILO). Other international organizations have a regional character; for example, the Association of South-East Asian Nations (ASEAN) and the Asian Development Bank (ADB). Many international organizations are relatively narrow in focus—mostly military, such as the North Atlantic Treaty Organization (NATO), or economic, such as the Organization of Petroleum Exporting Countries (OPEC). Some international organizations are discussion forums with little authority to operate either independently or on behalf of member states, for example, GATT and the Organization of Economic Cooperation and Development (OECD). Others, such as the IMF and the World Bank, have independent, multinational authority and power, performing functions that individual states cannot or will not perform on their own. Some international organizations integrate a portion of the economic or political activities of member countries—as, for example, the EU. International

FIGURE 12.21 Protests against the World Trade Organization. The WTO was formed in 1995 to reduce barriers to world trade by negotiating reductions in international tariffs and trade restrictions among the world countries, freeing up the movement of products, money by banks, corporations, and wealthy individuals. The WTO enforces agreements and attempts to stop violations, for example, of intellectual property rights in the age of the Internet, and infringement of patents. However, many people feel that the WTO is a secretive organization supportive of corporations rather than working class and poor people.

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organizations that promote regional integration are the most ambitious of all. Some observers believe that regional federations are necessary in the process of weakening nationalism and developing wider communities of interest. However, if a rigid, inward-looking regionalism is substituted for nationalism, the ultimate form of international integration—world federation—will be difficult to achieve. This section examines international economic organizations that affect the environment in which firms operate and thus influence developing countries. We look at international financial institutions, groups that foster regional economic integration, and groups such as commodity cartels that deliberately manipulate international commodity markets. International Financial Institutions International financial institutions are largely a phenomenon of the post–World War II period. The IMF and the International Bank for Reconstruction and Development (IBRD), or World Bank, were established in 1945 as part of the Bretton-Woods agreement. These institutions are significant sources of multilateral capital, especially aid for developing countries, which is particularly important for those countries that do not have access to private capital markets. The IMF is an international central bank that provides short- to medium-term loans to member countries (Figure 12.22), and the IBRD is an international development bank that provides longer-term loans for particular projects. Both institutions are made up of clusters of governments, each paying a subscription or quota based on the size of its economy. Because quotas determine a member’s voting power, the banks are dominated by the most powerful economies—particularly, by the United States.

FIGURE 12.22 The entrance of the International Monetary Fund (IMF) headquarters in Washington, DC. The IMF attempts to maintain foreign exchange balances and to promote economic modernization and growth in the Third World. Adjustment programs generally include measures to manage demand, improve the incentive system, increase market efficiency, and promote investment.

The IMF and the World Bank were originally established to prevent a recurrence of the crisis of the 1930s. At first, they embodied Keynesian principles, which offered a rationale for state intervention in markets. Starting in the 1980s, however, the IMF and the World Bank adopted firm neoliberal, as opposed to dependency, interpretations of development. Under pressure from the United States, they took on an adamantly market-oriented stance and imposed it on the governments of less developed countries that needed their assistance, often at the cost of enormous human suffering. Loans from the IMF and the World Bank, therefore, tend to reflect U.S. economic and foreign policy. This neoliberal “Washington Consensus” revolves around requiring less developed countries to follow tight monetary policies to combat inflation. This serves investors and bondholders well but raises interest rates for consumers. They are required as well to liberalize their financial markets by adopting a variety of deregulatory programs. In the name of budget balancing, governments are often forced to reduce subsidies for the poor for public transportation, kerosene, or cooking oil. Privatization policies encourage or require governments to sell off public assets to private investors, often at reduced prices; all over the world, formerly state-owned or state-operated power plants, hydroelectric facilities, bus routes, airlines, telecommunications firms, and other assets are rapidly being sold to the private sector on the assumption that it is more efficient than the public sector. Yet public services often exist precisely to overcome market failures, particularly the inability of markets to provide adequate services to the poor. Similarly, IMF policies require countries to liberalize trade policies, including ending tariffs, quotas, nontariff barriers, and subsidies. Critics note that such liberalization is often just a smokescreen for increased penetration of markets in less developed countries by firms from the United States, so the IMF is accused of doing the dirty work of American capital. Even as less developed countries are forced to give up subsidies, the U.S. government lavishes them on its farmers, giving them an unfair advantage in selling low-priced crops to foreign markets. Thus, the IMF imposes requirements on less developed countries that governments of developed countries would never accept. Critics deride these policies as neoliberal “market fundamentalism” (see Stiglitz, 2002). By the IMF’s own admission, its policies have often exacerbated the problems of less developed countries, such as during the Asian financial crisis of the late 1990s. The macroeconomic models employed to buttress these policies are often highly oversimplified and underestimate the complexity of local political and social contexts. Tight monetary policies can generate recessions and lead to high unemployment. Many less developed countries lack a proper institutional environment for privatization to work, including bankruptcy procedures, protection of property rights, and debt repayment programs. Moreover, the Washington Consensus increases inequality in less developed countries by protecting and rewarding investors at the expense of the poor.

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FIGURE 12.23 Headquarters of the World Bank, Washington, DC. The World Bank doles out loans to countries to reform governments and legal institutions; develop banks and financial institutions, which may give business loans to local firms; and develop infrastructure, transportation, and the social services sector of a deadlocking country.

Free Trade Area

REGIONAL ECONOMIC INTEGRATION Regional economic integration occurs when sovereign nations form a single economic region. It is a form of selective discrimination in which both free-trade and protectionist policies are operative: free trade among members and restrictions on trade with nonmembers. Four levels of economic integration are possible. At progressively higher levels, members must make more concessions and surrender more sovereignty (Figure 12.24). The lowest

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level of economic integration is the free-trade area, in which members agree to remove trade barriers among themselves but continue to follow their own trade practices with nonmembers. A customs union is the next higher level of integration. Members agree not only to eliminate trade barriers among themselves but also to impose a common set of trade barriers on nonmembers. The third type is the common market, which, like the customs union, eliminates internal trade barriers and imposes common external trade barriers; this regional grouping, however, permits free mobility to factors of production. At a still higher level, an economic union has the characteristics of the common market plus a common currency and a common international economic policy. There are a variety of regional trade organizations in the world (Figure 12.25). They range from loosely integrated free-trade areas such as the Latin American Free Trade Association (LAFTA) to common markets such as the EU. There are North-South ties between the EU and LAFTA,

Abolish tariffs and intra-trade restrictions

In pursuing policies that dramatically emphasize economic stabilization over job creation, the IMF is eager to bail out bankers but never the impoverished masses. Finally, market fundamentalism tends to be overly optimistic about the private sector and overly pessimistic about the public sector. Some developing countries have turned to two subsidiary World Bank organizations: the International Finance Corporation (IFC), founded in 1956, and the International Development Association (IDA), founded in 1960. These organizations provide loans with stipulations less stringent than those of the IBRD. For example, the IDA may charge no interest on loans, grant 10-year grace periods (no repayment of principal for the first 10 years), or allow 50-year repayment schedules for poorer developing countries. Because the IDA is much less creditworthy than the IBRD, all its resources must come from membergovernment contributions. These banks reflect the desire of developing countries to exert control over their financing needs. Of the three banks, the Asian Development Bank is most under the control of developed countries, in particular Japan. The AFDB has been the most independent, but it is also the smallest. International financial institutions are important to international business. The IMF, the World Bank (Figure 12.23), and regional development banks annually finance billions of dollars of the import portion of development projects. This can be valuable business for foreign companies involved in the projects, either occasionally as part owners or, more commonly, as contractors or suppliers.

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FIGURE 12.24 Types of regional economic integration.

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FIGURE 12.25 Regional trade organizations around the world.

and South-South ties between LAFTA and ASEAN. Most of these links are bilateral; that is, agreements between nations within different regions. Fully fledged interregional integration has yet to be achieved. Indeed, regional groups are more concerned with closer economic integration within regions than among regions. Barriers to successful regional integration are stronger in developing countries than in developed countries. The most significant barriers are political—an unwillingness to make concessions. Without concessions to the weaker partners of a regional group, the benefits from cooperation pile up in the economically more prosperous and powerful countries. Another difficulty is that developing countries have not historically traded extensively among themselves. Still another obstacle to integration is the lack of sufficient transportation and power networks. Nonetheless, much potential for integration exists in developing countries, particularly because many are too small and too poor to grow rapidly as individual units. Many developing countries turned to regional integration schemes in the 1960s and 1970s because they needed to gain access to larger markets, to obtain more bargaining power with the developed countries than they could if they adopted a “go-it-alone” policy, to create an identity for themselves, to strengthen their base for controlling

multinational corporations, and to promote cohesive solidarity. How companies feel about regional groupings differs from one company to another. Companies that enjoy a secure and highly profitable position behind national tariff walls are unlikely to favor removal of these barriers. Conversely, companies that see the removal of trade barriers as an opportunity to expand their markets see integration as a favorable development. Similarly, companies that traditionally exported to markets absorbed by a regional grouping have a strong interest in integration. They perceive these enlarged markets to be more attractive than they were in the past. But as outsiders, these foreign companies will be subject to trade controls, whereas barriers for internal competitors will decrease. Thus, they may lose their traditional markets because they are outside the integrated group of countries. As a result, there is an incentive to invest inside the regional grouping. This is why many U.S. firms invested directly in the European Economic Community (now EU) countries. The European Union The most successful example of economic integration is the European Union (EU). It began in 1957 with six nations: France, West Germany, Italy, Belgium, the

Chapter 12 • International Trade and Investment

Netherlands, and Luxembourg, and since then has added most European countries, including a steady expansion into Eastern Europe. By 2009, the EU had 27 members with a total population of more than 500 million (Figure 12.26). The EU today is the largest single trade bloc in the world and accounts for 40% of international trade, which is three times its world share of population. The intent of the EU was to give its members freer trade advantages while limiting the importation of goods from outside Europe. It called for (1) the establishment of a common system of tariffs applicable to imports from outside nations; (2) the removal of tariffs and import quotas on all products traded among the participating nations; (3) the establishment of common policies with regard to major economic matters such as agriculture, transportation, and so forth; (4) free movement of and access to capital, labor, and currency within the market countries; (5) transportation of goods, commodities, and people across borders with no inspection or passport examination; and (6) a common currency. The EU has made tremendous progress toward its stated goals. The member nations have enjoyed more efficient, large-scale production because of potentially larger markets within the EU, permitting them to achieve scale economies and lower costs per manufactured unit, something that pre-EU economic conditions had denied them. However, the current stumbling block seems to be the lack of a common economic unit of currency. In addition, some northern countries scoffed at open borders that would allow southern Europeans to immigrate and thereby take advantage of social welfare programs of cradle-to-grave economic assistance.

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Americans are concerned about the economic power of the EU. Present tariffs have been reduced to zero among EU nations, whereas tariffs for U.S.-made products have been maintained. Consequently, importing goods to EU nations is relatively more difficult. At the same time, increased prosperity among EU nations makes them potential customers for more American exports. THE EU’S SINGLE CURRENCY On New Year’s Day 1999,

many (but not all) members of the EU adopted a unified currency, the euro (Figure 12.27); Britain, Denmark, and Sweden opted to retain their own currencies. The currency exchange rates of participating countries are locked in to one another and to the euro. However, the euro floats against non-EU currencies such as the U.S. dollar (Figure 12.28). When members of the European Union adopted the single currency, they were aware that the sacrifice would be great. Each country effectively surrendered the right to independently balance its own budget and manage its own debt. Each country relinquished its individual monetary identity. There is no question that when the economic efforts of 25 countries and 500 million people are combined, European goods and services will be better represented in the world economy by a currency capable of maintaining price stability in member countries (Figure 12.29) North American Free Trade Agreement The economic pressure placed on the United States by the EU led it to promote freer trade through GATT and to develop the U.S.–Canadian Free Trade Agreement, which

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FIGURE 12.26 The European Union, 2009. With half a billion people and generally prosperous economies, it is one of the world’s major players in the global economy. The European Union was founded in 1958 as a trade block to reduce the cost of imports between six countries—Belgium, Luxembourg, Netherlands, France, Germany, and Italy—in the aftermath of World War II. With the emergence of the economic powerhouses of the United States and East Asia, the EU has expanded to 27 countries as of 2010, with more applications coming in from Turkey, Croatia, Macedonia, Albania, Bosnia, and a host of others.

The World Economy: Geography, Business, Development

FIGURE 12.27 The euro. A single currency has replaced national currencies in most, but not all, of the member states of the European Union.

phased out trade barriers between the world’s two largest trading partners. In 1992, the North American Free Trade Agreement (NAFTA) was signed by the U.S. and Mexican presidents and the Canadian prime minister, and

in 1994 the U.S. Congress approved it. NAFTA encompasses 310 million Americans, 33 million Canadians, and 100 million Mexicans. Unlike the EU, NAFTA includes a developing country. Access to the North American market is coveted by EU countries and Japan. Proponents of NAFTA argued that EU nations would negotiate a free-trade agreement between the two blocs. NAFTA was not well received by all parties in North America. The critics’ main argument was that it removes lower-skilled assembly and manufacturing jobs from the United States and transplants them to Mexico, where labor costs are one-fifth to one-eighth as much. In addition, companies might be tempted to flee the more stringent climate in the United States regarding environmental pollution and workplace safety controls. Critics of NAFTA also suggest that Japan, Korea, Taiwan, and other East Asian countries might build plants in Mexico and export goods duty-free to the American and Canadian markets, which would hurt U.S. firms and workers. The principal argument in favor of NAFTA was that free trade would enhance U.S., Canadian, and Mexican comparative advantages: raise per capita income in Mexico and increase Mexican demand for goods from the United States and Canada. Another argument was that higher living standards in Mexico would help control the flow of undocumented aliens crossing the U.S. border, now estimated to be 1 million per year. With free trade, wages would rise in Mexico; therefore, undocumented aliens could stay home and work in their native country. By reducing restrictions on the establishment of U.S. and Canadian financial service subsidiaries, NAFTA also frees up trade in financial and investment services. Thus, NAFTA deregulated Canadian and U.S. banking, securities brokering, and insurance operations in Mexico. In addition, Canadian and American trucking companies have free access to the Mexican market and Mexican truckers have free access to markets in the north. Before NAFTA, the United States’ tariff rates on imports from Mexico averaged approximately 5%, too low for NAFTA to have substantially raised the incentive for Canadians and

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FIGURE 12.29 London. The largest city in Europe, London is one of the world’s premier financial centers, the largest center of currency exchange, and a major hub of producer services. London, New York City, and Tokyo are the greatest centers of world trade and banking in the world today, with Shanghai coming on fast. London developed as the preeminent center in Europe because of its large market; good port for overseas trade; its relatively remote location from warring Europe; its large supply of skilled labor; and a merchant class with access to capital and proximity to banks, insurance firms, investors, and government support needed for business growth.

United States firms to invest in Mexico. A free-trade zone, extending 100 miles south of the border, had been in operation before NAFTA; NAFTA has in effect extended the maquiladora export assembly zone to all of Mexico, which means that duties are imposed only on the value added to imports by manufacture in the maquiladora plants. After 17 years, NAFTA’s lower tariffs have expanded trade and investment with Mexico, but American imports have grown more quickly than its exports, turning what was once a U.S. trade surplus with Mexico into a deficit. Mexico saw its U.S.-bound exports jump in the years since 1994 by 241%, while imports from the United States climbed by 170%. While U.S. tariffs disappeared overnight on many Mexican and Canadian exports, powerful lobbies have slowed the trend in some sectors, particularly agriculture. So, Mexican imports of cheaper, subsidized U.S. corn has flooded the country and bankrupted 2 million farmers there. Moreover, two-thirds of the increased shipments between the U.S. and Mexico are “revolving-door exports,” that is, products that stay in Mexico just long enough to be assembled into a product that is then sold in the U.S. market at a cheaper price than if produced in the United States itself. Mexico’s burgeoning maquiladora industry has grown by 150% since 1994 but has skimmed manufacturing jobs and depressed wages in U.S. border states. The U.S. Department of Labor has certified a loss of more that 600,000 U.S. jobs to Mexico as a result of NAFTA, many of them in manufacturing—a small fraction of the 150 million jobs that make up the U.S. labor force, about 15 million of which are in manufacturing. About an equal number of jobs have been created on the U.S. side of the border but these are concentrated in lower-paying service occupations. Meanwhile, the United States continues to lure Mexican workers, many of whom were uprooted from rural communities when Mexico opened its markets to subsidized U.S. agricultural goods. NAFTA was grossly oversold on both sides of the border as an instrument for reducing unwanted immigration. Illegal border crossings have increased steadily since 1994,

mainly because of Mexico’s disappointing economic performance and a large and growing wage disparity between the two countries. A very low minimum wage, 20% unemployment, and the lure of higher wages in the United States continue to draw millions of Mexicans. Full of undocumented immigrants, many communities along the U.S. side of the border remain as mired in poverty as they were a decade ago. The net impacts of these immigrants, who are largely unskilled and often illiterate, has been hotly debated. Many note that they take jobs typically unwanted by U.S. citizens, particularly picking fruits and vegetables and working in the garment industry, construction, and retail trade. Many concede that they increase the supply of unskilled labor and force wages down in those labor markets. Others note that they pay income and Social Security taxes but are ineligible to receive benefits such as Social Security. Many live in desperate destitution, vulnerable to employers who take advantage of their precarious situation. Critics alleged that NAFTA would create a “giant sucking sound” of industries moving to Mexico to reap high profits and low wages. But when comparing Canada and Mexico in terms of their auto industries, Canada has done a better job of increasing its auto exports. The largest exporter of cars and trucks to the United States is no longer Japan, but Canada. Since 1989, Canada has doubled the number of cars and trucks it exports to the United States. A decade after the NAFTA agreement was signed, which many feared would send the U.S. auto industry to Mexico, free trade is having the opposite effect. The United States actually gained jobs in the auto industry, though not higher-paying ones. Meanwhile, Canada has also been gaining jobs. Canada employs almost 60,000 workers installing mostly U.S. parts into motor vehicles—about 85% of which were exported to the United States. By 1995, Mexico had lost 13% of its 137,000 auto manufacturing jobs when foreign competition (particularly from Asia) wiped out Mexican parts suppliers. One year after NAFTA began, the peso collapsed and auto sales plummeted 70%. But due to the devaluation of the peso and reduced

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Case Study North American Free Trade Agreement (NAFTA) The North American Free Trade Agreement (NAFTA) was ratified in 1994, linking Canada, Mexico, and the United States under a regime of liberalized trilateral commerce that harmonized procedures for defining rules of origin, expedited customs clearance for cross-border trade, and provided for a wide variety of institutional reforms to safeguard environmental interests and the rights of workers (sidebar agreements). The accord also included provisions to maintain stable flows of energy, easier business travel, and reduced restrictions on foreign direct investment (FDI). Despite many side agreements covering spheres such as labor conditions and environmental protection, a central goal of the accord was to achieve a phased elimination of import duties for most products and services by 2004. This goal has been achieved, though many non-tariff trade barriers are still in place. A further goal was to dilute longstanding restrictions on capital mobility (FDI), and pave the way for new investment across the trilateral region. The net result over the past 17 years has been a dramatic expansion of intra-industry trade among the three nations. Much of this trade is conducted on an intracorporate basis. For example, Ford USA can import components or final assemblies on a duty-free basis from its subsidiaries located in Canada or Mexico—provided that such inputs qualify as 50% North American (i.e., “local content”). Automotive companies from outside NAFTA can also compete on the same basis, provided that 50% NAFTA content can be demonstrated. Transnational corporations headquartered outside the NAFTA zone have played an important role, too, especially in sectors such as automotive products, aerospace, and electronics. From the perspective of traditional trade theory, the NAFTA concept made good sense in 1994. With respect to comparative advantage, Mexico was cast as labor abundant with low skills, Canada had lots of natural resources, while the United States was capital rich with high labor skills. Linking the three economies together via free trade would theoretically allow for factor specialization, expanded output, and an aggregate rise in consumer welfare. Specialization would also promote economies of scale. Critics of the accord, in contrast, argued that a free trade agreement between two advanced industrial economies and a developing nation within a geographically contiguous region would spur a mass exodus of capital from north to south, as well as downward pressure on northern wages. Neither perspective appears to be entirely correct. Thus far, there is no evidence that NAFTA has caused trade diversion to any significant degree. Trade diversion takes place when a regional free trade agreement artificially displaces a lower cost producer from outside the club as a result of policy-driven cost advantages that accrue to in-club producers. NAFTA does not seem to be a factor in this regard, as witnessed by massive imports from China, India, and other low-cost producers located

in the newly industrializing countries of Asia and South America. Economic models have failed to uncover significant evidence of trade diversion, and points to either a zero or negligible impact of NAFTA on U.S. industrial employment. Some studies, in fact, suggest that NAFTA’s tariff reductions have decelerated the pre-NAFTA trend toward employment decay in the manufacturing sectors of both Canada and the United States. Between 1994 and 2000, for example, total employment in the U.S. manufacturing sector actually increased (albeit by a modest 1%). On a less optimistic note, there is at least some evidence that trade liberalization has contributed to rising income inequality among regions for all three NAFTA members. This said, most economists and economic geographers would agree that it is hard to disentangle the trade, income, or employment effects of free trade agreements from broader factors such as capital intensification (process automation), exchange rate movements, import competition from outside the bloc, and declining industrial competitiveness (e.g., lack of investment in new technology). For example, some studies have found a negative relationship between NAFTA-assisted export growth and local employment levels. Capital intensification appears to be the key driver in this rather odd relationship. Although NAFTA has been a topic of considerable debate, the accord is here to stay. Looking to the future, at least five areas of contention are likely to persist and/or emerge. These areas of contention include: 1. The increasingly adversarial relationship between the United States and Mexico regarding illegal immigration 2. The persistence of non-tariff trade barriers based on technical or environmental standards 3. The hardening of U.S. ports of entry in light of post-9/11 security threats 4. The management of NAFTA expansion into the Free Trade Area of the Americas 5. The development of more efficient border management systems Some of these concerns might be addressed by moving toward a secure external perimeter, where the boundaries of all three countries are monitored and controlled by common standards to facilitate security compliance. This will probably not happen soon, as such a scenario would push NAFTA closer toward a customs union (which is not a politically popular option). Other concerns might be addressed by further policy harmonization, notably with regard to border management (e.g., fast-track entry for people and merchandise). Still other concerns might be dealt with by broadening the mandate of NAFTA’s dispute resolution system to include issues such as illegal immigration, antiterrorism measures, and environmental compliance.

Chapter 12 • International Trade and Investment

labor costs, Mexican production of Nissan, Volkswagen, GM, Ford, and Chrysler vehicles hit 1.4 million in 2003, approximately 85% of which were exported to the United States. Yet new equipment and more efficient production have meant fewer jobs for Mexican auto workers than expected. NAFTA has been beneficial to the auto industry’s competitiveness because the trade agreement allowed U.S. automakers to win back a share of the domestic market that they had lost to cheaper Asian and European cars. In order to do this, they had to send some jobs to neighboring countries to keep costs down; unfortunately, large numbers of U.S. workers have been laid off. The pressure to keep reducing the cost of labor to produce a car is continuing. In the 1990s, the United States proposed an extension of NAFTA that would include 34 nations across the Western Hemisphere. The Free Trade Area of the Americas (FTAA) is sometimes referred to as “NAFTA on steroids.” Given the long U.S. hostility toward Cuba, that country would be excluded. Early negotiations to design the FTAA were met with hostile demonstrations. If the FTAA is successful, it would create the largest free-trade zone in the world, exceeding even the EU.

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Kuwait, Libya, Nigeria, Angola, Iraq, Algeria, Qatar, and the United Arab Emirates (Figure 12.30); Indonesia and Gabon are former members. The success of OPEC at raising oil prices encouraged other underdeveloped countries to create new nonoil cartels. The first oil shock OPEC created occurred in 1973, followed by another in 1979. The price for a barrel of crude petroleum oil peaked in 1981 at $36. American oil companies commenced major new exploration and billions of dollars worth of infrastructure was erected in territories of North America that were rich in oil, low-grade oil shales, and tar sands, notably Colorado, Wyoming, Alberta, and Montana. With the subsequent decline in world oil prices, these new oil operations and oil explorations likewise declined, which sent shock waves through the oil industry and depreciated home and business values throughout Houston, Texas, and other oil-dependent cities. In the late 1980s, the price of a barrel of crude petroleum on the world market sank to $15, but it rose again gradually in the 1990s to $21 because of the first Persian Gulf war and the destruction of wells in Iraq and Kuwait, where output has not returned to prewar production levels because of the devastation. The lower output, especially after the beginning of the Iraq war in 2003, required higher levels of production or refining capacity by other OPEC nations. By 2004, prices exceeded $120 per barrel, only to fall to roughly $70 in 2010. World oil prices depend on the resumption of economic growth in not only the developed nations but also the less developed nations, and the resulting growth in demand for crude petroleum. The resumption of production and refining in Russia and Central Asia will also affect world petroleum prices. At present, OPEC produces less

OPEC A cartel is an agreement among producers that seeks to artificially increase prices by arbitrarily raising them, by reducing supplies or by allocating markets. The most successful commodity cartel is the Organization of the Petroleum Exporting Countries (OPEC). Founded in 1960, membership in OPEC has fluctuated over time as members joined and dropped out; in 2010, it consists of 12 countries—Venezuela, Ecuador, Saudi Arabia, Iran,

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than 50% of the world’s output but controls 80% of the proven reserves. Surprisingly, despite their tremendous oil reserves of several trillion barrels, OPEC nations will have a problem generating enough money either to maintain

their production or to increase capacity because most have serious problems with debt. Much of their petrodollar accumulation is spent on military equipment to keep the wealthy sheiks in power.

Summary This chapter examined some aspects of the international sphere of economic geography. International business is any form of business activity that crosses a national border. It includes the international movement of almost any type of economic resource—merchandise, capital, or services. Our discussion of traditional trade theory introduced comparative advantage as the underlying explanation for international trade. The original, Ricardian conception argued that specialization within a larger international division of labor led to higher standards of living for all parties involved. Beyond predicting that everyone gains something from trade, including the most and least efficient producers, classical trade theory neglects too many issues to be realistic, including the roles of innovation, government, and economies of scale. Free trade was established in the nineteenth century within a colonial framework of inequality among countries. As primary goods producers, developing countries became dependent on foreign demand and, therefore, vulnerable to the business cycle of expansion and contraction in developed countries. Thus, some critics argue that free trade is a patina that disguises the ability of rich countries to take advantage of less developed ones. One country’s free trade may appear like another’s exploitation. A major extension of the original theory of comparative advantage, Porter’s notion of competitive advantage, includes the roles of labor skills, knowledge and innovation, agglomeration economies, financing, and government policy. Unlike comparative advantage, which is static, the theory of competitive advantage is dynamic, noting that regional and national patterns will always change over time. The discussion of international trade and investment was extended to a consideration of the basis of productionfactor flows. Production factors that are most readily movable among countries are capital, technology, and labor. We focused primarily on capital movements, enhancing understanding of FDI by using a managerial perspective. In many respects, the international movement of capital, technology, and managerial know-how is now more important than international trade. Theories of international trade and production-factor movements emphasize the benefits of a relatively deregulated, market-oriented business environment. However, a number of obstacles significantly impede flows of merchandise, capital, technology, and labor. These obstacles include distance, managerial behavior, and governmental barriers. Much progress was made in reducing governmental barriers—tariffs, quotas, and nontariff barriers—during the long postwar boom. International trade—the movements of outputs—is only one facet of globalization. Another is investment. There are many types of investment, including, for exam-

ple, purchases of government debt, but most attention has focused on FDI. Most FDI is organized through TNCs and originates in the economically developed countries. However, most TNCs invest in developed, not developing, countries. For example, various west European, Canadian, and Japanese firms invest heavily in the United States, where they generate jobs, wages, output, and profits. Money must be exchanged on international markets for goods and services, and so exchange rates play a critical role in influencing the prices of imports and exports among countries. Determination of exchange rates allows world trade to function. Explaining why exchange rates fluctuate is no easy matter but is related to levels of real output, inflation rates, demand factors, and currency speculation in trading-partner countries. Despite pressures for protectionism, countries continue to participate in myriad multinational operations. Major organizations that can be important to international business are international financial institutions and groups that promote regional integration. A common way of shaping global output and trade in a given sector is commodity cartels. Leaders in developed countries view commodity cartels as an unfortunate departure from market-oriented principles. In contrast, most leaders of less developed countries view commodity cartels as a means to reduce their vulnerability in a world of unequal exchange. The most famous cartel, OPEC, has played a fundamental role in affecting the price of petroleum worldwide. GATT reduced trade barriers worldwide. The Uruguay Round of GATT made progress on a number of difficult issues—farm policy, intellectual property rights, and trade barriers related to the growing international trade in services. In the 1990s, GATT transitioned into the WTO, a permanent institution designed to minimize trade barriers and arbitrate disputes among countries. A current issue at the center of WTO policies is the huge subsidies paid by the governments of countries such as the United States and western European states to their agribusinesses, resulting in low prices that cripple farmers in less developed countries. The most widely acclaimed regional integration to date is the EU, which at present involves 27 states in a powerful trade bloc of more than 500 million people that manages almost 50% of worldwide trade. The EU is the most complete economic integration among countries the world has ever seen, including the elimination of barriers to trade and investment among its member states as well as flows of labor. A common currency, the euro, has been accepted by most but not all of its members. Starting in 1994, the U.S.–Canadian free trade agreement was extended to include Mexico in the form of NAFTA.

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Key Terms absolute advantage 315 capital markets 321 cartel 343 common market 337 comparative advantage 315 competitive advantage 319 customs unions 337 economic union 337 euro 339 European Union (EU) 338 exchange rate 321 export-restraint agreement 332

export subsidies 333 foreign direct investment (FDI) 324 free-trade area 337 General Agreement on Tariffs and Trade (GATT) 332 infant industry 331 intellectual property rights 334 international currency markets 321 International Monetary Fund (IMF) 333

intracorporate trade 317 nontariff barriers 331 North American Free Trade Agreement (NAFTA) 340 Organization of the Petroleum Exporting Countries (OPEC) 343 protectionism 331 quota 332 regional economic integration 337

tariff 331 tax-haven country 321 terms of trade 317 trade deficit 323 transnational corporations (TNCs) 324 unequal exchange 317 World Bank 333 World Trade Organization (WTO) 334

Study Questions 1. Why does international trade occur? 2. What are the inadequacies of existing trade theory? 3. What is meant by the terms of trade? Why have they declined for many Third World nations? 4. What forces have driven the internationalization of banking? 5. How do exchange rates affect trade? 6. What caused the huge U.S. trade deficits? 7. What is foreign direct investment? What are its impacts?

8. How has the U.S. FDI balance changed over time? Why? 9. What are the principal barriers to international business? 10. What are the major arguments in favor of protectionism? 11. What are tariffs, quotas, and nontariff barriers? 12. What was the GATT and what is the WTO? 13. Why were the IMF and World Bank established? 14. What is regional economic integration and why does it occur? 15. Compare and contrast the EU and the NAFTA.

Suggested Readings Dicken, P. 2010. Global Shift: Mapping the Changing Contours of the World Economy, 6th ed. New York: Guilford Press. Friedman, T. 2005. The World Is Flat: A Brief History of the Twenty-First Century. New York: Farrar, Straus and Giroux. Hugill, P. 1993. World Trade since 1431: Geography, Technology, and Capitalism. Baltimore: Johns Hopkins University Press. Peet, R. 2003. Unholy Trinity: The IMF, World Bank, and WTO. New York: Zed Books.

Perkins, J. 2005. Confessions of an Economic Hit Man. New York: Plume. Porter, M. 1990. The Competitive Advantage of Nations. New York: Free Press. Stiglitz, J. 2002. Globalization and Its Discontents. New York: W. W. Norton.

Web Resources The World Trade Organization http://www.wto.org The principal agency of the world’s multilateral trading system. Its home page includes access to documents discussing international conferences and agreements, reviews of its publications, and summaries of the current state of world trade. The World Bank http://www.worldbank.org

trade. Its home page provides access to the contents of its publications, to its research areas, and to related Web sites. U.S. Department of Commerce http://www.doc.gov This government department is charged with promoting American business, manufacturing, and trade. Its home page connects with the Web sites of its constituent agencies.

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OBJECTIVES 쑺 To describe the evolving pattern of international commerce 쑺 To document the emerging markets for global exports

Container ships at a port in Melbourne, Australia, reveal the enormous quantities of goods that are traded internationally, mostly by sea. The economies of scale that such ships derive and mechanized loading and unloading systems help to keep the costs of imports and exports affordable, linking regions around the world through commodity flows.

쑺 To examine global trade flows of six major commodities groups