BUSINESS REFERENCE GUIDE

THE EFFECTS OF
GLOBALIZATION ON
INTERNATIONAL TRADE

The Editors of Salem Press

SALEM PRESS
A Division of EBSCO Information Services
Ipswich, Massachusetts
Copyright ©2014, by Salem Press, A Division of EBSCO Information Services, Inc.

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ISBN: 978-0-8242-1413-5

ebook: 978-1-4298-3573-2
Contents

Introduction v
Globalization & International Economics 1
Geopolitics 7
Nations, Politics & Markets 13
Business in the Global Political Environment 20
Role of International Financial Markets 27
Trade Creation & Diversion 33
Customs Union 40
Economic Unions 46
Export -- Import Operations 52
International Trade Economics 57
North American Free Trade Agreement 63
Applied Global Money Management. 69
Globalization & International Financial Management 75
Global Issues in Management 82
Global Outsourcing 87
Offshoring 93

iii
Introduction

Over the past few decades, the increasing presence of globalization has forced governments, nations, and corpora-
tions to define how they shape policies, conduct trade, and structure business operations. As a result, many emerging
markets have enjoyed unprecedented advancements, while current economic giants continue to experience sustained
growth.

The Business Reference Guide series is designed to provide a solid foundation for the research of various business
topics. This volume offers an expansive overview of globalization and its influence on international trade. The essays
are broken up into several sections that overview the effects of globalization on national policies, explore the changes
experienced by trade over the past century, and evaluate current multinational corporation methods.

This volume begins with an essay by Marie Gould that details the effects of globalization on international economic,
political, and social frameworks. As Gould explains, globalization can have prominent political implications, espe-
cially when it comes to its influence on geopolitics, or the practice of using political power over a given territory.
While geopolitics are often construed as being negative, Michael P. Auerbach explains how various elements of geo-
politics can play a positive role in shaping national foreign policies. International economic governance organizations
are another option when it comes to the formation of national economic policies. Simone I. Flynn outlines a number
of these organizations, such as the G-20, the International Organization of Securities Commissions, and the Basle
Committee on Banking Supervision. As a result of these newly formed corporations and their administration of busi-
ness in foreign environments, organizations have become more wary in carrying out their operations. To help protect
themselves, these businesses will often purchase political risk insurance and work to develop cross-border alliances.
Flynn overviews both of these options and also provides information on other strategies that businesses can implement
in order to mitigate political risk.

In addition to shaping the way that nations and businesses develop policies, globalization has also spurred interna-
tional trade to reach new levels. Some of the reasons for this drastic progress include free trade agreements, customs
unions, trade creation, and trade diversion. Customs unions, as with the other reasons mentioned, focus primarily on
national economic integration. Flynn offers details on customs unions and provides examples of some that already
exist, while Ruth A. Wienclaw delves into economic unions, another form of national economic integration. According
to Wienclaw, “economic unions are often characterized by a common currency and centralized bank, in which case
they are often referred to as economic and monetary unions.” She also notes that the best example of an economic
and monetary union is the European Union, which she analyzes in the following essay. Export and import operations,
among the more basic elements of trade, also experienced change due to globalization. Michael Jay Tucker outlines
the three rudimentary processes of these operations: pre-shipment, transport, and after-sale. Because of the globalized
economy, companies and governments who wish to experience success no longer have a choice as to whether or not
they want to conduct business across borders. Though governments often do conduct business globally, Steven R.
Hoagland notes that not all international trade practices are beneficial and efficient; in fact, there are many arguments
and rationales for limiting trade and adhering to trade restrictions. Some agreements exist to reduce trade restrictions
across nations, such as the North American Free Trade Agreement, which eliminates trade barriers between Canada,
Mexico, and the United States. The collection discusses the impact this agreement has on trade and labor in North
America as well as on certain industries within each nation.

v
The increase in globalization also promotes the growth of various management methods. International financial
management, as Flynn notes, incorporates exposure management, capital financial management, currency swap man-
agement, and international accounting management. Companies have also begun the process of global outsourcing
and the development of related management procedures. As mentioned by Wienclaw, the key to a successful offshore
operation is management; managers can help the organization enter into a new culture, meet the needs of the host
nation, and adhere to the host nation’s rules and regulations. This collection concludes with two analyses on the effects
of global outsourcing and the history and purposes of offshoring, both of which have become popular options for
corporations looking to reduce the cost of business and maintain comparative advantage in the global marketplace.

In the coming years, nations across the world will continue to experience the profound effects of globalization. This
volume will provide readers with an overview of globalization and its effects on international trade. Complete biblio-
graphic entries, a list of suggested readings, and relevant terms and concepts finish the essay.

vi
Globalization & International Economics

Table of Contents Overview

Globalization, which can be defined as the growing combina-
Abstract tion of the economic and social aspects of the world, has been a
point of contention in international economics. Although there
Overview
has been rapid growth and reduction of poverty in countries such
Four Aspects of Globalization as China and India, there has been increasing antagonism over
concerns that globalization has not improved matters of equality
Risks of Globalization and environmental promotion (World Bank, n.d.). The concept
of globalization has generated many different reactions. "Some
Political Risks
view it as a process that is beneficial-a key to future world eco-
Economic Risks & Political Risks nomic development-and also inevitable and irreversible. Others
regard it with hostility, even fear, believing that it increases
Emerging Markets inequality within and between nations, threatens employment
and living standards and thwarts social progress" (International
Application Monetary Group, 2000, Section IV, ¶ 2).
Emerging Markets
Four Aspects of Globalization
Representational Approaches The International Monetary Group (n.d.) defined four aspects
of globalization. These aspects were trade, capital movements,
Integrative Justice Model
movement of people and spread of knowledge and technology.
Viewpoint • Trade: Reports show that underdeveloped countries have
started to up their portions of world trade, which can be
Corporate & Local Leadership
shown through the increase in share from 19 percent in
Conclusion 1971 to 29 percent in 1999.

Terms & Concepts • Capital Movements: Individuals, such as venture capital-

ists, elevated private capital flows to developing countries
Bibliography throughout the 1990s.

Suggested Reading • Movement of People: It was found that many workers in

developing countries tend to relocate from one country
to another in an effort to gain work experience and job
opportunities. Most of the migration was found to be
between developing countries.
Abstract • Spread of Knowledge: Exchanging information tends to
be an overlooked aspect of globalization. Through the use
This article focuses on globalization and how it affects the eco- of direct foreign investment, there could be opportuni-
nomic, political, and social frameworks of countries across the ties for technical innovation as well as the expansion of
world. There is a discussion of the four aspects of globalization physical capital stock.
as well as the pros and cons of its implementation. In addition,
the article discusses the impact of globalization on emerging Although globalization provides opportunities for development
markets. across the world, many believe the process has not been pro-

1
2 ​​​Globalization & International Economics​

gressing evenly among all countries. It has been found that some to grow, with three quarters claiming to be actively investing
countries (i.e. East Asia) are integrating into the global system at in Central and Eastern Europe" (“Survey reveals,” 2005, p. 43).
a faster pace than others. However, other countries, such as those Such optimism was borne out. Antoine van Agtmael, a senior
in Latin America (other than Brazil) (Carranza Ko, 2013) and executive at World Bank Group, was the first person to use the
Africa, have not experienced the same level of change. Countries term "emerging markets" (Jana, 2007). Brazil, Russia, India, and
in these regions saw their economies stagnate or decline during China, which are known as the BRIC economies, were first iden-
the 1970s and 1980s. During the 1990s, the world experienced tified as countries poised for large and rapid economic growth.
a crisis in the emerging markets, though the early 2000s saw Real GDP was expected to grow three times faster in these coun-
robust growth in the BRIC nations. During the global financial tries over the next six years (Goldman Sachs, 2003). South Africa
crisis of 2008, Brazil, India and China were almost alone in the was later added to the list. In fact, between 2001 and 2010 the
world in experiencing economic growth (Yao & Zhou, 2011; BRICs GDP per capita growth leaped as much as 10%, a stag-
Carrasco & Williams, 2012). gering rate compared with the U.S. and Europe whose average
over the same period was a mere 1%. In 2013, China was pro-
Risks of Globalization jected to be the largest economy in the world by 2027, while the
One of the lessons learned from the emerging market crisis in the BRICs were expected to equal the G7 in size by 2032 (Nelson,
1990s was that there are risks when attempting to integrate to a Maniam & Leavell, 2013). The significance of emerging markets
global economy. Two major risks are volatile capital movements has reached a point where corporations have recognized their
as well as social, economic, and environmental degradation as a influence on the corporations' bottom line.
result of poverty. Some other risks include:
The Altradius survey reported that the highest percentage of
Political Risks respondents from the multinational corporations was investing
• Instability in national governments as follows: 74% invested in Central and Eastern Europe, 43%
• War, both civil and international invested in China, and 35% invested in India and Southeast Asia.
The countries that received the most funding in Central and East-
• Potential nationalization of an organization's resources ern Europe include Poland (60%), Czech Republic (46%), Russia
• Cancellation or non-renewal of export or import licenses (40%) followed by other EU accession countries. In Southeast
Asia, India was the top choice followed by Malaysia, Thailand,
• Confiscation of the importer's company and Indonesia (“Survey reveals,” 2005).
• Imposition of an import ban after the shipment of the goods
Although the news appeared to be promising for emerging mar-
• Imposition of exchange controls by the importer's country kets, there were some concerns that needed to be addressed.
or foreign currency shortages According to Olsen, Pinto and Virji (2005), some potential pit-
falls included:
• Surrendering political sovereignty
• Organizations must deal with the same growth challenges
Economic Risks & Political Risks that they face in other markets. Some of these challenges
• Differences and fluctuations in the value of different cur- deal with: Understanding what the customer wants,
rencies developing unique and cost effective offers, creating an
• Differences in prevailing wage rates effective marketing strategy and overcoming internal
organizational barriers.
• Difficulties in enforcing property rights
• Organizations must be prepared to cope with the change-
• Unemployment ability and imbalance of developing markets. Although
venture capitalists are willing to fund these ventures,
• Insolvency of the buyer
many seasoned venture capital managers are not willing
• Failure of the buyer to pay the amount due within six to deal with fund management for these types of ac-
months after the due date counts.
• Non-acceptance • Corporate headquarter offices tend to take too much time
when making decisions and communicating information,
• Surrendering economic sovereignty which hinders subsidiaries from reacting to problems in a
Emerging Markets timely manner. Organizations must eliminate the bu-
Although the 1990s was not a good time for emerging markets, reaucratic red tape and provide opportunities to respond
there was a rebound during the next decade. According to a study quickly when solving problems. Another option would
of multinational corporations, "two thirds of the respondents be to empower the subsidiaries to make decisions up to a
believed investment in emerging markets is likely to continue certain level.
 ​​​Globalization & International Economics​ 3

Application Both of these groups are considered to be "representers" as they

work to resolve issues that arise. Each situation is analyzed and
Emerging Markets evaluated on the representers' role in the situation and the world-
According to the 1999 World Development Report, there was view of the situation. The approaches attempt to understand how
an increasing difference between the developed and developing the ethical issues regarding international business are represented
countries (World Bank, 1999). Many had the perception that the in the underdeveloped world. The four different approaches are:
international community should be doing more to close the gap
since the aid per capita to developing countries was reduced by
• Approach 1 (No-speak): Foreigners are the representers
and the issue is expressed from a foreign world view-
one third in the 1990s. “As developing countries made strides to
point. The local residents have no voice and they have
open their economies and expand their exports, they were faced
no input into the world view. Local world views have no
with significant trade barriers with no aid or trade. To many in
place in the development of issues and the local experi-
the developing world, trade policy in the more advanced coun-
ence is not considered relevant in social equity issues.
tries seems to be more a matter of self-interest than of general
Most of the international business research follows this
principle" (Stiglitz, 2000, p. 438).
approach (i.e. Hofstede's Culture's Consequence).
It appears that if there was a good economic analysis, it is used • Approach 2 (Us-speak): The commonality between this
in favor of the advanced countries in order to support their approach and the first approach is that the foreigners are
self-interests. Given the number of opportunities for develop- the representers. However, the difference is that the world
ing countries to be placed at a disadvantage, supporters of trade view incorporates the local experience. This approach
liberalization argue that standard economic analysis will ben- attempts to represent local realities (local view) in a way
efit a developing country. Losses in one sector will be gained in that allows the local inhabitants to understand the situa-
another sector (i.e. job loss in one sector will be offset by job cre- tion. In many instances, the representer places himself in
ation in another sector). However, there is an assumption that the the local's position and attempts to articulate the view-
markets are functioning properly, which is not always the case. point based on the local's perspective.
As a result, the anticipated jobs may not be created in another
sector, and the process becomes unbalanced. When situations • Approach 3 (Same-speak): The locals are the represent-
such as this example arise, supporters of trade liberalization ers and the world view is the same as the foreigner's
must be prepared to respond to the concomitant challenges. perception. Locals represent themselves based on one or
more universal perceptions that originate from the West
One could argue that developing countries are at a disadvantage (i.e. modernism, post-structuralism, secular nationalism).
and the scales are tipped against them. In order to address the Many of the most influential representations of ethical
different types of inequities that may arise, those in the interna- issues that affect global organizations in underdeveloped
tional business arena must develop policies and procedures that nations are based on this approach.
address these issues and create a sense of fairness for everyone • Approach 4 (Other-speak): Locals are the representers,
involved. Many believe that there should be standards for social and international business issues are explained in the con-
responsibility and ethics in order to make sure that developing text of local viewpoints. When evaluating this approach,
countries are not exploited. Having a formal global approach representation is being explained by locals using local
to these types of challenges can ensure a sense of fairness for concepts.
everyone involved in the process.
The above approaches provide an explanation as to how foreign-
Representational Approaches ers and locals perceive the severity of social issues, which is
Khan (2007) introduced an abstract framework that identified important to the interactions of the business community. Multi-
four representational avenues to comprehend how social inequi- national corporations have to understand the culture and values
ties surface in developing countries as they attempt to venture of the countries in which they do business. Otherwise, the cor-
into international business. When the model was created, it poration may suffer as a result of conflict on social and business
was established that there are many parties associated with the ethics issues. There has to be some sense of social responsibility
process. Since representation ranged from local workers to inter- on the part of the multinational corporation.
national mass media institutions, each party was defined in terms
of geography. The two categories introduced are locals and for- Integrative Justice Model
eigners. Locals were defined as individuals or entities that are Santos and Laczniak (2013) suggest a normative ethics approach
primarily located in the developing countries. Locals are very to constructing a framework for multinational corporations to use
diverse and have different perspectives and interests. Individuals in order to avoid the tendency to exploit unsophisticated, low-
falling into the "foreign" category are those that do not fit into income consumers while establishing a profitable new market.
the local category. Significant players in the foreign group would
include international businesses that are directly involved in spe-
• Engage impoverished consumers with nonexploitative
intent
cific situations and their critics.
4 ​​​Globalization & International Economics​

• Work with customers to cocreate value to minimize opportunities of sharing information, and (c) the
• Invest in long-term consumption while protecting the organizational structure is outdated for the current trends and
environment there is a constant need to make adjustments in the organiza-
tional design.
• Recruit representation by all stakeholders
• Defining Roles & Decision Rights Between Headquarters
• Plan for long-term profit management instead of short- & the Local Leadership
term profit maximization

Many organizations may encounter problems when they attempt

Viewpoint to divide decision making rights regarding the corporate office
and the local subsidiaries. The two extreme approaches are when
Corporate & Local Leadership the corporate office micromanages the subsidiaries and when the
Olsen, Pinto & Virgi (2005) strongly believed that it was critical corporate office gives too much freedom to the subsidiaries and
to develop a set of practices that would assist local and corpo- does not keep the senior management informed as to what is
rate leaders with achieving long-term success. Six practices were going on in the business. It is important for these organizations
identified to aid these businesses with developing new models to create an organizational design and structure that will allow
on how to make the process successful and profitable. The six the two entities to share and divide the different levels of respon-
practices were: sibility and decision making rights so that the emerging market
can respond to the trends and conditions in the market.
• Establishing & Reviewing Long-term Direction
• Prioritizing Local Decisions
Given the level of uncertainty in emerging markets, it is almost
impossible to predict what the future will hold and many manag- Subsidiaries must develop an agenda that prioritizes the different
ers find it difficult to develop a long-term strategy about what levels of strategies that need to be performed in order to reach
direction the project should go. In lieu of a traditional approach long term objectives. A potential process for the agenda may be
to strategic management, the researchers have determined that to (a) place issues on the agenda list when they are recorded
managers can develop some sort of direction by outlining: and described by local and corporate managers and (b) move the
issues off the list when they have been dissolved.
• Opportunities for a future market as well an a SWOT
analysis • Making Resource Allocation More Flexible
• A broad, tangible plan that addresses financial, competi-
tive and operational needs Many multinational corporations do not have a resource allo-
cation system that can meet the needs of the emerging market
• A two to four year short-term plan that will allow the subsidiaries. Therefore, these organizations will need to define
organization to obtain its short-term goals. the criteria for emerging market subsidiaries and align them with
the corporate standards. In order to meet this need, some MNCs
Once these objectives have been obtained, the organization can are using the stage-gated funding method and linking it to spe-
focus on developing strategies over a period of time. These plans cific performance indicators.
should allow the organization to adjust its strategy to new con-
ditions. As the business continues to grow and be responsible
• Monitoring & Managing Performance
for addressing issues as they arise, it will be in a better position
to develop long-term strategies. Long term strategies “(a) serve Performance needs to be measured based on the economic
as an anchor against which decisions can be tested, (b) align market conditions in the local nation.
expectations between local and corporate leaders, (c) define the
criteria for when local market change should trigger a change in In order to fully experience the emerging market growth experi-
the strategy” (Olsen, Pinto & Virji, 2005, p. 39). ence, multinational corporations will be required to balance each
of the areas mentioned above.
• Fitting the Emerging Market Business Within the Organi-
zational Structure
Conclusion
Many multinational corporations hinder the decision making
process of their subsidiaries that function in the emerging mar- Trade liberalization should prove an asset to third world nations
kets. This type of problem may occur in three ways such as and the world at large. However, it must be "balanced in agenda,
(a) grouping emerging market subsidiaries with subsidiaries in process, and outcomes, including not only sectors in which
the larger developed markets, (b) units cannot learn from one developed countries have a comparative advantage, like finan-
another when the organizations allow the structure or a process cial services, but also those in which developing countries have
 ​​​Globalization & International Economics​ 5

a special interest, like agriculture and construction services" smaller growth companies, which involve high gains and high
(Stiglitz, 2000, p. 437). One could argue that developing coun- risks.
tries are at a disadvantage and that the scales are tipped against
them. In order to address the different types of inequities that Globalization: Globalization involves a combination of eco-
may arise, those in the international business arena must develop nomic, social, technological, cultural, and political adjustments
policies and procedures that address these issues and create a that are often found in developing countries that are advancing
sense of fairness for everyone involved. their integration, independence, and relationships with other
countries.
Globalization can prosper when there is consideration for the
whole package. According to the International Monetary Group, Physical Capital Stock: Physical capital stock is one example of
the entire package should include strategies, rules, financial and an economic aggregate. The stock is needed in order to divide the
technical aid, and help in erasing debt if possible and needed. total output among various other factors that may be involved.
Other factors within the package could include: It is used also to evaluate the advancement of capital and the
productivity of labor.
• Macroeconomic stability to create the right conditions for
investment and saving;
Trade: Trade or commerce, in its simplest form, is the agreed
• Outward oriented policies to promote efficiency through transaction of good and services from one willing party to
increased trade and investment; another. Trade is facilitated through a working market. Tradi-
tionally, trade involved bartering, but modern times have called
• Structural reform to encourage domestic competition; for negotiating through a similar medium like money.
• Strong institutions and an effective government to foster
good governance; Trade Liberalization: Trade liberalization is a policy or arrange-
ment that allows domestic providers to involve themselves in
• Education, training, and research and development to competing world markets without restriction. Similarly, foreign
promote productivity; providers can compete at their own volition within domestic
• External debt management to ensure adequate resources markets.
for sustainable development (International Monetary
Group, 2000, “How can the poorest”). World Development Report: The World Bank's annual World
Development Report (WDR) is a crucial source of information
Khan (2007) introduced a conceptual framework that identified regarding the current economic, social, and environmental con-
four representational approaches to understanding how social dition of the world. The WDR analyzes one detailed factor of
inequities surface in developing countries as they attempt to development per year; reports in the past have involved subjects
venture into international business. The approaches provide an like labor, health, poverty, and the role of the state, to name a
explanation as to how foreigners and locals perceive the sever- few.
ity of social issues, which is important to the interactions in the
business community.
Bibliography
Terms & Concepts Carranza Ko, N. (2013). Cementing class differences:
Globalization in Peru. Perspectives on Global
Capital Movements: Capital movements define the economic Development & Technology, 12(3), 411-426. Retrieved
status and position of a nation as it relates to other countries. November 15, 2013, from EBSCO Online Database
Capital movements are comprised of both the current account as Business Source Complete. http://search.ebscohost.com/
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company from one nation that makes some form of investment Carrasco, E. R., & Williams, S. (2012). Emerging econo-
into a different nation that is not its own. In other words, it is mies after the global financial crisis: The case of Brazil.
the creation of some enterprise or business venture by a foreign Northwestern Journal of International Law & Business,
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25761&site=ehost-live
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financial market that is adapting to the emerging capitalism by Darwis, Y. (2013). Communication media (e-commerce) as a
initiating its own form of stock market. They are analogous to supporting factor in Indonesia's fashion industry in the
6 ​​​Globalization & International Economics​

international business competition. International Journal Stiglitz, J. (2000). Two principles for the next round or, how
of Organizational Innovation, 5(3), 206-220. Retrieved to bring developing countries in from the cold. World
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International Monetary Group. (2000, April 12). Threat or Survey reveals major risks involved in trading with emergent
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www.imf.org/external/np/exr/ib/2000/041200.htm
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Jana, R. (2007, January 10). Lessons from emerging-market September 7, 2007, from http://www1.worldbank.org/
leaders. Business Week Online, 22. economicpolicy/globalization/World Bank (1999). World
development report 1999-2000: Entering the 21st century.
Khan, F. (2006). Representational approaches matter. Journal Washington, D.C.: World Bank.
of Business Ethics, 73(1), 77-89.
Yao, X., & Zhou, M. (2011). China's economic and trade
Nelson, G., Maniam, B., & Leavell, H. (2013). BRIC: development: Imbalance to equilibrium. World Economy,
Overview and future outlook. Journal of International 34(12), 2081-2096. Retrieved November 15, 2013, from
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Suggested Reading
Olsen, T., Pinto, M., & Virji, S. (2005). Navigating growth in
emerging markets: Six rules for improving decision mak- Driga, I. (2011). FDI flows and host country economic devel-
ing between corporate and local leadership. Journal of opment. Annals of the University of Petrosani Economics,
Business Strategy, 26(6), 37-44. 11(4), 101-108. Retrieved November 15, 2013, from
EBSCO Online Database Business Source Complete.
Reforming policies for the business sector to harvest the ben- http://search.ebscohost.com/login.aspx?direct=true&db=bt
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Netherlands, 2012(11), 41-70. Retrieved November 15,
2013, from EBSCO Online Database Business Source Eckhardt, G., & Mahi, H. (2004). The role of consumer agency
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Santos, N. C., & Laczniak, G. R. (2012). Marketing to the Kaminsky, G. (2007). Emerging markets and financial global-
base of the pyramid: A corporate responsibility approach ization sovereign bond spreads in 1870-1913 and today.
with case inspired strategies. Business & Politics, 14(1), Journal of International Economics, 73(1), 219-222.
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&site=ehost-live 96(5), 1631-1651.

Essay by Marie Gould

Marie Gould is an Associate Professor and the Faculty Chair of the Business Administration Department at Peirce College in Phila-
delphia, Pennsylvania. She teaches in the areas of management, entrepreneurship, and international business. Although Ms. Gould has
spent her career in both academia and corporate, she enjoys helping people learn new things — whether it's by teaching, developing or
mentoring.
Geopolitics

Table of Contents Overview

In 1904, the British geographer, Sir Halford Mackinder, observed
Abstract the countless British naval bases used to launch into the Empire's
holdings around the world. He speculated that the only element
Overview that could strike fear into British colonialists despite its obvi-
Geopolitics, Defined & Redefined ous naval power was an even greater power. If a nation were to
take possession of what he called the "World Island" (namely,
Geopolitics & Political Relations the giant land mass that contains Europe, Asia and Africa), the
Cyprus British Empire would fall.

Non-Governmental Associations German General Karl Haushofer, whose political views were
Geopolitics & Economics influenced heavily by Mackinder's ideas, would later take the
pursuit of the World Island quite seriously. He approached
Energy & International Outreach Adolph Hitler, who at the time was writing his seminal work,
Mein Kampf, from prison, and promoted what would become his
Conclusion life's work — the formation of an enormous alliance consisting
Benefits of Germany, Japan, India, Russia and China, all united against
Britain. Haushofer's credo would generate a significant propa-
Conflicts ganda campaign that claimed invasion of other states and regions
Economic Implications was justified. He was advocating for the invasion of neighbor-
ing states and areas through the use of skewed and even flawed
Terms & Concepts information to convince the German people that annexation was
a viable activity. To the uninitiated, the concept of "geopolitics"
Bibliography provided a reason for incorporating any part of the globe that
contained something the German society wanted or needed into
Suggested Reading the German territorial expanse.

Meanwhile, in the years preceding World War II, Mackinder

was asked his thoughts on the philosophy of his would-be dis-
ciple, Haushofer, as the General put the German interpretation of
Abstract Mackinder's geopolitical ideal into policy.

The broad strokes that attempt to define the concept of geo- My up-to-date views on geopolitics? As I understand
politics may be the primary reason for misinterpretations (both that word, which I myself never employ, it is the name
inadvertent and sinister) of this theory. These misunderstandings, given by Germans to a political theory which, by
if unchecked, may contribute to flawed or even dangerous for- exploiting the geographical pattern of the globe, will
eign policy development. Still, there are some undeniable truths lead to a world, empire under German control. I have
contained within the overarching notion of geopolitics; elements always felt, and am still of the opinion, that the group-
that may play a positive role in creating effective foreign policy ing of lands and seas is such as to lend itself to the
in the modern world. This paper takes a closer look at the con- growth of empires and, in the end, to a single empire
cept of geopolitics and its role, both real and perceived, in the (Dorpalen, 1943).
20th and 21st century global environment.

7
8 ​​​Geopolitics​

As is often the case in international politics, a seemingly innocu- all the governments and peoples associated together against the
ous theory can be used for ill gain. In this case, the Makinder Imperialists. We cannot be separated in interest or divided in pur-
notion of collectivizing regions to counter a larger hypothetical pose" (Brigham Young University, 2007).
entity was twisted and manipulated when utilized for politi-
cal purposes. The Nazis, for example, abutted what was then Wilson's iconic words are reflective of the importance of geo-
Czechoslovakia on either side. Even though this country was an politics to the global community. After all, the concepts of
internationally-recognized sovereign state, Haushofer was able international political relations and international business are
to seemingly rationalize annexing the Sudetenland to the Nazi predicated on the notion that few global powers or business
leadership who, in turn, acted almost dumbfounded about why entities are totally self-subsistent. Similarly, targeted partners in
they had not yet taken over that region. geopolitics likely see opportunities not for conflict but for sym-
biotic relationship-building. This paper next looks at these two
Then again, the broad strokes that attempt to define the concept arenas and the ways in which geopolitics has become an integral
of geopolitics may be the primary reason for misinterpretations contributor.
(both inadvertent and sinister) of this theory. These misun-
derstandings, if unchecked, may contribute to flawed or even Geopolitics & Political Relations
dangerous foreign policy development. Still, there are some As stated earlier, in an era in which globalization is the norm,
undeniable truths contained within the overarching notion of geopolitical (which is to say, external policy that is based on
geopolitics; elements that may play a positive role in creating geographical need) relations are a necessity for most political
effective foreign policy in the modern world. This paper takes institutions. A lack of political territoriality that is suggested
a closer look at the concept of geopolitics and its role, both real by a fundamentalist view of geopolitics gives way to intergov-
and perceived, in the 20th and 21st century global environment. ernmental organizations (IGOs), international treaties, security
relationships and mutual cooperation institutions. Examples
Geopolitics, Defined & Redefined include NATO, the Association of Southeast Asian Nations
As the illustration of Karl Haushofer's interpretation of the (ASEAN), OPEC, the International Monetary Fund and the
theory suggests, the idea of geopolitics can be used to justify a World Health Organization. Each of these organizations and
wide range of foreign policy actions. Geopolitics, after all, is a institutions have proven able to withstand the test of time and,
broad-based term subject to a multitude of political, academic more importantly, the demands of an ever-changing global cli-
and individual interpretations. Simply defined, geopolitics is the mate.
formulation of policy based on external environmental factors.
In terms of international relations, geopolitics takes on a char- Still, one cannot paint a picture of the international community
acteristic not dissimilar from pure realism — a nation will seek as wholly symbiotic and at peace. Even President Wilson viewed
to maximize the assets it needs in order to advance itself in the the emerging post-World War I international environment, which
international community, and if it views any element (whether was weary from hegemonic conflict, with respect to the competi-
tangible or intangible) evident in an extraterritorial environment tive nature of the interstate system. After all, geopolitics stems
to be of value or a threat to its stability, it will work towards from the development of state policy with respect to extra-terri-
involving itself in that environment. torial conditions. When multiple states see external resources of
value to their own infrastructures, competitiveness and even ter-
On its surface, this definition does appear ominous. In truth, ritoriality can arise, fostering conflict. Some political scientists
throughout human history, this negative connotation has come see the next phase in world order, with geopolitics as the driving
to bear many times. The myriad "empires" that have cropped force, as formed from a series of concentric spheres of influence,
up on virtually every continent provide evidence of this point. clearly defined by territoriality (Chaturvedi & Painter, 2007).
The Greek, Roman, and Ottoman Empires are examples as are
the countless "colonial" entities that hailed from Europe until Cyprus
the early 20th century. Most often, these political entities both Perhaps one of the most glaring examples of the conflicts that can
expanded and declined with violence and war. As such, linking arise as result of geopolitics in the modern international regime
national interest and external resources and environments does is the situation that exists in Cyprus. The small Mediterranean
create the potential for conflict. island republic has been, since its independence in 1960, at the
center of a tug-of-war between Turkey and Greece. Its value to
Still, the hegemonic conflicts that have littered human history both is clear — throughout history, its geographic location at
under the flag of geopolitics (or at least loose interpretations the eastern end of the Mediterranean Sea could serve as a gate-
of that term) are offset by the benefits of appreciating a geopo- way to Asian or European territory, and its nearby oil reserves
litical doctrine. In truth, the idea of a world in which interests only add to its strategic and economic worth. It also contains
and needs eschew geographic borders is reflective of the liberal an element of ethnic solidarity, one that has created significant
tenets offered by President Woodrow Wilson after the first World tensions in the region that have yet to be alleviated. Its popula-
War: "In regard to these essential rectifications of wrong and tion is split between ethnic Greek Cypriots, who in a de facto
assertions of right we feel ourselves to be intimate partners of sense, represent the administrative government, and minority
 ​​​Geopolitics​ 9

Turkish Cypriots, whose self-ruled government is confined to the and countries in the New World could at the time offer much
northeast territory. Greek and Turkish infiltration of the island, beyond natural resources without heavy Colonial investment).
which has been ongoing since the island was divided, has fur- Rather, they were addressing economic interests by pursuing
ther inflamed the populace, and while there is a United Nations development of those resources they needed. Of course, the
peacekeeping force in Cyprus (UNFICYP), the "two countries in inequities of these economic relationships often left the under-
one" have yet to reconcile. Adding fuel to the fire is the fact that, developed nation at a perpetual disadvantage, while the Colonial
with the strong encouragement of the Greek government, Cyprus power used such resources for its own power centralization. Such
was admitted into the European Union (EU) in 2004, in spite of imbalances inevitably led to revolt, not just in the case of 18th
Turkish opposition (Turkey is not a member of the EU). While Century America, but as far forward as the late 20th Century.
the EU had previously indicated that it would only admit Cyprus
when its issues have been resolved, the island became part of Energy & International Outreach
that organization in the late 1990s without resolution (Boedeltje, Still, it is an undeniable fact that the wealthiest countries will still
2007). With Greece and Turkey asserting their geopolitical influ- need to satisfy their needs by investing heavily in developing
ence on the island nation, the tug of war continues, though the countries. Nowhere else in the current economic environment
two countries have made diplomatic strides since the beginning is this statement more true than it is concerning the business of
of the twenty-first century. energy. The United States, for example, produces about 6.5 mil-
lion barrels of crude oil per day, but the country consumes nearly
Non-Governmental Associations 19 million barrels per day (US Energy Information Association,
Not all political institutions are created on the national gov- 2012, 2013). In Europe, the same situation exists: Only a handful
ernmental stage. Some sub-national (or non-governmental) of the European Union's (EU) twenty-eight countries produces
organizations, associations and subgroups gel based on common crude oil, but with production down, the EU states depend on
need, but may not look to their national governmental authori- foreign imports at a rate of 85 percent (Eurostat, 2013).
ties to sanction their cross-border networks. Many organizations
have established linkages with groups of similar interests without With a lack of substantive domestic oil production representing
regard to official government policy. An example can be found a sort of "Achilles Heel" for otherwise industrialized Western
in the countries closest to the Arctic Circle. Indigenous peoples countries, strong linkages are needed with oil-producing nations,
from countries like Norway and the other Scandinavian states, particularly those who do not belong to the major oil conglom-
Russia, Greenland and Canada all represent relative minorities erate, OPEC. Many of these oil-rich countries are in virtually
in their respective nations. However, since the late 1980s, these every other capacity underdeveloped, politically unstable and
various groups have reached across borders to develop link- economically anemic. In the former Soviet country of Tajikistan,
ages with and even activate peoples of the same ethnicity. In for example, an effort is ongoing to woo Western countries and
one case, a Norwegian tribe of indigenous peoples, in an attempt others to take advantage of its oil resources (and the means to
to halt the utilization of a major river, reached out to peers in a transport them via pipeline), which have largely been unused
neighboring country to help take up the cause. While the effort since a devastating civil war took place in that country in the
fell short, the activation of this tribe gave rise to a sentiment of early 1990s. In 2010, an oil pipeline was completed running
self-determination and identity that was not present previously from Tajikistan to China through Uzbekistan and Kazakhstan.
(Heininen, 2004). China has a shown a great interest in exploiting the oil and gas
reserves in Turkmenistan. The potential benefits are self-explan-
Geopolitics & Economics atory — as-yet under-utilized oil and natural gas reserves in a
Arguably, the most important component of economics is at relatively unknown area. Of course, there are risks involved, as
its core: The relationship between supply and demand. On the Tajikistan is one of the world's poorest countries, with spotty
demand side are the consumers eager to spend their money on security (Business Monitor International, 2006; Lee, 2013).
goods and services made available by supply-side entities. Both Nevertheless, the Tajik government, and likely other countries
of these components operate within an economic system (such with similar resources and shortcomings, is forging ahead with
as a state or country). The latter of these two integral elements, its outreach program.
supply, is rendered somewhat nebulous when taken out of theo-
retical frameworks and applied in a 21st century international As this case demonstrates, geopolitics drives the Tajik govern-
political economy. In most cases, supply is not a singular mecha- ment as well as the US, EU, Chinese and other governments
nism that can on its own meet the needs of the consumers within willing to invest in that country's energy resource potentials. In a
that system. Rather, it relies on external resources and networks best-case scenario, such links are well-worth the risks.
to assist in meeting those needs.

As is the case in international political relations, geopolitics has Conclusion

been known to generate conflicts when applied to international
economic relations. Colonial European powers went abroad not Karl Haushofer's misinterpretation of Halford MacKinder's
necessarily in search of equitable trade relations (few territories views of the pre-World War I environment was certainly not
10 ​​​Geopolitics​

the only instance in which Nazi leaders used an innocuous con- or less-developed nation may be enormous. For a country like
cept to further their militaristic and totalitarian agenda. Many landlocked Tajikistan, for example, which after the demise of
historical tenets and ideals were twisted to aid Hitler's pro- the Soviet Union was left to deal with extreme poverty, crum-
paganda machine. In this case, the Nazis used the idea that a bling infrastructure, weak governance, and at-best unreliable
decades-old theory, which stated that Britain's empire could be security measures, enticing countries such as the United States
countermanded if a nation (or group thereof) were to empower China seems worth the gamble. Conversely, for these countries,
the European and Asian landscape, as justification for expanding becoming invested in that obscure state's energy program is also
its own empire. risky, but in this age of steady concern over the price of energy
and oil, the benefits may outweigh the risks.
Still, the fact that Haushofer could reshape MacKinder's notion
of geopolitics (a term MacKinder himself was surprised was Similar to the case of international relations, the geopolitical
attributed to him) suggests the flexibility with which the term implications for economics can also create potential for conflict.
can be employed. After all, at its most fundamental levels, geo- The former Soviet Union, of which Tajikistan was once a part,
politics is broad-based and therefore subject to interpretation. drew heavily from its satellites, investing only in the elements
of the economy from which it could see a return for Moscow.
Benefits When it folded, the USSR left a group of nations, spanning
In some situations, geopolitics creates positive benefits for the from the Baltic states south to the Black Sea and eastward to the
participating parties. As demonstrated in this paper, policy that Chinese border, most with predominantly industrial economies,
is deployed to address externally-based interests has created with no business partners except a financially decimated Russia.
the International Monetary Fund and the US Agency for Inter- Many, such as Latvia, Lithuania, and Estonia have looked to the
national Development, both of which satisfy domestic needs European Union and even NATO as partners, much to the con-
(namely, laying the groundwork for stronger interstate political sternation of the Russian Republic. Meanwhile, Russia has been
and economic relations) while serving the more noble practice wary of letting go of its former components, even as they have
of assisting developing nations. It has also given rise to one of become independent. The former leader of the Soviet Union has
the strongest security alliances in modern human history in the been implicated in the poisoning of a Georgian Prime Minister,
North Atlantic Treaty Organization, and a critical organization and it maintained a military presence in the breakaway region of
dedicated to researching and preventing the spread of disease and Azerbaijan until 2013. The reasons for its continued involvement
other public health threats, the World Health Organization. By (and at times interference) in the region are largely economic, as
nature of its apolitical fundamentals, geopolitics also has given was largely the case when the Soviet Union began, and almost
empowerment to individuals who otherwise do not have a voice singularly geopolitical in nature.
in their own country. Put simply, this concept potentially presents
a number of benefits to the field of international relations, both on Regardless of its genesis and the manipulations hostile forces
an inter-governmental level and a non-governmental level. have conducted of it in pursuit of their own ill gains, geopoli-
tics does have its place in the international community. After
Conflicts all, the 21st century world is one in which no one nation can
As the case of Haushofer clearly illustrates, geopolitics can be completely self-sufficient — each country relies on at least
also foment international and domestic conflict. Turkey and a semblance of external relations and interstate business for
Greece, as the example shown in this paper illustrates, remain its own survival. Furthermore, non-political entities, such as
at odds over influence on the sovereign island state of Cyprus. socially-motivated organizations and business groups, may also
The country's geography, coupled with the presence of nearby formulate policy based on the pursuit of foreign assets (or con-
oil, has led the two larger countries to military confrontation on nectivity with foreign-based peers). In a world that relies on
more than one occasion, and has left the United Nations and the interstate linkages, geopolitics drives that contact.
European Union in a geopolitical conundrum of its own — seek-
ing a resolution to a tense regional conflict that could potentially
destabilize a wider area and ultimately impact the interests of Terms & Concepts
the EU, NATO, the Middle East and the former Soviet states.
As this example demonstrates, geopolitics can prove dangerous Geopolitical: The formulation of policy based on external or
when interested parties find themselves competing for the same foreign-based assets or conditions.
resources in a particular region.
Globalization: Trend in which nations and businesses establish
Economic Implications and extend lines of communication and networks between them-
As this paper has offered, geopolitics does not necessarily encom- selves and foreign entities.
pass international political relations. Policy that is derived from
externally-based factors also has economic implications. Some Inter-governmental Organizations: Institutions established and
of these permutations are positive in nature. The potential ben- operated by national governments for the purposes of working
efits of accepting the influence of a foreign power by a smaller with foreign governments.
 ​​​Geopolitics​ 11

International Relations: Practice of establishing and maintain- Energy dependency rate, EU-27, 2000-2010. Retrieved
ing networks and lines of communications with other states. November 19, 2013 from http://epp.eurostat.ec.europa.eu/
statistics%5Fexplained/index.php/Energy%5Fproduction
Non-governmental Organizations: Institutions established to %5Fand%5Fimports
address concerns or interests without the involvement of a gov-
ernment agency. Heininen, L. (2004, November). Circumpolar international
relations and geopolitics. IArtic Human Development
ReportI. Retrieved December 29, 2007, from http://www.
Bibliography svs.is/AHDR/AHDR%20chapters/AHDR%5fchp%2012.
pdf. Lee, Y. (2013, June 18). CNPC, partners sign
Boedeltje, F. J., Kramsch, O.T., Houtum, H.V. & Plug, R. Tajikistan oil and gas deal. Wall Street Journal. Retrieved
(2007). The fallacious imperial geopolitics of EU enlarge- November 19, 2013 from http://online.wsj.com/news/
ment. IJournal of Economic and Social Geography, 98I(1), articles/SB1000142412788732452090457855245425200351
130-135. Retrieved January 1, 2008, from EBSCO Online 8 US Energy Information Association. (2012). Frequently
Database Academic Search Premier. http://search.ebsco- asked questions: How much oil does the United States
host.com/login.aspx?direct=true&db=aph&AN=23827627 consume per year? Retrieved November 19, 2013 from
&site=ehost-live http://www.eia.gov/tools/faqs/faq.cfm?id=33&t=6 US
Energy Information Association. (2013). Frequently
Brigham Young University. (2007, November). World War I asked questions: How much of the oil produced in the
Document Archive. Retrieved December 28, 2007, from United States is consumed in the United States? Retrieved
http://wwi.lib.byu.edu/index.php/President%5fWilson%27 November 19, 2013 from http://www.eia.gov/tools/faqs/
s%5fFourteen%5fPoints faq.cfm?id=268&t=6

Growing in confidence. (2006). IEmerging Europe Monitor:

Russia & CIS, 10I(9), 10. Retrieved January 1, 2008, from Suggested Reading
EBSCO Online Database Business Source Complete.
http://search.ebscohost.com/login.aspx?direct=true&db=bt Bohr, A. (2004). Regionalism in central Asia. IInternational
h&AN=21975251&site=ehost-live Affairs, 80I(3), 485-502. Retrieved January 1, 2008, from
EBSCO Online Database Academic Search Premier.
Chaturvedi, S. & Painter, J. (2007). Whose world, whose http://search.ebscohost.com/login.aspx?direct=true&db=a
order? ICooperation & Conflict, 42I(4), 375-395. ph&AN=13424567&site=ehost-live
Retrieved December 28, 2007, from EBSCO Online
Database Business Source Complete. http://search.ebsco- Claval, P. (2006). The scale of political geography. IJournal
host.com/login.aspx?direct=true&db=bth&AN=27960072 of Economic and Social Geography, 97(3)I, 209-221.
&site=ehost-live Retrieved January 1, 2008 from EBSCO Online Database
Academic Search Premier. http://search.ebscohost.com/
Dorpalen, A., Horrabin, J.F. & Whittlesey, D. (1943, January login.aspx?direct=true&db=aph&AN=21123940&site=eh
11). The mysteries of geopolitics. ITime MagazineI. ost-live
Retrieved December 20, 2007, from http://www.time.com/
time/magazine/article/0,9171,884770-1,00.html. Kelly, P. (2006). A critique of critical geopolitics. IGeopolitics,
11I(1), 24-53. Retrieved January 1, 2008, from EBSCO
Energy Information Administration. (2007, December 11). Online Database Academic Search Premier. http://search.
Short-term energy outlook. Retrieved December 31, 2007, ebscohost.com/login.aspx?direct=true&db=aph&AN=200
from http://www.eia.doe.gov/emeu/steo/pub/contents.html 63232&site=ehost-live

Energy in the EU. (2006). Eurostat Retrieved December Rozov, N. (2012, July). Geopolitics, geoeconomics, and geo-
31, 2007, from http://epp.eurostat.ec.europa.eu/pls/por- culture. Sociological Research 51(4):67–90. Retrieved
tal/docs/PAGE/PGP%5fPRD%5fCAT%5fPREREL/ November 19, 2013 from EBSCO online database,
PGE%5fCAT%5fPREREL%5fYEAR%5f2006/PGE Business Source Complete. http://search.ebscohost.com/
%5fCAT%5fPREREL%5fYEAR%5f2006%5fMON login.aspx?direct=true&db=bth&AN=79629493&site=eh
TH%5f09/8-21092006-EN-AP1.PDF Eurostat. (2013). ost-live
12 ​​​Geopolitics​

Essay by Michael P. Auerbach

Michael P. Auerbach holds a Bachelor's degree from Wittenberg University and a Master's degree from Boston College. Mr. Auerbach
has extensive private and public sector experience in a wide range of arenas: Political science, business and economic development, tax
policy, international development, defense, public administration and tourism.
Nations, Politics & Markets

of international economic governance approaches and practices,

Table of Contents
including the G-20, Financial Stability Forum, the International
Organization of Securities Commissions Organization for Eco-
Abstract nomic Co-operation and Development (OECD), and the Basle
Committee on Banking Supervision, will be described and
Overview analyzed. Issues related to national representation in the devel-
Globalization of Nations, Politics, & Markets opment of economic governance practices will be introduced.

The Political Economy of Nations, Politics,

& Markets Overview
Applications In the twenty-first century, nations, politics, and markets are
Global Financial Governance deeply interconnected units of a global system. Nations—large
aggregations of people sharing rules of law and identity based
G-20: International Finance Architecture on common racial, linguistic, historical, or cultural heritage—
Financial Stability Forum: International rarely act unilaterally. Nations operate within a framework of
Market Stability international alliances and partnerships. Politics is defined as the
art and science of government or governing a political entity and
Securities Regulation the administration and control of its internal and external affairs.
Corporate Governance Politics plays a crucial role in economic policy. The term “mar-
kets” refers to the social arrangement that allows buyers and
Banking Supervision Standards sellers to discover and trade information and carry out the vol-
untary exchange of goods and services within politically defined
Issues
systems and governmental institutions (Bowles, 1991). Markets
Representation in International Economic are economic and political entities.
Organizations
The interdependence between nations, politics, and mar-
Conclusion kets has encouraged the development and implementation of
global economic governance practices, methods, and standards.
Terms & Concepts National and international economic reforms, such as imple-
menting new financial architectures, market structures, and
Bibliography trade policies, result from political debate—and political tur-
moil—within countries and regions. The development of global
Suggested Reading economic governance tools is a complicated and contentious
process involving multiple stakeholders with conflicting agen-
das (Helleiner, 2000). Global economic governance standards
and recommendations are made within international institutions
Abstract such as regulatory commissions, international trade organi-
zations, European Union commissions, and United Nations
This article will focus on the ways in which globalization effects agencies. Global stakeholders, such as national governments,
the interrelationship of nations, politics, and markets. This arti- multinational corporations, parties and public officials, interest
cle describes the current global context for nations, politics, and associations, and citizen advocacy organizations, shape the new
market relationships as well as the evolving political economy global governance models and related transnational political
of nations, politics, and markets in the global arena. Examples regimes (Bennett, 2004).

13
14 ​​​Nations, Politics & Markets​

This article describes how the process of globalization impacts flows with nonresidents and become more accessible to foreign
the relationships that exist between nations, politics, and mar- investors.
kets. The following sections, including Globalization of Nations,
Politics, and Markets and the Political Economy of Globaliza- The new global market is based on a capitalist model in which
tion, will serve as a foundation for later sections summarizing business, and to some degree politics, is responsive primarily
and analyzing economic governance practices developed by to economic forces. Capitalism is a type of economic system in
international economic organizations including the G-20, the which individuals or companies in the private sector own and
Financial Stability Forum, the International Organization of control the majority of a state’s means of production. Capitalism
Securities Commissions, the Organization for Economic Co- applies market principles, such as the concepts of profit incentive
operation and Development (OECD), and the Basle Committee and private property, to all aspects of economic activity within
on Banking Supervision. Issues related to national representa- and between nations. Capital markets are the financial institu-
tion in the development of economic governance practices are tions that channel people's savings from households to business
discussed. firms for the purposes of productive investments and economic
growth. The market capitalism model requires the interrelation-
Globalization of Nations, Politics, & Markets ship and cooperation of nations, politics, and markets. Issues of
Nations, politics, and markets have been brought together government regulation of public sector and private sector activi-
through the process of economic globalization. Economic and ties, property ownership, ethics, investments, corporate behavior,
political environments around the world have changed because and social well-being between national and international stake-
of globalization. Globalization in its modern form is character- holders in the global economic and political arena are constantly
ized by the permeability of the traditional boundaries of nations, updated and negotiated.
cultures, and economic markets. Some of the fundamental
economic forces and political events influencing globalization National political arenas and environments, intimately connected
around the world include the fall of the Soviet Union; the shift to and motivated by economic conditions, are characterized by
from a global economy based on natural resources to one based the regulatory environment, local attitudes toward corporate
on knowledge industries; demographic shifts; the development governance, reaction to international competition, and labor
of global shipping infrastructure; increased liberalization of laws. Political environments around the world are continually
trade policy; advancements in communication technology; and changing due to the forces of globalization. Economic intercon-
the threat of global terrorism. The modern trend of globalization, nectedness creates a turbulent global socio-political environment
and resulting shifts away from centralized to market economies characterized by competing political actors, shifting power rela-
in much of the world, has created opportunities for increased tions, and politically driven changes in national economies
trade between nations. This includes increases in foreign invest- around the world.
ment, multinational business partnerships, and access to once
closed global markets for developing countries. Global markets The Political Economy of Nations, Politics, & Markets
are characterized by an increasing mobility in capital, research Political economy is a subfield of economics dating back to
and design processes, production facilities, customers, and the eighteenth-century that analyzes the interactions between
regulators. Global markets, created in part by socio-economic political processes and economic variables and policies. Politi-
changes, political revolutions, and advanced communication cal economy describes how political institutions, the political
technologies, have no borders. environment, and market forces and structures—such as capi-
talism—influence each other. Thus, the political economy of
Economic and political opportunities, including international globalization is an examination of the relationship between
investments and joint ventures, in the global economy are nations, politics, and markets.
increasingly tied to alliances, partnerships, and trade pacts such
as the North American Free Trade Agreement (NAFTA) between Globalization has created a new model of political economy
the United States, Canada, and Mexico, the Mercosur trade pact forged by corporations, communities, markets, and national
between Argentina, Uruguay, Brazil, and Paraguay, and the Asia governments that is characterized by innovations such as par-
Pacific Economic Cooperation (APEC) trade zone. In addition, ticipative leadership, client-driven marketing, decentralized
international economic opportunities for some nations have been structures, entrepreneurship, democratic corporate governance,
created by increasing privatization. Many countries have moved strategic alliances, deregulation, privatization, and business-
to privatize various state-owned industries and allowed foreign government partnerships. The following innovations in the
investors to purchase pieces of them through joint ventures. In political economy of globalization represent an era of increased
many places, local operations have participated in these proj- competition and cooperation (Hallal, 1990):
ects. Emerging markets have formed and expanded to capitalize
on opportunities in new global economy. The term emerging
• Democratic model of the firm: A large number of
companies are now accountable to a variety of stakehold-
markets refers to the capital markets of developing countries
ers, including workers, customers, suppliers, distribu-
that have liberalized their financial systems to promote capital
 ​​​Nations, Politics & Markets​ 15

tors, investors, and the public. Some companies operate

operation and Development (OECD), and the Basle Committee
through collaborative governance rather than traditional
on Banking Supervision.
top-down, hierarchical governance.
• Research consortia: Corporations are increasingly prac- G-20: International Finance Architecture
ticing cooperative research. Companies, including some The G-20, an international organization formed in 1999 to
competitors, often pool resources to undertake collabora- strengthen international financial architecture, promotes open and
tive large-scale or highly technical projects. constructive discussion between industrial and emerging-market
countries on key issues related to global economic stability. The
• Strategic alliances among competitors: Some large G-20 has a stated mission to provide opportunities for dialogue
corporations—particularly in the auto, steel, and electron- between industrial and emerging-market countries on national
ics industries—have become increasingly connected with policies, international co-operation, and international economic
each other and formed strategic alliances that encompass and financial institutions. G-20 members include finance minis-
both cooperation and competition. ters and central bank governors of nineteen countries, including
• Government-business partnerships: Working partner- Argentina, Australia, Brazil, Canada, China, France, Germany,
ships between corporations, universities, labor unions, India, Indonesia, Italy, Japan, Mexico, Russia, Saudi Arabia,
and civic groups are increasingly common. South Africa, South Korea, Turkey, the United Kingdom and the
United States of America, and the European Union. The G-20
• Economic blocs: Geographic-based economic alliances, member country representatives meet annually. G-20 policy rec-
such as the Pacific Basin Alliance and the European ommendations require consensus from member countries.
Union, are examples of common entities formed to create
and foster economic advantages for member nations. G-20 member countries represent 90 percent of global gross
national product, 80 percent of world trade, and two-thirds of
the world's population. The economic and political influence of
Applications G-20 member countries legitimizes the G-20's efforts to manage
the global economy and financial system. The Managing Direc-
Global Financial Governance tor of the International Monetary Fund (IMF), the President of
Global financial governance, including the development and the World Bank, the chairs of the International Monetary Fund,
management of international financial architecture, plays a cen- and Financial Committee and Development Committee of the
tral role in the world economy. As the relationship between capital IMF and World Bank participate in G-20 meetings to promote
markets and international standards for financial governance has institutional cooperation, coalition building, and information
evolved, emerging markets and developed nations have become sharing.
more interconnected. Beginning in the mid-twentieth century,
international economic organizations began forming to manage The G-20, formed in 1999, is part of a longer historical tradition
and promote economic growth. Economic development has been of international economic forums. For example, the G-7, which
a primary motivating force in international relations since the includes the world's major financial nations of Britain, Canada,
end of WWII. The modern era of aid to developing countries France, Germany, Italy, Japan, and the United States, formed in
began in the 1940s as World War II ended. 1976 as a forum for Western, industrial economies to discuss
and resolve economic imbalances among member countries.
In the modern era, developing countries, found primarily in The G-20 differs from the G-7 in its inclusive membership of
Africa, Asia, and Latin America, are characterized by low per industrial and developing countries. Ultimately, the G-20 is a
capita income, widespread poverty, and low capital formation. carefully built and managed forum. Member countries are care-
After WWII, world leaders and governing bodies put structures fully chosen based on their geography and population. The goals
into place, such as the World Bank, United Nations, World Trade and objectives of the G-20 require the G-20 to be both powerful
Organization, and International Monetary Fund, to prevent the and representative of a wide range of nations and markets.
economic depressions and instability that characterized the years
following World War I and to help rebuild and repair the wide- Financial Stability Forum: International Market Stabil-
spread devastation in Europe that resulted from the war. ity
The Financial Stability Forum (FSF), like the G-20, is an inter-
Modern international economic organizations work to respond national organization concerned with managing and improving
to the economic and political forces of globalization. Interna- international economic governance. The Financial Stability
tional lending institutions, both corporate and non-profit, use Forum, founded in 1999, has a stated mission to accomplish the
the recommendations and standards created and promoted by following goals and objectives:
various international economic institutions, including the G-20,
the Financial Stability Forum, the International Organization of
• Promote international financial stability
Securities Commissions, the Organization for Economic Co- • Improve the functioning of financial markets
16 ​​​Nations, Politics & Markets​

• Reduce the tendency for financial shocks to propa- • Code of Good Practices on Transparency in Monetary
gate from country to country and destabilize the world and Financial Policies
economy
• Code of Good Practices in Fiscal Transparency
• Assess vulnerabilities affecting the international financial
system
• Special Data Dissemination Standard and General Data
Dissemination System
• Improve coordination and information exchange among
the various authorities responsible for financial stability
• Principles and Guidelines for Effective Insolvency and
Creditor Rights Systems

The Financial Stability Forum includes member representa- • Principles of Corporate Governance
tives from national financial authorities, international financial • International Accounting Standards
institutions, international regulatory and supervisory groupings,
committees of central bank experts, and the European Central • International Standards on Auditing
Bank. The Financial Stability Forum includes twenty-six rep- • Core Principles for Systemically Important Payment
resentatives from the following national economic institutions: Systems and Recommendations for Securities Settlement
Reserve Bank of Australia, Canadian Department of Finance, Systems
Bank of Canada, Canadian Office of the Superintendent of Finan-
cial Institutions, French Ministry of the Economy, Autorité des • The Forty Recommendations of the Financial Action Task
Marchés Financiers (AMF), Banque de France, German Minis- Force and Eight Special Recommendations on financing
try of Finance, Bundesanstalt für Finanzdienstleistungsaufsicht, terrorism
Deutsche Bundesbank, Hong Kong SAR, Hong Kong Monetary
• Core Principles for Effective Banking Supervision
Authority, Italian Ministry of the Economy and Finance, Banca
d'Italia, CONSOB, Japanese Ministry of Finance, Japanese Finan- • Objectives and Principles of Securities Regulation
cial Services Agency, Bank of Japan, De Nederlandsche Bank,
Monetary Authority of Singapore, Swiss National Bank, Bank of
• Insurance Core Principles
England, UK Financial Services Authority, H M Treasury, United Securities Regulation
States Department of the Treasury, United States Securities &
Exchange Commission, United States Board of Governors of the The International Organization of Securities Commissions
Federal Reserve System, International Monetary Fund (IMF), (IOSCO), an international organization committed to high stan-
World Bank, Bank for International Settlements (BIS), Organi- dards of regulation in order to maintain just, efficient and sound
zation for Economic Co-operation and Development (OECD), markets, promotes the adoption of their Objectives and Princi-
Basel Committee on Banking Supervision (BCBS), International ples of Securities Regulations by industrialized and developing
Accounting Standards Board (IASB), International Association countries. These principles and regulations, developed in 1998
of Insurance Supervisors (IAIS), International Organization of and revised in 2002, include thirty principles based upon three
Securities Commissions (IOSCO), Committee on Payment and main objectives:
Settlement System (CPSS), Committee on the Global Financial
System (CGFS), and the European Central Bank.
• The protection of investors
• Ensuring that markets are fair
The Financial Stability Forum promotes the adoption of twelve
Key Standards for Sound Financial Systems. These standards • Efficient and transparent and the reduction of systemic
articulate good principles, practices, and guidelines in mul- risk
tiple economic areas. The Financial Stability Forum promotes
these twelve standards as free of national bias and argues that The principles are grouped into eight categories including reg-
the development, adoption, and implementation of international ulator, self-regulation, enforcement of securities regulation,
standards will produce both stronger national and international cooperation in regulation, issuers, collective investment schemes,
economic systems. National benefits include better regulation, market intermediaries, and the secondary market.
more supervision, greater transparency, and stronger institutions,
markets, and infrastructure. International benefits include better Corporate Governance
informed lending and investment decisions, improved market The Organization for Economic Co-operation and Development
integrity, and reduced risks of global financial distress or panic. (OECD), an international organization founded in 1961 includ-
The twelve standard areas, overseen and implemented by institu- ing thirty member nations committed to democratic government
tions such as the International Monetary Fund, World Bank, the and the market economy, promotes its Principles of Corporate
International Organization of Securities Commissions, the Orga- Governance. The OECD principles, developed in 1999 and
nization for Economic Co-operation and Development (OECD), revised in 2003, serve as the international standard and refer-
and the Financial Action Task Force, are broadly accepted as ence for corporate governance practices. The OECD principles
representing minimum requirements for good practice: cover six main areas including ensuring the basis for an effective
 ​​​Nations, Politics & Markets​ 17

and reports publicly available, and encourage public and

corporate governance framework, the rights of shareholders, the
parliamentary debate thereon throughout the world.
equitable treatment of shareholders, the role of stakeholders in
corporate governance, disclosure, transparency, and the respon- • The G-20 should significantly expand its agenda to ad-
sibilities of the board. dress the full range of problems and issues in the interna-
tional monetary and financial system.
Banking Supervision Standards
The Basle Committee on Banking Supervision, an international Exclusive economic, political, and national alliances, while they
economic forum for regular cooperation on banking supervisory influence the membership and agendas of international economic
matters with representatives from Belgium, Canada, France, institutions, do not benefit global stakeholders in equal ways.
Germany, Italy, Japan, Luxembourg, the Netherlands, Spain,
Sweden, Switzerland, the United Kingdom and the United Ultimately, economic institutions, such as G-20, Financial
States, promotes the use of Core Principles of Effective Bank- Stability Forum, the International Organization of Securities
ing Supervision. These twenty-five principles, developed in Commissions Organization for Economic Co-operation and
1997, define the treatment and requirements for preconditions Development (OECD), and the Basle Committee on Bank-
for effective banking supervision, licensing and structure, pru- ing Supervision, have the challenge of representing, to varying
dential regulations and requirements, information requirements, degrees, the needs of all countries and populations.
formal powers of supervisors, and cross-border banking. These
principles encompass the basic elements of an effective bank
supervisory system. These principles are intended to serve as a Conclusion
reference for public authorities worldwide that are responsible
for supervising banking institutions. Ultimately, the Basle Com- In the final analysis, nations, politics, and markets are deeply
mittee operates to promote common understanding on national interconnected entities that increasingly operate within geo-
and international bank supervisory issues. political partnerships and alliances. Globalization creates deep
political and economic linkages that require the support of inter-
national economic governance standards, requirements, and
Issues methods. Numerous international economic institutions repre-
senting the interests of developing and industrialized countries
Representation in International Economic and populations, such as the G-20, the Financial Stability Forum,
Organizations the International Organization of Securities Commissions, the
Criticisms of the G-20 forum focus on issues of representation Organization for Economic Co-operation and Development,
and procedures. For example, Helleiner (2000) argues that the and the Basle Committee on Banking Supervision, are actively
G-20's membership is not fully representative, its mandate is responding to the force of economic globalization by develop-
much too narrow, and its procedures lack provisions for non- ing economic governance standards and financial architecture to
governmental participation, accountability or transparency. The strengthen global markets and facilitate the economic participa-
G-20 country membership, while it does include developing tion of industrial and developing countries alike.
nations, does not contain representation either from the poorest
or smallest developing countries. These small and poor countries
remain voiceless in international economic governance forums. Terms & Concepts
Much of the criticism made against the G-20 can be extended to
the international economic governance forums, described above, Capitalism: An economic system in which individuals or
in general. companies in the private sector own and control the means of
production.
The G-20, and international economic governance forums in
general, may resolve many of its issues related to representation Developing Countries: Countries characterized by an underde-
and transparency through the adoption of the following practices veloped industrial base, low per capita income, and widespread
and remedies (Helleiner, 2000): poverty.
• The G-20 should alter its membership to improve range Emerging Markets: The capital markets of developing coun-
of countries represented and institute a constituency sys-
tries that have liberalized their financial systems to promote
tem to ensure full reporting and a sense of ownership and
capital flows with nonresidents and are broadly accessible to
participation even for non-member countries.
foreign investors.
• The G-20 should declare its accountability jointly to the
UN Secretary-General, the Managing Director of the G-20: An international organization formed in 1999 to strengthen
IMF, and the President of the World Bank. international financial architecture that promotes open and con-
structive discussion between industrial and emerging-market
• The G-20 should make its discussion papers, documents, countries on key issues related to global economic stability.
18 ​​​Nations, Politics & Markets​

Globalization: A process of economic and cultural integration Complete. database. http://search.ebscohost.com/login.asp

around the world caused by changes in technology, commerce, x?direct=true&db=bth&AN=21808470&site=ehost-live
and politics.
Fligstein, N. (1996). Markets as politics: a political-cultural
Markets: A social arrangement that allows buyers and sellers approach to market institutions. American Sociological
to discover information and carry out a voluntary exchange of Review, 61(4), 656-673. Retrieved May 11, 2007, from
goods and services. EBSCO Online Database Business Source Complete.
http://search.ebscohost.com/login.aspx?direct=true&db=bt
Nations: Large aggregations of people sharing rules of law and h&AN=9701220202&site=ehost-live
an identity based on common racial, linguistic, historical, or cul-
tural heritage; rarely act unilaterally. Frequently asked questions about G-20. (2007). G-20 website.
Retrieved May 11, 2007, from http://www.g20.org/
Political Economy: A subfield of economics dating back to the
eighteenth-century; refers to the interactions between political HAY, C., & JO-ANNE SMITH, N. (2010). HOW
processes and economic variables such as economic policies. POLICY-MAKERS (REALLY) UNDERSTAND
GLOBALIZATION: THE INTERNAL
Politics: The art or science of government or governing a politi- ARCHITECTURE OF ANGLOPHONE
cal entity, and administration and control of its internal and GLOBALIZATION DISCOURSE IN EUROPE. Public
external affairs. Administration, 88(4), 903-927. doi:10.1111/j.1467-
9299.2010.01863.x Retrieved November 20, 2013 from
Private Sector: All enterprises that are outside of government EBSCO online database Business Source Complete with
control including micro, small, medium, and large enterprises. Full Text:http://search.ebscohost.com/login.aspx?direct=tr
ue&db=bth&AN=55595193&site=ehost-live
Public Sector: The economic and administrative enterprises of
a local, regional, or national government. Helleiner, G. (2000). Markets, politics and globalization:
can the global economy be civilized? United Nations
The World Bank: An international economic development Conference on Trade and Development. Retrieved May
assistance organization that was founded in 1944. 11, 2007, from http://www.unctad.org/en/docs/prebi-
sch10th.en.pdf.

Bibliography Johnson, P. (1994). A glossary of political economy

terms. Auburn University website. Retrieved May 11,
Bennett, W. (2004). Global media and politics: Transnational 2007, from http://www.auburn.edu/~johnspm/gloss/
communication regimes and civic cultures. Annual political%5feconomy
Review of Political Science, 7(1), 125-148. Retrieved May
11, 2007, from EBSCO Online Database Business Source Karunaratne, N. (2012). The Globalization-Deglobalization
Complete. http://search.ebscohost.com/login.aspx?direct=t Policy Conundrum. Modern Economy, 3(4), 373-383.
rue&db=bth&AN=13986395&site=ehost-live doi:10.4236/me.2012.34048 Retrieved November 20, 2013
from EBSCO online database Business Source Complete
Bowles, S. (1991). What markets can — and cannot — do. with Full Text:http://search.ebscohost.com/login.aspx?dire
Challenge, 34(4), 11-16. Retrieved May 11, 2007, from ct=true&db=bth&AN=80415103&site=ehost-live
EBSCO Online Database Business Source Complete.
http://search.ebscohost.com/login.aspx?direct=true&db=bt Kavale, L. (2011). Tax policy under the conditions of global-
h&AN=9111111215&site=ehost-live ization. Applied Economics: Systematic Research, 5(2),
51-64. Retrieved November 20, 2013 from EBSCO online
Capital markets and corporate governance international stan- database Business Source Complete with Full Text:http://
dards. (2007). The European Bank for Reconstruction search.ebscohost.com/login.aspx?direct=true&db=bth&A
and Development website. Retrieved May 11, 2007, from N=69859327&site=ehost-live
http://www.ebrd.com/country/sector/law/corpgov/standard/
index.htm Mbemba, A. (2012). The Effects of Globalization on U.S.
Monetary Policy. International Journal Of Economics &
Drope, J. (2006). Drope, J. (2006). Don't buy from me Finance, 4(6), 187-197. doi:10.5539/ijef.v4n6p187 Retrieved
Argentina: politics, economics, and trade liberaliza- November 20, 2013 from EBSCO online database
tion in Argentina, 1992-2001. Studies in Comparative Business Source Complete with Full Text:PASTE EBSCO
International Development, 41(1), 53-75. Retrieved May URL
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Paul, B. (2012). GLOBALIZATION AND MONETARY- Suggested Reading

POLICY INDEPENDENCE IN INDIA. Journal Of
Developing Areas, 46(2), 205-211. Retrieved November Birdsall, N., Rodrik, D., & Subramanian, A. (2005). How
20, 2013 from EBSCO online database Business Source to help poor countries. Foreign Affairs, 84(4), 136-152.
Complete with Full Text:http://search.ebscohost.com/ Retrieved May 11, 2007, from EBSCO Online Database
login.aspx?direct=true&db=bth&AN=76341318&site=eh Business Source Complete. http://search.ebscohost.com/
ost-live login.aspx?direct=true&db=bth&AN=17327842&site=eh
ost-live
Roe, M. (2006). Legal origins, politics, and modern stock
markets. Harvard Law Review, 120(2), 462-527. Retrieved Checa, N., Maguire, J., & Barney, J. (2003). The new world
May 11, 2007, from EBSCO Online Database Business disorder. Harvard Business Review, 81(8), 70-79.
Source Complete. http://search.ebscohost.com/login.aspx? Retrieved May 11, 2007, from EBSCO Online Database
direct=true&db=bth&AN=23462564&site=ehost-live Business Source Complete. http://search.ebscohost.com/
login.aspx?direct=true&db=bth&AN=10256891&site=eh
Thurow, L. (1995). Surviving in a turbulent environment. ost-live
Planning Review 23(5), 24-29. Retrieved May 11,
2007, from EBSCO Online Database Business Source Wibbels, E. (2006). Dependency revisited: international mar-
Complete. http://search.ebscohost.com/login.aspx?direct=t kets, business cycles, and social spending in the develop-
rue&db=bth&AN=9510022024&site=ehost-live ing world. International Organization, 60(2), 433-468.
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Who we are. (2002). The Financial Stability Forum. Retrieved Business Source Complete. http://search.ebscohost.com/
May 11, 2007, from http://www.fsforum.org/about/ login.aspx?direct=true&db=bth&AN=20832669&site=eh
who%5fwe%5fare.html ost-live

Essay by Simone I. Flynn, Ph.D.

Dr. Flynn earned her Doctorate in cultural anthropology from Yale University, where she wrote a dissertation on Internet communities.
She is a writer, researcher, and teacher in Amherst, Massachusetts.
Business in the Global Political Environment

political risk. Strategies used by companies to mediate political

Table of Contents
risk, such as political risk insurance and cross-border alliances,
will be discussed. In addition, a case study of the political risks
Abstract facing international e-commerce companies will be included as
an opportunity to see how industry-specific businesses respond
Overview to political risk in the global political environment.
Global Political Environment
Political Risk Overview
Applications Business practices and operations in the international political
Assessing and Managing Political Risk environment are influenced by the forces and processes of glo-
balization, including political, social, and policy risks. Political
Global Strategy risks refer to the potential effects of a change in government on
Organizational Planning a business. Social risks refer to pressures put on businesses by
environmental or other pressure groups. Policy risks refer to the
Issues potential effects resulting from change in policy or rights on a
business (Frynas, 2002). The process of globalization refers to
Political Risk insurance and Cross-Border the increasingly free flow of ideas, people, goods, services, and
Alliances capital that is leading to the integration of economies and soci-
Political Risk Insurance eties. Businesses have adapted to the changing global political
environment by identifying political risks prior to investment
Cross-Border Alliances in foreign business activities and investments. The following
Case Study: Political Risk and International sections provide an overview of the current global political envi-
Internet Firms ronments and political risks.

Conclusion Global Political Environment

A political environment is characterized by the regulatory envi-
Terms & Concepts ronment, local attitudes towards corporate governance, reaction
to international competition, and labor laws. Political envi-
Bibliography ronments around the world are changing due to the forces of
globalization. Globalization is characterized by the permeability
Suggested Reading of traditional boundaries of nations, cultures, and economic mar-
kets. According to Thruow (1995), the fundamental economic
forces and events influencing globalization and political turmoil
around the world include:
Abstract • The end of communism
This article will focus on business practices in the global politi- • The shift from an economy based on natural resources to
cal environment. Globalization, and the resulting problem of one based on knowledge industries
political risk for businesses operating in the global economy or
marketplace, will be discussed. This article will provide an anal- • Demographic shifts
ysis of the different types of political risk as well as the strategies • The development of a global economy
most commonly used for identifying, assessing, and managing

20
 ​​​Business in the Global Political Environment​ 21

• Increased trade liberalization Political risk arises from factors and events such as governmen-
• Advances in communication technology tal change, shifts in national ideology or policy, civil war, social
unrest, economic instability, nationalization, and corruption.
• Increased threat of global terrorism Political, economic, and religious environments influence busi-
• An era without a dominant economic, political, or mili- ness operations for exporters, traders, investors, banks, and other
tary power organizations involved in international commerce. In addition,
national governments may institute forced shutdowns and relo-
Globalization creates a turbulent global socio-political environ- cations of foreign business. Companies entering foreign markets
ment characterized by competing political actors, shifting power for the first time, either as investors or manufacturers, as well as
relations, and politically-driven changes in national economies established multinational corporations expanding into new for-
around the world. Businesses work to find opportunity and eign markets or ventures must address certain questions in order
profit to be had from these political and economic changes. The to assess potential political risk (Wade, 2005):
political turbulence and upheaval has resulted in a move from
centralized economies to a decentralized global economy and
• Is there a tradition of peaceful governmental transition?
has created numerous emerging markets. These emerging mar- • How resilient is the political system?
kets refer to the capital markets of developing countries that
have liberalized their financial systems to promote capital flows • How do nongovernmental agencies, such as trade unions,
with nonresidents and have become broadly accessible to foreign churches, media, and the legal system, influence the soci-
investors. ety and government?
• Is there demographic stability?
Business opportunities, including international investments and
joint ventures, in the global economy are increasingly tied to • Are there internal social, ethnic or religious tensions that
trade pacts such as the North American Free Trade Agreement could lead to a civil war or unrest?
(NAFTA) between the United States, Canada, and Mexico, the • What is the country's trade credit history?
Mercosur trade pact between Argentina, Uruguay, Brazil, and
Paraguay, and the Asia Pacific Economic Cooperation (APEC) • What is the level of unemployment among citizens?
trade zone. In addition, business opportunities are resulting from
privatization worldwide. Countries are privatizing many state- Political risk, as a general, global category, is characterized by
owned industries and allowing foreign investors to purchase three factors: catastrophic events, business environment, and
pieces of them through joint ventures or allowing local opera- public policy (Dugan, 1999).
tions to participate in these projects (Stites, 1995).
• Catastrophic events: catastrophic events refer to the
political developments that can affect operations of all
Emerging markets, often occurring in countries experiencing
foreign firms in a country. Theoretical examples include
political upheaval, will continue to increase in the expand-
racial and ethnic unrest, civil strife, terrorism, civil war,
ing global market. Businesses, participating in the new global
international conflict, and systemic failure. Real word
economy, will continue to seek out new manufacturing and sales
examples include former Yugoslavia's ethnic unrest, civil
opportunities in foreign markets and countries. Ultimately, glo-
war, and international conflict.
balization brings businesses new opportunity and new risks.
Political risks are one of the major problems and considerations • Business environments: business environment risks faced
for businesses in the global political environment. Opportuni- either by all foreign businesses in a region or industry
ties and liabilities are growing proportionately in the new global specific risks (related to government corruption, labor
economy. The following section describes and analyzes the strife, and the judicial system). Examples include labor
influence of political risk on business activities and operations. and elections. Labor organizations through much of the
world are closely tied to political organizations. This con-
Political Risk nection between labor and politics brings foreign compa-
Multinational corporations conducting global business in emerg- nies into the midst of political struggles and issues. For-
ing markets experience lucrative investment opportunities as eign elections, which seldom influence foreign business
well as challenges and turmoil. Multinational corporations operations directly, do influence public policy. Elections
conducting business in today's global political environment are may bring in new officials who alter or shift the business
challenged by political risk. Political risk refers to the risk of a environment to match the new regime. For example, new
strategic, financial, or personnel loss for a firm because of events officials may change the tax code or structure.
related to political instability such as riots, terrorism, coups,
civil war, and insurrection, as well as non-market factors such • Public policies: public policy risks include political
as macro-economic and social policies (fiscal, monetary, trade, initiatives such as changes in the tax system, regulatory
investment, industrial, income, labor, and developmentally) structure, and monetary system. For example, when a
(Morales & Kleiner, 1996). foreign government is forced to devalue currency due
22 ​​​Business in the Global Political Environment​

to economic crisis, interest rates rise and alter domestic

political risk, interest rate differential, and tax rate differential.
spending habits. This change in monetary policy could
Examples of political risk include frequency of government
potentially ruin a foreign business' investment.
changes, amount of violence in the country, number of armed
insurrection, conflicts with other countries, inflation, balance of
The new global political environment is often unpredictable or payments, deficits, surpluses, and the growth rate of the gross
dangerous. Multinational companies may experience work stop- national product (GNP). Country risk surveys and country rat-
pages, hijackings, physical attacks, and more as they manufacture ings, produced by independent services, provide the information
or distribute their products and services in the global business businesses use to measure political risk. Organizations that rate
environment. In addition, goods produced by foreign companies and quantify political risk of different countries include the fol-
may be subject to confiscation by competing political actors and lowing (Martinson, 2000):
manufacturing facilities may be nationalized (Stites, 1995).
• Euromoney magazine: Euromoney magazine produces
an annual country rating risk report based on different
countries' access to international credit and payment record.
Applications
• Economist Intelligent Unit: Economist Intelligent Unit
Assessing and Managing Political Risk produces an annual country rating risk report based on
Companies manage political risk through global strategies and external debt, foreign-exchange reserves, and consistency
organizational planning. These two approaches, global strategy of government policy.
and organizational planning, differ in scale. Global strategy is a
macro-level activity that actively tries to connect the proposed • International Country Risk Guide: International Country
project to a firm's overall goals and objectives. Organizational Risk Guide produces an annual country rating risk report
planning is a micro-level activity that actively works to con- including composite risk rating as well as individual rat-
nect the proposed project with project-level goals, objectives, ings for political, financial, and economic risk.
and tools. The following sections describe how global strategy • Country Forecasts: Country Forecasts produces a semi-
and organizational planning aid companies in the identification, annual country forecast.
management, and avoidance of political risk.
Risk managers are responsible for understanding the potential
Global Strategy problems and complex risks of emerging markets. Political risk
Companies develop global strategies, in part, to assess and assessment, including organizational planning, knowledge of the
manage political risk. Global strategy refers to the methods, political environment, and diligence, has developed in response
approaches, and objectives developed by a business to increase to the influence that the political environment has on foreign
competitive advantage in the market by increasing competi- business operations. A business' foreign or overseas operations
tive scope worldwide. A global strategy allows a company to will inevitably be influenced by the actions of host governments
determine the real cost of capital for a foreign investment. The and competing political actors (Stites, 1995).
majority of global strategies involve a combination of trade and
direct investment in foreign countries. Global strategy requires Organizational Planning
capital investment decisions. The investment decision-making Political risk to specific foreign investment is managed, in large
process involves seven steps: part, through organizational planning. Organizational planning
is conducted prior to final investment decisions. The pre-entry
1. Determine that the project meets the firm's strategic
planning or pre-investment stage involves the following steps:
objectives.
2. Compute the costs, revenue, and benefits of the project. • Describe investment objectives.
3. Assess the risk associated with the project. • Assess company's knowledge and expertise related to
proposed foreign investment.
4. Determine the cost of capital to be used in the evaluation.
• Integrate political risk assessment into global strategy.
5. Conduct the evaluation analysis.
6. Select or reject the project.
• Identify opportunities that benefit the company and avoid
risk.
7. Perform a follow-up evaluation and tracking on selected
project. • Establish a structure of operations.
• Development of strategy and contingency plans.
Determining the true cost of capital required for a foreign project
is crucial to the profit margin of the project. Martinson (2000) • Develop security plans for the protection or evacuation of
argues that the appropriate cost of capital for an investment proj- employees.
ect is a function of the perceived risk of the investment. Country • Choose insurance coverage.
specific factors that influence perceived investment risk include
 ​​​Business in the Global Political Environment​ 23

Organizational planning occurs both within and outside of orga- to make prompt payments if a claim is made. MIGA urance
nizations. In-house centers gather, process, and disseminate includes services such as:
information. Consulting firms also assess country, regional, and
global political risk and monitor foreign political environments
• Mediating disputes
(Dugan, 1999). • Accessing funding
When political risk assessment is completed, the information • Lowering borrowing costs
and knowledge gained through global strategizing and organi- • Providing extensive country knowledge
zational planning allows managers to make informed decisions
about the type, degree, and probability of political risk in a • Providing environmental and social expertise
business scenario. With this information in mind, political risk
managers may choose to mediate political risk through the use The World Bank's political risk insurance and political risk
of a political risk strategy such as adapting, politick, negotiating, insurance in general, creates new investment opportunities for
or withdrawing (Morales & Kleiner, 1996). businesses in developing countries by covering risks the private
market is unable or unwilling to sustain.

Issues Cross-Border Alliances

In addition to political risk insurance, cross-border alliances offer
Political Risk insurance and Cross-Border Alliances the opportunity and means to mitigate, reduce, or control political
In addition to political risk management strategies such as adapt- risk. Cross-border alliances are international agreements on collab-
ing, negotiating, and withdrawing, businesses mitigate political oration between two or more independent companies who exploit
risk by obtaining coverage against possible losses resulting from a tangible or intangible asset. Examples of cross-border alliances
political actions or inaction by the host government through the include joint ventures, cooperative business arrangements, supplier
purchase of political risk insurance and the formation of cross- contracts, and management or technology contracts. Cross-border
border alliances. The following sections describe and analyze business alliances involve shared risk, cost, and reward. Cross-
political risk insurance and cross-border alliances as they relate border alliances are particularly useful for new market entries and
to the problem of political risk. new business start-ups in foreign countries. Cross-border alliances
are formed when they promise economic or structural benefits
Political Risk Insurance that cannot be achieved by the company alone or through outright
Worldwide political upheaval has resulted in the demand for acquisition or mergers. Cross-border alliances allow businesses to
political risk insurance (PRI) to protect businesses engaged in participate in emerging markets where involvement of a local part-
international business. Businesses obtain political risk insurance ner is desirable or required by the local government.
coverage during the initial stages of the project. Businesses pay
a small commitment fee to the underwriters and are guaranteed The main principles for successful cross-border alliance design
coverage often for the life of the project. include:

The market and demand for a political risk marketplace has

• Strategic objective
grown throughout the 1990s. In addition, political risk insur- • Mutual dependence
ance has expanded and adapted to meet the changing needs
of global businesses. Political risk insurance guarantees small • Alliance independence
business transactions and ever increasing amounts. Increas- • Shared vision and rewards
ingly private sector and public sector political risk insurance
underwriters work together to increase insurance capacity • Barriers to exit
(Wagner, 1999). Common political risk insurance options
include the U.S. government's Overseas Private Investment Challenges to cross-border alliances include management diffi-
Corporation (OPIC) (which pays claims on losses occurring culties, costs, inflexibility, coordination difficulties, and risk of
from expropriation, inconvertibility and political violence) and competitive conflict (Jagersma, 2005).
the World Bank.
Case Study: Political Risk and International Internet
The World Bank issues political risk insurance through their Firms
Multilateral Investment Guarantee Agency (MIGA). MIGA Managing political risk improves global business performance for
helps investors mediate political risk by ensuring eligible all types of companies conducting international business. Politi-
projects against political losses caused by currency trans- cal risk affects companies with physical and intellectual products
fer restriction, expropriation, war and civil disturbance, and alike. For example, internet companies worldwide are currently
breach of contract by the host government. MIGA simultane- struggling to assess and manage political risk caused by govern-
ously works to prevent incidents and claims as well as promises ment efforts around the world to regulate new technology.
24 ​​​Business in the Global Political Environment​

Frynas' study of the political risks faced in international e-com- Risk assessment and management mediates risks and allows for
merce reveals that internationally operating internet firms face ever-increasing global expansion of multinational corporations
serious political and legal challenges in different countries and into established and emerging markets.
markets (2002). The country-specific variations between issues
such as consumption tax and intellectual property rights dem-
onstrate that internet firms experience country or region-specific Terms & Concepts
risks and uncertainties. National governments tax internet busi-
nesses and try to regulate various aspects of internet activities such Cross-Border Alliance: International agreements on collabora-
as e-commerce. Examples of government efforts at internet regu- tion between two or more independent companies who exploit a
lation include the Chinese government's efforts to introduce Web tangible or intangible asset.
site censorship and the European Union directives on copyright.
Globalization: The increasingly free flow of ideas, people,
Internet firms face political risks such as non-enforcement of goods, services, and capital that leads to the integration of econ-
intellectual property rights, uncertainty over the legal validity omies and societies.
of electronic contracts, changes in taxation, non-recognition of
electronic signatures and legal liability of internet service pro- Global Strategy: Methods, approaches, and objectives devel-
viders for third-party content. Internet businesses are vulnerable oped by a business to increase competitive advantage in the
to changing national feelings toward technology. Unpredictable market by increasing competitive scope worldwide.
changes in political business environments worldwide affect the
profits and future of internet businesses. Multinational corporations (MNC): Companies with holdings
in multiple countries.
Risk managers of international internet and e-commerce compa-
nies minimize risk in the international political environment by Nationalization: Seizure of private, foreign-held assets by a host
following these strategies: regime.
• Research and monitor the legal and political develop- Policy Risk: The potential effects on a business resulting from
ments in target markets
change in policy or rights.
• Design the firm's Web site carefully to ensure strict com-
pliance with the law Political Environment: A country's regulatory environment,
local attitudes to corporate governance, reaction to international
• Carefully choose the jurisdiction when deciding on the competition, and labor laws.
home base for the Internet firm
• Purchase political risk insurance Political Risk: The threat that social, political or economic
factors in a foreign country may affect the feasibility and profit-
• Use legal and political weapons to fight competitors ability of an organization's global operations.

In the final analysis, political risk for internet companies, as for Political Risk Insurance (PRI): Insurance that protects busi-
all types of businesses, is a subjective account of how events nesses engaged in international business from loss associated
may affect business activities and operations (Frynas, 2002). with political upheaval such as regime or policy change.

Social Risk: Pressures put on businesses by environmental or

Conclusion other pressure groups.

Profitable foreign investment strategies in the new global politi- World Bank: An international economic development assistance
cal environment depend on political risk management. Political organization that was founded in 1944.
risk assessment and management is particularly important to for-
eign direct investment in the economies of developing countries.
Companies committed to foreign investment have systems in Bibliography
place for analyzing a country's political risk. The main principles
of political risk management include (Morales & Kleiner, 1996): Bendell, J., & Kearins, K. (2004). World review. Journal of
Corporate Citizenship, 14, 6-17. Retrieved March 31,
• Staying in touch with a country's daily developments 2007 from EBSCO Online Database Business Source
• Analyzing industry, project, and management character- Complete. http://search.ebscohost.com/login.aspx?direct=t
istics rue&db=bth&AN=14072429&site=ehost-live
• Following a proactive instead of reactive management
 ​​​Business in the Global Political Environment​ 25

Dong, M., Li, C., & Tse, D. (2013). Do Business and Political Moncada, E. (2013). Business and the Politics of Urban
Ties Differ in Cultivating Marketing Channels for Foreign Violence in Colombia. Studies In Comparative
and Local Firms in China?. Journal Of International International Development, 48(3), 308-330. doi:10.1007/
Marketing, 21(1), 39-56. doi:10.1509/jim.12.0088 Retrieved s12116-013-9135-x Retrieved November 18, 2013 from
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2957&site=ehost-live
Morales, R. & Kleiner, B. (1996). New development in tech-
Dugan, W. (1999). Global dangers. Risk Management, 46(9), niques for analysing diversified companies in today's
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Database Business Source Complete. http://search.ebsco- 41-49.
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&site=bsi-live Ramírez Solís, E., Baños Monroy, V., & Orozco-Gómez,
M. (2012). THE INNER CIRCLE: HOW POLITICS
Frynas, J. (2002). The limits of globalization — legal and AFFECTS THE ORGANIZATIONAL CLIMATE. Allied
political issues in e-commerce. Management Decision, Academies International Conference: Proceedings Of The
40(9), 871-881. Retrieved March 31, 2007 from EBSCO Academy Of Organizational Culture, Communications
Online Database Business Source Complete. http://search. & Conflict (AOCCC), 17(2), 7-8. Retrieved November
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2998&site=bsi-live Complete with Full Text:http://search.ebscohost.com/
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executive suite. Journal of Business Strategy, 26(1), 41-50.
Retrieved March 31, 2007 from EBSCO Online Database Roemer-Mahler, A. (2013). Business conflict and global
Business Source Complete http://search.ebscohost.com/ politics: The pharmaceutical industry and the global
login.aspx?direct=true&db=bth&AN=16116142&site=eh protection of intellectual property rights. Review Of
ost-live International Political Economy, 20(1), 121-152. doi:10.10
80/09692290.2011.645848 Retrieved November 18, 2013
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MANAGING AT THE FRINGES: THE IMPLICATIONS with Full Text:http://search.ebscohost.com/login.aspx?dire
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miga.org/sitelevel2/level2.cfm?id=1058 Wagner, D. (1999). The cluster trend: political risk, Part II.
Risk Management, 46(9), 18-22. Retrieved March 31,
Martinson, O. (2000). Global investments: discover your real 2007 from EBSCO Online Database Business Source
cost of capital — and your real risk. Journal of Corporate Complete. http://search.ebscohost.com/login.aspx?direct=t
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31, 2007 from EBSCO Online Database Business Source
Complete. http://search.ebscohost.com/login.aspx?direct=t The World Bank. (2006). World Bank political risk insurance.
rue&db=bth&AN=16853716&site=ehost-live Retrieved March 31, 2007 from http://web.worldbank.org/
26 ​​​Business in the Global Political Environment​

WBSITE/EXTERNAL/OPPORTUNITIES/0,,contentMD Bremmer, I. (2005). Managing risk in an unstable world.

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~theSitePK:95480,00.html 01, 2007 from EBSCO Online Database Business Source
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Suggested Reading
Noordin, B., Harjito, D., & Hazir, A. (2006). Political risk
Althaus, C. (2005). A disciplinary perspective on the episte- assessment of Malaysian based multinational corpora-
mological status of risk. Risk Analysis: An International tions. Investment Management & Financial Innovations,
Journal, 25(3), 567-588. Retrieved April 01, 2007 from 3(2), 91-99. Retrieved April 01, 2007 from EBSCO Online
EBSCO Online Database Business Source Complete. Database Business Source Complete. http://search.ebsco-
http://search.ebscohost.com/login.aspx?direct=true&db=bt host.com/login.aspx?direct=true&db=bth&AN=23039266
h&AN=17588531&site=ehost-live &site=ehost-live

Essay by Simone I. Flynn, Ph.D.

Dr. Simone I. Flynn earned her Doctorate in cultural anthropology from Yale University, where she wrote a dissertation on Internet com-
munities. She is a writer, researcher, and teacher in Amherst, Massachusetts.
Role of International Financial Markets

to Taylor (2007), finances are a crucial factor in foreign policy.

Table of Contents
Let's step back and look at the foundation of financial markets,
then tie the concept to its role in a global economy.
Abstract
Financial markets could be defined in two ways. The term could
Overview refer to organizations that facilitate the trade of financial prod-
ucts or it can refer to the interaction between buyers and sellers
Application to trade financial products. Many who study the economic field
Influences on the International Financial will utilize both definitions, but finance scholars tend to apply
Markets the second meaning most often. Economic markets have the
potential to be both domestic and foreign.
Viewpoint
Financial markets can be explore on an economic basis terms
The Role of International Banking because it focuses on how individuals purchase and sell financial
security, assets and other forms of capital with cheap transaction
Conclusion
fees and prices that symbolize the efficiency of the markets. The
Terms & Concepts overall objective of a financial market is to gather all of the sell-
ers and put them in one place that they can meet and interact with
Bibliography potential buyers. The goal is to create a process that will make it
easy for the two groups to conduct business.
Suggested Reading
When looking at the concept of "financial markets" from a
finance perspective, one could view financial markets as a way to
facilitate the process of raising capital, transferring risk and con-
Abstract ducting international trade. The overall objective is to provide
an opportunity for those who want capital to interact with those
This article focuses on the different aspects of the international who have capital. In most cases, a borrower will issue a copy of
financial market. There are many influences on the international the purchase to the borrower agreeing to pay back the finances
financial markets, and the article will provide an exploration in full. These receipts are known as securities and are able to be
of the role of international banking, the euro, hedge funds and purchased or sold. Lenders expect to be compensated for lending
moral hazards within international financial markets. Financial the money. Their compensation tends to be in the form of interest
markets could be defined in two ways, and there are different or dividends.
categories of financial markets.
There are different categories of financial markets, and some of
them are:
Overview • Capital markets. Capital markets are comprised of
primary and secondary markets, and are considered a
Money is power. A former Treasury Department official has
critical factor in American capitalism. Recently estab-
stated that the most significant conflicts countering terrorism
lished securities are purchased and sold in the primary
following 9/11 took place in the buildings and boardrooms of
market and investors sell their securities in the secondary
economic corporations (Taylor, 2007). Taylor, in an interview
markets. Companies rely on these markets to raise the
with USINFO, stated that he believes that "financial issues
funds needed to purchase the equipment required to run
should be treated jointly with the two other pillars of interna-
a business; conduct research and development; and assist
tional relations, military and political" (Anders, n.d.). According

27
28 ​​​Role of International Financial Markets​

in securing other items needed for the operations of the fund at the time, Long Term Capital Management, practi-
company. cally brought down the U.S. economy” (Amadeo, n.d.
“What are hedge funds”).
• Stock markets — In order to raise a large amount of
cash at one time, public corporations will sell shares of
ownership to investors. Investors gain profits when the Application
corporations increase their earnings. Many view the Dow
Influences on the International Financial Markets
Jones Industrial Average as the stock market, but it is one
of many components. Two other components are the Dow There are many influences on the international financial markets.
Jones Transportation Average and the Dow Jones Utilities This section will discuss three of them: The euro, moral hazard,
Average. Stocks are traded on world exchanges such as and hedge funds.
the New York Stock Exchange and NASDAQ.
1. The Euro.
• Bond markets — Bonds are the opposite of stocks. "Economic and monetary union (EMU) prompted some specu-
Usually, when stocks go up, bonds go down. The forms lation as to the future international role of the new European
of bonds include Treasury Bonds, corporate bonds, and currency" (Detken & Hartmann, 2002). Many had speculated
municipal bonds. Each bond has a crucial influence on that the euro would challenge the dollar's dominance as the
mortgage interest rates. number one currency in the world while others were skeptical
• Commodity markets. Facilitate the trading of raw or that the euro would last. “The emergence of one currency as a
primary commodities. The commodities are traded on medium of exchange in currency trading is an important dimen-
regulated commodities exchanges. According to Amadeo sion of a currency's role in international financial markets, and is
(n.d.), “the most important commodity to the American related to a currency's trading volume and trading costs” (Detken
economy is oil, and its price is determined in the com- & Hartmann, 1998, p. 564). Detken and Hartmann (2002) found
modities futures market. Futures are a way to pay for that the euro's role is similar to the deutschemark before EMU
something today that is delivered tomorrow, which helps and features a prominent position in spot trading in the Nordic
to remove some of the volatility in the American econo- and other Central European nations. The euro was severly tested
my. However, futures also increase the trader's leverage during the euro-zone crisis, as first Greece and then Italy sank
by allowing him to borrow the money to purchase the under economic pressures and required financial assistance from
commodity. This can have a huge impact on the stock stronger EU members. Fields & Vernengo (2013) contended that
market, and the American economy, if the trader guesses despite predictions of euro supremacy, the dollar would remain
wrong” (Amadeo, n.d., “What are commodities”). the hegemonic international currency for the foreseeable future.

• Money markets. Provides short term debt financing and 2. Moral Hazard.
investment. The money market is the international finan- Moral hazard in international financial markets has received con-
cial market for temporary borrowing and lending. The siderable attention in the past years. Moral hazard refers to "the
allow for short-term liquid financing for the international possibility that the provision of insurance, by diminishing the
economic system. In most financial markets, borrowers incentives to prevent a particular outcome, may actually lead to a
tend to repay their debts after about a year of lending, in rise in the incident of that outcome" (Kamin, 2004, p. 26). Many
most cases. Money markets use “paper” as their instru- believe that efforts to stall financial crises were unsuccessful and
ments in short-term financing. moral hazard has developed as a result of when the IMF started
• Derivatives markets. Provides tools for the administra- to offer large funding packages to emerging market countries.
tion of economic risk.
Multinational corporations (MNC) are looking for growth
• Futures markets Offer standardized contracts for ex- opportunities, and they are finding them in emerging markets.
changing products in the future. According to a study of multinational corporations, "two thirds
• Insurance markets. Facilitates the redistribution of dif- of the respondents believed investment in emerging markets is
ferent risks. likely to continue to grow, with three quarters claiming to be
actively investing in Central and Eastern Europe" (Credit Con-
• Foreign exchange markets. Facilitates the trading of trol, 2005, p. 43). Antoine van Agtmael, a senior executive at
international exchange. World Bank Group, was the first person to use the term "emerg-
ing markets". (Jana, 2007). Many of the new ventures can be
• Hedge fund markets. “Recently, hedge funds have in-
found in developing countries such as Brazil, Russia, India, and
creased in popularity due to their supposed higher returns
China, which are known as the BRIC economies. The combined
for high-end investors. Since hedge funds invest heavily
GDP of the BRIC countries in 2012 was close to $14 trillion,
in futures, some have argued that they have decreased
almost equal to the annual GDP of the United States (Van Agt-
the volatility of the stock market and therefore the U.S.
mael, 2012). The significance of emerging markets has reached a
economy. However, in 1997, the world's largest hedge
point where corporations have recognized their influence on the
 ​​​Role of International Financial Markets​ 29

corporations' bottom line. For example, Coca-Cola expected the 3. Hedge Funds.
BRIC countries to contribute 41 percent to its soft drink growth in Hedge funds have become popular over the last years due to
2008 (Chakravarty, 2004). Ford Motors predicts that the emerg- their ability to take both short (sold) and long (bought) positions
ing markets (i.e. Asian countries) will contribute 80 percent to its (Lubochinsky, Fitzgerald & McGinty, 2002). In other words,
automotive sales growth (Ford Motor, 2003). Emerging markets positions are "market neutral" but with leverage (Edwards,
have become an important source of revenue. 1999). The funds are well received because they have the abil-
ity to utilize "active management skills to earn positive returns
The Altradius survey reported that the highest percentage of on capital regardless of the market direction" (Lubochinsky,
respondents from the multinational corporations was investing Fitzgerald & McGinty, 2002, p. 33).
as follows: 74% invested in Central and Eastern Europe, 43%
invested in China, and 35% invested in India and Southeast Asia. Most hedge funds have two distinct features. First, the funds
The countries that received the most funding in Central and East- have to be what is called absolute return funds. The goal is not
ern Europe include Poland (60%), Czech Republic (46%), Russia to acquire additional returns over a prescribed benchmark, but to
(40%) followed by other EU accession countries. In Southeast acquire the proper absolute returns for the risk that is involved.
Asia, India was the top choice followed by Malaysia, Thailand, The other aspect is the funds’ use of leverage. The level of lever-
and Indonesia (“Survey reveals major risks,” 2005, ¶ 11). age used by hedge funds tends to vary. There are three main
mechanisms that hedge funds can use to leverage new asset posi-
With the growth of investment in these emerging markets, there tions. They are (Lobochinsky, Fitzgerald, & McGinty, 2002):
is a pressure to determine whether or not the right thing is being
done when offering financial packages. Kamin (2004) wrote a
• Traditional margin loans extended by prime brokers to
their clients.
paper and provided evidence on “whether anticipations of IMF
assistance by investors have distorted the price and quantity • Fixed income hedge funds that extensively use repur-
of private capital being offered to emerging market countries” chase agreements.
(Kamin, 2004, p. 53). He sought to find out if IMF programs had
an effect on creditor moral hazard. His research begins by estab- • The use of all types of derivative positions including
lishing the point that before the Mexican crisis, investors did not future contracts, total return swaps, and options.
expect bail out packages to be awarded to countries struggling
financially. As a result, one can assume that the pre-1995 period Viewpoint
represents a period where there is no moral hazard.
The Role of International Banking
Kamin's second step was to compare “recent measures of spreads One of the focal points for many multinational corporations is to
and capital flows to emerging market countries with those have the ability to perform financial transactions outside of the
prevailing in the pre-1995 period. He found some evidence indi- United States. These corporations have identified a need to par-
cating that credit was very easy to obtain during the mid-1996 ticipate in the international trade process. "The burgeoning impact
through mid-1998 period” (Kamin, 2004, p. 24). However, this of technology, the globalization of trade, and the general trends
practice did not last long. The final step was to determine whether towards political and regulatory liberalization is highlighted by
or not countries that were designated to receive a large sum of the emergence and growth of the multinational bank (MNB)"
IMF funding had easier access to credit than countries who were (Moshirian, Sadeh, & Zein, 2004, p. 351). Some of the key bank-
not in the same financial situation. Kamin concluded that moral ing services that are needed include letters of credit, wire transfers,
hazard did not correlate with distortions in the international capi- collections, and foreign exchange (Teller Sense, 2003). It is
tal markets. It is notable, however, that Brazil, China, and India important for organizations to have the ability to wire deposits in
were almost alone among major economies to experience growth a timely manner, have the credibility for banks to provide a letter
during the global financial crisis, while Iceland, Ireland, Portu- of credit on their behalf, and collect payments quickly and easily.
gal, Greece, Italy, and Spain struggled with implosions in their
financial institutions and economies. The U.K and Netherlands "The establishment of multinational banks across national
bore the cost of Iceland's largest bank default, bailing out their boundaries, together with the increasing importance of other
own nationals who had invested in the Icelandic bank and going international capital mechanisms has meant that the growth of
unreimbursed by Icelanders who refused to repay the two larger a given economy is no longer constrained by its ability to main-
governments for the failure of a "bad bank." (Touryalai, 2011). tain surplus capital above its own gross national expenditure"
By 2010 the European Central Bank was arranging rescues for (Moshirian, Sadeh, & Zein, 2004, p. 351). In March of 2004,
banks in Ireland and Portugal (Richards & Sinclair, 2010). Bail- the International Banking Federation was established when the
outs for Greece, Italy, and Spain were already on the horizon banking associations from Europe, the United States, Australia,
(Tora, 2012). Though Touryalai predicted in Forbes that Iceland and Canada united. The headquarters for the group was London.
would rue its revolt, Greenstein reported in the same magazine The purpose of this consortium was to provide an international
in 2013 that Iceland was the only troubled economy in Europe to forum to address issues such as legislation, regulations and other
have landed softly (Greenstein, 2013). issues that affected the countries and the global banking system.
30 ​​​Role of International Financial Markets​

risk-return profile to traditional asset categories such as

One of the main objectives of the group was to accentuate the
equities and bonds.
efficiency of the banking industry's reaction to national and
international affairs (Teller Vision, 2004). • Greater diversification benefits could be obtained by in-
troducing individual hedge fund styles rather than via the
One issue that this group may discuss is the ability for the market composite index. In this case, arbitrage and relative value
to absorb shocks in times of financial crises such as the crash of strategies played a specific role.
1987, the Asian crisis of 1997, and the Russian crisis of 1998.
One of the effects of globalization in the financial industry is that • Even a small addition of hedge funds investments to a
the banking sectors across the world have become interdepen- traditional asset mix produced consistent return benefits
dent across borders (Elyasiani & Mansur, 2003). Given the fact at all levels of risk (p. 53).
that the banking systems in different countries are not the same
in structure and regulatory constraints, it is important that the Terms & Concepts
international financial community is responsible and collaborate
on what type of plan should be in place for the global financial Euro: The single currency for Europeans.
market. Organizations such as the International Banking Federa-
tion need to develop a plan of action to address these types of Hedge Funds: Funds that take short (or sold) positions in the
events so that the members are not adversely affected when a securities as well as the long (or bought) positions. Funds aiming
crisis happens. They are responsible for minimizing the risk of to utilize active management abilities to receive positive returns
the occurrence of a domino effect. on capital despite which direction the market heads in.

International Banking: Banking transactions crossing national

Conclusion boundaries.

A former Treasury Department official has stated that some International Banking Federation: A consortium of banking insti-
of the most significant battles opposing terrorism after 9/11 tutions from Europe, the United States, Australia, and Canada
have occurred in the workrooms and boardrooms of economic charged with addressing financial service issues on a national and
companies (Taylor, 2007). There are many influences on the international level.
international financial markets, and the article will provide an
exploration of the role of international banking, the euro, hedge Financial Markets: A market for the trading of capital and credit,
funds and moral hazards in international financial markets. such as money and capital markets.
Financial markets could be defined in two ways, and there are
different categories of financial markets. Letters of Credit (LOCs): A document issued by banks in the
event that a customer wants to purchase goods from an over-
Detken & Hartmann's (2002) study found that: seas supplier. The supplier is guaranteed being paid because the
bank’s credit sponsors the customer.
• The euro dominated spot interbank trading in the Nor-
dic countries and several Central and Eastern European
Moral Hazard: The prospect that being insured from risk might
countries.
promote a different behavior than might be expected if it were
• In Denmark and Norway, the euro share increased to 83% completely exposed to the risk.
and 93%, respectively, compared to 1998; in Sweden it
almost remained constant at around 80%. Wire Transfers: Wire transfers are forms of transferring and
moving money from one individual or corporation to another. A
• Large euro shares between 80% and 98% existed in customer can usually purchase, sell, or wire transfer any form of
the Czech Republic, Hungary, the Slovak Republic and currency in 48 hours or less.
Slovenia, with a fundamental change in Hungary from
a dollar dominated market in 1998 to a euro dominated
market in 2001. Bibliography
• The dollar continued to dominate in regions such as Asia,
the Middle East, North and Latin America (Detken & Anders, J. (2007, January). Financial warriors stand guard
Hartmann, 2002, p. 564). over global markets.

Lobochinsky, Fitzgerald, & McGinty (2002) conducted a study Retrieved July 31, 2007, from http://usinfo.state.gov/xarchives/
of hedge funds and arrived at the following conclusions: display.html?p=washfile-english&y=2007&m=January&x
=20070122135539zjsredna5.479068e-02
• During the period of 1990-2000, the performance of a
composite hedge fund index showed a significant superior
 ​​​Role of International Financial Markets​ 31

Amadeo, K. (n.d.) An introduction to the financial markets. held by non-banks. Journal of International Financial
Retrieved on July 31, 2007, from http://useconomy.about. Markets, Institutions and Money, 14(4), 351-365.
com/od/themarkets/a/capital%5fmarkets.htm.
Richards, J., & Sinclair, R. (2010). Europe mobilises rescue
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17(35), 554-569. Retrieved July 31, 2007, from EBSCO Database Business Source Complete. http://search.ebsco-
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Survey reveals major risks involved in trading with emer-
Edwards, F. (1999). Hedge funds and the collapse of long term gent markets. (2005). Credit Control Journal. Retrieved
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13(2), 189-210. news/2005/11/00118.htm

Elyasiani, E., & Mansur, I. (2003). International spillover Taylor, J. (2007). Global financial warriors: The untold story
of risk and return among major banking institutions: A of international finance in the post 9/11 world. New York:
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perspective. Review of International Political Economy, Touryalai, H. (2011). Iceland's stand against bailout repay-
20(4), 740-759. Retrieved November 15, 2013, from ment will hurt. Forbes.Com, 28. Retrieved November 15,
EBSCO Online Database Business Source Complete. 2013, from EBSCO Online Database Business Source
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h&AN=89683205&site=ehost-live rue&db=bth&AN=65418540&site=ehost-live

Hartmann, P. (1998). Currency competition and foreign The world of international banking. (2003, April 1). Teller
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Bordo, M., & Murshid, A. (2006). Globalization and chang-
Kamin, S. (2004). Identifying the role of moral hazard in ing patterns in the international transmission of shocks
international financial markets. International Finance, in financial markets. Journal of International Money &
7(1), 25-59. Retrieved July 31, 2007, from EBSCO Online Finance, 25(4), 655-674.
Database Business Source Complete. http://search.ebsco-
host.com/login.aspx?direct=true&db=bth&AN=13801464 Claessens, S., & Schmukler, S. (2007). International finan-
&site=ehost-live cial integration through equity markets: Which firms
from which countries go global? Journal of International
Lubochinsky, C., Fitzgerald, M., & McGinty, L. (2002). The Money & Finance, 26(5), 788-813.
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Banca Monte dei Paschi di Siena SpA, 31(1), 33-57. Lin, A., & Swanson, P. (2004). International equity flows and
developing markets: The Asian financial market crisis
Moshirian, F., Sadeh, I., & Zein, J. (2004). International revisited. Journal of International Financial Markets,
financial services: Determinants of banks' foreign assets Institutions & Money, 14(1), 55.
32 ​​​Role of International Financial Markets​

Essay by Marie Gould

Marie Gould is an Associate Professor and the Faculty Chair of the Business Administration Department at Peirce College in Phila-
delphia, Pennsylvania. She teaches in the areas of management, entrepreneurship, and international business. Although Ms. Gould has
spent her career in both academia and corporate, she enjoys helping people learn new things — whether it's by teaching, developing or
mentoring.
Trade Creation & Diversion

Table of Contents Abstract

This article focuses on trade creation and trade diversion. The
Abstract article provides an overview of trade theory including Jacob
Overview Viner's theory of the connection between free trade agreements,
customs unions, trade creation, and trade diversion. The rela-
Trade Agreements tionship between economic integration, trade creation, and trade
diversion is explored. The issues and outcomes associated with
Trade Creation vs. Trade Diversion
African regional trade agreements will be addressed.
Reasons for Forming Trade Agreements
Trade Theory Overview
Limited Free Trade Trade Agreements
Modern Trade Theory Countries actively use trade policy to control national import and
export levels and the economy in general. In the twentieth cen-
Applications tury, free trade agreements emerged as one of the main forms of
Trade Creation, Diversion, & Economic trade control and cooperation between nations. Under free trade
Integration agreements, also referred to as preferential trade agreements
(PTAs), goods and services can be exchanged between coun-
Economic Integration tries or regions without tariffs, quotas, or other trade restrictions
Free Trade Agreements being levied (Holden, 2003). Trade agreements affect trade in
two main ways: Trade creation and trade diversion.
Customs Unions
• Trade creation refers to the overall increase in trade that
Common Markets results from the displacement of domestic production.
Issues • Trade diversion refers to the diversion of existing trade
that results from the displacement of imported goods and
African Regional Trade Agreements, Trade services.
Creation & Trade Diversion
Trade Creation vs. Trade Diversion
Southern African Customs Union
Economists and policymakers study the effect that the processes
The West African Economic & Monetary of trade creation and trade diversion have on the economy. Trade
Union creation and trade diversion tend to have very different effects on
the aggregate economy.
The Monetary & Economic Community of
Central Africa • Trade creation generally produces a net economic gain.
Countries enter into free trade agreements, with trade
Conclusion creation a desired result, primarily when the price of a
Terms & Concepts particular imported good or service is lower than the cost
of producing the same good or service domestically. The
Bibliography trade relationship allows countries to purchase goods and
services at prices less than they would pay domestically
Suggested Reading for the same goods or services.

33
34 ​​​Trade Creation & Diversion​

• In contrast, trade diversion generally produces a net Limited Free Trade

economic loss. In trade diversion scenarios, countries pay
Following World War II, the Allied powers, countries in oppo-
more for imported goods and services than they would
sition to the Axis powers, promoted a limited form of free
under a trade agreement. Domestic purchasers must pay
trade within a dollar-exchange monetary system. The General
the cost of the imported item and a government tariff.
Agreement on Tariffs and Trade of 1947 prohibited quantitative
Reasons for Forming Trade Agreements restrictions on trade between leading industrialized economies.
In the years following World War II, nations have been engag-
According to the U.S. Congressional Budget Office, countries ing in trade agreements as a means of increasing economic
engage in free trade agreements for two main reasons. efficiency, productivity, and growth. Regional trade zones facili-
tate commercial expansion. Today, trade relationships between
• First, foreign trade agreements stimulate and strengthen nations are also political relationships. Trade relationships, as
the economy. Industrialized countries tend to seek out
expressed in customs unions, have become political-economic
free trade agreements in the interest of promoting and
unions for the world's major trading nations including the United
facilitating trade creation. Free trade agreements strength-
States, the countries of the European Union (especially those
en national economies and international relationships
in Western Europe), Japan, China, and South Korea, as well as
through trade creation but sacrifices certain domestic
developing nations.
business sectors and international relationships through
trade diversion. As long as free trade agreements exist Modern Trade Theory
between individual countries rather than as an inclusive
Economic theory, post World War II, was deeply engaged with
global pact, trade creation and trade diversion will remain
real-world trade concerns and relationships. Modern trade theory
conflicting and competing forces and outcomes. Global
began with economist Jacob Viner (1892-1970). Viner's theory
free trade, also referred to as multilateral free trade,
of customs unions argues that customs unions have two major
would end the problem of trade diversion.
effects: Trade creating and trade diverting.
• Second, free trade agreements are a form of foreign • Trade creation refers to the shift of consumption of the
policy and alliance building. Wealthier nations enter into
importable good from a high-cost domestic producer to a
free trade agreements with developing nations as a means
lower-cost external foreign producer.
of building international partnerships and aiding develop-
ing economies. • Trade diversion refers to a switch from the lowest-cost
external producers to a higher-cost producer. Viner's
The following section provides an overview of trade theory theory argues that trade creation always improves the
including Jacob Viner's theory of trade creation and trade diver- country's welfare but trade diversion dampens the coun-
sion. This section serves as a foundation for later discussion of try's welfare (Parai & Yu, 1989).
the relationship between economic integration, trade creation,
and trade diversion. The issues and outcomes associated with Trade creation is characterized by a shift in a high-cost domestic
African regional trade agreements are addressed. product or service to a lower cost imported product or service.
Trade diversion is characterized by a shift from low-cost imports
Trade Theory from third-party country to high-cost imports from a member
Modern trade theory has its roots in the economic theory of country. Viner believed that all relevant stakeholders in a trade
the eighteenth century. Eighteenth century economists, such relationship should analyze the economic implications of trade
as Adam Smith (1723-1790) and David Ricardo (1772-1823), agreements. Trade agreements cause movement between levels
explored how trade between nations affected national econo- of production. This movement can result in a gain or loss of eco-
mies. Modern trade theory emerged after World War II. Modern nomic efficiency for member nations.
trade theory considers the effect trade barrier removal has on
trade flows between countries. Trade theory emerged after World Stakeholders should examine the following variables to judge
War II as economic theory evolved and grew to address changing the economic effect of trade agreements:
global economic relationships. After World War II, economists,
world leaders, and governing bodies put trade agreements and
• The total volume of trade on which costs have been
lowered.
economic structures into place, such as the World Bank, United
Nations, World Trade Organization, and International Monetary • The total volume of trade on which costs have been
Fund, to prevent the economic depressions and instability that raised.
characterized the years following World War I. National agree-
ments promoted and facilitated free trade. Free trade is trade in • The degree to which costs have risen on diverted trade.
which goods and services can be exchanged between countries • The degree to which costs have lowered on created trade,
or regions without tariffs, quotas, or other trade restrictions supply curves, and tariffs.
being levied.
 ​​​Trade Creation & Diversion​ 35

Customs unions and free trade agreements change nations' pro-

• First, member nations must agree to follow dispute-reso-
lution procedures.
ductive efficiency and consumption habits and levels. Jacob
Viner's critics argue that the outcome of customs unions and free • Second, member nations must agree to follow rules-of-
trade agreements may reach beyond the fixed outcomes of trade origin procedures for all third-party products entering
creation and trade diversion (Wexler, 1960). the free trade area. Rules of origin, which refer to laws,
regulations and administrative processes that establish a
product's country of origin, make up an expensive process
Applications for all free trade agreement member nations.
Trade Creation, Diversion, & Economic Integration Free trade agreements tend to be applicable to a geographical
Economic Integration region and form a free trade area. A free trade area, according
Trade creation and trade diversion, as outcomes of trade agree- to the Organization for Economic Co-operation and Develop-
ments, are part of a larger process of economic integration. ment, refers to a grouping of countries within which tariffs and
Economic Integration refers to the integration of commercial non-tariff trade barriers between member nations are generally
and financial activities among countries through the abolishment abolished without instituting common trade policy toward non-
of nation-based economic institutions and activities. Processes members. Free trade agreements result in significant amounts
of regional economic integration, such as Europe's, have been of trade diversion as trade with non-member nations remains an
shaping the economic relations between countries significantly. important source of imported goods and services.
At the same time, an increasing integration of all national econ-
omies into the global economy has affected these economic Customs Unions
relations, too (Krieger-Boden & Soltwedel, 2013). Customs unions, which are free trade areas that also establish a
common tariff and other shared trade policies with non-member
Economic integration among nations includes the following countries, require trade policy harmony and cooperation between
four stages: Free trade agreements (FTA), customs unions (CU), member nations. Customs unions establish a common external
common markets, and economic unions (Holden, 2003). Nations tariff (CET) and import quotas on products entering the region
choose different levels of economic integration based on vari- from third-party countries but also offer free movement of labor
ables such as the strength of their national economy and trade and capital among member nations. Customs unions offer four
relationships and forecasted trade prospects. Nations may have main benefits to member nations:
multiple trade relationships and levels of economic integration
with other countries or none at all. Nations that reject or do not
• First, customs unions eliminate the need for rules of
origin and, as a result, provide member nations with sig-
pursue the stages of economic integration, as described above,
nificant administrative cost savings and efficiency gains.
are characterized as autarky.
• Second, customs unions establish common trade remedy
Autarky, or an autarkic nation, refers to self-sufficient countries policies such as anti-dumping and countervail measures.
that do not participate in international trade. Autarky, which
means self-sufficiency in Greek and provides independence • Third, customs unions require a level of cooperation that
from other states, results in both benefits and costs (Anderson & makes trade dispute-resolution procedures between mem-
Marcouiller, 2005). The stages of economic integration are rarely ber nations unnecessary.
fixed or permanent but instead are generally fluid and overlap- • Fourth, customs unions work together as a single entity to
ping. Economic integration, as described below, is an evolving negotiate multilateral trade initiatives as a single bloc.
process responsive to the shifting socio-economic climates. The
levels of trade creation and trade diversion decrease as countries The benefits gained from participation in customs unions come
move toward greater economic cooperation and economic inte- at a cost to political and economic independence of member
gration. nations. (For example, in 2013 Armenian President Serzh Sarg-
syan entered his country into a customs union led by Russia-a
Free Trade Agreements move that prevents Armenia from being integrated into the Euro-
Free trade agreements are agreements that state that goods and pean Union.) Member nations exchange their independent trade
services can be exchanged between countries or regions without and foreign policy freedoms for the benefits described above.
tariffs, quotas, or other trade restrictions being levied. Examples Trade creation and trade diversion levels in customs unions will
of free trade agreements include the North American Free Trade vary based on the number of member nations and the remaining
Agreement (NAFTA) and the Central European Free Trade trade relationships with non-member nations.
Agreement (CEFTA). Free trade agreements may be limited to
a business or industry sector or be applied to all levels and types Common Markets
of international trade. Free trade agreements tend to impose two Common markets, as described by the Organization of Eco-
main requirements on member nations: nomic Co-operation and Development, are customs unions with
36 ​​​Trade Creation & Diversion​

provisions to liberalize movement or mobility of people, capi- developed in the hopes of fostering trade creation, economic
tal and other resources and eliminate non-tariff barriers to trade development, and, finally, economic integration throughout
such as the regulatory treatment of product standards. Common Africa. Three of the main regional trade agreements in Africa
markets are a significant step toward economic integration for include the Southern African Customs Union, the West African
member nations. Common markets tend to share labor policies Economic and Monetary Union, and the Monetary and Eco-
as well as fiscal and monetary policies. Common markets, which nomic Community of Central Africa. These three regional trade
facilitate increased economic interdependence, tend to produce agreements, discussed below, experience different levels of trade
increased economic efficiency and economic growth for all creation and trade diversion.
member nations.
Southern African Customs Union
Economic unions, as the final stage of economic integration, are The Southern African Customs Union, established in the Cus-
common markets with provisions for the harmonization of cer- toms Union Agreement of 1910, includes the five member states
tain economic policies such as macroeconomic and regulatory of Botswana, Lesotho, Namibia, South Africa and Swaziland.
policies. The European Union is one example of a large-scale The South African Customs Union agreement was revised in
effective economic union. Economic unions, the last and great- 1969 and 1994. The Southern African Customs Union has mul-
est stage of economic integration among nations, share nearly all tiple goals:
economic policies and regulations including monetary policies,
fiscal policies, labor policies, development policies, transporta-
• Regional integration.
tion policies, and industrial policies. Economic unions generally • The facilitation of trade between the members of the
share a common currency and a unified monetary policy that Agreement.
controls and coordinates national interest rates and exchange
rates. Economic unions require supranational legal and eco- • Improved Trade Negotiations between SACU and third
nomic institutions to regulate commerce and ensure uniform parties.
application of the economic union rules and regulations. Eco- • Improved economic development of the Member States.
nomic unions, with the highest degree of economic integration,
tend to promote and facilitate high levels of trade creation. The Southern African Customs Union, which provides shared
decision-making and a sustainable revenue-sharing arrangement,
has been very active in the years following the end of apartheid
Issues in 1994. The Southern African Customs Union is challenged
by the member nations' varying trade policies and trade policy
African Regional Trade Agreements, Trade Creation
divergences, and by the perception that South Africa displays
& Trade Diversion
an avuncular relationship with its much smaller SACU-member
Economic integration efforts among nations characterize inter- wards because of its greater size, wealth, and overall regional
national relations at the end of the twentieth and beginning of the economic dominance (African Business, 2013).
twenty-first centuries. Regional economic integration between
developing and developed countries is common and believed to The Southern African Customs Union, eager to increase the
lead to economic stability and development. Developing coun- benefits from economic cooperation, is involved in active trade
tries and international development organizations, such as the negotiations with both the European Union and the United States
World Bank and the Organization for Economic Co-operation (Kirk & Stern, 2003).
and Development, promote regional trade agreements as a means
of facilitating stability, development, and trade creation. Exam- The West African Economic & Monetary Union
ples of regional trade agreements include European Free Trade The African Western Union Economic and Monetary, estab-
Agreement (EFTA), Southern African Customs Union (SACU), lished in 1994, includes the member nations of Benign, Burkina
Gulf Cooperation Council (GCC) Customs Union, Monetary and Faso, the Ivory Coast, Mali, Niger, Senegal, Guinea-Bissau, and
Economic Community of Central Africa (CEMAC), European Togo. The West African Economic and Monetary Union facil-
Union Taxation and Customs Union, Southern Cone Common itates trade through the use of a common currency. The West
Market (MERCOSUR), and West African Economic and Mon- African Economic and Monetary Union has the following goals
etary Union (UEMOA). and objectives:

Regional trade agreements in Africa are characterized by the

• “To reinforce the competitiveness of the economic and
financial activities of the member states within the frame-
developing-nation status of most member nations. Regional
work of an open and competing market and a rationalized
trade agreements in Africa began appearing in the 1980s. Two
and harmonized legal environment”
treaties, the Lagos Plan of Action (1980) and the Abuja Treaty
(1991), created a framework for regional economic integration • “To ensure the convergence of the performances and the
in Central, Eastern, Northern, Southern, and Western sub-regions economic policies of the member states by the institution
in Africa. A process of trade liberalization and cooperation was of a procedure of multilateral monitoring”
 ​​​Trade Creation & Diversion​ 37

• “To create between member states a common market • Common language.

based on freedom of movement of the people, the goods,
the services, the capital and the right of establishment of
• Willingness of countries to reduce tariffs.
the people carrying on an independent or paid activity, • Willingness of countries to eliminate non-tariff barriers
like on a common external tariff and a marketing policy” to trade such as visa requirements, and socio-political
stability.
• “To institute a coordination of the national policies by
the implementation of common actions, and possibly,
of common policies in particular in the following fields: Conclusion
human resources, regional planning, agriculture, energy,
industry, mines, transport, infrastructures and telecom- In the final analysis, Jacob Viner's theory of trade creation and
munication” trade diversion has had a lasting impact on trade theory and trade
policy. Trade creation, which refers to the net increase in trade
• “To harmonize, to the extent necessary with the correct that result from the displacement of domestic production, and
operation of the common market, the legislations of the trade diversion, which refers to the diversion of existing trade
member states and particularly the mode of the taxation" that results from the displacement of imports, have significantly
(Diop, 2008, p.1) different effects on national economies. The U.S. Congressional
Budget Office promotes more inclusive free trade agreements in
The Monetary & Economic Community of
an effort to eliminate trade diversion and foster trade creation.
Central Africa
Ultimately, the hybrid nature of trade policy, a combination of
The Monetary and Economic Community of Central Africa, economic and foreign policy, will likely continue so long as a
established in 1992, includes the six member nations of Cam- trade policy is a strategic tool for policymakers.
eroon, Central African Republic, Chad, Republic of the Congo,
Equatorial Guinea, and Gabon. The Monetary and Economic
Community of Central Africa has the following goals and objec- Terms & Concepts
tives:
Common Markets: Customs unions with provisions to liberalize
• Promote the establishment of a Central African Common movement or mobility of people, capital and other resources and
Market.
eliminate non-tariff barriers to trade.
• Eliminate the obstacles to trade between member nations.
Customs Unions: Free trade areas that also establish a common
• Coordinate development programs to benefit underprivi- tariff and other shared trade policies with non-member countries.
leged countries and areas.
Economic Integration: The integration of commercial and
Economists debate the effects of the African regional trade financial activities among countries through the abolishment of
agreements, described above, on the developing economies nation-based economic institutions and activities.
of Africa. Regional trade agreements in Africa are intended to
foster trade creation but may result in trade diversion. For exam- Economic Unions: Common markets with provisions for the har-
ple, Economic Community of Central Africa has experienced monization of certain economic policies such as macroeconomic
greater amounts of trade diversion than trade creation. Goods and regulatory policies.
produced outside the regional trade agreements area are priced
high due to tariffs and, as a result, pose an economic hardship on Free Trade Agreements: goods and services can be exchanged
the national economy. Regional trade agreements increase the between countries or regions without tariffs, quotas, or other
volume of trade without necessarily facilitating trade in areas trade restrictions being levied.
with high growth potential. Variables that effect trade creation
and trade diversion effects of regional trade agreements include International Trade: The purchase and sale of goods or services
the following (Musila, 2005): between residents of different countries.
• Exporting country gross national product (GNP). Markets: A setting that allows buyers and sellers to obtain
• Importing country gross national product. information and engage in a voluntary exchange of goods and
services.
• Exporting country population.
• Importing country population. Nations: Large aggregations of people sharing rules of law and
an identity based on common racial, linguistic, historical, or cul-
• Distance. tural heritage; rarely act unilaterally.
• Regional transportation and communication network.
Tariffs: A tax imposed on a good imported into a country.
38 ​​​Trade Creation & Diversion​

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Koo, W., Kennedy, P., & Skripnitchenko, A. (2006). Regional
preferential trade agreements: Trade creation and diver- Switzer, L., & Redstone, J. (1989). The impact of a Canada-US
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78818&site=ehost-live login.aspx?direct=true&db=buh&AN=4614607&site=eh
ost-live

Essay by Simone I. Flynn, Ph.D.

Dr. Simone I. Flynn earned her Doctorate in cultural anthropology from Yale University, where she wrote a dissertation on Internet com-
munities. She is a writer, researcher, and teacher in Amherst, Massachusetts.
Customs Union

an exploration of the welfare consequences of customs unions

Table of Contents
for member and non-member nations.

Abstract
Overview
Overview
Stages of Economic Integration Customs unions, according to the Organization for Economic
Co-operation and Development (OECD), are free trade areas
Free Trade Agreements that also establish a common tariff and other trade policies with
Customs Unions non-member countries. A tariff is a form of tax imposed on a
good imported into a country. Customs unions abolish tariffs
Common Markets among member countries and set common external tariffs in
Economic Unions order to maximize the joint welfare of the member countries (Yi,
1996). Customs unions are affected by variables such as trends
Customs Union Theory in globalization, location of production, consumption patterns,
Trade Agreement & Economic Structures terms-of-trade, economies-of-scale, and levels of efficiency
(Krauss, 1972). Increasing levels of international trade and
Trade Creation & Diversion investment are promoting and facilitating a growing number of
customs unions around the world.
Applications
Active Customs Unions The following sections provide an overview of the main stages
of economic integration, free trade agreements (FTA), customs
Issues unions (CU), common markets, and economic unions, and the
main points and origin of customs union theory. This overview
Welfare Consequences of Customs Unions serves as the foundation for later discussion of active customs
unions around the world and the welfare consequences of cus-
Conclusion
toms unions for member and non-member nations.
Terms & Concepts Stages of Economic Integration
Bibliography Customs unions are one stage in the process of economic inte-
gration between nations. Economic integration between nations
Suggested Reading includes the following four stages: Free trade agreements (FTA),
customs unions (CU), common markets, and economic unions
(Holden, 2003).

Free Trade Agreements

Abstract Free trade agreements (also referred to as preferential trade
agreements (PTAs)) state that products can be purchased and
This article focuses on customs unions. It provides an overview sold across country or regional borders without trade restric-
of the main stages of national economic integration (including tions such as tariffs or quotas being levied. Examples of free
free trade agreements, customs unions, common markets, and trade agreements include the North American Free Trade Agree-
economic unions) occurring as a result of globalization. The ment (NAFTA) and the Central European Free Trade Agreement
main points and origin of customs union theory are described. (CEFTA). Free trade agreements may be limited to a business or
Numerous examples of customs unions are included as well as industry sector or applied to all levels and types of international

40
 ​​​Customs Union​ 41

trade. Free trade agreements tend to impose two main require- sions to liberalize movement or mobility of people, capital and
ments on member nations: other resources and eliminate non-tariff barriers to trade such as
the regulatory treatment of product standards. Common markets
• Member nations must agree to follow dispute-resolution are a significant step toward economic integration for member
procedures.
nations. Common markets tend to share labor policies as well as
• Member nations must agree to follow rules of origin pro- fiscal and monetary policies. Common markets, which facilitate
cedures for all third-party products entering the free trade increased economic interdependence, tend to produce increased
area. Rules of origin, which are the legal stipulations, economic efficiency for all member nations.
restrictions and administrative processes used to establish
a product’s country of origin, is an expensive process for Economic Unions
all free trade agreement member nations. Economic unions are common markets with provisions for the
harmonization of certain economic policies such as macroeco-
nomic and regulatory. The European Union is one example of
Free trade agreements tend to be applicable to a geographical a large-scale effective economic union. Economic unions, the
region and form a free trade area. A free trade area, according to last and greatest stage of economic integration between nations,
the Organization for Economic Co-operation and Development, share nearly all economic policies and regulations including
refers to a grouping of countries within which tariffs and non-tar- monetary policies, fiscal policies, labor policies, development
iff trade barriers between member nations are generally abolished policies, transportation policies, and industrial policies. Eco-
without instituting common trade policy toward non-members. nomic unions generally share a common currency and a unified
monetary policy that controls and coordinates national interest
Customs Unions rates and exchange rates. Economic unions require supranational
Customs unions, which are free trade areas that also establish a legal and economic institutions to regulate commerce and ensure
common tariff and other shared trade policies with non-member uniform application of the economic union rules.
countries, require trade policy harmony and cooperation between
member nations. Customs unions implement a uniform external Nations choose different levels of economic integration based
tariff (CET) and import quotas on products entering the customs on variables such as the strength of their national economy and
union region from outside countries but also provide for the free trade relationships and forecasted trade prospects. Nations may
movement of labor and capital between member nations. Cus- have multiple trade relationships and levels of economic integra-
toms unions offer four main benefits to member nations: tion with other countries or none at all. Nations that reject or
do not pursue the stages of economic integration, as described
• Customs unions eliminate the need for rules of origin above, are characterized as autarky. Autarky, or an autarkic
and, as a result, provide member nations with significant
nation, refers to self-sufficient countries that do not participate
administrative cost savings and efficiency gains.
in international trade. Autarky, which means self-sufficiency in
• Customs unions establish common trade remedy policies Greek and provides independence from other states, results in
such as anti-dumping and countervail measures. both benefits and costs (Anderson & Marcouiller, 2005).
• Customs unions require a level of cooperation that makes Customs Union Theory
trade dispute-resolution procedures between member na- Customs union theory has its roots in the trade theory of the eigh-
tions unnecessary. teenth century. Eighteenth century economists, such as Adam
• Customs unions work together as a single entity to nego- Smith (1723-1790) and David Ricardo (1772-1823), explored
tiate multilateral trade initiatives as a single bloc. how trade between nations affected national economies. Modern
customs union theory emerged post World War II. Modern cus-
toms union theory examines the way trade is impacted by the
The benefits gained from participation in customs unions come removal of barriers (such as quotas and tariffs) as related to the
at a cost to political and economic independence of member relationship between member countries and their establishment
nations. Member nations exchange their independent trade against other countries. Customs unions, and related theory,
and foreign policy freedoms for the benefits described above. emerged post World War II as economic theory evolved and
One example of a successful and evolving customs union is the grew to address changing global economic relationships.
Southern Cone Common Market (MERCOSUR) of Argentina,
Brazil, Paraguay and Uruguay. MERCOSUR, established in Trade Agreement & Economic Structures
1991, is actively working toward becoming a common market After World War II, economists, world leaders, and governing
as member nations have become more economically integrated. bodies put trade agreements and economic structures into place,
such as the World Bank, United Nations, World Trade Organiza-
Common Markets tion, and International Monetary Fund, to prevent the economic
Common markets, as described by the Organization of Economic depressions and instability that characterized the years following
Co-operation and Development, are customs unions with provi- World War I. National agreements promoted and facilitated free
42 ​​​Customs Union​

Herzegovina in Europe, and Costa Rica and Panama in

trade. Free trade is trade in which goods and services can be pur-
Central America (EFTA Signs, 2013). The European Free
chased and sold across country or regional borders without trade
Trade Agreement member nations are part of the Euro-
barriers such as tariffs or quotas being imposed. Post World War
pean Economic Area (EEA). The European Economic
II, the allied powers, countries in opposition to the axis powers,
Areas, established in 1992, includes the EFTA member
promoted a limited form of free trade within a dollar-exchange
nations as well as the twenty-five European Community
monetary system. The General Agreement on Tariffs and Trade
member states.
of 1947 prohibited quantitative restrictions on trade between
leading industrialized economies. In the years following World • Southern African Customs Union (SACU): The South-
War II, nations have been engaging in trade agreements as a ern African Customs Union, established in the Customs
means of increasing economic efficiency, productivity, and Union Agreement of 1910, includes the five member
growth. Regional trade zones facilitate commercial expansion. states of Botswana, Lesotho, Namibia, South Africa and
Today, trade relationships between nations are also political rela- Swaziland. The South African Customs Union agreement
tionships. Trade relationships, as expressed in customs unions, was revised in 1969 and 1994. The Southern African Cus-
have become political-economic unions for the world's major toms Union has multiple goals: Regional integration, the
trading powers including the United States, the countries of the facilitation of trade between the members of the Agree-
European Union (especially those in Western Europe), Japan, ment, improved Trade Negotiations between SACU and
China, and South Korea as well as developing nations. third parties, and improved economic development of the
Member States. The Southern African Customs Union,
Trade Creation & Diversion which provides shared decision-making and a sustain-
Economic theory, post World War II, was deeply engaged with able revenue-sharing arrangement, has been very active
real world trade concerns and relationships. Modern customs in the years following the end of apartheid in 1994. The
union theory began with economists Jacob Viner (1892-1970). Southern African Customs Union is challenged by the
Viner's theory of customs unions argues that customs unions member nations' varying trade policies and trade policy
have two major effects: Trade creating and trade diverting. Trade divergences. The Southern African Customs Union, eager
creation refers to the shift of consumption of the importable to increase the benefits from economic cooperation, is
good from a high-cost domestic producer to a lower-cost exter- involved in active trade negotiations with both the Euro-
nal foreign producer. Trade diversion refers to a switch from the pean Union and the United States (Kirk & Stern, 2003).
lowest-cost external producers to a higher-cost producer. Viner's
theory argues that trade creation always improves the country's • Gulf Cooperation Council (GCC) Customs Union: The
welfare but trade diversion dampens the country's welfare. Crit- Gulf Cooperation Council Customs Union, established
ics of customs union theory argue that Viner's assumption that in 2002, is comprised of Bahrain, Kuwait, Oman, Qatar,
factors are perfectly mobile between industries in a country is Saudi Arabia, and the United Arab Emirates. The Gulf
not accurate. Critics argue that labor and capital are not uni- Cooperation Council Customs Union is a single customs
formly mobile across regions and industries (Parai & Yu, 1989). zone with a unified customs tariff of 5% on most goods.
The Gulf Cooperation Council Customs Union, a unified
trading bloc, is involved in active negotiation with the Eu-
Applications ropean Union to reduce tariffs on products, such as alumi-
num, that are particularly significant in the economies of
Active Customs Unions GCC member nations. Members of the Gulf Cooperation
Numerous active and anticipated customs unions exist around Council Customs Union have the power to impose higher
the world. Customs unions, which are one stage in the process of or lower tariffs on certain goods as they see fit. For ex-
economic integration between nations, are an evolving economic ample, Saudi Arabia, the nation with the largest economy
relationship. Some customs unions progress to common market in the GCC Customs Union, places higher external tariffs
and economic union status and some customs unions remain than the GCC Customs Union 5% tariff on approximately
as stable customs unions. Variables that affect customs unions 800 goods and products (Matthews & Issa, 2003).
include location of production, consumption patterns, terms- • Monetary and Economic Community of Central
of-trade, economies-of-scale, and levels of efficiency (Krauss, Africa (CEMAC): The Monetary and Economic Com-
1972). The following list of customs unions includes small and munity of Central Africa, established in 1992, includes
large-scale customs unions: the six member nations of Cameroon, Central African Re-
• European Free Trade Agreement (EFTA): The Euro- public, Chad, Republic of the Congo, Equatorial Guinea,
pean Free Trade Agreement, established in 1960, is a free and Gabon. The Monetary and Economic Community
trade convention between Iceland, Liechtenstein, Norway, of Central Africa has the following goals and objectives:
and Switzerland. European Free Trade Agreement mem- Promote the establishment of a Central African Common
ber nations have jointly established free trade agreements Market; eliminate the obstacles to trade between member
with other non-member nations, including Bosnia and nations; and coordinate development programs to benefit
underprivileged countries and areas.
 ​​​Customs Union​ 43

• European Commission Taxation and Customs Union: by the free movement of people, goods, services, capital;
The European Commission Taxation and Customs Union, ensuring the right of establishment for persons participat-
which includes all member nations of the European ing in an independent or lucrative activity; coordinating
Union, imposes no taxes on goods moving between uniform actions and policies in terms of human resources,
member nations, imposes a common external tariff on regional planning, agriculture, energy, industry, mines,
all goods entering the European Union, and negotiates transportation, infrastructure, and telecommunications;
with non-member nations as a unified trade block. The and facilitating the operation of the common market,
European Union Taxation and Customs Union has the the legislations of the member states, and the shared
following goals and objectives: "Manage, defend and mode of taxation.
develop the customs union as a vital part of protecting
the external borders of the EU; tackle the tax obstacles
that currently prevent individuals and companies from
Issues
operating freely across borders and from exploiting the Welfare Consequences of Customs Unions
full benefit of the Internal Market and encourage changes
Economists debate the effects that customs unions have on the
to tax systems so that they support Community objec-
welfare of member and non-member nations. Member nations of
tives such as competitiveness and sustainable develop-
customs unions, a set of countries which agree to abolish tariffs
ment; respond effectively to the international challenges
among member countries and to set common external tariffs in
associated with customs and tax policies; facilitate better
order to maximize the joint welfare of the member countries,
co-operation between Member States to combat tax and
establish their own external tariffs on non-member countries.
customs fraud" (Franckx, 2005, p.65). The European
The variations and variability in trade relationships between cus-
Union also has customs unions with Turkey, Andorra and
toms union member nations and non-member nations creates a
San Marino. These customs union agreements are viewed
wide range of welfare outcomes. Nations, aware of the effect
as a step in the process of Turkey and San Marino becom-
that customs unions have on member nations and non-member
ing full members of the European Union.
nations alike, are increasingly working to create welfare-max-
• Southern Cone Common Market (MERCOSUR): imizing customs unions (Yi, 1996). Potential customs union
The Southern Cone Common Market, more commonly members estimate both the union's net economic costs and the
referred to as MERCOSUR, was established in 1991 union's non-economic benefits to assess whether or not the union
by the Treaty of Asuncion. MERCOSUR, founded on benefits the community (Krauss, 1972). In an efficient economic
an agreement between Brazil, Argentina, Uruguay and market, customs unions are believed to increase welfare if the
Paraguay, is a customs union working toward becoming a exportable sector pays higher prices to all member nations (Parai
common market. Paraguay was temporarily suspended in & Yu, 1989). Ultimately, there are multiple incentives for nations
2012 during a period of political instability, and Venezuela to form customs unions. The welfare consequences of customs
joined (Paraguay's Dispute, 2013). MERCOSUR includes unions include economic and non-economic benefits for member
the following goals and objectives: negotiating free trade and non-member nations (Yeh, 1998).
agreements between MERCOSUR and the other member
nations of the Latin American Association of Integration;
implementing the Inter-Regional Framework Agreement Conclusion
for Economic and Trade Co-operation (approved in De-
cember of 1995 by MERCOSUR and the European Union; In the final analysis, economic integration of nations, which
and co-ordinating views regarding the scope of trade includes the integration of commercial and financial activities
discussions in forming the Hemispheric Free Trade Area. among countries through the abolishment of nation-based eco-
nomic institutions and activities, includes four fluid and dynamic
• West African Economic and Monetary Union (UE- stages of integration. The four stages of economic integration
MOA): West African Economic and Monetary Union are being actively negotiated by nations eager to achieve the
(UEMOA): The African Western Union Economic and economic benefits of increased productivity, growth, and trade.
Monetary, established in 1994, includes the member Customs unions exist between the stages of free trade agree-
nations of Benign, Burkina Faso, the Ivory Coast, Mali, ments and common markets. Nations will move between these
Niger, Senegal, Guinea-Bissau, and Togo. The West stages based on their interest in and ability to facilitate economic
African Economic and Monetary Union facilitates trade partnership.
through the use of a common currency. The West African
Economic and Monetary Union has the following goals
and objectives: reinforcing economic competition among Terms & Concepts
member states within an open and competitive market;
ensuring the equalization of activities and economic poli- Allied Powers: Countries (including the United States, Britain,
cies of member states by instituting a process of multilat- France, New Zealand, India, Canada, and Greece) that opposed
eral managing; creating a common market characterized the axis powers during World War II.
44 ​​​Customs Union​

Common Markets: Customs unions with provisions to liberalize Premier. http://search.ebscohost.com/login.aspx?direct=tru

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Essay by Simone I. Flynn, Ph.D.

Dr. Simone I. Flynn earned her Doctorate in cultural anthropology from Yale University, where she wrote a dissertation on Internet com-
munities. She is a writer, researcher, and teacher in Amherst, Massachusetts.
Economic Unions

Table of Contents Overview

Globalization brings with it many changes. From a business
Abstract point of view, globalization increases the marketplace in which
Overview a business can sell its goods and services. On the other hand,
globalization often makes doing business more difficult, requir-
Free Trade Agreements ing, for example, the management of an international supply
chain, dealing with the intricacies of managing an international
Customs Unions
workforce, or marketing to different cultures. In addition, glo-
Common Markets balization affects not only businesses; it also affects the countries
within which a business operates. Before globalization, most
The Economic Union countries are able to be economically self-sufficient and did not
Applications rely on international trade or imported goods to survive. How-
ever, with increasing globalization comes an increasing reliance
The European Union on the goods and services of other countries. Thus, while an
international company can market its goods and services in other
Monetary Policy
countries, those other countries can market their own goods and
Advantages of the Euro services locally to the new company. To help facilitate the eco-
nomic realities of globalization, a number of nations are forming
Opting Out economic unions.
Conclusion
An economic union is a type of common market that permits the
Terms & Concepts free movement of capital, labor, goods, and services. Economic
unions harmonize or unify their social, fiscal, and monetary poli-
Bibliography cies (often including having a united currency). Examples of
economic unions include:
Suggested Reading
• The African Union,
• Andean Community (Comunidad Andina),
Abstract
• Arab Maghreb Union (Union du Maghreb Arabe),
Economic unions are a natural response to the realities of glo- • Association of Caribbean States,
balization and represent one stage in the process of economic
integration. In theory, nations move from free trade agree- • Association of South East Asian Nations,
ments to form customs unions and then common markets before • Caribbean Community,
forming economic unions. In practice, however, the path is not
always that clear. Economic unions often are characterized by a • Commonwealth of Independent States,
common currency and centralized bank, in which case they are • East African Community,
sometimes referred to as economic and monetary unions. The
best example of an economic and monetary union today is the • European Union, and
European Union (EU). In many ways, the EU today is a living • Pacific Community.
laboratory for observing the effects of macro economic policy
cooperation on regional growth and cross-border economic,
trade, and investment ties.

46
 ​​​Economic Unions​ 47

Although in practice, the path from national economic self-suffi- be imposed on exported goods. Customs unions remove inter-
ciency to economic integration varies from situation to situation; nal trade barriers, and require participating states to harmonize
in general, there are four stages to this transformation: external trade policies. Part of this harmonization includes the
development of a common external tariff. These are shared
• Free trade agreements, customs duties, import quotas, preferences, or other non-tariff
• Customs unions, barriers imposed by a customs union or common market on
imports to any or all countries in the union or market. Common
• Common markets, and external tariffs are actually a simple form of economic union.
• Economic unions (Holden, 2003). Customs union may prohibit the use of trade remedies with
the union and may also negotiate multilateral trade initiatives.
These stages are summarized in Figure 1. Because all goods imported into a customs union are subject to
the same tariff no matter their point of origin, custom unions
Figure 1: Basic Elements of the Stages of Economic Integration have no need for rules of origin as required in free trade agree-
ments. However, in order to gain the benefits of a customs union,
participating nations must by necessity relinquish their right
to establish an independent trade policy. As a result, member
nations also experience some restriction of foreign policy.

Common Markets
The third stage in economic integration is the development of a
common market. This is a group of countries or sovereign states
within a geographical area with a mutual agreement to permit the
free movement of capital, labor, goods, and services among its
members. Although common markets promote duty-free trade
for the member nations, they impose common external tariffs on
imports from countries that are not members. Common markets
have unified or harmonized social, fiscal, and monetary policies.
This feature of common markets severely limits the ability of
member nations to implement independent economic policies.
However, common markets offer gains in economic efficiency
that could not otherwise be realized. Because of the nature of
common markets, both labor and capital can move within the
Free Trade Agreements area of the common market, leading to a more efficient alloca-
The first stage toward economic integration is represented by tion of resources than could otherwise be achieved.
the free trade agreement. Free trade is the exchange of good
and services between countries or sovereign states without The Economic Union
high tariffs, non-tariff barriers (e.g., quotas), or other inhibiting The fourth stage in economic integration comprises the eco-
requirements or processes. Free trade does not apply to capital nomic union. This is a type of common market which permits the
or labor. Free trade agreements (also referred to as preferential free movement of capital, labor, goods, and services. Economic
trade agreements) eliminate import tariffs and quotas between unions harmonize or unify their social, fiscal, and monetary poli-
the signatories to the agreement. They may apply to all aspects cies. When economic unions also have a common currency with
of international trade between the signatories or may be limited a concomitant central bank for all member states, they may be
to a few sectors. Often, free-trade agreements include formal referred to as economic and monetary unions. Economic unions
mechanisms that are to be used to resolve disputes. The primary include significant harmonization of policy among the member
advantage of the free trade agreement is that it liberalizes trade states, particularly the formal coordination of monetary and
among the member nations. However, free-trade agreements oth- fiscal policies, and labor market, regional development, trans-
erwise place few limitations on the member nations. In order for portation, and industrial policies.
a free-trade agreement to properly function, it must also include
rules of origin that apply to all third party goods imported from
outside the free-trade area. Applications
Customs Unions The European Union
The next stage in economic integration comprises the develop- Arguably, the best known economic union today is the European
ment of customs unions. Customs are duties or taxes that are Union (EU) comprising 27 different sovereign states in Europe.
imposed by a country, sovereign state, or common union on According to the Delegation of the European Commission to the
imported goods. In some situations, duties or taxes may also United States, the roots of the EU trace back 50 years ("Eco-
48 ​​​Economic Unions​

nomic & Monetary," 2007). The EU started as a "customs union and to maintain a public debt while all of less than sixty percent
that allowed trade to move freely among its member states" (p. of the gross domestic product. The European Central Bank, an
1). The EU facilitates the flow of labor, capital, goods, and ser- independent bank with the governing board that represents all
vices by providing a single market among the member states. euro area member states, determines and implements the mon-
The EU went a step further and became an economic and mon- etary policy for all nations in the euro area.
etary policy with "coordinated fiscal policies and a common
currency, the euro, €" (p. 1). In many ways, the EU today is a Monetary policy for members of the EU that are not members
living laboratory for observing the effect of macro economic of the euro area, on the other hand, is set by their national cen-
policy cooperation on regional growth and cross-border eco- tral banks. Similarly, government budgets and structural policies
nomic, trade, and investment ties. for labor, pensions, and capital markets continue under the
jurisdiction of individual EU member states whether or not the
The roots of today's EU began in 1970 with the publication of state belongs to the euro area ("Economic & Monetary," 2007).
the first feasibility report for a European monetary union. At this Member states within the euro area are required to pay a finan-
time, much of Europe was suffering from stagnant and unstable cial penalty or face other sanctions if they do not meet these
economies. In 1973, the gold standard was broken up, and in requirements of the pact (barring exceptional circumstances).
1979, the European Monetary Standard was established. These Although member states that do not belong to euro area are also
steps paved the way for today's economic and monetary union in required to avoid excessive deficits, they do not face sanctions if
Europe. In 1989 and 1992, the Delors Report and the Maastricht they do not or cannot comply.
Treaty respectively set out a single currency for the EU. In 1999,
member states of the EU entered the first stage of becoming an Advantages of the Euro
economic and monetary union by more closely coordinating eco- Despite prognostications of failure, the EU's experiment with
nomic policies and beginning to dismantle the barriers to the free becoming an economic and monetary union has been success-
movement of capital within the EU ("Economic & Monetary," ful. Before the EU became an economic and monetary union,
2007). inflation in Europe was as high as ten percent in some European
countries. By 1998, however, inflation had dropped 1.5 percent
In 1994, the second stage toward becoming an economic and and has remained under two percent across the euro area. In
monetary union was entered. At this time, the EU liberalized addition, the introduction of a common currency has resulted in
the movement of capital and payments to non-EU countries. benefits not only for businesses, consumers, and travelers, but
Member states of the EU also adopted a budget and debt ceilings also for Europe in general and for the world economy. Since
and instituted a monitoring system. In 1998, Austria, Belgium, the implementation of the euro as a common currency, doing
Germany, Finland, France, Ireland, Italy, Luxembourg, the business in member states has become easier for businesses,
Netherlands, Portugal, and Spain qualified to join the European consumers, and travelers. Because of lower inflation rates and
economic and monetary union and adopt its currency parities. In more sound public finances, both businesses and consumers are
1999, the third stage was entered, and the euro was introduced. faced with less economic uncertainty than before. In addition,
At this time, monetary authority in the euro zone was transferred businesses are no longer faced with exchange rate risks when
to the European System of Central Banks. Also in 1999, 11 of the doing business within the euro area. The use of the common
euro area member states fixed their exchange rates and adopted euro also reduces requirements for paperwork and transaction
the euro. In 2001, Greece became a member of the euro area. costs resulting from the use of multiple currencies. Having a
In 2002, euro notes and coins were introduced within the euro common currency also reduces corporate accounting require-
area. In 2007, Slovenia also joined the euro area ("Economic & ments because there are fewer transactions involving multiple
Monetary," 2007). currencies.

Monetary Policy The new economic environment within the European economic
Most people associate the creation of the euro with the trans- and monetary union also makes investment more attractive to
formation of the EU to being an economic and monetary union. foreign entities due to the lower costs of doing business and
However, this is only the tip of the iceberg. Underlying the euro obviates the necessity for travelers of exchanging currency. As a
is an entire infrastructure of economic policies intended to inte- result, member states have become more attractive tourist desti-
grate the economies of member states, maintain low and stable nations. Similarly, no lower interest rates also make it easier for
inflation and interest rates, foster sustained economic growth, and euro area companies and consumers to borrow money ("Eco-
improve competitiveness and productivity. Because the success nomic & Monetary," 2007). Banks, insurance agencies, and
of the EU is dependent on the efforts of the member states, they pension funds also have greater flexibility in the types of finan-
have agreed by treaty to address economic policies as a common cial services they can offer because they are no longer affected
concern. Accordingly, member states have agreed to the Stability by fluctuating exchange rates. The use of the euro also allows
and Growth Pact which requires the central government within consumers, wholesalers, and traders to compare prices more
each member state to maintain an annual budget with a deficit easily. This leads to greater competition and a resultant lowering
of no greater than three percent of the gross domestic product of prices.
 ​​​Economic Unions​ 49

The movement of the EU to become an economic and monetary bers remained fragile and Cyprus joined the list of troubled
union has also resulted in benefits for Europe in general. By eurozone countries.
banding together in the common euro area, member states are
better protected from crises in the international economy. For In the aftermath of the crisis, El-Erian (2013) warned that the
example, member states can adjust more easily to fluctuations euro was fragmented, freely circulating in some areas of the euro-
in external exchange rates with other currencies including the zone and trapped by capital controls in others. The euro was also
U.S. dollar and the Japanese yen. The transition to becoming subject to flight, especially to Switzerland and the United States.
an economic and monetary union has also given the EU a more Neo-Keynesian Hetzel (2013) concluded that the ECB should
prominent place in international institutions such as the G-8, purchase as many government securities as necessary to drive
the World Bank, the International Monetary Fund ("Economic growth in aggregate nominal demand and commit to structural
& Monetary," 2007). In addition, the establishment of the euro reform, allowing the inflation rate of effected countries to exceed
area has led to greater trade within the area. This has resulted in 2 percent. The U.K., though financially regulated chiefly from
higher employment in the manufacturing and service industries, Brussels, retained its own currency, and fears arose that resent-
and has also stimulated economic growth and expanded the tax ments might negatively impact the financial services sector there
base. In addition, the establishment of the euro area has impacted (Dale, 2013). The role of Germany, though critical to sustaining
the world economy. This move has resulted in a stronger, more its poorer sister countries in the eurozone, was not free from crit-
competitive economy in Europe with greater price and exchange icism. German wealth was undoubtedly the product of a culture
rate stability and lower interest rates. of financial prudence, with an emphasis on savings, and repeated
demands for bailouts from what it deemed profligate nations was
Opting Out met with resentment. As Greeley (2013) pointed out, however,
Not all member states of the EU are part of the euro area. For German euros were invested aggresively — and profitably —
example, both the United Kingdom and Denmark have negoti- in the very countries it later accused of reckless borrowing. In
ated an opt-out clause in the treaty allowing them to retain their other words, the euro flowed from weaker countries to stronger
own national currencies. Member states of the EU, however, countries, and EU policy did not adequately foster a return trip of
have committed to adopt the euro once they meet certain cri- euros to weaker countries in the form of growth.
teria. First, member states desiring to join the euro area must
have an inflation rate no more than 1.5 percent greater than the
three best performing EU member states for the previous year. Conclusion
In addition, the national budget deficit for the applying member
needs to be less than three percent of the nation's gross domestic Economic unions are a natural response to the realities of glo-
product and the ratio of its debt to its gross domestic product balization. As nations develop and begin to interact more with
cannot exceed sixty percent. The national exchange rate for the their neighbors, free trade agreements are often developed to
applying member also needs to have been within predefined eliminate tariffs between parties and to reduce other, non-tariff
margins for the past two years. Interest rates within the applying barriers to trade. As interaction and interdependency increase,
state can be no higher than two percentage points above those of customs unions form to impose a common external tariff in addi-
the three best performing EU member states during the previous tion to the benefits of a free trade agreement. When the benefits
year ("Economic & Monetary," 2007). of a customs union become insufficient to promote trade at the
level desired by the participating parties, common markets may
In early 2010, Eurozone member Greece began imposing mea- be developed. These provide the benefits of a customs union
sures to rein in its expanding public debt. Greece was only one along with free movement of capital and labor as well as some
of a number of EU countries with substantially unbalanced bud- policy harmonization. The next step in responding to increas-
gets. The global financial crisis was creating massive demand ing globalization is the development of an economic union. This
for public services, and very high levels of unemployment lim- provides not only the benefits of a common market, but also
ited those countries' ability to raise revenues. The European establishes common economic policies and institutions for the
Central Bank, following the lead of German Chancellor Angela member states. A further refinement on the economic union is
Merkel, demanded deep austerity measures in Greece, Ire- the economic and monetary union which also gives the member
land, Portugal, Italy, and Spain in return for bailouts to prevent states the benefit of a common currency and centralized bank.
national insolvency. Resistance by recession battered populaces The best example of an economic and monetary union today is
pitted economically strong Germany and to some extent France the EU.
against the eurozone's weaker but still important members. As
the political situation in Greece became increasingly unstable
and stock markets globally began to sink, the U.K. urged a Terms & Concepts
solution be found more rapidly. Ratings agencies downgraded
not only Greece, Portugal, and Spain (all reduced to junk bond Common External Tariff (CET): Common external tariffs are a
status), but also Italy, Belgium, France, and Austria. By 2013, simple form of economic union which implies shared customs
stock markets had bounced back, though the weaker EU mem- duties, import quotas, preferences, or other barriers imposed by a
50 ​​​Economic Unions​

customs union or common market on imports to any or all coun- includes the total consumer, investment, and government spend-
tries in the union or market. ing in addition to the value of exports minus the value of imports.

Common Market: A group of countries or sovereign states Labor: The sum of all human physical and mental effort that is
within a geographical area with a mutual agreement to permit the used to produce goods or services. Although labor includes the
free movement of capital, labor, goods, and services among the application of knowledge to produce goods or services, it does
members. Although common markets promote duty-free trade not apply to the knowledge itself.
for the member nations, they impose common external tariffs on
imports from countries that are not members. Common markets Monetary Policies: The regulation of the supply of money and
have unified or harmonized social, fiscal, and monetary policies. interest rates by the central bank (e.g., the Federal Reserve in the
United States) of the country or union to control inflation and
Currency: Money that is circulated and generally accepted for stabilize currency.
the exchange of goods or services within a given jurisdiction.
Domestic governments typically set their own currency and
penalize individuals or businesses under its authority that do Bibliography
not accept it. Although currency is technically only legal within
a given jurisdiction, some countries informally accept the cur- Beck, G. W. & Weber, A. A. (2005). Inflation rate disper-
rency of another country or countries. Resources for two or more sion and convergence in monetary and economic unions:
countries can also be pooled to make an international currency Lessons for the ECB. CFS Working Paper Series, 2005/31.
accepted by all parties to the agreement. Retrieved 12 October 2009 from Center for Financial
Studies http://www.ifk-cfs.de/fileadmin/downloads/publi-
Customs Union: An agreement between two or more nation cations/wp/05%5f31.pdf
states to impose a common external tariff, remove trade barriers,
and reduce or eliminate customs on trade among members of the Dale, S. (2013). MEPs warning of EU's resentment towards
union. These unions generally place the common external tariff UK. Money Marketing, 5. Retrieved November 15,
on imports from countries outside the group, but do not allow 2013, from EBSCO Online Database Business Source
free movement of capital or labor among the member countries. Complete. http://search.ebscohost.com/login.aspx?direct=t
rue&db=bth&AN=91951566&site=ehost-live
Customs: Duties or taxes that are imposed by a country, sovereign
state, or common union on imported goods. In some situations, Economic and monetary union in the EU: A force for
duties or taxes may also be imposed on exported goods. European and global economic stability. (2007, January).
Eufocus. Retrieved 12 October 2009 from European
Economic Union: A type of common market that permits the Union Website http://www.eurunion.org/news/eunewslet-
free movement of capital, labor, goods, and services. Economic ters/EUFocus/2007/EU Focus-EMU.pdf
unions harmonize or unify their social, fiscal, and monetary poli-
cies. When economic unions also have a common currency with El-Erian, M. A. (2013). Europe's hard choices. Fortune, 167(6),
a concomitant central bank for all member states, they may be 12. Retrieved November 15, 2013, from EBSCO Online
referred to as economic and monetary unions. Database Business Source Complete. http://search.ebsco-
host.com/login.aspx?direct=true&db=bth&AN=87076007
Free Trade: The exchange of good and services between coun- &site=ehost-live
tries or sovereign states without high tariffs, non-tariff barriers
(e.g., quotas), or other onerous requirements or processes. Free Greeley, B. (2013). Can the Germans admit their role in the
trade does not apply to capital or labor. crisis?. Bloomberg Businessweek, (4346), 49-50. Retrieved
November 15, 2013, from EBSCO Online Database
Globalization: Globalization is the process of businesses or Business Source Complete. http://search.ebscohost.com/
technologies to spread across the world. This creates an inter- login.aspx?direct=true&db=bth&AN=90249083&site=eh
connected, global marketplace operating outside constraints of ost-live
time zone or national boundary. Although globalization means
an expanded marketplace, products are typically adapted to fit Hetzel, R. L. (2013). ECB monetary policy in the recession: A
the specific needs of each locality or culture to which they are new Keynesian (old monetarist) critique. Working Papers
marketed. Series (Federal Reserve Bank Of Richmond), 13(7), 2-43.
Retrieved November 15, 2013, from EBSCO Online
Gross Domestic Product (GDP): The total market value of all Database Business Source Complete. http://search.ebsco-
final goods and services produced within the borders of a coun- host.com/login.aspx?direct=true&db=bth&AN=89906531
try during a given period of time. The gross domestic product &site=ehost-live
 ​​​Economic Unions​ 51

Holden, M. (2003, Feb). Stages of economic integration: From Suggested Reading

autarky to economic union. Retrieved 12 October 2009
from Government of Canada Web site http://dsp-psd. Avery, W. P. & Cochrane, J. D. (1973). Innovation in Latin
tpsgc.gc.ca/Collection-R/LoPBdP/inbrief/prb0249-e.htm American regionalism: The Andean Common Market.
International Organization, 27 (2), 181-222. Retrieved 12
Howarth, D., & Quaglia, L. (2013). Banking union as Holy October 2009 from EBSCO Online Database Business
Grail: Rebuilding the single market in financial services, Source Premier http://search.ebscohost.com/login.aspx?dir
stabilizing Europe's banks and 'completing' economic and ect=true&db=buh&AN=5185511&site=ehost-live
monetary union. Journal of Common Market Studies,
51103-123. Retrieved November 15, 2013, from EBSCO Etro, F. (n.d.). International policy coordination with economic
Online Database Business Source Complete. http://search. unions. Retrieved 12 October 2009 from Intertic Website
ebscohost.com/login.aspx?direct=true&db=bth&AN=896 http://www.intertic.org/Unions Papers/IPCEU.pdf
80505&site=ehost-live
Lorz, O. & Willmann, G. (2007, Nov.). Enlargement vs. deep-
Nau, H. R. (1979). From integration to interdependence: Gains, ening: The trade-off facing economic unions. Retrieved 12
losses and continuing gaps. International Organization, October 2009 from Intertic Website http://www.intertic.
33 (1), 127-155. Retrieved 12 October 2009 from EBSCO org/Unions Papers/LorzWillman2.pdf
Online Database Business Source Premier http://search.
ebscohost.com/login.aspx?direct=true&db=buh&AN=518 McLure, C. E. Jr. (2008). Harmonizing corporate income taxes
1778&site=ehost-live in the European Community: Rationale and implica-
tions. NBER/Tax Policy and the Economy, 22, 151-195.
Semmler, W. (2013). The macroeconomics of austerity in Retrieved 12 October 2009 from EBSCO Online Database
the European Union. Social Research, 80(3), 883-914. Business Source Premier http://search.ebscohost.com/
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Database Business Source Complete. http://search.ebsco- ost-live
host.com/login.aspx?direct=true&db=bth&AN=91979375
&site=ehost-live Srivastava, R. K. & Green, R. T. (1986). Determinants of
bilateral trade flows. Journal of Business, 59 (4), 623-640.
Retrieved 12 October 2009 from EBSCO Online Database
Business Source Premier http://search.ebscohost.com/
login.aspx?direct=true&db=buh&AN=4584438&site=eh
ost-live

Essay by Ruth A. Wienclaw

Dr. Ruth A. Wienclaw holds a Ph.D. in Industrial/Organizational Psychology with a specialization in Organization Development from
the University of Memphis. She is the owner of a small business that works with organizations in both the public and private sectors,
consulting on matters of strategic planning, training, and human/systems integration.
Export -- Import Operations

the tactical and strategic decisions and actions necessary to take

Table of Contents
a product from a source in one country to a market in another.

Abstract As such, Export-Import Operations may be profitably considered

a three-part process-1) actions that occur before the actual ship-
Overview ment of the product, 2) those that relate to the shipment of the
product to a customer, and finally, 3) those that occur after the
Applications sale. For sake of simplicity, this article will refer to them as pre-
Pre-Shipment shipment, transfer, and after-sales.

Transport Many businesses (particularly American) have historically

After-Sale avoided participation in international markets. However, the
reality is that we dwell in an increasingly global economy. Even
Conclusion the smallest, most "domestic" transaction may involve suppliers
of raw materials in one country, production in another, value-
Terms & Concepts added remarketing in a third, and final consumption in a fourth.
Ergo, every business professional must have some idea of the
Bibliography factors involved in international trade, simply because more and
more business happens there (U.S. Department of Commerce).
Suggested Reading​​​

Applications
Abstract Pre-Shipment
While this taxonomy is in no way standard, export-import opera-
Export-Import Operations are the actions and decisions nec- tions can be thought of as a three-part process. The first of these
essary to take a product or raw material from a source in one is pre-shipment, i.e, all operations that occur prior to the actual
country to a market in another. This article will discuss export- transport of the product, or even prior to the sale. Thus, it is pos-
import operations as a three part process: pre-shipment, transport, sible to regard as a legitimate part of pre-shipment operations
and after-sale. Each of the three will be considered in turn from even so fundamental a thing as determining a company's serious-
the perspective of business professionals attempting to expand ness about entering the import/export business. Fortunately, one
their companies' interests across national boundaries. Export- of the first tasks of pre-shipment is also an easy and effective
import can be considerably more complex than doing business way for managers to test their companies' ability and willingness
in a single, domestic market, but the realities of a globalizing to enter the import-export business. To wit, they must determine
economy are such that most companies and most people must how willing their companies are to modify their products (or
increasingly deal across frontiers whether they wish to or not. assist a supplier to do so) for foreign markets. It is useful, then, to
keep in mind the (perhaps apocryphal but still instructive) story
of the American automakers who complained of Tokyo's barriers
Overview to their imports, but then declined to produce left-hand models
of their cars when given a chance to enter the Japanese market.
Export-Import Operations are in some ways a misnomer given
that, in a globalized economy, the distinctions between domestic If executives find that their companies and/or employers really
and foreign trade are ever more indefinite. However, for the pur- are committed to import-export, and get genuine buy-in from top
poses of this article, we can consider them to be the sum total of management, then the next issue is channels. As in most other

52
 ​​​Export -- Import Operations​ 53

business ventures, these boil down to just two-direct and indi- number of political problems. Americans, for example, cannot
rect (Seyoum, 1998). The former is the option of companies that legally do business with a number of individuals or regimes
either have or are willing to invest in a sales force resident in the around the world-those believed to be connected to terrorist
nations where they wish to do business. As such, it is often the organizations, for example. By like token, American businesses
best choice for larger concerns with deeper pockets, or which may be asked by some customers to honor boycotts against other
have some method of reaching individual consumers without buyers and sellers in third nations. Some nations, for example,
a middleman. For example, the Internet, Web-based sales, and have led a drive to boycott Israeli commercial interests. The U.S.
direct package shipping companies (Federal Express, UPS, etc.) government forbids its nationals to participate in such boycotts
have given some companies the ability to directly address indi- and, indeed, requires that requests to do so be reported to the
vidual customers no matter how far away they might be. proper authorities. For more on these and other issues regarding
export controls, see the Department of Commerce's Bureau of
If the exporting or importing company does not have a direct Industry and Standard website (http://www.bis.doc.gov/index.
sales option, then indirect sales are the obvious alternative, and htm).
import-export sales channels range from the familiar to the quite
exotic. The former consists of the distributors and resellers, not Transport
greatly different from those of any other indirect channel, except Transport is the actual process of moving a product from point
that they may be based across national borders and must be han- A to point B, as well as from country X to country Z. Transport
dled with additional understanding of cultural differences. For across national borders is similar to any other problem in ship-
example, a distributor located in a Muslim nation probably will ping. Indeed, most of the issues-logistics, deciding on proper
not be available on Fridays, just as many American businesses modes of transport (bulk or piece, rail or air, etc.) are identical.
do not operate on Sundays. The major difference is that in international trade, goods cross
frontiers and the business professional has to consider a formi-
The more exotic, meanwhile, include specialist firms that do dable host of additional documentation, tariff, and bureaucratic
nothing but conduct international trade. The two most famed complexities.
kinds of these, perhaps, are the Export Trading Company (ETC)
and Export Management Company (EMC). An ETC, also called Fortunately for the company that wishes to engage in transna-
an International Trade Company (ITC), is a company that dis- tional trade, there are many independent services and firms to
covers customers in one nation, finds suppliers in another, assist navigating the logistical maze. These range from the ubiq-
purchases and takes title to products in the second country, and uitous package delivery services (which in recent years have
then arranges transport and sales to buyers in the first. EMCs added sophisticated logistics features to their core offerings) to
are similar but do not take title to product and instead operate more traditional Freight Forwarders. A Freight Forwarder is a
as a kind of out-sourced export department for other companies firm or person who acts for the exporter or importer to ensure
(Seyoum, 1998). In addition, there are various modifications of that shipments get from their sources to their destinations with
these two models. For example, a number of manufacturers may a minimum of fuss. Forwarding is something of an arcane art,
band together to co-operatively export their products. requiring its practitioners to be familiar with everything from the
vagaries of international law to the mysteries of truck mechan-
Until very recently, American exporters could also set up a ics. As such, their services are invaluable and even very large
Foreign Sales Corporation (FSC), an export-oriented quasi-com- and very sophisticated corporations employ them rather than
pany based overseas. The benefit to the exporter was that the attempting to develop similar expertise in house (Jones and
economic activity of the FSC was, in theory, conducted outside Jones, 2004).
U.S. jurisdiction and therefore not as heavily taxed. However, the
European Union objected on the grounds that this constituted an A similarly invaluable professional is the customs broker. A com-
unfair trade advantage, the World Trade Organization concurred, pany employs the broker to manage a product's movement across
and the U.S. government finally abandoned the FSC ("FSCs national borders. The broker makes certain the merchandise is
agreement," 2006). In 2004, as part of the Jobs Act, a temporary properly classified, that taxes and duties are properly paid, and
measure to give a tax break to small and medium U.S. companies that any refunds owed to the company are remitted to it. Again,
with foreign sales was introduced. The Interest-Charge Domestic customs brokerage requires a unique set of skills-nothing that a
International Sales Corporation(IC-DISC) federal tax incentive company could not learn of its own, but probably not worth the
was extended for two more years in December, 2010, but was effort to obtain by a firm, whose core business is not customs
allowed to expire at the end of 2012 (homas, 2012). brokerage.

Lastly, the relative distance of customer from supplier means However, the transnational executive does need to be aware of at
that managers doing international business need to be particu- least the broad outlines of international law and custom regard-
larly careful about whom they sell to or buy from. It can be hard ing international trade, as well as American law on the subject.
to collect an overdue account when the customer is not even on Since these all can change at the whim of parliaments and tax
the same continent. Moreover, importers and exporters face a authorities, the executive must become an habitué of the pub-
54 ​​​Export -- Import Operations​

lications and websites of the relative parties. Regular visits to, ing)" (http://www.exim.gov). Ex-Im, in other words, does not
for example, the websites of Export.gov (http://www.export. compete with private lenders, but will step in if there are none
gov), which promotes U.S. exports by offering information from in sight, and, preferably, assume enough of the risk of a failed
several different agencies; the U.S. Commercial Service (http:// transaction to make private lenders willing to become involved
www.buyusa.gov), which works to link American companies to with exports.
foreign partners; the U.S. Department of Commerce's Interna-
tional Trade Administration (www.trade.gov), which provides After-Sale
information about investments that are worth making. Equally After the sale, the chief concern of the importing company is to
useful are subscriptions to various private information services, gain possession of the products it has bought. By contrast, the
newsletters, and trade magazines that keep abreast of changing exporting company's chief concern is getting paid. Both can be
laws and situations. somewhat less simple than might seem. For the company or indi-
vidual importing goods into the United States, particularly after
In addition, the executive should keep in mind the grander scheme 9-11, moving products through customs can be time-consuming.
of things in international trade. This includes knowledge of the Again, if the importer can afford it, then the services of a customs
multinational organizations and regimes that tend to set the rules broker and/or freight forwarder are invaluable. If not, then the
for the game-for example, the World Trade Organization (http:// business professional must become proficient in the use of the
www.wto.org). The WTO is perhaps the most important umpire Department of Homeland Security's Customs and Border Protec-
in international trade today, but still, executives must keep in tion webpage (www.cbp.gov), as well as the Department's other
mind regional trading and tariff zones. The North American Free publications and services. There the reader can garner informa-
Trade Agreement (NAFTA), which seeks to remove most tar- tion on everything from the requirements for a custom's broker's
iffs and other trade barriers between Canada, the United States, license to the wait times at major ports. Particularly important
and Mexico; the venerable European Union; the Association for the importer is the CBP website's section on import quotas-
of Southeast Asian Nations (ASEAN); along with a number of certain items, many textiles for example, are subject to import
other trade blocs can significantly impact a multinational's strat- restrictions. As importantly, the individual who is moving cargo
egy. For instance, in the case of North America, selection of a into the United States (or the other way) should make frequent
vendor or subcontractor in a NAFTA member state can make all visits to the U.S. International Trade Commission (USITC)'s
the difference between a profit and a loss to someone selling into tariff database (http://www.usitc.gov/tata/hts/other/dataweb/) to
another NAFTA member state. determine the tariffs and other fees due on their products.

After the September 11 terrorist attacks in 2001, security advo- The exporter's goal of being paid, meanwhile, can also be com-
cates pushed for tamper-proof shipping containers and more plicated. A company based in the United States, for example,
inspections at the ports of arriving cargo containers. Customs- attempting to settle accounts with a firm located thousands of
Trade Partnership Against Terrorism Guidelines were issued in miles away, in a nation with a radically different legal system,
November of that year, and all stakeholders in the importation and which may or may not have special or even familial con-
business were invited to cooperate in a voluntary partnership to nections with the government, is not in an enviable position.
help reduce the inherent risk of terrorist violence being accom- However, there are resources at hand. First, of course, the Ameri-
plished through more or less unsupervised ports. The Coast can firm should not have done business without doing a diligent
Guard instituted advance manifests for all containers bound for background and credit check on the potential partner ("Back-
the U.S., a measure that met opposition for slowing just-in-time ground," 2006). Second, even if it had, the exporting company
shipping. By 2011, container traffic was still relatively free from might find considerable benefits in seeking ways of reducing
regulation by national security agencies (Odoyo, 2011). its risk. Letters of Credit (LOC) are thus a mainstay of interna-
tional trade. Also known documentary credit, an LOC is issued
Equally important are finance and risk management. Trans- by a bank or other financial institution as a guarantee that a debt
national trade is, of course, inherently risky. When one sends owned by a client of that institution will, in fact, be made. If the
merchandise overseas, they are to be subject to the whims of client can't make the payment, the institution provides the neces-
nature or foreign governments, and there is always a chance sary funds. Thus, in a transaction backed up by a LOC, the seller
that ships will sink or cargo will be seized. As such, particu- can rest assured that, so long as the buyer's bank is solvent, its
larly smaller exporters and importers (but sometimes large as bill will be paid.
well) have had significant problems financing their operations.
Banks and other lenders have simply not wanted to buy into the Also useful are the services of Factors and Forfeiters. These
problems of international trade. Again, fortunately, governments sorts of companies, in effect, purchase other business' accounts
have stepped in where private lenders have feared to tread or to receivable at a discount. The exporter thus gets its money up
trade. American exporters, for example, can take advantage of front, and off loads any difficulties in the collection to the Factor
the Export-Import Bank (Ex-Im) which provides such things as or Forfeiter. (A Factor and Forfeiter perform the same function.
"working capital guarantees (pre-export financing); export credit However, a Factor tends to be a company which is in business
insurance; and loan guarantees and direct loans (buyer financ- to do nothing but Factoring. A Forfeiter may be, for example,
 ​​​Export -- Import Operations​ 55

a banker or other financial professional who puts together the well-informed about the process, can go to the Department of
resources for a one-time deal.) Homeland Security's Customs and Border Protection webpage
(www.cbp.gov), as well as the Department's other publications
Another middleman that importers and exporters may need to and services, for additional information.
consult is the countertrade specialist. In recent years, multina-
tional deals have been increasingly structured around barter The exporter, meanwhile, is chiefly interested in being paid.
or the premise that if a customer in country A is to buy some- Traditionally, international trading has been done with letters
thing from an exporter in country B, than the exporter must also of credit (LOC)s. However, factors and forfeiters (companies
buy something from country A, or at least take one of country which purchase the accounts receivable of other companies) can
A's products as payment. This means that an exporter of, for also be important partners for any professional in the import and
example, farm equipment may find itself in possession of large export business.
amounts of sugar or copper ore. The exporter can then attempt to
market these materials itself, or, as is rather more likely, will turn Quite simply, import-export is risky. The fact of the matter
to one of the many counter-trade management specialists who is that any time one does business across oceans or national
will handle the transaction for a fee or commission. boundaries, one faces dangers ranging from ship-wrecks to
civil wars. Yet, in an economy that is now world-wide, anyone
Currency value is yet another factor to consider. The trans- in business anywhere is ever more doing business across bor-
national business professional faces the grim fact that a price ders. As such, it is no longer a question of whether or not one
negotiated yesterday in Pounds or Dollars may not be worth the is going to enter the "international" market, but rather how one
same thing tomorrow in Yen or Euros. Again, fortunately, there may prosper in a "domestic" market that stretches from Siberia
are specialists who can offer some relief. Many banks and other to Tasmania.
financial institutes can offer access to hedging deals where-by a
set price for one currency can be locked in for a transaction to
take place at some specified future date. Terms & Concepts
Counter-trade: Trade in which the exporter agrees to take good
Conclusion or services from the importer or the importer's country as partial
or complete payment.
Thus, to restate, Export-Import Operations can be defined as all
those actions which are required to take goods and services from Export-Import Bank: A United States government institution
producers in one country to customers in another. These can be designed to encourage exports by providing such financial ser-
grouped into three distinct sorts of acts and decisions: pre-ship- vices as working loan guarantees, export credit insurance; and,
ment, transfer, and after-sales. Pre-shipment is everything up to when necessary, direct loans.
the actual transport of products and services. It includes even
such fundamental things as determining the willingness and abil- Export Management Company (EMC): A business venture that
ity of a firm to export, learning the ins and outs of international manages export sales for other companies.
trade, and deciding on the appropriate sales channel (viz., direct,
indirect, etc.). Export Trade Company (EMC) or International Trade Com-
pany (ITC): A company that purchases goods in one country for
Transfer is, of course, the actual shipment of goods. This is subsequent sale in others.
almost identical to shipping in domestic sales, except that the
exporter-importer faces much additional documentation, tariff, Freight Forwarder: A company or individual who assists an
and bureaucratic difficulties. To deal with these, the business exporter-importer in the movement of cargo from one location to
professional may wish to turn to the host of independent services another. Freight Forwarders can assist with such things as docu-
and firms that exist to make business across national frontiers mentation and the selection of a carrier.
less complex-freight-forwarders, customs brokers, and so on.
However, traders should also keep well informed of international Letter of Credit or Documentary Credit: a letter issued by a
regulations and practices, something they can do with regular bank or other financial institution guaranteeing that a payment
visits to U.S. and other governmental websites dealing with made that bank or institution's client will, in fact, be made. If the
international trade. client can't make the payment, the institution provides the neces-
sary fund and then charges the client. LOCs are used extensively
Finally, after-sales is everything that happens once an imported in international trade.
or exported good has arrived at its destination. For importers,
this means gaining access to their purchases. Once again, the North American Free Trade Agreement: A trade bloc established
services of a licensed customs broker are invaluable. However, by the United States of America, Mexico, and Canada to encour-
the importer who cannot afford one, or who merely wishes to be age the free exchange of goods and services between them.
56 ​​​Export -- Import Operations​

World Trade Organization (WTO): A multinational organiza- Thomas, M. K. (2012). IC-DISC offers tax advantages for
tion that attempts to regulate world trade and encourage the free closely held export companies. Tax Adviser, 43(8), 509-
exchange of goods and services. 510. Retrieved October 21, 2013, from EBSCO Online
Database Business Source Complete. http://search.ebsco-
host.com/login.aspx?direct=true&db=bth&AN=79170357
Bibliography &site=ehost-live

Background checks reduce risk of int'l partnerships. (2006). United States Department of Commerce Spokesperson,
Managing Exports & Imports, 2006(3), 1-15. Retrieved Personal Communication, April 13, 2007.
April 15, 2007, from EBSCO Online Database Business
Source Complete. http://search.ebscohost.com/login.aspx?
direct=true&db=bth&AN=19642751&site=ehost-live Suggested Reading
A basic guide to exporting. (1998). U.S. Department of Aristei, D., Castellani, D., & Franco, C. (2013). Firms'
Commerce with the assistance of Unz & Co., Inc. exporting and importing activities: Is there a two-way
Retrieved April 13, 2007, from http://www.unzco.com/ relationship?. Review Of World Economics, 149(1),
basicguide/index.html 55-84. Retrieved October 21, 2013, from EBSCO Online
Database Business Source Complete. http://search.ebsco-
FSCs agreement breaks out. (2006). Accountancy, 137(1354), host.com/login.aspx?direct=true&db=bth&AN=85386510
107-107. Retrieved April 13, 2007, from EBSCO Online &site=ehost-live
Database Business Source Complete. http://search.ebsco-
host.com/login.aspx?direct=true&db=bth&AN=21324847 Fast. (2006). Managing Exports & Imports, 2006(3), 9.
&site=ehost-live Retrieved April 20, 2007, from EBSCO Online Database
Business Source Complete. http://search.ebscohost.com/
Jones, D. and Jones, S. (2004). Coping with licensing and login.aspx?direct=true&db=bth&AN=19642761&site=
customs. Export Wise, Spring2004, p14-15. Retrieved bsi-live
April 13, 2007, from EBSCO Online Database Business
Source Complete. http://search.ebscohost.com/login.asp Morris, L. (2007). Shipping out. Incentive, (181), 32-35.
x?direct=true&db=bth&AN=13071390&site=bsi-live Retrieved April 15, 2007, from EBSCO Online Database
Odoyo, S. (2011). The effects of U.S. anti-terrorist laws Business Source Complete. http://search.ebscohost.com/
on international business and trade. Syracuse Journal of login.aspx?direct=true&db=bth&AN=24667110&site=
International Law & Commerce, 38(2), 257-294. Retrieved bsi-live
October 21, 2013, from EBSCO Online Database Business
Source Complete. http://search.ebscohost.com/login.aspx? Online trade resource: Tradestats express. (2007) Managing
direct=true&db=bth&AN=62528158&site=ehost-live Exports & Imports, 2007(2), 8. Retrieved April 20,
2007, from EBSCO Online Database Business Source
Seyoum, B. (2000). Export-Import: Theory, practices, and Complete. http://search.ebscohost.com/login.aspx?direct=t
procedures. New York: International Business Press. rue&db=bth&AN=23850664&site=bsi-live

Essay by Michael Jay Tucker

Michael Jay Tucker was involved for a number of years in trade press journalism during which time he performed many different aspects
of editing within the magazine world. In 2002, he went back to academia to attain degrees in history. Currently, he is working on his
doctoral studies in United States History from Clark University.
International Trade Economics

Table of Contents Abstract

Economics is the study of reconciliations between unlimited
Abstract wants and limited resources. Those reconciliatory attempts
extend across geographic boundaries. A central issue in inter-
Overview national trade is whether gains accrue to citizens in the global
Basic Economic Concepts & International market place due to their exchanges. Theoretically, larger quanti-
Trade Components ties and wider choices of goods are available with international
trade than without it. Exchanges include both goods and curren-
Absolute Advantage cies because of the interactions among firms, households, and
governments located around the globe. In this essay, students
Opportunity Cost will learn economic concepts and philosophical differences
that allow them to examine policies affecting the prices and the
Marginal Analysis quantities of items traveling between nations. We will focus
some initial attention on the production possibilities model,
Microeconomics & Macroeconomics
the opportunity cost concept, and the foreign exchange market.
Positive & Normative Economics Afterwards, readers will gain a better understanding about the
processes and content of payments between trading partners.
Expenditures Those exchanges take into account how much of one currency
is worth in terms of another currency, which is something that
Applications continues to captivate the attention of many peoples. Read-
ers will find that international trade is a rather odd concoction
Prices of Exports: The Need to Convert of free trade practices and trade restrictions. Across time and
Currencies space, international leaders and their countries come together
in an attempt to lessen trade restrictions in some instances and
Exchange Rates increase them in other instances. The essay closes by providing
Currency Demand & Supply: The Foreign readers some insight into various arguments and rationales for
Exchange Market trade restrictions.

Free Trade, Restricted Trade, or Both?

Overview
The International Monetary Fund
Readers may come to understand economics as a study of rec-
Tariffs onciliations between unlimited wants and limited resources.
Reconciliation is an attempt to find some optimal middle ground
Arguments for Trade Limitations
in problem solving. The economic problem arises due to resource
scarcity and it prompts decision makers to make rational choices
Conclusion
from amongst all the alternative solutions. Each and every choice
Terms & Concepts involves a sacrifice because it is very difficult, if not impossible,
to avoid tradeoffs.
Bibliography
International trade is an interesting topic and lends itself to being
Suggested Reading one of the most controversial topics in economics. Getting to
the conceptual foundations for international trade, the main

57
58 ​​​International Trade Economics​

purpose of this essay is to inform undergraduate students about inition is the ability of one country to produce more of something
the economic context in which exchanges of physical quantities than another country. However, maximizing the gains from trade
of products and currencies occur between countries. To some is reliant upon a country's ability to produce more than another,
extent, the author assumes readers are familiar with principles doing so in a most efficient manner.
of economics. Nonetheless, the information found in this essay
appeals to those unfamiliar with economics, but engages all Opportunity Cost
readers in pondering and attempting to answer some important The gains from trade are observable when a country's citizenry
initial questions. attains a combination of goods that consists of larger amounts of
each good than would be possible in the absence of trade. Com-
Where do you stand regarding the issue of international trade? parative advantage by definition is specializing in that product
Do you favor protecting domestic jobs? If so, what cost attach- for which the country's sacrifice in terms of other goods is mini-
ments are there to job preservation measures? To what extent mal. The value of the foregone alternative is, by definition, an
are you willing to make sacrifices in terms of accepting fewer opportunity cost. In essence, finding solutions to the economic
choices in the market place and paying higher prices for them? problem of scarcity involves minimizing opportunity costs. In
Where does product quality and safety fit into all this? Perhaps brief, the gains from trade accrue through specialization, which
recent news reports about recalls of foreign-made products in turn, reflects a country's recognition of what it can and should
diminishes the concern about higher prices. One could reason- produce at a lower opportunity cost than another country.
ably argue that consumers realize that high quality is available
at a high price though some major retailers of imported goods Opportunity costs sometimes take the form of sacrifices that are
claim quality is available at a low price. linear in their relationship, which translate into the correspon-
dence of a benefit with some given or constant amount of cost.
Basic Economic Concepts & International However, economists tend to view the equation as one involving
Trade Components increasing amounts of cost in the form of a curvilinear relation-
At issue is whether benefits or gains accrue through international ship. The illustration of the opportunity cost concept is most
trade. Economists tend to believe that international trade does effective when one attempts to consider all the possible choice
indeed provide benefits to consumers, producers, and workers. combinations whether the opportunity costs are increasing as in
However, their views fall short of being universally acceptable the case of a curved-line concave-shaped arrangement or they
due, in part, to the various dimensions of any international trade are constant as in the case of a straight-line downward-sloping
issue. Free trade may be an ideology given the existence of arrangement. A study of international trade introduces students
constraints such as trade barriers, international politics, and iso- to both forms within a larger model of production, specialization,
lationist strategies. All those issues and concerns provide a rich and exchange often in the context that the world contains only
backdrop against which to learn the major tenets of international two countries. Furthermore, students and other readers should
trade theory as the reader may find in an introductory economics think of a model as a tool that simplifies reality and remain cog-
course. nizant of the fact that a key component in any economics model
is the ceteris paribus assumption, which in translation from Latin
International trade theory fits well with a basic understanding of into English means all else held constant.
how a country progresses through various stages of an economic
maturation process. As countries move from an economy pri- Under this and some other assumptions, Country A will eventu-
marily based on hunting and gathering through manufacturing, ally purchase products from Country B and vice versa by virtue
services, and information heading toward and beyond a knowl- of their being trading partners within the population of countries
edge-based economy, a larger portion of domestic production around the globe. At any given moment, for the sake of simplicity
becomes available for exchange with a trading partner. Opportu- if for no other reason, there is an immediate need to hold con-
nities arise to trade that excess production for other goods, which stant the state of technology, the availability of resources, and the
are the excess production of another country. In accordance with level of productivity. This constraint limits production possibili-
theory, specialization in production creates those opportunities ties to an initial set of specific combinations. With a view toward
(Razmi & Refaei, 2013). a nation's current ability to produce two items, say goods X and
Y, there is some precise point at which a specific combination of
Absolute Advantage X and Y is possible in equal amounts, but any attempt to produce
For varied reasons some countries are better at producing spe- more of one essentially translates into the production of less of the
cific items than are other countries. As a case in point, the US is other. In brief, the opportunity cost associated with producing one
better at growing wheat and Columbia is better at growing coffee unit of X is the sacrifice of one unit of Y. This situation illustrates
beans. In essence, each country will specialize in producing the opportunity cost concept while holding all else constant.
those goods best suited to their resource bases. Specialization
arises from the discovery and acknowledgement that one country Marginal Analysis
in the absolute sense is better suited at producing more of one Economics, in general, involves applying the opportunity cost
specific item than is another country. Absolute advantage by def- concept to decisions made at the margin. In other words, how a
 ​​​International Trade Economics​ 59

change in one variable results in a change in another variable. As The aforementioned set of clarifications, distinctions, and
an introduction to the orientation of economics toward marginal assumptions provide a foundation with which readers can form
analysis, the production possibilities frontier is a model that an understanding of the way economists view the world. In the
portrays all those combinations that a country's entire economy pages that lay ahead, readers will also gain a better sense of
can produce. It is a macroeconomic concept, which effectively international trade theory and they will receive suggestions for
conveys the interdependencies among scarcity, choices, and learning reinforcement. As they move through this condensed
tradeoffs. The difference between those economic divisions essay, readers are encouraged to consult textbooks and other
resides in their scope. Macroeconomics is a study of economics sources for additional details, examples, and cases because those
using models of the whole economy whereas microeconomics omissions help achieve brevity.
is a study of the behaviors of consumers and producers as they
interact through price mechanisms in models we can refer to as
a market. Applications
Microeconomics & Macroeconomics Any study of international trade will hone student abilities to
International trade is a topic that spans microeconomics and mac- apply microeconomics and macroeconomics. In addition, they
roeconomics. The foundation of microeconomics emphasizes will find it integrates normative and positive economics by
consumers and demand as integral components. With regard to examining policies that affect the prices and the quantities of
the consumer or demand side, students learn very early in their items exchanged on a global scale. Furthermore, students will
coursework that an inverse relationship exists between price and recognize value in applying the production possibilities model
quantity demanded in accordance with the Law of Demand. Rel- and opportunity cost concept. However, Pearce (1992) and
atively speaking, smaller amounts are in demand at higher prices others point out that the essential difference between domestic
and vice versa. On the producer or supply side, they learn that a or internal trade and international or foreign trade is the use of
positive relationship exists between price and quantity supplied different currencies in payment for the exchanges between and
according to the Law of Supply. among countries.

Positive & Normative Economics Prices of Exports: The Need to Convert Currencies
International trade is also a topic that spans positive econom- It is prudent to begin by taking note that each trading partner
ics and normative economics. A call for governmental policies pays in the currency of the country from which they are acquir-
or interventions suggests that something should occur in order ing the product. Most countries have foreign currencies on hand
to alleviate a problem. That call would fit the classification of in addition to their own currency. For example, most banks in the
normative economics, which is one of two types of economic United States contain deposits of the Japanese Yen and other cur-
analysis. The other type is positive economics which occurs rencies along with the US Dollar. In order for a buyer located in
when analysts deal strictly with data or facts centering their the US to purchase a motor vehicle made in Japan, for instance,
attention on whether that information is accurate. For example, the buyer needs to convert Dollars into Yens as part of the pay-
individuals are more likely to agree on matters regarding the ment processes. Likewise, purchases of US-made products by
accuracy of data than they are on matters regarding what ought foreigners require payment in some amount of Dollars equiva-
to occur in response to their interpretations of the data. In sum, lent to the agreed-upon price of that item.
differences exist in the content of a statement containing the
word "is" versus others containing the word "ought" or "should." Prices in a global context usually reflect international market-
Macroeconomics is more normative than microeconomics due place situations whether left to free trade or artificial sanctions.
primarily to its orientation toward policies promoting economic Sometimes governments restrict trade through regulations or
growth, employment, and price stability. they impose a tariff or a tax on an import thereby raising the
item's price. The tariff becomes revenue for the government
Expenditures of a country that purchases the imported item. An import is by
Students in macroeconomics courses receive an introduction definition an item received by one country from another country
to how the total expenditures of the household sector, the busi- whereas an export is an item sent from the providing country
ness sector, the public sector, and the trade sector provide an to the purchasing country. Price increases can also result from
aggregate numeric estimate of a county's annual production. The the imposition of a quota, which by definition is a limit on the
last sector is comprised of national expenditures on imports and quantity of an item imported into a country. An import quota
exports. Subtracting import expenditures from export expendi- effectively reduces the amount of an item available for purchase
tures yields a mathematical difference, which defines the term or the quantity of that item supplied.
net exports. The value of net exports may be negative (known as
a trade deficit), zero (balanced trade), or positive (trade surplus). Exchange Rates
Expression of trade balances and expenditures are in terms of the Exchange rates are, by definition, the price of a domestic cur-
importing country's own unit of currency; for instance, the US rency in terms of foreign currency. As they examine exchange
Dollar or the Japanese Yen. rates, which are readily available through daily publications,
60 ​​​International Trade Economics​

students will find the US dollar as a standard against which to mixed results prompting other agreements and sub-agreements
compare foreign currencies. In general, there are a variety of per- all with mixed results. In a concise summary of more recent
spectives on exchange rate determination, but two are worthy of agreements directly involving the United States, Guell (2007)
brief mention at this juncture. refers to: The World Trade Organization (WTO) as an organi-
zation that arbitrates trade disputes; the North American Free
• One perspective holds that exchange rates originate from Trade Agreement (NAFTA), which involves the US, Canada,
supply and demand conditions that exist in the foreign
and Mexico; and the CAFTA, which involves the US and five
exchange market. For instance, a trade surplus will gener-
other countries in Central America.
ate a greater demand for the currency of the exporting
country than would a trade deficit as trading partners seek The International Monetary Fund
to convert their currencies into that of the exporter. If the
About the same time GATT came about, the International Mon-
supply of its currency remains constant, then the domestic
etary Fund (IMF) began its pursuits encouraging international
price of its currency will rise affecting the exchange rate.
cooperation among monetary authorities or central banks, facili-
• Another perspective, which takes into account actual tating a balanced expansion in international trade, and promoting
and expected changes in the domestic supply of money, stability in foreign exchange markets. Consequently, exchange
holds that exchange rate is a direct function of fluctua- rates became both constant, but indexed to allow for a slight
tions in the value of a nation's currency. According to this deviation around the value of the US Dollar; at that time, the
perspective, the value of a unit of currency depends on its Dollar was directly convertible into gold according to a fixed
relative scarcity. Therefore, any increase in the supply of rate. Readers who have an interest in learning how international
a currency while holding demand for the currency con- trade stabilization relates to the manipulative exchange of cur-
stant will then decrease its price and affect the exchange rencies in detail are encouraged to examine the IMF and the
rate. so-called "Bretton Woods System."

Currency Demand & Supply: The Foreign Tariffs

Exchange Market The international trade literature contains a lot of material
Whether one emphasizes the supply side or the demand side of describing various organizational attempts to orchestrate free
the foreign exchange market, any exchange rate is an expression trade by reducing barriers to trade. Tariff and non-tariff barriers
of how much of one currency it will take for the conversion into form a useful dichotomy. By way of a review, as we head toward
or the purchase of another currency. Certainly, it will take more this essay's closure, a tariff is like a tax as it effectively raises the
foreign currency to acquire a US Dollar when there is an increase price of import. Non-tariff barriers are of different types. A quota
in the latter's value. This situation represents an increase in the is one type and it limits the amount of imports. Other methods
price of exports from the US to a trading partner because it has to of limiting trade include government regulations, which may
convert more of its currency to obtain the dollar amount required arise from politics and/or address issues of safety or quality, and
in payment for that export or their import. By extension, a higher voluntary export restraints. The latter, as the name implies, will
price may spark a chain of events increasing the likelihoods of a likely occur in the absence of and/or as a precursor to official
decrease in the quantities sold, a lower amount of expenditures regulations or sanctions.
on exports, a smaller level of national output, higher unemploy-
ment rates, and/or a lower rate of economic growth; immediately, Arguments for Trade Limitations
the reader may see the value of holding other things constant. In The final section of this essay lists six reasons and arguments for
essence, the volume of goods traded internationally is partly a limiting trade. It draws from the presentations in introductory
function of comparisons between the world price and the domes- economics' textbooks authored by Arnold (2005), Guell (2007),
tic price (Yutaka, 2013). A country selling at a price that is lower and McConnell & Brue (2008) and many others.
than most other countries may increase its volume of exports.
That is the situation when free trade occurs on a global level.
• First, the national-defense argument designates some
industries as being vital to homeland security.
Free Trade, Restricted Trade, or Both? • Second, the infant-industry protection argument, as
International trade is an odd combination of free trade practices introduced long ago by Alexander Hamilton, encour-
and trade interventions. From a historical standpoint, countries ages a level playing field and protected the colonies from
banded together with their trading partners and established the potential abuse by Europe.
parameters through which they engaged in and promoted free
exchange in the global marketplace. Evidently, that undertaking • Third, the anti-dumping argument is used to prevent for-
was and is a formidable challenge. In 1948, the General Agree- eigners from selling exports below cost in order to drive
ment on Trade and Tariffs (GATT) came into existence in which domestic competitors out of business
a number of countries set out to find ways to resolve trade prob- • Fourth, the foreign-export subsidies argument discour-
lems, eliminate tariffs, and reduce barriers to trade. A series of ages the negotiation of below-market interest rates that
rounds occurred during the course of almost five decades with could favor trade with specific organizations or countries.
 ​​​International Trade Economics​ 61

• Fifth, the low-foreign-wages argument addresses the Market: A virtual space where consumers and producers inter-
lower costs of, and wages paid by, offshore producers
act while exchanging a specific item in accordance with their
and calls into question the quality of exports and the
demand and supply schedules.
regulatory and safety orientations of foreign govern-
ments.
Microeconomics: A division within economics for studying
• Lastly, the saving-domestic-jobs argument is an attempt behaviors of firms and households as they engage themselves in
to protect domestic jobs and to promote full employment. the exchange of resources and goods.

Net Exports: The difference after subtracting import expendi-

Conclusion tures from export expenditures; if value is negative, it is a trade
deficit; zero is balanced trade; and, positive is a trade surplus.
International trade as a topic of study in economics certainly
exhibits a dynamic tension between free trade and restricted Normative Economics: A branch within economics that suggests
trade. Perhaps those dynamics alone explains why it is so fas- what should occur to achieve a goal or objective.
cinating yet challenging at the same time. Nonetheless, this
essay presents a conceptual framework that allows students and Opportunity Cost: The value of the best, yet foregone alterna-
others to realize how the gains from international trade are the tive because of making a decision due to scarcity.
consequence of scarcity-induced choices, opportunity cost mini-
mization, and product specialization. In closing, this essay aims Positive Economics: A branch within economics that deals with
to shed some light on the complexities and the components in an facts and their accuracy.
exchange of goods and services that happen to cross a nation's
geographical boundaries. Production Possibilities Frontier: A model portraying all combi-
nations an entire country can produce while holding constant the
state of technology, the amount of resources, and the productiv-
Terms & Concepts ity of workers.

Absolute Advantage: Occurs when one country produces more Quantity Demanded: The amount of goods or services that con-
of something than another country. sumers desire at given prices.

Comparative Advantage: Occurs when a country specializes in Quantity Supplied: The amount of goods or services that suppli-
products for which the sacrifice in terms of other goods is mini- ers are willing and able to produce at given prices.
mal.
Quota: A limit imposed by governmental action on the quantity
Ceteris Paribus: A key assumption in economics, which trans- of an item imported into a country.
lates from Latin into English meaning "all else held constant."
Tariff: A tax imposed by a governmental body on an import.
Exchange Rate: The price of a domestic currency in terms of
foreign currency.
Bibliography
Export: An item produced in one country and sent to consumers
in another country. Arnold, Roger A. (2005). Economics (7th ed.) Mason, OH:
Thomson South-Western.
Import: An item produced in one country and received by con-
sumers in another country. Guell, R. C. (2007). Issues in economics today (3rd ed.).
Boston, MA: McGraw-Hill Irwin.
Law of Demand: Specifies the inverse or negative relationship
that exists between an item's demand quantity and its price; McConnell, C. R. & Brue, S. L. (2008). Economics (17th ed.).
quantity and price move in opposite directions. Boston, MA: McGraw-Hill Irwin.

Law of Supply: Specifies the direct or positive relationship that Razmi, M., & Refaei, R. (2013). The effect of trade openness
exists between an item's demand quantity and its price; quantity and economic freedom on economic growth: The case
and price move in same direction. of Middle East and East Asian countries. International
Journal of Economics & Financial Issues (IJEFI), 3(2),
Macroeconomics: A division within economics for studying a 376-385. Retrieved on November 25, 2013, from EBSCO
nation's whole economy. Online Database Business Source Complete. http://search.
62 ​​​International Trade Economics​

ebscohost.com/login.aspx?direct=true&db=bth&AN=925 Gilbert, J., & Oladi, R. (2011). Excel models for international
28956&site=ehost-live trade theory and policy: An online resource. Journal of
Economic Education, 42(1), 95. Retrieved on November
Yutaka, K. (2013). Effects of exchange rate fluctuations 25, 2013, from EBSCO Online Database Business Source
and financial development on international trade: Complete. http://search.ebscohost.com/login.aspx?direct=t
Recent experience. International Journal of Business rue&db=bth&AN=57225292&site=ehost-live
Management & Economic Research, 4(5), 793-801.
Retrieved on November 25, 2013, from EBSCO Online Hainmueller, J., & Hiscox, M. (2006). Learning to love glo-
Database Business Source Complete. http://search.ebsco- balization: Education and individual attitudes toward
host.com/login.aspx?direct=true&db=bth&AN=91750634 international trade. International Organization, 60(2),
&site=ehost-live 469-498. Retrieved October 12, 2007, from EBSCO
Online Database Business Source Premier. http://search.
ebscohost.com/login.aspx?direct=true&db=buh&AN=208
Suggested Reading 32670&site=ehost-live

Crenshaw, E., & Robison, K. (2006). Globalization and the Hira, A. (2003). The brave new world of international educa-
digital divide: The roles of structural conduciveness and tion. World Economy, 26(6), 911-931. Retrieved October
global connection in internet diffusion. Social Science 12, 2007, from EBSCO Online Database Business Source
Quarterly (Blackwell Publishing Limited), 87(1), 190- Premier. http://search.ebscohost.com/login.aspx?direct=tru
207. Retrieved October 12, 2007, from EBSCO Online e&db=buh&AN=10219929&site=ehost-live
Database Business Source Premier. http://search.ebsco-
host.com/login.aspx?direct=true&db=buh&AN=19615863 Thurow, L. (2004). Do only economic illiterates Argue that
&site=ehost-live trade can destroy jobs and lower America's national
income? Social Research, 71(2), 265-278. Retrieved
Fuller, D., & Geide-Stevenson, D. (2003). Consensus among October 12, 2007, from EBSCO Online Database
economists: Revisited. Journal of Economic Education, Business Source Premier. http://search.ebscohost.com/
34(4), 369-387. Retrieved October 12, 2007, from EBSCO login.aspx?direct=true&db=buh&AN=13986318&site=eh
Online Database Business Source Premier. http://search. ost-live
ebscohost.com/login.aspx?direct=true&db=buh&AN=108
46231&site=ehost-live Winchester, N. (2006). A classroom tariff-setting game.
Journal of Economic Education, 37(4), 431-441. Retrieved
Gawande, K., & Hoekman, B. (2006). Lobbying and agri- October 12, 2007, from EBSCO Online Database
cultural trade policy in the United States. International Business Source Premier. http://search.ebscohost.com/
Organization, 60(3), 527-561. Retrieved October 12, 2007, login.aspx?direct=true&db=buh&AN=23427975&site=eh
from EBSCO Online Database Business Source Premier. ost-live
http://search.ebscohost.com/login.aspx?direct=true&db=b
uh&AN=21924420&site=ehost-live

Essay by Steven R. Hoagland, Ph.D.

Dr. Steven Hoagland holds Bachelor's and Master's degrees in economics, a master of urban studies, and a doctorate in urban services
management with a cognate in education all from Old Dominion University. His background includes service as senior-level university
administrator responsible for planning, assessment, and research. It also includes winning multi-million dollar grants, both as a spon-
sored programs officer and as a proposal development team member. With expertise in research design and program evaluation, his
recent service includes consulting in the health care, information technology, and education sectors and teaching as an adjunct professor
of economics. In 2007, he founded a nonprofit organization to addresses failures in the education marketplace by guiding college-bound
high school students toward more objective and simplified methods of college selection and by devising risk-sensitive scholarships.
North American Free Trade Agreement

scope of the NAFTA including, but not limited to intellectual

Table of Contents
property, telecommunications, and environmental protection.
This article will provide an overview of the history of NAFTA
Abstract and its impact on trade and labor in North America. There will
also be a discussion of the agreement's effect on certain indus-
Overview tries in each signatory country as well as recent issues related to
History of NAFTA NAFTA.

Effects of NAFTA

Applications
Overview
History of NAFTA
Benefits
In January of 1994, the United States, Canada, and Mexico
Canadian Furniture Industry entered into the North American Free Trade Agreement (NAFTA
American Manufacturing or the Agreement), and in so doing created the largest free trade
zone in the world. At that time, NAFTA was the most compre-
North American Markets hensive free trade agreement implemented by friendly nations.
American Economy Moreover, the Agreement marked the first time that a develop-
ing nation entered into such a trade relationship with developed
Calls for Free Trade nations (Hirsch, 1995).
Viewpoints
NAFTA was essentially an expansion of the Free Trade Agree-
Political, Economic & Environmental Issues ment (FTA) entered into between the United States and Canada
in 1989. Canada and the United States were already each other's
Benefits of a Common Tariff for Mexico largest trading partners and the FTA was aimed at eliminating
Central American Free Trade Agreement tariffs between the two countries. Even though the U.S. and
Canada had long established trading relations, there were numer-
Terms & Concepts ous disputes over tariffs imposed on certain products. This was
particularly the case with respect to trade of softwood lumber.
Bibliography
Softwood lumber is the largest product that Canada exports to
Suggested Reading the United States and is used extensively by U.S. homebuild-
ers. Softwood lumber is produced from pine, spruce, firs, and
other "softwood" trees. In addition to softwood lumber, Canada
also supplies the United States with oil and natural gas while the
Abstract United States exports significant amounts of beef as well as a
broad array of agricultural products to Canada. So the FTA was
This article concerns the North American Free Trade Agreement aimed at eliminating barriers to trade between the two nations,
(NAFTA) that became effective in 1994. This is an agreement and ultimately to make the agreement multilateral.
signed by the United States, Canada and Mexico aimed at
eliminating trade barriers among the three nations. Essentially, Prior to the enactment of NAFTA, goods traded between Canada
NAFTA is an extension of the Free Trade Agreement between and the United States received most favored nation treatment.
Canada and the United States that was established in 1989. There This is the manner in which nations must treat each other's goods
are a number of other considerations beyond free trade under the and services. Most favored nation status provides equal levels of

63
64 ​​​North American Free Trade Agreement​

"preferential" treatment to products manufactured in countries trols to verify the country of origin of imported products. This
who are signatories to the General Agreement on Tariffs and was an especially sensitive issue for Canada, since certain wood
Trade (GATT), an agreement initially negotiated in 1947 among products from the U.S. are manufactured with wood from other
23 countries including the United States, Canada, and those in countries. Therefore, NAFTA established a system that places
Western Europe. Over the ensuing years, GATT was expanded to the burden on manufacturers and importers to verify the country
include many of the developing nations. The so-called Uruguay of origin. The administrative procedures put into place require
Round of negotiations during the 1980s resulted in the establish- the completion of a certificate of origin. This is a statement pro-
ment of the World Trade Organization (the WTO) in 1995. The vided by the supplier of a good or service that the product is in
purpose of this organization is to oversee the further implemen- compliance with the rules of origin requirements of the agree-
tation of GATT and the agreements established by the Uruguay ment (Hirsch, 1995).
Round. Included in those agreements were the elimination of
duty restrictions and a timetable to eliminate tariffs on certain At the time NAFTA was being negotiated, it was a hot button
products. These are important developments to consider as the political issue that played a role in the presidential campaigns
expansion of world trade has affected trade among the U.S., in all three nations. However, since the Agreement was signed
Mexico, and Canada. in 1994, there has been an increase in free trade among Canada,
Mexico and the United States. Trade is considered "free" or open
In addition to goods and services traded between the United when goods or services can be delivered into markets without
States and Canada being granted most favored nation treatment, duty restrictions and, therefore, prices are ultimately determined
under the terms of the FTA, Canadian manufactured goods that by supply and demand. One of the objectives of free trade is
were made from products imported from the United States and to provide consumers expanded choices for goods and services.
which were subsequently exported back to the U.S. were entitled This increased competition should result in lower prices and
to the return of duty that had been imposed on the imported prod- improved quality of products and most importantly economic
ucts. A duty is essentially a tax on an imported good or service, stability in the North American marketplace.
and in some ways is similar to a tariff. A tariff, moreover, is a fee
imposed on imported goods that gives locally produced goods While each of the signatory nations to NAFTA has benefited
a price advantage over similar goods that are produced abroad. from the pact, there have been complications. The establishment
Essentially, there are two types of tariffs: of the WTO in 1995 and the agreements of the Uruguay Round
contained provisions for eliminating tariffs that replaced or
• An ad valorem tariff is a fee calculated as a percentage of superseded those established by NAFTA. Moreover, after China
the value of the imported good.
was granted most favored nation status by the U.S. and even-
• A specific tariff, on the other hand, is a set dollar amount tually admitted into the WTO, increased trade between China
applied to each imported unit of a product. and the United States affected trading levels with Mexico and
Canada. In fact, for a time, China became America's largest trad-
With respect to products that were exported from Mexico to ing partner and American manufacturing jobs that many claimed
Canada, duty rates were decreased because Mexico is considered would be lost to Mexico were actually lost to China; however, as
a developing country (Hirsch, 1995). of 2013, Canada and Mexico are again the largest trading part-
ners with the United States (Bury, 2004; US Census, 2013).
Including Mexico in a free trade agreement was a natural pro-
gression of the FTA since both the United States and Canada
were trading with Mexico under separate bilateral agreements. Applications
Further, the fact that disputes still remained between Canada and
the United States required revisions to the FTA. The main objec- Benefits
tives of NAFTA were to eliminate trade barriers and expedite Notwithstanding the foregoing impediments to the success of
the shipment of products among the nations, to allow for fair NAFTA, the Agreement has been positive for all three signato-
competition and enhanced investment opportunities, to establish ries. In addition to the benefits that have arisen for consumers,
effective implementation procedures and a system to resolve dis- there have also been benefits for certain North American busi-
putes, and finally, to create a framework for the expansion of the nesses and industries. From the perspective of the United States,
Agreement to establish greater multi-lateral trade and coopera- many businesses gained access to a greater market throughout
tion (Hirsch, 1995). North America and have been the beneficiaries of new export
and investment opportunities. For Mexico, all products imported
Effects of NAFTA from the country became duty free by 2008, as all of the act’s
NAFTA effectively eliminated duty rates for products flowing provisions became vested in January of that year. Canada has
through the three nations and requires the importer to verify the also benefited because the Agreement established procedures to
origin of the goods. Since NAFTA was initially limited to the resolve trade disputes that were not as extensive as the provi-
three signing nations, there was a need to establish strict con- sions originally set forth in the FTA. Ultimately these procedures
 ​​​North American Free Trade Agreement​ 65

prompted the United States and Canada to resolve the longstand- well an increased spotlight on border security (Passel, Cohn, &
ing dispute over the tariffs imposed by the U.S. on Canadian Gonzalez-Barrera, 2012).
softwood lumber (Howard, 2006).
One factor contributing to the influx of migrant workers into
Canadian Furniture Industry the U.S. is the increased need for low skilled labor, especially
On a corollary note, the Canadian wood furniture industry in the hospitality, construction, and agricultural industries. In
has seen an increase in trade with the United States. Increased this regard, the Mexican government has not been successful in
exports to the U.S. of Canadian produced wood furniture has establishing economic policies to create these jobs in their own
helped provide Canada with the opportunity to invest in modern country. In addition to the increased need for low-skilled work-
technology, which ultimately led to more efficient and produc- ers, however, the United States and Mexico have also established
tive companies. On the other hand, in connection with rules and programs for the recruiting, training and seasonal allocation of
requirements for certificate of origin mentioned above, some managers, technicians and skilled professionals. These develop-
Canadian manufacturers now use wood or other products that are ments have far reaching implications for both countries (Quan,
manufactured in China and other Asian countries. In addition, 2005).
these countries are also producing wood furniture at a lower cost
than the Canadian producers, some of whom claim that the Asian American Economy
nations are not competing fairly. Despite this development, there Overall, the Agreement has had a positive impact on the United
is still a great deal of opportunity for Canadian manufacturers, States' economy. For example, during the 1990s, U.S. exports
particularly those that emphasize the quality of their products to Mexico increased 400% while exports to Canada increased
(Howard 2006). by more than 200%. Further, exports from these two countries
to the United States and each other also rose dramatically. This
American Manufacturing trend continued in the first decade of the twenty-first century.
Some of the other industries that have benefited from NAFTA However, there have been other world developments that have
include those involved with agricultural trade, the automo- tampered the positive effects of NAFTA. While China, as a
tive industry and the textile and apparel industry. For the U.S., most favored nation, became the largest exporter of goods to
NAFTA has enhanced the production and efficiency of the the United States and the integration of the European Union has
agricultural sector as the market has become more integrated. resulted in increased global competition for the North Ameri-
Moreover, vehicles and automotive parts that are manufac- can trading partners, another significant event had an effect on
tured in America have become more competitive and efficient. the early promise of NAFTA: the September 11, 2001 terror-
While some of these manufacturing jobs have been displaced ist attacks on the United States. The ensuing war years have
from Midwestern states, there has been a net gain of manufac- prompted America to partially turn its attention away from trade
turing jobs in this sector in the Southeast. There has also been relations with Mexico to focus attention on the Mideast and Cen-
improvement in the American textile and apparel industry. Prior tral Asia (Field, 2004).
to NAFTA, America faced stiff opposition from Asian markets
and this sector saw many textile market job losses. However, Calls for Free Trade
the effect of the Agreement has been enhanced efficiency and In response to these world developments, however, there have
productivity and manufacturing investment in the United States' been increasing calls for the NAFTA members to reinvigorate
textile and apparel industry (Field 2006). the potential of free trade. Achieving this goal, however, will
require North American companies, businesses and industries to
North American Markets produce and trade goods more efficiently in order to be able to
One of the effects of increased international trade and compe- compete more effectively on a global scale with China, Asia, and
tition has been the need for foreign businesses to establish a the European Union. With respect to the latter, some have sug-
presence in North America. Moreover one of the most significant gested looking at initiatives taken in Europe as a way forward for
impacts of NAFTA has been the effect the Agreement has had on NAFTA. One idea has been to create the development of a North
the North American labor market. This is being manifested in American customs union that would establish a common tariff
the integration of a bi-national labor market particularly in the for similar products that are manufactured in all three countries.
United States and Mexico; a result of the dramatic influx of Mex- The proceeds from this tariff could then be used to finance eco-
ican citizens into the United States. Between 1994 and 2004, 10 nomic development in Mexico, particularly in areas other than
million Mexicans moved to America. However, since that time, the northern states (Field, 2004). Such a proposition is no longer
Mexican immigration to the United States has dropped off con- part of mainstream discussion, though it remains a possibility.
siderably. From 2005 to 2010, 1.4 Mexicans immigrated to the
United States (Passel, Cohn, & Gonzalez-Barrera, 2012). The In Mexico, funds from a common tariff could be used to develop
influx of Mexican immigration from 1994 to 2004 correlates to the infrastructure of regions in central Mexico where there are
the implementation of NAFTA, while its decline in subsequent isolated communities and where there are insufficient roads con-
years is attributable to the financial crisis that began in 2008 as necting these communities. Developing the infrastructure would
66 ​​​North American Free Trade Agreement​

create construction jobs, and this would also lead to the devel- ing partners. The ultimate goals are to compete globally and to
opment of other service occupations in that region. Moreover, enhance the economic prosperity of the developing countries.
by developing this region, natural resources could be tapped,
produced and manufactured and ultimately traded. This would
stimulate economic growth in Mexico and benefit the U.S. since Terms & Concepts
many of the migrant workers coming to America have fled this
region of Mexico because of the lack of jobs (Field, 2004). Central American Free Trade Agreement (AKA DR-CAFTA):
(2005) A pact among the United States, Costa Rica, the Domini-
can Republic, El Salvador, Guatemala, Honduras, and Nicaragua
Viewpoints that eliminates tariffs on U.S. goods and contemplates direct for-
eign investment by the U.S. in each of the signatory countries.
Political, Economic & Environmental Issues
There are many political, economic and environmental issues Certificate of Origin: Under the provisions of NAFTA, the cer-
related to trade relations. In particular, the "Doha Round" of tificate that a manufacturer or importer is required to obtain from
negotiations in WTO has contemplated the elimination of all tar- a supplier that verifies the origin of a product.
iffs for products manufactured and traded among WTO members
by 2018, which has the potential to mitigate possible future ben- Common Tariff: A concept being considered that would create
efits of NAFTA, and could also result in increased global trading a common tariff on similar products manufactured in the U.S.,
competition. However, the WTO members participating in the Canada and Mexico the funds from which would be used to
Doha Round reached an impasse in 2008 over the issues, and no finance the development of infrastructure in central Mexico.
significant progress has been made since. Notwithstanding the
concerns of global trade agreements, the North American Free Doha Round: The current round of negotiations by the WTO
Trade Agreement has benefited the three signing countries, albeit aimed at implementing the agreements originally established
in different ways and to different degrees. under GATT which call for the elimination on all tariffs among
the participating countries.
Benefits of a Common Tariff for Mexico
All three countries have seen increased volumes of trade which, Duty: 1A tax imposed on an imported good.
in turn, have led to the evolution of programs designed to expe-
dite customs release and duty elimination. As trade grew, border Free Trade: Trade that allows for goods and services to be deliv-
patrol along the United States-Mexican border began to evolve ered to markets without duty restrictions.
and systems were put into place to track and expedite the move-
ment of labor. Initially the goal was to enhance trade efficiency; Free Trade Agreement ("FTA"): (1989) The Agreement entered
however, the events of September 2001 shifted the empha- into between Canada and the U.S. that eliminated certain trade
sis from trade efficiency to security. Further, the slowdown in barriers and ultimately led to the establishment of NAFTA.
the Mexican economy contributed to the influx of immigrants
from Mexico to the United States. Despite the problems facing General Agreement on Tariffs and Trade ("GATT"): The agree-
free trade in North America, there has been a push for renewed ment entered into in 1947 that established international trade
emphasis on NAFTA. policy among the signatory nations in an effort to ensure eco-
nomic security after WWII.
Central American Free Trade Agreement
In addition to the aforementioned initiatives, the provisions of Most Favored Nation: Status given to a signatory nation to
NAFTA were expanded by the signing of the Central American GATT (and its successor, the WTO), that ensures equal treatment
Free Trade Agreement in 2005. This is an agreement based on of all signed countries regardless of size, economic status, etc.
the principles of NAFTA that was entered into among the United
States and its new Central American trading partners: Costa Rica, The North American Free Trade Agreement (NAFTA): (1994)
the Dominican Republic, El Salvador, Guatemala, Honduras, and Agreement among the U.S., Canada, and Mexico that replaced
Nicaragua. CAFTA eliminates most of the duties on certain U.S. the FTA and that eliminates trade barriers and duty restrictions
products exported to those countries and has potential benefits for on products traded among the three countries.
the chemical, environmental, and transportation equipment indus-
tries. At the same time, this agreement calls for investment by the Products: Goods and services that are manufactured and ulti-
United States in each of these countries. The aim of this invest- mately traded among countries.
ment is to develop infrastructure and to create jobs (Field 2006).
Rules of Origination: Provisions established under NAFTA that
By reinvigorating NAFTA and following through on the imple- require the verification by a supplier that a good or service con-
mentation of CAFTA, there is a way forward for the Americas tains products exclusively from the providing country or one of
to become more efficient producers, manufacturers, and trad- the trading partners.
 ​​​North American Free Trade Agreement​ 67

Tariff: A fee imposed on a good or service that gives local goods Quan, M., Chelini, E., Fanning, K., Mohar, G. & Fanning, K.
a price advantage over goods produced abroad. (2005). A silent integration.

Uruguay Round: (1986-1994) Trade negotiations that estab- Passel, J.S., Cohn, D., & Gonzalez-Barrera, A. (2012, Apr 23).
lished the WTO from what was the General Agreement on Tariffs Net migration from mexico falls to zero—and perhaps
and Trade, and called for elimination of duty restrictions and the less. Pew Research Center. Retrieved December 3, 2013
easing of certain tariffs. from http://www.pewhispanic.org/2012/04/23/net-migra-
tion-from-mexico-falls-to-zero-and-perhaps-less/
World Trade Organization (WTO): (1995) The organization
responsible for overseeing the implementation of GATT and the Rothlisberger, L. (2012). Nafta, labor, and the recovery project.
agreements of the Uruguay Round. WorkingUSA, 15(1), 67–86. Retrieved December 3, 2013
from EBSCO online database, Business Source Complete.
http://search.ebscohost.com/login.aspx?direct=true&db=
Bibliography bth&AN=72908598&site=ehost-live US Census Bureau.
(2013, Nov 14). Top trading partners—September 2013.
Bordering on reform. (2005). Latin American Monitor, 22(3), Retrieved December 3, 2013 from http://www.census.gov/
1-3. Retrieved on January 12, 2007, from EBSCO Online foreign-trade/statistics/highlights/top/top1309yr.html
Database Business Source Premier. http://search.ebsco-
host.com/login.aspx?direct=true&db=buh&AN=16596714
&site=ehost-live Suggested Reading
Bury, S. (2004). NAFTA: 10 years after. Wood & Wood Carpentier, C.L. (2006). NAFTA Commission for
Products, 49(1), 46-50. Retrieved on January 12, 2007, Environmental Cooperation: Ongoing assessment of trade
from EBSCO Online Database Business Source Premier. liberalization in North America. Impact Assessment and
http://search.ebscohost.com/login.aspx?direct=true&db=b Project Appraisal, 24(4), 259-272. Retrieved on January
uh&AN=12124652&site=ehost-live 11, 2007, from EBSCO Online Database Business Source
Premier. http://search.ebscohost.com/login.aspx?direct=tru
Business Mexico, 15(3), 46-47. Retrieved on January 12, 2007, e&db=buh&AN=23423119&site=ehost-live
from EBSCO Online Database Business Source Premier.
http://search.ebscohost.com/login.aspx?direct=true&db=b Frickel, B.J., Kotcherlakota, V.V., Tenkorang, F.A., & Elder,
uh&AN=16499557&site=ehost-live B.R. (2011). The effect of NAFTA on trade and invest-
ment between member countries. International Business
Field, A.M. (2004). A new vision for NAFTA. The Journal of & Economics Research Journal, 10(6), 1–8. Retrieved
Commerce, 5(26), 16-17. Retrieved on January 12, 2007, December 3, 2013 from EBSCO online database, Business
from EBSCO Online Database Business Source Premier. Source Complete. http://search.ebscohost.com/login.aspx?
http://search.ebscohost.com/login.aspx?direct=true&db=b direct=true&db=bth&AN=62812597&site=ehost-live
uh&AN=13632413&site=ehost-live
Hakim, P. (2006). Is Washington losing Latin America?
Field, A.M. (2006). CAFTA's payoff. The Journal of Foreign Affairs, 85(1), 39-53. Retrieved on January 12,
Commerce, 7(50), 38-39. Retrieved on January 12, 2007, 2007, from EBSCO Online Database Business Source
from EBSCO Online Database Business Source Premier. Premier. http://search.ebscohost.com/login.aspx?direct=tru
http://search.ebscohost.com/login.aspx?direct=true&db=b e&db=buh&AN=19250175&site=ehost-live
uh&AN=23475179&site=ehost-live
Ley-Borras, R. (2005). A decision analysis approach to policy
Hirsch, J. (1995). The real day-to-day business of NAFTA. issues: The NAFTA case. Review of Policy Research,
CMA Magazine, 69(7), 11. Retrieved on January 12, 2007, 22(5), 687-708. Retrieved on January 12, 2007, from
from EBSCO Online Database Business Source Premier. EBSCO Online Database Business Source Premier. http://
http://search.ebscohost.com/login.aspx?direct=true&db=b search.ebscohost.com/login.aspx?direct=true&db=buh&A
uh&AN=9510060823&site=ehost-live N=18316325&site=ehost-live

Morton, R. (2006). NAFTA: Twelve years after. Logistics

Today, 47(2), 10. Retrieved on January 11, 2007, from
EBSCO Online Database Business Source Premier. http://
search.ebscohost.com/login.aspx?direct=true&db=buh&A
N=19724323&site=ehost-live
68 ​​​North American Free Trade Agreement​

Edited by Richa S. Tiwary, Ph.D., MLS

Dr. Richa S. Tiwary holds a Doctorate in Marketing Management with a specialization in Consumer Behavior from Banaras Hindu Uni-
versity, India. She earned her second Masters in Library Sciences with dual concentration in Information Science & Technology, and,
Library Information Services, from the Department of Information Studies, University at Albany-SUNY.
Applied Global Money Management

an explanation as to why the international monetary system is

Table of Contents
necessary as well as some of the problems that are encountered
in the international capital budgeting process. Finally, there is
Abstract a discussion about the international financial system, especially
the new international financial architecture (NIFA).
Overview
International Monetary System
Overview
The Gold Standard
The Gold-Exchange Standard What is money management? Money management is the method
of controlling and governing money, which can involve invest-
The Bretton Woods System ing, budgeting, banking, and the implementation of taxes. This
The Growth of the Global Economy article provides a preview of how it is applied in a global econ-
omy. Some of the highlighted areas include the international
Application monetary system, the international financial system, and interna-
tional capital budgeting.
International Capital Budgeting
International Monetary System
Challenges Unique to Capital Budgeting for
The Gold Standard
the Multinational Corporation
The international monetary system is needed in order to better
Viewpoint describe an ordinary form of value for the world to use as its
currency. During the late 19th and early 20th centuries, the gold
International Financial Systems standard became the first international monetary system. "It
Importance of International Cooperation has often been assumed in the international political economy
literature that the classical gold standard of the late 19th cen-
The New International Financial Architecture tury represented a turning point in monetary history because it
International Monetary Fund Improvements marked the end wherein states manipulated their currency to
increase their revenues" (Knafo, 2006, p. 78). One advantage
Conclusion of this type of system is that gold has a stabilizing influence.
However, a disadvantage of the system is that it lacks liquidity.
Terms & Concepts In addition, if there was an unexplainable increase in the supply
of gold, prices could rise abruptly. Given the number of disad-
Bibliography vantages, the international gold standard failed in 1914 and was
replaced by the gold bullion standard during the 1920s. How-
Suggested Reading ever, the gold bullion standard ceased to be used in the 1930s.

The Gold-Exchange Standard

The gold-exchange standard was used to conduct international
Abstract trade during the period after World War II. This system encour-
aged countries to set the value of their currency to some foreign
This article focuses on various global money management currency, which was set and redeemed in gold. Many countries
systems and practices. Three of the featured topics include set their currency to the dollar and maintained dollar reserves in
the international monetary system, the international financial America. The United States was seen as the leading country for
system and the international capital budgeting process. There is currency. It was during the 1944 Bretton Woods International

69
70 ​​​Applied Global Money Management​

conference that a method of fixed exchange rates was conceived Challenges Unique to Capital Budgeting for the Multi-
and implemented. In addition, the International Monetary Fund national Corporation
was established and charged with conserving stable exchange Capital budgeting for the multinational corporation presents
rates globally. many problems that are rarely found in domestic capital bud-
geting (Shapiro, 1978; Ang & Lai, 1989). Financial analysts
The Bretton Woods System may find that foreign projects are more complex to analyze than
The Bretton Woods system was charged with developing and domestic projects due to the need to:
implementing the rules and regulations for global commercial
and financial transactions. The International Bank for Recon-
• Distinguish between parent cash flow and projects
cash flow. Multinationals will have the opportunity to
struction and Development was established as a result of this
evaluate the cash flow associated with projects from
endeavor. It was the first effort at creating a system that would
two approaches. They may look at the net impact of the
control monetary relationships between autonomous nation-
project on their consolidated cash flow or they may treat
states. The greatest accomplishments of the Bretton Woods
the cash flow on a stand alone or unconsolidated basis.
system occurred when: Each country agreed to implement a
The theoretical perspective asserts that the project should
monetary policy that would maintain the exchange rate of its
be evaluated from the parent company's viewpoint since
currency in a fixed amount through the value of gold. They also
dividends and repayment of debt is handled by the parent
agreed that the International Monetary Fund had the right to con-
company. This action supports the notion that the evalu-
nect fleeting inequalities of payments. Unfortunately, the method
ation is actually on the contributions that the project can
broke down in 1971 because of Americas' suspending of conver-
make to the multinational's bottom line.
sion from dollars to gold.

The Growth of the Global Economy Some organizations may want to evaluate the project from the
According to a new report conducted by Oliver, Wyman & subsidiary's (local) point of view. However, the parent compa-
Company for Strategic Finance, global net revenue from money ny's viewpoint should supersede the subsidiary's point of view.
management is expected to triple to $900 billion by 2010, which Multinational corporations tend to compare their projects with
is up from $277 billion in 1996 (Chernoff, 1998). The report the subsidiary's projects in order to determine where their invest-
predicts that revenue will grow at a 9% annual clip. As a result, ments should go. The rule of thumb is to only invest in those
money management will become one of the quickest spreading projects that can earn a risk-adjusted return greater than the local
sectors in the global financial industry. competitors performing the same type of project. If the earnings
are not greater than the local competitors, the multinational cor-
Chernoff (1998) alleges that growth is driven by a variety of fac- poration can invest in the host country's bonds since they will
tors such as "modest economic growth; faster wealth buildup pay the risk free rate adjusted for inflation.
among the affluent; continued growth in investments as a share
of total financial assets: aging populations in Western countries; Although the theoretical approach is a sound process, many mul-
and an emerging middle class in developing companies" (p. 8). tinationals tend to evaluate their projects from both the parent
and project point of view because of the combined advantages.
When looking from the parent company's viewpoint, one could
Application obtain results that are closer to the traditional net present value
technique. However, the project's point of view allows one to
International Capital Budgeting obtain a closer approximation of the effect on consolidated
When the financial management team determines whether or not earnings per share. The way the project is analyzed is dependent
to invest in specific capital projects, the process is called capital on the type of technique utilized to report the consolidated net
budgeting. An organization usually has to deal with capital budget- earnings per share.
ing issues when it plans to acquire new assets or replace existing
obsolete assets in order to maintain efficiency. The financial man-
• Recognize money reimbursed to parent company
when there are differences in the tax system. The
agement team must determine which projects are good investment
way in which the cash flows are returned to the parent
opportunities, which projects are the most desirable to acquire, and
company has an effect on the project. Cash flow can be
how much the organization should invest in each asset.
returned in the following ways:
International capital budgeting refers to when projects are • Dividends — It can only be returned in this form if the
located in host countries other than the home country of the mul- project has a positive income. Some countries may im-
tinational corporation. Some of the techniques (i.e. calculation of pose limits on the amounts of funds that subsidiaries can
net present value) are the same as traditional finance. However, pay to their foreign parent company in this form.
"capital budgeting for a multinational is complicated because of
the complexity of cash flows and financing options available to • Intrafirm Debt — Interest on debt is tax deductible and
the multinational corporation" (Booth, 1982, p. 113). it helps to reduce foreign tax liability.
 ​​​Applied Global Money Management​ 71

• Intrafirm Sales — This form is the operating cost of the capital. International projects tend to have more risk than
project and it helps lower the foreign tax liability. domestic projects. Therefore, it is advantageous to review
the risk based on the parent's and project's perspective.
• Royalties and License Fees — This form covers the Each perspective has a different way of adjusting risk.
expenses of the project and lowers the tax liability.
For example, the parent company may propose to treat
• Transfer Pricing — This form refers to the internally all foreign risk as a single problem by increasing the dis-
established prices where different units of a single enter- count rate applicable to the foreign projects or incorporate
prise buy goods and services from each other. all foreign risk in adjustments to forecasted cash flows of
the project. The first option is usually not recommended
because it may penalize the cash flows that are not really
Anticipate the differences in the inflation rate between coun-
affected by any sort of risk and it may ignore events that
tries given that it will affect the cash flow over time.
are favorable to the organization. The four components
• Analyze the use of subsidized loans from the host are initial investment outlay, net cash benefits (or savings)
country since the practice may complicate the capital from the operations, terminal cash flow, and net present
structure and discounted rate. The host country may value (NPV) technique.
target specific subsidiaries in order to attract specific
types of investment (i.e. technology). Subsidized loans
can be given in the form of tax relief and preferential fi-
Viewpoint
nancing, and the practice will increase the net present val- International Financial Systems
ue of the project. Some of the advantages of this practice
There was much growth and change in national and interna-
include: Adding the subsidiary to project cash inflows and
tional financial systems in the 20th century. During the Post
discount; discounting the subsidiary at some other rate,
War period, many countries had the opportunity to experience
risk free, and; lowering the risk adjusted discount rate for
economic increases, steady low unemployment and continu-
the project in order to show the lower cost of debt.
ous deregulation in their respective economic markets. Positive
• Determine if the political risk will reduce the value steps have been taken to change the way business was done
of the investment. Expropriation is the ultimate level of through acts such as the implementation of the European Union,
political risk, and the effects of it depends on when the the North America Free Trade Agreement and the Asia Pacific
expropriation takes place, the amount of money the host Economic Cooperation. In addition, international institutions
government will pay for the expropriation, how much like the World Bank, the International Monetary Fund and the
debt is still outstanding, and the tax consequences of Bank for International Settlements have assisted in the man-
expropriation and the future cash flow. agement of the changes that have occurred in the international
financial arena. All of the efforts mentioned above have been an
• Assess the different perspectives when assessing the attempt to produce a sound international financial system that
terminal value of the project. Estimating the salvage will be able to sustain over the years. "The financial system
value or terminal value depends on the value of the in the 21st century should provide a financial environment that
project if retained, the value of the project if purchased is conducive to contributing to further global financial integra-
by outside investors and the value of the project if it were tion as well as better macroeconomic coordination" (Moshirian,
liquidated. The corporation would use the assessment that 2002, p. 274).
yields the highest value.
• Review whether or not the parent company had Importance of International Cooperation
problems transferring cash flows due to the funds be- There are some key issues that may have an effect on the interna-
ing blocked. An example would be when a host country tional financial system. Therefore, it is imperative that all of the
limits the amounts of dividends that can be paid. If this organizations and initiatives listed above come together in order
were to occur, the multinational corporation would have to create an international financial architecture versus work-
to reexamine its reinvestment return and other methods in ing in isolation. "Globalization and increasing interdependence
which the funds could be transferred out of the country. amongst all the nations of the world have allowed people to have
The blocked funds can be used to repay bank debt in the a better understanding of key factors which affect the welfare
host country and allow the organization to have open and interest of all people and nations and their absence could
lines of credit to other countries. harm both developed and developing countries. Some of these
issues are sustainable development, world peace and security,
Make sure that there is no confusion as to how the discount sound global environmental policies, international trade, stable
rate is going to be applied to the project. monetary systems, sound financial institutions, universal educa-
tion and health, sound and all embracing technological changes
• Adjust the project cash flow to account for potential and effective and universally accessible telecommunication"
risks. One must assume that every project has some level
(Moshirian, 2002, p. 276).
of risk. The risk is usually seen as part of the cost of
72 ​​​Applied Global Money Management​

The establishment of the International Monetary Fund and the

• Encourage members to put procedures in place when they
are not experiencing any problems so that they are not
World Bank is probably one of the most important success stories
responding to a crisis. It's an opportunity to be proactive
for international economic cooperation. Since the mid-twentieth
versus reactive.
century, there have been many changes in terms of the political
and economic climate on a global level, which has caused the • Aid countries in assessing their extrinsic liabilities and
world's top international financial institutions to shift in terms of choosing the proper exchange rate programs.
how they operate their businesses. Given the number of financial
crises that have surfaced during in the twenty-first century, many
scholars and practitioners in the field have called for a reform in Conclusion
how the international financial system is structured. These crises
have exposed the weaknesses that are in the international finan- The international monetary system is needed in order to better
cial system as well as highlight the fact that globalization has describe the shared standards of value for global currencies.
pros (benefits) and cons (risks). During the late 19th and early 20th centuries, the gold stan-
dard became the first international monetary system. One of the
The New International Financial Architecture advantages of this type of system is that gold has a stabilizing
“The new international financial architecture (NIFA) was created influence. However, a disadvantage of the system is that it lacks
by the G-7 countries due to the growing volatility in developing liquidity. In addition, if there was unexplainable increase in the
countries. Some key components of the NIFA include: The G-20, supply of gold, prices could rise abruptly. Given the number of
the Financial Stability Forum and the Reports on Observance of disadvantages, the international gold standard failed in 1914
Standards and Codes, the latter involving areas such as corpo- and was replaced by the gold bullion standard during the 1920s.
rate governance” (Soederberg, 2002, p. 612). The purpose of the However, the gold bullion standard ceased to be used in the
architecture is to offer governments, businesses and individuals 1930s.
a mechanism (i.e. institutions, markets) to conduct economic
and financial activities. The goal is to create an environment The Bretton Woods system was charged with developing and
that strengthens and stabilizes the international financial system implementing the rules and regulations for global commercial
and minimizes the global exposure to financial dilemmas. Some and financial transactions. The International Bank for Recon-
advances have been made in order to reach these goals. The struction and Development was established as a result. It was
International Monetary Fund (IMF) has been instrumental in the first effort at creating a system that would govern mon-
making some of these goals a reality. According to the IMF's fact etary relations among independent nation-states. The greatest
sheet (2000), some of the major accomplishments include: accomplishments of the Bretton Woods system occurred when
each country agreed to implement a monetary policy that would
• Increased availability of information from governments maintain the exchange rate of its currency in a fixed amount
and other institutions to the general public
through the value of gold. They also agreed that the International
• Increased usage of codes of healthy practices that are Monetary Fund had the right to connect fleeting inequalities of
needed for an economy to function successfully payments. Unfortunately, the method broke down in 1971 when
the United States suspended conversion from dollars to gold.
• The creation of the Contingent Credit Lines.
International capital budgeting refers to when projects are
International Monetary Fund Improvements located in host countries other than the home country of the mul-
IMF is working diligently to provide continuous improvements tinational corporation. Some of the techniques (i.e. calculation of
to practices that affect many sectors. For example, this body con- net present value) are the same as traditional finance. However,
tinues to: "capital budgeting for a multinational is complicated because
of the complexity of cash flows and financing options available
• Stimulate the release of public information reports that to the multinational corporation" (Booth, 1982, p. 113). Capi-
detail the IMF Executive Board's evaluation of a nation’s
tal budgeting for the multinational corporation presents many
financial state and economic policies.
problems that are rarely found in domestic capital budgeting
• Encourage members to reveal the description of policies (Shapiro, 1978; Ang & Lai, 1989).
that the members might adhere to in order to maintain
financial stability through the IMF-supported program. There was much growth and change in national and interna-
tional financial systems in the 20th century. During the Post
• Help countries implement guidelines, such as the Reports War period, many countries had the opportunity to experience
on the Observance of Standards and Codes, that will economic growth, low unemployment and gradual deregulation
evaluate a nation's development in practicing globally in their respective financial markets. Positive steps have been
accepted standards and codes. taken to change the way business was done through acts such as
• Address gaps in regulatory standards through the Basel the emergence of the European Union, the North America Free
Committee on Banking Supervision. Trade Agreement and the Asia Pacific Economic Cooperation.
 ​​​Applied Global Money Management​ 73

In addition, international institutions such as the World Bank, global economy. The size of the nation also determines its voting
the International Monetary Fund and the Bank for International control within the IMF. The United States, for example, has a
Settlements have assisted in the management of the changes 17% voting stake. The IMF contributes to global financial gains
that have occurred in the international financial arena. All of through loan grants and technical aid directed at underdeveloped
the efforts mentioned above have been an attempt to produce a or needy countries. The institution was developed in 1944 with
sound international financial system that will be able to sustain the help of 45 nations as a means to counter the issues raised by
over the years. "The financial system in the 21st century should the catastrophic events following the stock market crash of 1929.
provide a financial environment that is conducive to contributing
to further global financial integration as well as better macroeco- International Monetary System: Guidelines and policies by
nomic coordination" (Moshirian, 2002, p. 274). which differing currencies are traded for each other during global
exchanges. The system is needed in order to create and impose a
According to a report conducted by Oliver, Wyman & Com- universal standard of value for finances across the globe.
pany for Strategic Finance in the 1990s, global net revenue from
money management was expected to triple to $900 billion by Money Management: The process of controlling and governing
2010, up from $277 billion in 1996 (Chernoff, 1998). In fact, finances through investing, budgeting, banking, and taxing.
by 2013, money management was a $53 trillion dollar industry
(Bradford, 2013). North America Free Trade Agreement: An agreement that sup-
ports the implementation of free trade between Mexico, America,
and Canada.
Terms & Concepts
World Bank: An organization whose focus is on foreign
Asia Pacific Economic Cooperation: A financial forum for an exchange reserves and the balance of trade.
alliance of Pacific Rim nations to altercate over issues regard-
ing the global and regional economy, the level of cooperation
needed to function successfully, and the ins and outs of trading Bibliography
and investing.
Ang, J., & Lai, T. (1989). A simple rule for multinational
Bank of International Settlements: An institution that extends capital budgeting. Global Finance Journal, 1(1), 71-76.
its service to central banks around the world in addition to other Retrieved July 5, 2007, from EBSCO Online Database
global and national financial institutions. Individuals and busi- Business Source Complete. http://search.ebscohost.com/
nesses, however, are not allowed to deposit or otherwise receive login.aspx?direct=true&db=bth&AN=6338721&site=eh
services from this bank. ost-live

Basel Committee on Banking Supervision: A company first Booth, L. (1982). Capital budgeting frameworks for the mul-
establishing by the central bank Governors of the Group of Ten tinational corporation. Journal of International Business
nations. It was instilled in 1974 and joins together quarterly. Studies, 13(2), 113-123.

Capital Budgeting: The process by which the financial manager Bradford, H. (2013). Report gives money managers pause.
decides whether to invest in specific capital projects or assets. Pensions & Investments, 41(22), 2-43. Retrieved
November 15, 2013, from EBSCO Online Database
European Union: A financial and governmental alliance cre- Business Source Complete. http://search.ebscohost.com/
ated in 1993 following the ratification of the Maastricht Treaty login.aspx?direct=true&db=bth&AN=91756508&site=eh
by members of the European Community. The union - which ost-live
includes Austria, Finland, Sweden, Syprus, the Czech Republic,
Estonia, Hungary, Latvia, Lithuania, Malta, Poland, Slovakia, Chernoff, J. (1998). Global money management boom pre-
and Slovenia – increased the political scope of the European dicted. Pensions & Investments, 26(12), 8. Retrieved
Economic Community, particularly in foreign policies and August 25, 2007, from EBSCO Online Database Business
security initiatives. The union also initiated the establishment Source Complete. http://search.ebscohost.com/login.aspx?
of a common European bank and central currency known as direct=true&db=bth&AN=919587&site=ehost-live
the euro.
Dent, C. M. (2013). Paths ahead for East Asia and Asia-
International Monetary Fund: An institution of over 180 nations Pacific regionalism. International Affairs, 89(4), 963-
motivated to promote worldwide monetary cooperation and the 985. Retrieved November 15, 2013, from EBSCO Online
wellbeing and security of the international monetary system. Database Business Source Complete. http://search.ebsco-
Every member fulfills its position by contributing to quota pay- host.com/login.aspx?direct=true&db=bth&AN=89024370
ments that relates directly to the nation’s size and position in the &site=ehost-live
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Knafo, S. (2006). The gold standard and the origins of 607-620. Retrieved August 2, 2007, from EBSCO Online
the modern international monetary system. Review of Database Business Source Complete. http://search.ebsco-
International Political Economy, 13(1), 78-102. Retrieved host.com/login.aspx?direct=true&db=bth&AN=7484752&
July 31, 2007, from EBSCO Online Database Business site=ehost-live
Source Complete. http://search.ebscohost.com/login.aspx?
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Suggested Reading
Moshirian, F. (2002). New international financial architecture.
Journal of Multinational Financial Management, 12(4-5), Appell, D. (2007). So that's where the money goes. Pensions
273-284. Retrieved July 28, 2007, from EBSCO Online & Investments, 35(6), 8. Retrieved August 26, 2007, from
Database Business Source Complete. http://search.ebsco- EBSCO Online Database Business Source Complete.
host.com/login.aspx?direct=true&db=bth&AN=7865954& http://search.ebscohost.com/login.aspx?direct=true&db=bt
site=ehost-live h&AN=24545460&site=ehost-live

Shapiro, A. (1978). Capital budgeting for the multinational Garrone, F., & Solnik, B. (1976). A global approach to money
corporation. Financial Management (1972), 7(1), 7-16. management. Journal of Portfolio Management, 2(4),
Retrieved July 5, 2007, from EBSCO Online Database 5-14.
Business Source Complete. http://search.ebscohost.com/
login.aspx?direct=true&db=bth&AN=5029365&site=eh Top 40 money managers. (2007). Benefits Canada, 31(4),
ost-live 36-37. Retrieved August 26, 2007, from EBSCO Online
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Soederberg, S. (2002). On the contradictions of the new inter- host.com/login.aspx?direct=true&db=bth&AN=25030632
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for emerging markets? Third World Quarterly, 23(4),

Essay by Marie Gould

Marie Gould is an Associate Professor and the Faculty Chair of the Business Administration Department at Peirce College in Phila-
delphia, Pennsylvania. She teaches in the areas of management, entrepreneurship, and international business. Although Ms. Gould has
spent her career in both academia and corporate, she enjoys helping people learn new things — whether it's by teaching, developing or
mentoring.
Globalization & International Financial
Management

Table of Contents Abstract

This article focuses on international financial management.
Abstract International financial management is a growing management
Overview practice with significant implications for the economic rela-
tionship between countries and the global economy as a whole.
The Global Economy This article provides a description and analysis of the main
The Financial Management Association international financial management practices including expo-
sure management, capital financial management, international
International Financial Innovation supply chain management, capital budgeting management, cur-
Applications rency swap management, distribution management, futures,
options, and derivatives management, investment management,
International Financial Management Practices and international accounting management. The issues associated
International Supply Chain Management with the use of international financial management software will
be discussed.
Exposure Management
Capital Financial Management
Overview
Capital Budgeting Management
Currency Swap Management International financial management is a growing field with sig-
nificant implications for the economic relationship between
Distribution Management countries, businesses, and the global economy as a whole. Inter-
Futures, Options, & Derivatives Management national financial activity requires active management practices
and tools. International financial management combines the fields
Investment Management of international finance and financial management. International
International Accounting Management finance refers to the field of economics that involves exchange
rates, foreign investment, and international trade. Financial
Issues management refers to a division of management responsible for
International Financial Management Software both resource management and finance operations. International
financial management concerns multinational corporations as
Financial Management Software Packages whole entities and involves cross-disciplinary decision-mak-
Financial Accounting Software ing. International financial management is a holistic endeavor
involving international financial planning, financial control, and
Evaluation of International Accounting Software
financial decision-making.
Conclusion
Multinational corporations rely on international financial man-
Terms & Concepts agement to achieve the goals of creating a competitive advantage
Bibliography in the global marketplace and maximizing shareholder profits
(Delk, 2000). Traditional models of corporate financial manage-
Suggested Reading ment are changing as a result of new technological, business,
and market environments. International financial managers now

75
76 ​​​Globalization & International Financial Management​

manipulate and combine unbundled financial products, such as is considered to be one of the global leaders in developing and
futures, swaps, collars, and floors, to meet the needs of individ- disseminating knowledge about international financial decision
ual clients (Levich, 1989). Common concerns for international making. The goals and objectives of the Financial Management
financial managers include the following: Exchange rate fluc- Association include "broadening the common interests between
tuations, forecasting efficiency, transactions exposure, long-term academics and practitioners; providing opportunities for profes-
financing, direct foreign investment, futures and options, country sional interaction between and among academics, practitioners
risk, international working capital management, transfer pricing, and students; promoting the development and understanding of
and economic exposure (Madura & McCarty, 1989). basic and applied research and of sound financial practices; and
enhancing the quality of education in finance" (History, 2007,
The Global Economy ¶2).
International financial management is growing in importance
as international financial activity and global markets become International Financial Innovation
increasingly common. Global markets are characterized by an In the twenty-first century, international financial innovation
increasing mobility in capital, research and design processes, is impacting and directing corporate financial management
production facilities, customers, and regulators. Global markets, practices. International financial innovation is associated with
created through socio-economic changes, political revolutions, product innovation, securitization, liberalization, globalization,
and new Internet and communication technology, have no and interpenetration.
national borders. The modern trend of globalization, and result-
ing shifts from centralized to market economies in much of the
• Financial product innovation refers to the development of
new risk management and funding vehicles.
world, has created opportunities for increased trade, investment,
business partnerships, and access to once closed global markets. • Securitization refers to a greater tendency toward market-
able financial instruments rather than bank loans.
Economic environments around the world are changing due
to the forces of globalization. Globalization is characterized • Liberalization refers to the expansion of domestic finan-
by the permeability of traditional boundaries of nations, cul- cial market practices through deregulation.
ture, and economic market. The fundamental economic forces • Globalization refers to the internationalization of finan-
and events influencing globalization around the world include cial markets.
the end of communism; the shift from an economy based on
natural resources to one based on knowledge industries; demo- • Interpenetration refers to the increased competition
graphic shifts; the development of a global economy; increased among financial institutions that result from reduced
trade liberalization; and advances in communication technology boundaries between types of banks and securities firms
(Thurow, 1995). (Levich, 1989).

Business opportunities, including international investments and The following section provides a description and analysis of the
joint ventures, in the global economy are increasingly tied to main international financial management practices including
trade pacts. In addition, business opportunities are resulting from international supply chain management, exposure management,
privatization worldwide. Countries are privatizing many state- capital financial management, capital budgeting management,
owned industries and allowing foreign investors to purchase currency swap management, distribution management, futures,
pieces of them through joint ventures or local operations so that options, and derivatives management, investment management,
they can participate in these projects. and international accounting management. This section serves as
a foundation for later discussion of the growing trend in interna-
Emerging markets, often occurring in countries experiencing tional financial management software use.
political upheaval, will continue to increase in the expand-
ing global market. Businesses, participating in the new global
economy, will continue to seek out new manufacturing and sales Applications
opportunities in foreign markets and countries (Sites, 1995).
International Financial Management Practices
The Financial Management Association There are a common set of international financial management
Multinational corporations in the global economy require new practices found across businesses and industries. Popular inter-
forms of financial management. Professional finance organi- national financial management practices include:
zations have contributed to the development of international
financial management tools and practices. For example, one of
• International supply chain management
the most influential professional international financial man- • Exposure management
agement organizations, the Financial Management Association
(FMA), was founded in 1970. The Financial Management Asso- • Capital financial management
ciation, which brings together academic and business interests, • Capital budgeting management
 ​​​Globalization & International Financial Management​ 77

• Currency swap management Economic exposure refers to the amount a firm's present value of
• Distribution management current cash flows is affected by exchange rate fluctuations. Inter-
national financial managers control economic exposure through
• Futures, options, and derivatives management the application of techniques such as debt restructuring, modi-
• Investment management fied sales activity, adjusted orders with suppliers, and adjusted
production volumes by country. International financial managers
• International accounting management. adjust their orders with suppliers and their production volume
in different countries in an effort to reduce their economic risks.
These international financial management practices are described Translation exposure, also known as accounting exposure, refers
and analyzed below (Delk, 2000). to the risk that a firm's equities, assets, liabilities, and income
will change in response to exchange rate fluctuations. Interna-
International Supply Chain Management tional financial managers control translation exposure through
International financial managers oversee and engage in supply the use of consolidation techniques and carefully-chosen cost
chain management in an effort to coordinate business operations accounting evaluation procedures.
across and between countries. Supply chain refers to the con-
nections between trading partners extending from the supplier's Capital Financial Management
supplier to the customer's customer. International supply chains International financial managers are responsible for capital
are those that cross national boundaries. Issues related to logis- financing decisions. International financial managers must
tics, taxes, quotas, regulations, and differences in currencies, procure the capital necessary for growth. International finance
languages, and cultures challenge and complicate interna- opportunities are plentiful. For example, numerous multinational
tional supply chains. International supply chains often involve corporations rely on international chain financing as a primary
multiple currency exchanges. International supply chain man- source of capital. Chain financing refers to the process of pooling
agement is three stage process involving getting information to loans to finance the activities of supply chain partners.
run the business, delivering products to customers, and getting
the cash to generate profits. International supply chain man- Capital Budgeting Management
agement and international financial management intersect at International financial managers control capital budgeting deci-
numerous points including vendor selection, risk management, sions between countries. Financial mangers are generally directly
and asset management. In particular, supply chain management involved in capital budgeting decisions. Capital budgeting refers
and financial management are equally effected by political, to the strategic process used to ascertain a firm's future invest-
exchange rate, and lead-time risks. International financial man- ments such as new machinery, replacement machinery, new
agers may reduce costs for all parties involved in a supply chain plants, new products, and research and development projects.
or business transaction by combining transactions through one Computational methods for capital budgeting analysis include
financial institution. Factors that affect these sorts of shared a conceptual options framework for capital budgeting; quantify-
transactions include fund transfers, currency exchange, hedg- ing flexibility in capital budgeting; discrete and continuous time
ing, funding credit, and the sharing of financial information models; interactions among multiple real options; hybrid real
(Delk, 2000). options valuation of risky projects; and strategic analysis.

Exposure Management Currency Swap Management

International financial managers are responsible for exposure International financial managers are responsible for currency
management. Exposures refer to categories of risks faced by swaps between national offices and accounts. Currency swaps
a firm. International financial managers protect the firms from refer to a swap that involves the exchange of principal and inter-
exchange rate exposure, transaction exposure, economic expo- est in one currency for the same in another currency. Currency
sure, and translation exposure. International financial managers swaps require special management due to their special reporting
work to reduce exposures faced by their firms. Exchange rate requirements. Most governments consider currency swaps to be
exposure refers to the extent to which currency exchange and foreign exchange transactions that do not require reporting on
exchange rate fluctuations will affect firm activities and prof- balance sheets.
its. Transaction exposure refers to the degree to which future
cash transactions are affected by exchange rate fluctuations. Distribution Management
International financial managers control transaction exposure International financial managers oversee distribution between
by analyzing extent and range of exposure by country for all national offices, production facilities, and distribution centers.
activities of the organization. International financial managers Distribution management is an integral part of international
are responsible for developing inflows and outflows of cash in financial management. Distribution is a crucial concern for
multiple currencies. In scenarios in which the transaction expo- businesses that operate in global markets transformed by new
sure is high, international financial managers may choose to use information and communication technologies. Products and ser-
a hedging technique to reduce the risk (Delk, 2000). vices are increasingly developed, produced, and sold in different
78 ​​​Globalization & International Financial Management​

geographic regions. Companies outsource as many non-core analyzing the following variables within a client's portfolio:
activities to other firms around the world as possible. Thus, trans- Exceptional return, benchmark return, opportunity loss, trans-
portation and distribution networks may influence performance action cost, objective value, and information ratio.
and competitiveness within international markets (Zeng, 2003).
• Exceptional return refers to the residual return plus
Futures, Options, & Derivatives Management benchmark timing return.
International financial managers are actively involved in busi- • Benchmark return refers to the standard value against
ness investment decisions and futures, options, and derivatives which the performance of a security, index, or investor
analysis. Futures, options, and derivatives are an important cat- can be measured.
egory of investment used to protect investors from dips in stocks
or indexes as well as to create portfolio diversification. Deriva- • Opportunity loss refers to the estimated lost resulting
tives refer to financial instruments, such as options and futures, from not choosing the best option or solution.
which do not constitute ownership but a promise to convey • Transaction cost refers to the cost resulting from buying
ownership. Options, such as stock or index option, are a form or selling assets including commissions.
of derivative that derives its value from something else. Futures
refer to an agreement to buy or sell a commodity at a fixed price • Objective value refers to the prevailing value established
on a fixed date. International financial managers use computa- by the market.
tional methods to analyze advisability of investing in futures, • Information ratio refers to the expected exceptional return
options, and derivatives. Computational methods for futures, divided by the amount of risk assumed in pursuit of that
options, and derivatives analysis include the following: Deter- exceptional return (Grinold, 2005).
minants of option values; portfolio strategies; binomial models;
option deltas; hedging; forward rate agreements; interest rate and
equity swap methods; and the analytic formula for derivative International Accounting Management
pricing and option pricing. International financial managers oversee and participate in
international accounting and reporting activity. International
Investment Management accounting management is an integral part of international
International financial managers participate in international financial management. International finance managers in mul-
investment decisions. Investment management, also called tinational corporations must choose which accounting systems
money management and asset management, refers to the process and standards their firms will use. Options include national and
of investment analysis involving portfolio management, budget international standards and systems. The predominant inter-
making, banking, tax planning, and investment risk assessment. national accounting standards include IFRS and US GAAP
Investment managers work for pension funds, corporations, gov- (Tarca, 2004). Accounting systems, which include accounting
ernments, institutions, endowments, foundations, and high net concepts, reporting practices, and principles, reflect the cul-
worth individuals. Investment managers help grow and manage ture, philosophy, goals, and objectives of their users. Modern
assets through multiple products and services including analy- accounting systems are increasingly international in scope and
sis, research, and risk management. Investment management is standards. Economic globalization has created the demand for
divided into two main types: Active investment management and shared international accounting principles, standards, and prac-
passive investment management. tices. International accounting refers to accounting practices that
cross national boundaries or is conducted in a location other
• Active investment management is an approach based on than the firm's home country. International accounting encom-
informed and independent investment decisions. Active
passes multinational enterprises, global movements to shape the
investment management generally involves the frequent
direction of accounting, and comparative accounting require-
buying and selling of bonds. Active investment manage-
ments and practices (Prather-Kinsey & Rueschhoff, 2004). The
ment has as its primary goal to outperform benchmark
stakeholders of international accounting, including shareholders,
returns.
corporations, and governments, require accurate and comparable
• Passive investment management, also referred to as economic data to make economic decisions (Speidell & Bavishi,
indexing, involves investing in a wide range of assets 1992). Comparable systems of transnational financial reporting
classes and working to match the overall performance of facilitate international investment.
the market. Passive investment management generally
involves holding bonds to the point at which they mature. Ultimately, international financial management includes a wide
range of practices and tools that allow financial managers to
respond to changing international business environments. The
Investment managers, both active and passive money manag- main practices of international financial management are charac-
ers, work to control and balance investment return, risk, and terized by flexibility and market responsiveness.
cost. Investment managers control return, risk, and cost by
 ​​​Globalization & International Financial Management​ 79

Issues Evaluation of International Accounting Software

International financial managers evaluate international account-
International Financial Management Software ing software with the following questions: How does the
International financial managers are responsible for controlling accounting system handle inter-company processing and cur-
and aligning financial information between national corporate rency handling? How effectively does the accounting system and
offices and headquarters. Financial managers rely on ready the vendor meet the demands of the international marketplace?
access to company information or knowledge such as data, Does the software maker offer simultaneous release across all
company history, production processes, and financial reports. countries and regions? Are multilingual capabilities built into the
Information or knowledge management (KM), which refers to accounting software? In the twenty-first century global economy,
the systematic and explicit management of vital information, and international accounting financial systems are necessary tools
financial management are intersecting as the physical distance for international business. International financial management
between offices and co-workers grow in multinational corpo- software systems support company funding, maintain true cash
rations. Knowledge management tools must be matched to the balances in different accounts, and make all account balancing
technological interests and abilities of the organization. Interna- adjustments automatically (O'Brien, 1995).
tional financial management software is one important example
of international knowledge management.
Conclusion
Financial Management Software Packages
Financial management packages, specifically developed to deal In the final analysis, international financial management has
with international business operations, are growing in popularity. much in common with traditional or classical management.
International financial management packages are considered to Management refers to the work or act of directing and control-
be value-added business solutions. International finance issues, ling a group of people within an organization for the purpose
such as complex tax laws, international regulations, and cur- of accomplishing shared goals or objectives. People in manage-
rencies are made easier by the use of accounting and reporting ment positions control and coordinate organizational activities,
software. Multinational corporations need financial account- employees, processes, resources, goals, and objectives in every
ing systems that provide significant flexibility and the ability field and industry. The structure of organizations, from financial
to grow with the company. Firms choose their international investment firms to industrial production facilities to colleges
financial management packages based on the scalability, flex- and universities to hospitals and medical facilities, are simi-
ibility, customization, multi-currency capabilities, ease-of-use, lar in their goals of establishing a work flow, clear leadership,
and implementation assistance of the software. Software imple- and shared objectives. Managers, in all industries, must handle
mentation usually requires training by the software company. employees, information, change, crisis, and ethical issues. While
International financial management packages create a standard international financial management shares much in common
global chart of accounts, implement standard global processes, with traditional or classical management, there are significant
and offer centrally controlled procurement. International differences. International financial managers are responding to
financial management packages create lower costs, increased economic and political change resulting from economic global-
flexibility in training, interchangeability, and knowledge-sharing ization. International financial management is a field requiring
(Wolfendale, 2002). great flexibility, adaptability, and cultural sensitivity.

Financial Accounting Software

International financial managers use financial software to handle Terms & Concepts
international accounting issues. Financial accounting software
and manual accounting systems have significant differences. Benchmark Return: The standard value against which the per-
Financial accounting software has the potential to optimize formance of a security, index, or investor can be measured.
multicurrency transactions, offer significant auditing capabili-
ties, minimize transaction costs, optimize cash management, Capital Budgeting: The strategic process used to ascertain a
and improve cash flow. In particular, international account- firm’s future investments such as new machinery, replacement
ing systems have the potential to facilitate currency handling. machinery, new plants, new products, and research and develop-
International financial managers use accounting systems to ment projects.
summarize and analyze changing currency environments. Mul-
tinational corporations that rely on international accounting Emerging Markets: Capital markets of developing countries that
software must take the following issues into account: The release have decided to liberalize their financial systems to encourage
of the accounting software must be uniform worldwide to pre- capital flows and foreign investment.
vent communication difficulties; multilingual capabilities must
be built into the product; and multiple address formats must be Exceptional Return: Residual return plus benchmark timing
editable into any language. return.
80 ​​​Globalization & International Financial Management​

Futures: An agreement to buy or sell a commodity at a fixed ebscohost.com/login.aspx?direct=true&db=bth&AN=3757

price on a fixed date. 0134&site=ehost-live

Global Markets: The economic markets of countries and regions Grinold, R. (2005). Implementation efficiency. Financial
open to foreign trade and investment. Analysts Journal, 61(5), 52-64. Retrieved October 3, 2007,
from EBSCO Online Database Business Source Premier.
Globalization: The internationalization of financial markets. http://search.ebscohost.com/login.aspx?direct=true&db=b
uh&AN=18486605&site=ehost-live
Information Ratio: The expected exceptional return divided by
the amount of risk assumed in pursuit of that exceptional return. History. (2007). The Financial Management Association.
Retrieved October 3, 2007, from http://www.fma.org/
International Financial Management: A division of manage-
ment responsible for both resource management and finance Lasmin. (2012). Culture and the globalization of the
operations across multiple countries. International Financial Reporting Standards (IFRS) in
developing countries. Journal of International Business
Interpenetration: The increased competition among financial Research, 1131-44. Retrieved November 15, 2013, from
institutions that results from reduced boundaries between types EBSCO Online Database Business Source Complete.
of banks and securities firms. http://search.ebscohost.com/login.aspx?direct=true&db=bt
h&AN=85227515&site=ehost-live
Investment Management: The process of investment analysis
involving investments, portfolio management, budget making, Levich, R. (1989). Recent international financial innova-
banking, tax planning, and investment risk assessment. tions: implications for financial management. Journal of
International Financial Management & Accounting, 1(1),
Liberalization: Deregulating domestic financial markets to pro- 1-14. Retrieved October 3, 2007, from EBSCO Online
mote expansion. Database Business Source Premier. http://search.ebsco-
host.com/login.aspx?direct=true&db=buh&AN=6124461
Objective Value: Prevailing value established by the market. &site=ehost-live

Opportunity Loss: The estimated lost resulting from not choos- Madura, J. & McCarty, D. (1989). Research trends and gaps in
ing the best option or solution. international financial management: A note. Management
International Review, 29(2), 75-80.
Options: A form of derivative that derives its value from some-
thing else. O'Brien, M. (1995). Going global: What to look for in finan-
cial software. Management Accounting, 76(10), 59-61.
Organization: A formal arrangement of people committed to
shared goals and objectives. Prather-Kinsey, J. (2004). An analysis of international
accounting research in U.S.- and non-U.S.-based academic
Securitization: A greater tendency toward marketable financial accounting journals. Journal of International Accounting
instruments rather than bank loans. Research, 3(1), 63-81. Retrieved October 1, 2007, from
EBSCO Online Database Business Source Premier. http://
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Bichut, D. (2005). Going global: The widespread effects of Sites, J. (1995). Going forward with global investments. Risk
IFRS. Business Performance Management Magazine, Management. 42(11), 12-17.
3(3), 23-28.
Sorensen, S. M., Zhaohui, X., & Kyle, D. L. (2012). Currency
Delk, J. (2000). International financial management concepts translation's effects on reported earnings and equity: An
strengthen supply chain links. Production and Inventory instructional case. Issues in Accounting Education, 27(3),
Management Journal, 41(2), 59-64. 837-854. Retrieved November 15, 2013, from EBSCO
Online Database Business Source Complete. http://search.
Fosbre, A. B., Kraft, E. M., & Fosbre, P. B. (2009). The ebscohost.com/login.aspx?direct=true&db=bth&AN=9171
globalization of accounting standards: IFRS versus US 3079&site=ehost-live
GAAP. Global Journal of Business Research (GJBR),
3(1), 61-71. Retrieved November 15, 2013, from EBSCO Speidell, L., & Bavishi, V. (1992). GAAP arbitrage: Valuation
Online Database Business Source Complete. http://search. opportunities in international accounting standards.
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Financial Analysts Journal, 48(6), 58-66. Retrieved Suggested Reading

October 1, 2007, from EBSCO Online Database Business
Source Premier. http://search.ebscohost.com/login.aspx?di Ferguson, M., Lam, K., & Lee, G. (2002). Voluntary dis-
rect=true&db=buh&AN=6944523&site=ehost-live closure by state-owned enterprises listed on the stock
exchange of Hong Kong. Journal of International
Tarca, A. (2004). International convergence of accounting Financial Management & Accounting, 13(2), 125.
practices: Choosing between IAS and US GAAP. Journal Retrieved October 3, 2007, from EBSCO Online Database
of International Financial Management & Accounting, Business Source Premier. http://search.ebscohost.com/
15(1), 60-91. Retrieved October 3, 2007, from EBSCO login.aspx?direct=true&db=buh&AN=6639585&site=eh
Online Database Business Source Premier. http://search. ost-live
ebscohost.com/login.aspx?direct=true&db=buh&AN=118
53435&site=ehost-live Glaum, M. (2000). Bridging the GAAP: the changing atti-
tude of German managers towards Anglo-American
Thurow, L. (1995). Surviving in a turbulent environment. accounting and accounting harmonization. Journal of
Planning Review, 23(5), 24. International Financial Management & Accounting, 11(1),
23-47. Retrieved October 3, 2007, from EBSCO Online
Walter, I. (1989). Competitive positioning in international Database Business Source Premier. http://search.ebsco-
financial services. Journal of International Financial host.com/login.aspx?direct=true&db=buh&AN=4374179
Management & Accounting, 1(1), 15-40. Retrieved &site=ehost-live
October 3, 2007, from EBSCO Online Database Business
Source Premier. http://search.ebscohost.com/login.aspx?di Jaggi, B., & Tsui, J. (2007). Insider trading, earnings manage-
rect=true&db=buh&AN=6124470&site=ehost-live ment and corporate governance: Empirical evidence based
on Hong Kong firms. Journal of International Financial
Wolfendale, M. (2002). Going global. CMA Management, Management & Accounting, 18(3), 192-222. Retrieved
76(1), 32-36. October 3, 2007, from EBSCO Online Database Business
Source Premier. http://search.ebscohost.com/login.aspx?di
Zeng, A. (2003). Global sourcing: process and design for effi- rect=true&db=buh&AN=26516941&site=ehost-live
cient management. Supply Chain Management, 8(3/4),
367-380.

Essay by Simone I. Flynn, Ph.D.

Dr. Simone I. Flynn earned her Doctorate in cultural anthropology from Yale University, where she wrote a dissertation on Internet com-
munities. She is a writer, researcher, and teacher in Amherst, Massachusetts.
Global Issues in Management

be through more efficient production processes and practices or

Table of Contents
even through reducing the size of the work force. At other times,
it is through the practice of sustainable innovation; the process
Abstract by which an organization systematically analyzes various indi-
cators of customer needs and industry trends and leverages these
Overview into cutting edge products and services that allow them to main-
tain their competitive edge and become leaders in the industry. In
Application other situations, reorganization may be the key to performance
improvement, and employees may be arranged into teams that
Terms & Concepts
can produce synergy and develop products or services that they
could not have done alone. Alternatively, the organization may
Bibliography
emphasize quality as a way to pull its workforce together and
Suggested Reading earn repeat sales from its customer base. The solutions to this
problem are as varied as the organizations that search for them.

Increasingly, among the solutions considered by many organiza-

tions are the options of outsourcing and offshoring. Outsourcing
Abstract is the practice of contracting work that could be performed by the
organization in-house to another company. This is typically done
Although the potentially lower costs of offshoring parts of an to reduce the costs related to putting in an infrastructure for the
organization's operations can be an attractive proposition, such stated function or process; to reduce hiring, selection, training,
a venture has associated risks, as well as opportunities. Man- and other human resources costs associated with having addi-
agement is the key to managing the risks and leveraging the tional employees on the payroll to do the new job; or because
opportunities in offshore operations. In addition to expatriate production or personnel costs are lower in the contract organiza-
managers who oversee the day-to-day functioning of offshore tion. Sometimes, this practice means that the work takes place
operation, it is also important to hire global managers who oper- on foreign soil where costs can be significantly lower. When this
ate across national lines. These individuals can help smooth the is done, the practice is called offshoring, and refers to any of the
entry of the organization into the new culture and help the orga- organization's activities that take place in another country. This
nization accommodate the needs of the host country. Working is a particularly attractive option when labor rates in a foreign
in a foreign culture under a different set of laws and regulations country are one-tenth of domestic labor rates, and the concomi-
brings with it new concerns in the host county. Offshore opera- tant employee credentials appear — at least on paper — to be the
tions can also exacerbate existing management concerns such same as those of the domestic workforce.
as security issues and quality control, or even bring new domes-
tic concerns including problems with public opinion. All such The process of globalization, however, is not without its draw-
considerations need to be taken into account as part of a cost/ backs. Even organizations whose operations are spread across
benefit tradeoff analysis before making the decision to globalize a single nation have learned that managing under such circum-
the organization. stances can be more of a challenge than if all the employees were
under one roof. Despite the proliferation of high tech methods of
communication such as satellite videoconferencing, encrypted
Overview e-mail, and electronic white boards, communication flow in
management at a distance is not nearly as good as in manage-
It is the goal of most businesses not only to survive but to thrive. ment by walking around. When the organization's workforce is
To support this goal, most businesses typically look for better global, however, this situation becomes even more complicated.
ways to reduce costs and increase income. Sometimes, this may Even if the employees in the foreign operation or branch speak

82
 ​​​Global Issues in Management​ 83

the same language as those in the organization's home country, if ments of the host country. To do this, special types of managers
it is not the primary language for the international workers, com- are required.
munication can be a tedious process. Nuances of idiom, dialect,
and vocabulary can be easily missed, resulting in misunder- Although good expatriate managers are essential for keeping
standings on a personal level and inefficient processes or even the international organization competitive within the global
customer dissatisfaction on a higher level. In addition, differ- marketplace, another level of manager is also necessary: the
ences in culture can color communications, subtly nuancing the global manager. These individuals are top managers who operate
text from the literal word. For example, in order to help others across national lines. Global managers need the ability to watch
save face, Japanese business persons may say one thing (e.g., "I trends both at home and abroad in order to proactively deal with
will give your proposal serious consideration") while displaying potential problems within the organization as well as to spot
body language that says just the opposite. Without understanding opportunities for the organization to increase its market share
these intricacies in cross-cultural communication, getting one's or take or maintain the leading edge in the industry. In addition,
message across can become more difficult than usual. global managers need to be closely attuned to the needs of the
customer, both in the home country and in the host country, so
Other differences in culture — including the basic shared that the potential gains resulting from offshored work are not
assumptions, beliefs, norms, and values consciously or uncon- offset by losses caused by decreased customer satisfaction. This
sciously held by the various national groups — can also affect ability to think and act both locally and globally requires a spe-
communication. In addition, such differences often result in cial kind of manager.
culture shock for expatriate managers (i.e., managers from the
home country who work in the host country) as a result of their The most common characteristic cited as a requirement for a
immersion in the foreign culture. This includes such symptoms good global manager is a "global mindset." This has been vari-
as homesickness, irritability, hostility toward local nationals, and ously defined as the ability to conceptualize complex geopolitical
ineffectiveness at work, all of which can negatively impact not and cultural forces and their impact on business; or the ability to
only the expatriate's effectiveness at work but his or her mental scan the world from a broad perspective, looking for unexpected
and physical health as well. Differences in the assumptions, opportunities to reach both organizational and personal goals
values, and other aspects of culture also means that differ- and objectives. However, political savvy alone is not enough.
ent management styles are often required in operations in host A good global manager must also have well-honed managerial
countries than are required at home. Not understanding the dif- skills. These include excellent leadership skills, the ability to
ferences resulting from issues of comparative management can build effective multicultural teams, and the ability to act as a
lead to managerial ineffectiveness, poor management-employee change agent — someone who guides an organization through a
relations, and decreased organizational effectiveness. change effort. To be effective in this role, global managers need
to have knowledge of how to conduct a change effort, an under-
Offshoring operations to different countries also means that one standing of the organization, and sufficient power to implement
must deal with different legal, political, and economic systems. change.
Any of these factors may restrict the way that the organization
is allowed to conduct business in the host country, and manage- The literature also suggests that global managers need to be
ment needs to understand these new parameters and learn how to visionaries, with the ability to observe trends and opportunities
work effectively within them. For example, in France, employ- around them and turn these into successful strategies to help the
ees are legally allowed to work up to a restricted maximum organization grow and be more successful. This ability includes
number of hours per week. On the other hand, the ability of the skillfully sorting relevant from irrelevant data, systematically
employer to fire employees is severely restricted. In European analyzing various indicators of customer needs and industry
Union (EU) countries, organizations are required to "inform and trends across countries, and leveraging these into cutting edge
consult" employees on an ongoing basis on various actions that products and services that allow the organization to maintain its
affect employees. Other issues such as minimum wage, maxi- competitive edge and become leaders in the industry.
mum work hours per week, and minimum number of holidays
can also vary from country to country. Global managers can be divided into three categories, all three
of which are necessary to resolve the complex and often contra-
Globalizing an organization, however, requires more than merely dictory problems that can arise within the global organization.
setup or contracting for cloned operations in another country. These are global business managers, country mangers, and func-
Global management needs to take into account the cultural, tional managers.
legal, and other constraints of the host country and develop or
adapt a local management style so that the employees in the host The global business manager acts as a strategist, architect, and
country can be successfully led and become productive mem- coordinator within the organization, bringing together its vari-
bers of the larger organizational family while still recognizing ous components and leveraging the strengths of each into a
the individual needs attendant with the cultural and legal require- successful overall organization. Global business managers are
constantly looking for opportunities and concomitant risks for
84 ​​​Global Issues in Management​

the organization in order to better position it within the market manage, and often offset any savings gained by outsourcing or
and increase its levels of performance and success. As opposed offshoring in the first place.
to top managers whose work is limited in scope to one coun-
try, global business managers look for opportunity wherever it Another major concern faced by managers of global organiza-
may be found, even when it is across functional or national lines. tions is the problem of quality assurance and maintaining the
Global business managers work toward coordinating and linking same standards in a host country that one has in the home coun-
capabilities across these artificial barriers in order to fully cap- try. Whether the work is outsourced to a foreign contractor or
ture the benefit of running an integrated global operation. done in-house at a foreign operation, the same high standards
that are used to judge work in the home country should be
Another type of managerial specialist that the global organiza- applied to the work done at the offshore facility. If this is not
tion needs is the country manger. This person's role is to act as done, substandard products and increased costs to redo the work
sensor, builder, and contributor. The global country manager will offset the savings gained in having the function or process
ensures that the needs of the local customers in the host coun- done offshore. Policies and procedures need to be specified up
try are met and that any legal requirements in the host country front, as do the standards to which work is to be done. Further,
or locality are satisfied. In addition, the global country manager good communication between the offshore workers, between
defends the organization's market position against local competi- the workers and their managers, and between the managers and
tors. corporate headquarters is essential. Good communication is also
essential for shaping the workers at the offshore facility into a
The third type of global manager that is essential for successful high functioning team that works well together and contributes
global operations is the global functional manager. This person to the effectiveness and success of the organization.
acts as a champion for the organization function and a cross-
pollinator with other functions. Part of the global functional Maintaining high levels of customer satisfaction is another
manager's tasks are to build an organization that learns from its important issue in managing the global organization. If quality
experience — both successes and failures — and to leverage assurance levels are not high, the number of defects can rise or
this knowledge into the creation of innovation in order to stay the quality of service can decrease. If this situation reaches the
on the leading edge of the industry. To do this, the global func- threshold where it is noticeable by the consumer, it can nega-
tional manager seeks specialized information and best practices tively impact customer satisfaction as well as the likelihood of
from both domestic and foreign sources in order to bolster the the customer continuing to use the organization's product or
organization in its pursuit of excellence. The global functional service. In many cases — particularly with high tech products —
manager also acts as a champion of innovation within the orga- the reputation of the organization depends not only on how well
nization, encouraging and nurturing the creativity of employees a product works, but how the organization responds to requests
and teams. for technical help or other customer service.

Application Although outsourcing call center activities to a country where

As discussed above, there are many general management con- labor costs are lower can be attractive, these savings are often
cerns that need to be taken into account before making the offset by other costs. Research has found that nearly 80 percent
decision to move or outsource part of the organization's operations of organizations who outsourced their customer service function
to another country. However, even if the right global and expatri- to an overseas facility failed to meet their cost savings projec-
ate managers are found, issues of culture shock and comparative tions. This fact is accounted for by various factors, including:
management resolved, and sufficient qualified employees found high costs associated with quick turnover of overseas employ-
in the host country, both corporate management, in general, and ees, the concomitant costs to hire and train replacements, and
the global and expatriate managers, specifically, are left with the loss of customers due to their dissatisfaction with the ser-
other concerns that could negatively impact the foreign opera- vice they receive. In fact, research findings show that up to 60
tions. percent of organizations that outsource a portion of their cus-
tomer service capabilities will lose customers as well as incur
One major issue for management is security in the overseas opera- additional costs.
tion. This includes the confidentiality of proprietary information,
processes, and products. These issues can be better controlled if This situation is associated with another problem that must be
management is on site, but in completely outsourced operations, dealt with by management in global organizations: public per-
this can be a difficult task indeed. Since the potential loss of rev- ception. Sending jobs overseas typically results in a loss of jobs
enue, market share, and customer confidence resulting from lost and layoffs in the home country. This fact, combined with the
data can have disastrous impacts on a company, it is important potential for increased customer dissatisfaction, can severely
that the organization remain in possession of sensitive mate- damage an organization's reputation for quality and service.
rial even if that means the task cannot be outsourced. There are Loss of jobs not only affects public opinion: It can also affect
some ways that an organization can protect itself from potential the employees' satisfaction on the job as well as their perfor-
security breaches, but these tend to be expensive and difficult to mance. Also, it must be remembered that layoffs can be a costly
 ​​​Global Issues in Management​ 85

affair. Severance packages for those who leave as well as reten- Host Country: A foreign country in which an organization has
tion bonuses for employees who stay during the transition to set up an offshored branch or operation or in which it has con-
offshore operations can cause costs to escalate. If these costs tracted for outsourced work to be performed.
cannot be recouped by offshoring, the move will have been in
vain. Management: The process of efficiently and effectively accom-
plishing work through the coordination and supervision of others.
Offshoring parts of an organization's operations has the potential
to reduce costs. However, managing functions that are dispersed Management by Walking Around (MBWA): The practice in
not only across miles but across nations can make this a very which top management of the organization get out of the office
tricky proposition. To make it work, managers need to be on-site and talk directly to their employees. This practice helps manag-
to supervise the day-to-day operations of the offshore operation ers better understand the needs and concerns of the employees,
as well as to deal with local laws and regulations, make sure that reduces the filtering of the data, gives them quicker access to the
the new employees transition smoothly into the organizational data, and improves communication flow throughout the organi-
culture, and that the organization accommodates the special zation.
needs of the culture in the host country. In addition, managers
need to be alert to the opportunities of working in a global econ- Management Style: The way in which a manager supervises his
omy as well as the associated risks. The opportunities should be or her employees. Different management styles (e.g., coercive,
leveraged by a good global manager into new opportunities that permissive, persuasive) are appropriate depending on the ability
bring personal and organizational success. The risks — including and needs of the workers, the situation in which they are work-
problems with security, quality assurance, customer satisfaction, ing, and the personality of the manager.
and public relations — need to be managed and minimized.
Before making the decision to offshore some of the organiza- Market Share: The proportion of total sales of a given type of
tion's operations, corporate managers need to carefully consider product or service that are earned by a particular business or
all these and other advantages and disadvantages in a cost/ben- organization.
efit tradeoff analysis to determine whether or not the potential
gains of offshoring outweigh the potential costs. Offshoring: The practice of relocating part of an organization's
business to another country with lower costs. Off-shore work is
performed by local employees in the new country and was previ-
Terms & Concepts ously performed by domestic employees.

Comparative Management: The study of management practices Organizational Culture: The set of basic shared assumptions,
in different countries. values, and beliefs that affect the way employees act within an
organization.
Culture: The basic shared assumptions, beliefs, norms, and
values held by a group of people. These may be either con- Outsourcing: Work that could be done by an organization that
sciously or unconsciously held. is instead performed by another company on a contract basis.
Outsourcing can include support (e.g., cleaning and janitorial
Culture Shock: The psychological toll experienced by expatri- services), production (e.g., the manufacture of parts needed to
ates after approximately four to six months of living in another make a product), or services (e.g., customer service provided by
country. Symptoms of culture shock include homesickness, irri- a contract organization).
tability, hostility toward local nationals, and ineffectiveness at
work. Risk: The quantifiable probability that a financial investment's
actual return will be lower than expected. Higher risks mean
Expatriate: A person who is not a citizen of the country in which both a greater probability of loss and a possibility of greater
he or she is working. return on investment.

Global Manager: A top manager who operates across national

lines. Bibliography
Globalization: Globalization is the process of businesses or Dabic, M., & Zorko, I. (2011). Insights into the transforma-
technologies spreading across the world. This creates an inter- tion of multinational managers into global managers.
connected, global marketplace operating outside constraints of International Journal of Human Resources Development
time zone or national boundary. Although globalization means & Management, 11(2–4), 257–273. Retrieved November
an expanded marketplace, products are typically adapted to fit 21, 2013, from EBSCO Online Database Business Source
the specific needs of each locality or culture to which they are Complete. http://search.ebscohost.com/login.aspx?direct=t
marketed. rue&db=bth&AN=63543143
86 ​​​Global Issues in Management​

Grosse, C. (2011). Global managers’ perceptions of cultural Suggested Reading

competence. Business Horizons, 54(4), 307–314. Retrieved
November 21, 2013, from EBSCO Online Database Kanter, R. (1991). Globalism/localism: A new human
Business Source Complete. http://search.ebscohost.com/ resources agenda. Harvard Business Review, 69(2), 9–10.
login.aspx?direct=true&db=bth&AN=66694710 Retrieved April 27, 2007, from EBSCO Online Database
Business Source Complete. http://search.ebscohost.com/
Harvey, M., Novicevic, M., Leonard, N., & Payne, D. (2007). login.aspx?direct=true&db=bth&AN=9888387&site=bsi-
The role of curiosity in global managers' decision-making. live
Journal of Leadership & Organizational Studies, 13(3),
43–58. Retrieved April 27, 2007, from EBSCO Online Lambert, Z. V. (1980). Consumer alienation, general dissatis-
Database Business Source Complete. http://search.ebsco- faction, and consumerism issues: Conceptual and mana-
host.com/login.aspx?direct=true&db=bth&AN=24402027 gerial perspectives. Journal of Retailing, 56(2), p3–24.
&site=bsi-live Retrieved April 27, 2007, from EBSCO Online Database
Business Source Complete. http://search.ebscohost.com/
Kakumanu, P., & Portanova, A. (2006). Outsourcing: Its login.aspx?direct=true&db=bth&AN=4668793&site=bsi-
benefits, drawbacks and other related issues. Journal of live
American Academy of Business, 9(2), 1–7. Retrieved April
27, 2007, from EBSCO Online Database Business Source Mihalache, O. R., Jansen, J. P., Van Den Bosch, F. J., &
Complete. http://search.ebscohost.com/login.aspx?direct=t Volberda, H. W. (2012). Offshoring and firm innovation:
rue&db=bth&AN=22994812&site=bsi-live The moderating role of top management team attributes.
Strategic Management Journal, 33(13), 1480–1498.
Okoro, E. (2012). Cross-cultural etiquette and communica- Retrieved November 21, 2013, from EBSCO Online
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for managing corporate expansion. International Journal host.com/login.aspx?direct=true&db=bth&AN=82616054
of Business & Management, 7(16), 130–138. Retrieved
November 21, 2013, from EBSCO Online Database Ramaseshan, B., Bejou, D., Jain, S. C., Mason, C., & Pancras,
Business Source Complete. http://search.ebscohost.com/ J. (2006). Issues and perspectives in global customer rela-
login.aspx?direct=true&db=bth&AN=79243470 tionship management. Journal of Service Research, 9(2),
195–207. Retrieved April 27, 2007, from EBSCO Online
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rue&db=bth&AN=5526200&site=bsi-live

Essay by Ruth A. Wienclaw, Ph.D.

Dr. Wienclaw holds a doctorate in industrial/organizational psychology with a specialization in organization development from the Uni-
versity of Memphis. She is the owner of a small business that works with organizations in both the public and private sectors, consulting
on matters of strategic planning, training, and human/systems integration.
Global Outsourcing

tions from developed nations like the U.S. to developing nations

Table of Contents
began in the 1950s. Today, technological advances have acceler-
ated the ability of firms to procure and source products across
Abstract the globe. Commonly outsourced functions include informa-
Overview tion technology tasks such as microchip development as well as
many business services such as finance and accounting, human
Growth of Outsourcing resources, and customer support centers. Global outsourcing
Outsourcing Strategies has had a tremendous impact on how companies do business.
This article examines the evolution of global outsourcing and its
The Outsource Model effect on business and labor.
The Captive Model
Applications Overview
Considerations
The concept of outsourcing began when large companies decided
Risk to eliminate routine work that could be performed by third par-
Cost ties at a lower cost. Initially, many businesses started outsourcing
everything but core business activities to other companies within
Market Opportunity the same national boundaries. But as the global economy started
Outsourcing & the Information Technology to evolve, businesses in developing countries began offering ser-
Industry vices to perform functions that companies had been outsourcing
domestically. Transferring an organization's internal functions
Policy Adjustments to a foreign country is known as Global Outsourcing, while the
Proliferation of Technological Advancement entities that are set up to perform these functions are part of
what's called offshoring.
Development of the Global Marketplace
Growth of Outsourcing
Viewpoints
Outsourcing continues to be a rapidly growing segment of the
Comparative Advantage global economy, with spending surpassing the $5 trillion mark.
It is estimated that more than 3 million jobs and approximately
Global Economic Growth
$135 billion in wages will be outsourced abroad over the next
Terms & Concepts 7 years (Clott, 2004). Global outsourcing encompasses a vari-
ety of transactions including those focusing on both goods and
Bibliography services. A U.S. firm, for example, can outsource the produc-
Suggested Reading tion of goods, such as car parts, as well as services, including
customer service positions. Companies that rely on outsourcing
benefit from reduced labor costs and increased profits while the
foreign countries that acquire outsourced jobs are enticed by the
economic advancement. Another benefit to global outsourcing is
Abstract that a company is able to focus more on its core responsibilities
by transferring non-critical operations to a company that is better
This article discusses Global Outsourcing, the transfer of an equipped to handle them. By outsourcing ancillary functions,
organization's internal functions to a foreign country in search of businesses deliver products and services to the market more effi-
skilled labor at a lower cost. The transfer of manufacturing func- ciently, thus enhancing their profits (Clott, 2004).

87
88 ​​​Global Outsourcing​

Outsourcing Strategies Risk

Generally, there are two basic models used in outsource strate- Some of the risks involved in outsourcing are geopolitical and
gies: The outsource model and the captive model. economic. In certain "hot spot" areas where there is a great deal
of conflict and political turmoil, transferring functions to these
The Outsource Model regions can pose a threat to the health and safety of the employ-
Within the outsource model, functions are transferred overseas ees as well as the economic well being of the organization
and performed mostly by third-party providers. There are two (Minevich, 2005). The terrorist attacks on certain subsidiaries
subgroups within the outsource model: Information technology of oil companies and service providers in Saudi Arabia is evi-
outsourcing and business process outsourcing. dence of the geopolitical risks just as the nationalization of the
oil industry in Venezuela is evidence of economic risk. Other
• Information technology outsourcing, or ITO, is the trans- risk factors that a business must consider are quality of service,
fer of the development and processing of information
loss of operations control and security of data and stored infor-
technology systems such as help desk functions, systems
mation (Sinnett, 2006).
administration, network management and web develop-
ment. Cost
• Business process outsourcing, or BPO, is the transfer In addition to understanding the risks associated with a particu-
of the management and processes of certain business lar outsource market, organizations must also consider the cost
operations like accounting, human resource functions (in of outsourcing and must be familiar with foreign wage struc-
particular payroll processing and health benefits manage- tures. To be sure, there are skilled workers in many areas of the
ment), and customer service call centers (Sen, 2005). world who are willing to work for lower wages than workers in
the U.S., but as companies tap into these markets, competition
ITO transfers do not require an organization to establish a pres- eventually results in turnover as workers in those markets seek
ence in a foreign country since third-party providers normally higher wages. Other costs include infrastructure costs, taxes and
perform these functions. BPO transfers, however, sometimes regulatory fees. Finally, a company needs to determine market
require a company to establish an overseas subsidiary in order to opportunity and identify those countries that provide workers
control the functions being transferred. In addition to establish- in their particular industry. A skilled workforce and established
ing a foreign subsidiary, some companies may opt to invest in an infrastructure will allow a company to expediently bring products
overseas company to which functions are being transferred. An and services to a market without sacrificing quality. Conversely,
investment of 10% or more in a foreign enterprise is considered a company needs to also be ready to cease the operation in the
direct foreign investment (Sen, 2005). event that the demand for the outsourced product or service
declines (Minevich, 2006).
The Captive Model
BPO and direct foreign investments form the basis for yet another Market Opportunity
method — the captive model. Under this model, the outsourcing Before entering a global outsourcing market a business needs to
company establishes a foreign subsidiary, bypassing reliance on determine what types of products and services are best suited for
a third party. Under this model, a company maintains control of outsourcing. When global outsourcing first came into play, the
the operations being transferred, as well as the hiring process production of labor-intensive products and manufactured goods
and management of the workers performing the work. Because was transferred abroad. At the time, labor-intensive products
there is less risk for a company to establish a foreign subsidiary, and manufactured goods were some of the only products that
a larger percentage of global outsourcing occurs following this could be produced more efficiently in other countries. However,
method (Sinnett, 2006). as time went on, advancements in the overseas economies and
technologies made it possible to outsource products and services
Global outsourcing has also caused a ripple effect on labor mar- that required more advanced technology and know-how. This
kets throughout the world. As jobs shift overseas, permanent constant shifting and advancement allows for the creation and
jobs disappear, giving way to an increase in part-time, temporary emergence of other outsource markets that specialize in different
and freelance workers. types of production. For example, consumer goods and textile
manufacturing were some of the first products to be outsourced
to China. However, as that market matured and economic devel-
Applications opment expanded, China as well as other Asian markets became
outsource locations for products and services that required more
Considerations advanced technology. In particular, electronic components, tele-
When a business decides to enter the global outsourcing market, communications equipment, microchips, and computer boards
there are a number of factors that contribute to that decision. were produced in China, Taiwan and Hong Kong. This left the
These include, but are not limited to: Risk, cost, and market textile and other labor-heavy markets for other countries where
opportunity. such products could be produced in a similarly efficient manner.
 ​​​Global Outsourcing​ 89

Outsourcing & the Information Technology Industry ness process outsourcing (BPO) is currently the most rapidly
The industry that has been most affected by global outsourc- evolving model in the global outsourcing markets (Clott, 2004).
ing has been information technology. India has become a leader
in this area because as demand for technology and its inherent Initially, the types of jobs or business processes that were
complexities and costs grew, so did India's ability to provide outsourced under this system were so-called "back office opera-
low-cost, but capable assistance. During the 1990s, many U.S. tions." These operations include payroll, accounts payable and
corporations began to increasingly rely on data storage and receivable as well as accounting for financial services compa-
retrieval systems and this increased the demand for IT special- nies, insurance companies and property management firms. As
ists that were capable of implementing and monitoring these these operations were outsourced, workers in the source markets
systems. Eventually, the demand for these specialists exceeded became more sophisticated and well trained, leading to further
the supply, and many firms sought out contract workers, consult- expansion of outsourced services. Initially, outsourced services
ing firms and specialists throughout the world. Initially, many included data entry, processing and customer service call center
of these companies brought workers to the U.S. to work in their support. In particular, many credit card companies and large con-
domestic information technology and engineering divisions. But sumer finance enterprises transferred their call centers abroad.
over a period of time the number of skilled workers in foreign Today, more complex tasks such as credit card collections, ben-
countries grew in conjunction with the establishment of offshor- efits administration, and insurance-claims processing are being
ing businesses and companies became more comfortable with outsourced by U.S. businesses (Clott, 2004).
using third parties abroad (Clott, 2004).
Development of the Global Marketplace
Policy Adjustments Although outsourcing has become an inevitable process for
In response to outsourcing, the U.S. government made adjust- multinational businesses to effectively compete in the global
ments to its policies on temporary work visas for immigrants. marketplace, the rapid evolution makes it difficult to determine
The goal of this policy was to assist businesses in meeting what effect increased globalization will have on business and
the demand for skilled workers. As more visas were issued, a labor because sufficient data is not currently available. Despite
greater number of workers were brought to America. Many of this lack of information, the changing nature of the global labor
these workers came from India, because of its large pools of market does have significant implications for companies, work-
engineering and IT graduates who had the advanced technical ers and countries and there are some general conclusions that
skills, English language skills and the willingness to work for can be drawn. First, global outsourcing will continue to create
lower wages than their American peers. At the same time, India a fluctuating worldwide labor market. Further, wage rates for
had begun deregulating and modernizing its economy and this some functions will be increased in low wage countries while
spurred investment in its domestic telecom and computer indus- wage-earners in wealthy nations like the U.S., Great Britain
tries. The combination of these events facilitated the growth and Germany will find themselves competing with workers in
of the information technology industry and its proliferation developing countries. Finally, supply and demand for skilled
throughout the world markets during the 1990s (Clott, 2004). workers in outsource markets is not efficiently matched. In some
emerging outsource markets, the demand for available workers
Proliferation of Technological Advancement exceeds the supply while in well established outsource markets
This development eventually triggered further technological the opposite holds true (Farrell, 2005).
advances that transformed the nature of goods and services
that could be sourced throughout the world. Because of vast One reason for the inefficiencies in the global outsource markets
improvements in telecommunications, many services that were is the concentration of outsourced functions to a limited number
considered non-tradable were transformed into services that of countries. By focusing on a few regions, many businesses
were capable of being delivered electronically around the globe have made investments that have limited their ability to establish
(Blinder, 2006). The confluence of these factors helped India to themselves in other emerging markets. One possible result of
emerge as a leader in the outsource market for ITO and later this concentration will be that the demand for skilled labor will
on BPO. Initially, jobs outsourced to India included data entry be greater than the supply and this will force wages to rise. Of
and minor software development; however, these roles expanded course, wages in these lower wage cost regions will not match
into larger software projects, and even to running information wage rates in wealthy nations like the U.S. However, increased
technology departments for many organizations. Today, approxi- wage pressures will have an effect on a company's profitability
mately 30% of transferred jobs are outsourced to India (Dolan, (Farrell, 2005).
2006).
In response to the concentration of global outsource markets in
While information technology has been greatly transformed particular countries, there is another emerging trend in global
by global outsourcing, technological advances have also made outsourcing. As mentioned above, India has been a leader in the
it possible to have workers produce a variety of services from global outsourcing market. Today, in addition to jobs being trans-
almost anywhere in the world. Because of these advances, busi- ferred to India, jobs are also being sourced from India to other
90 ​​​Global Outsourcing​

countries. Many staffing agencies based in India are establishing Global Economic Growth
offices in other countries where global outsourcing markets are One result of continued outsourcing will be the expansion of
emerging. global economic growth and this has the potential to raise the
standard of living in certain countries. Multinational businesses
In addition to this secondary outsourcing of jobs by India, will derive benefits by continuing to rely on ITO and BPO which
other markets are emerging throughout the world. In North will ultimately lower the cost of doing business and increase
America, jobs from the U.S. have been transferred to Canada organizational productivity as goods and services are delivered to
and Mexico, partially the result of the North American Free the global markets more efficiently. At the same time, outsourc-
Trade Agreement of 1994. In Central and South America, out- ing poses challenges and risks for both wealthy and developing
sourcing markets are rapidly developing in Costa Rica, Chile, nations and there are labor and ethical issues that must be con-
and Brazil. Canada is an attractive outsource market for Infor- sidered. As businesses in wealthy nations continue to seek lower
mation Technology because the country has a highly skilled wage markets, the availability of skilled labor markets in these
workforce capable of research and development, while Mexico outsource markets may not meet demand and this will result in
is a destination for high volume, low level IT projects. The a larger wage gap between skilled and unskilled workers (Clott,
production of textile goods has contributed to the expansion of 2004).
outsource markets in Chile, while Brazil has a large labor pool
with solid technological skills. In Europe, outsourcing markets Further, the wage rates in wealthy nations will be suppressed
for IT are emerging in the Czech Republic, Hungary, Ireland, because workers are competing with others in foreign nations
and Romania. Regardless of the specific methods that busi- who are willing to work at a lower rate. Also, in order to remain
nesses employ in order to compete in the global marketplace, competitive many workers in wealthy nations are now perform-
global outsourcing will continue as companies seek skilled ing functions on a part time or contract basis. This has resulted
workers at lower wages as well as new markets for their goods, in a loss of job stability as well as traditional benefits such as
products and services (Dolan 2006). health insurance. In addition to the challenges facing workers,
businesses must also be able to respond to the challenges of
globalization by changing the way that they are structured. Busi-
Viewpoints nesses that are not able to make innovative changes to the way
they provide services and develop new products and services
Global outsourcing can be viewed as a natural progression from will not survive (Clott, 2004).
the increased connectivity of the world's economies, fostered by
the expansion of free trade and technological advances. While These challenges will require society to adapt. The U.S., for
there are proponents as well as critics, outsourcing of various example, currently enjoys a comparative advantage in knowl-
functions will accelerate as the nature of work evolves. Essen- edge-based jobs due to its well-established health and education
tially, more knowledge-based jobs will be subject to outsourcing. services, professional and business services and leisure and hos-
Information and knowledge are now the key assets of production pitality services. However, the U.S. will need to reorganize its
in the world markets. As information becomes readily trans- workforce in order to maintain this advantage. These transforma-
ferred via the global workforce, knowledge and expertise can tions, in turn, will require changes in the country's educational
be transported instantaneously around the world. In light of this system in order to prepare workers for jobs that are available
transformation, a business can most effectively command com- within the country (Blinder, 2006). Another possible develop-
parative advantage through an ability to combine market and ment is a retreat from the free trade agreements that have been
technological know-how with the creative talents of knowledge implemented over the last 50 years in an attempt by countries to
workers, such as those in the life sciences, logistics, and infor- maintain their position in the global markets and retain jobs by
mation technology (Clott, 2004). implementing protective tariffs (Clott, 2004).

Comparative Advantage In the end, global outsourcing will continue to be a method

Comparative advantage is a fundamental economic theory that employed by multinational businesses in order to remain com-
explains why it is beneficial for two parties — whether they are petitive in the world economy. The question remains as to how
countries, regions or businesses, to trade their goods and ser- ready business, society and governments are to respond to the
vices. A key factor in determining comparative advantage is how challenges of the globalization of the world's economies.
readily the two regions can produce different goods that will
subsequently be traded. If the U.S. can produce certain goods or
services at lower cost than a foreign country, and if the foreign Terms & Concepts
country can produce other goods and services at a lower cost
than the U.S., both countries may gain from trading each other's Business Process Outsourcing: The transfer of a business pro-
relatively inexpensively produced goods and services (Blinder, cess to a foreign third party provider that is guided by a set of
2006). performance standards determined by the outsourcing entity.
 ​​​Global Outsourcing​ 91

Captive Model: The model of outsourcing that involves an over- Online Database Business Source Premier. http://search.
seas business operation that is directly owned by the outsourcing ebscohost.com/login.aspx?direct=true&db=buh&AN=158
entity and that does not involve a third party. 35672&site=ehost-live

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ness individual and unique in delivering a product, good or Critical Factors in Human Resource Outsourcing.
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N=91732315&site=ehost-live
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that can be performed by a firm in another country. Outsourcing Clott, C.B. (2004). Perspectives on global outsourcing and the
involves shared management and control; a cooperation between changing nature of work. Business and Society Review,
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Dolan, K. A. (2006). Offshoring the offshorers. Forbes, 177(8),
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efficiency and to focus on core responsibilities. N=17937032&site=ehost-live

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e&db=buh&AN=20499174&site=ehost-live Retrieved on February 21, 2007, from EBSCO Online
Database Business Source Premier. http://search.ebsco-
host.com/login.aspx?direct=true&db=buh&AN=16744259
Suggested Reading &site=ehost-live

Bean, M. & Meyer, M. (2005). Career strategies for the age of Schwartz, E. (2006). Salesforce goes to India. Infoworld,
global outsourcing. Certification Magazine, 7(2) 16-44. 28(51), 11. Retrieved January 22, 2007, from EBSCO
Retrieved on February 21, 2007, from EBSCO Online Online Database Business Source Premier. http://search.
Database Business Source Premier. http://search.ebsco- ebscohost.com/login.aspx?direct=true&db=buh&AN=235
host.com/login.aspx?direct=true&db=buh&AN=15692584 42996&site=ehost-live
&site=ehost-live

Edited by Richa S. Tiwary, Ph.D., MLS

Dr. Richa S. Tiwary holds a Doctorate in Marketing Management with a specialization in Consumer Behavior from Banaras Hindu Uni-
versity, India. She earned her second Masters in Library Sciences with dual concentration in Information Science & Technology, and,
Library Information Services, from the Department of Information Studies, University at Albany-SUNY.
Offshoring

remotely and that do not require one to one interaction. In decid-

Table of Contents
ing whether to offshore service sector jobs, businesses must
consider a number of factors including cost, turnover rates, risk,
Abstract infrastructure and the availability of qualified personnel. The fol-
lowing article provides an overview of offshoring and discuss
Overview some of the implications for the U.S. labor force.
Benefits of Offshoring
Considerations for the Offshoring Overview
of Operations
India as a Leading Offshoring Sight The integration of the world's economies has led to an increase in
offshoring; the transfer of jobs from wealthy nations to develop-
Applications ing nations. In previous decades, offshoring was limited to the
manufacturing sector; however in recent years, service sector
Transfer from Manufacturing towards the jobs like customer service jobs and call center activity have also
Service Industry been sent abroad. In order to better understand this development,
Comparative Advantage it is necessary to differentiate offshoring from outsourcing. Off-
shoring essentially concerns a variety of functions that can be
Results of Improving Technologies performed by a firm in another country. This includes a company
that establishes a foreign subsidiary or a business that transfers
Viewpoints
these tasks to a foreign third party enterprise (Harrison, 2006).
Evolution of Free Trade & its Effect
on Offshoring Outsourcing, on the other hand, is the purchase of services by
one firm from another. A US firm, for example, can outsource
Challenges Faced by the United States the production of goods, such as car parts, as well as services,
such as customer service positions. In some cases, US-based
Terms & Concepts
manufacturers of electronics may contract with other US busi-
Bibliography nesses to produce electronic components. This is referred to as
outsourcing. At the same time, transferring production of these
Suggested Reading components to a manufacturer in China or India would be con-
sidered offshoring (Harrison, 2006).

Benefits of Offshoring
A firm that increases its profits by decreasing its labor costs
Abstract through offshoring will improve its ability to compete in the
global economy. In the US, firms that establish foreign subsid-
This article focuses on offshoring -the transfer of certain jobs iaries are referred to as multinationals. In addition to establishing
from the United States and other wealthy nations to develop- a subsidiary in a foreign country, a company may also choose to
ing nations. Offshoring has become a necessity in order for invest in a company that is not based in the United States. Fur-
multinational companies to reduce the cost of doing business ther, the ownership of 10 percent of a company abroad by a US
and maintain comparative advantage in the global marketplace. multinational is referred to as direct foreign investment. Some
Initially, manufacturing jobs were offshored; however, the contend that establishing foreign subsidiaries and direct foreign
jobs currently being transferred to developing nations are cer- investments results in job losses in the United States. However,
tain service sector jobs. These are jobs that can be performed many economists believe that the number and availability of jobs

93
94 ​​​Offshoring​

in an economy is determined more by macroeconomic factors for offshoring in a region or town that will grow in conjunction
than by international competition (Harrison, 2006). with their presence in the area. In the final analysis, offshoring
will continue to be a model for businesses in the global economy.
Other beneficiaries of offshoring are those nations where jobs Multinationals will continue to seek skilled workers at lower
have been transferred or where there has been an increase in wages as well as new markets for their goods, products and ser-
direct foreign investment. In particular, India, China, the Philip- vices (Dolan 2006).
pines and a number of Latin American and Eastern European
countries have reaped the rewards of offshoring. Further, in
addition to manufacturing jobs that were offshored in previous Applications
decades, service sector jobs are now also being offshored to
these countries including clerical positions, sales and marketing Transfer from Manufacturing towards the
jobs, accounting and financial services, engineering, and analyst Service Industry
positions (Farrel, 2006). While there are many benefits that multinational companies
can derive from transferring jobs to other developing nations,
Considerations for the Offshoring of Operations offshoring is a contentious topic in the United States and other
There are a number of factors that a business needs to consider wealthy nations. Some believe that offshoring has resulted in
when deciding where to offshore jobs and these include cost, significant job losses and that the labor standards in developing
turnover rate, available skilled workers, risk assessment, accessi- nations are lower than in wealthy nations. On the other hand,
bility, and infrastructure. While cost is a significant determinant there is another school of thought that claims increased employ-
in a businesses decision to transfer jobs abroad, location is also ment overseas has led to increased employment domestically.
critical to the future of a company's overseas investment. In this This is so because the cost savings provided by offshoring com-
regard, companies often focus on regions with good colleges bined with technological advances have increased productivity
where skilled employees are available at low wages. In addition, in all sectors and has also enhanced the growth of the services
companies also seek out locations that are close to airports so that sector. However, what is not in dispute is the fact that the Ameri-
personnel from outlying areas can be flown in for training. This, can economy and the economies of other wealthy nations like
in turn, leads to the development of the infrastructure (i.e., power Great Britain, Japan, and many Western European nations have
supply, real estate development, telecommunications and trans- been undergoing a dramatic change away from manufacturing
portation) and further encourages other companies to offshore toward servicing (Blinder, 2006).
jobs. This is so because these companies will derive residual
benefits of offshoring that result from developing an infrastruc- Rather than producing manufactured goods such as automobiles,
ture and establishing a pool of skilled workers. Development of durable appliances, and mechanical equipment, these countries
infrastructure also mitigates the risk of future involvement as it now provide more services such as health services, educational
elevates these regions out of poverty and helps to stabilize the services, hospitality and leisure services, financial services and
government (Farrel, 2006). the like. These jobs are known as personal service jobs. This is
so because personal services are those that require face-to-face
India as a Leading Offshoring Sight contact or human interaction. At the same time, technological
While a number of foreign countries have been the beneficiaries advances are also leading to improvements in global commu-
of outsourcing, India has become a leader in the international off- nications and many personal services are now readily delivered
shore market. This is largely the result of the fact that India has a electronically over long distances without adversely affecting the
well-educated and highly skilled workforce — moreover, many quality of the service being provided. These services are termed
workers in India speak fluent English. Initially, jobs offshored impersonal services and include such jobs as customer service
to India included data entry and minor software development; positions as well as radiologists. Further, international trade of
however, by the 1990s, these roles expanded into larger software new products and services can be the impetus for improvements
projects, back office operations such as accounting, and even in productivity, and this will have an impact on a company's
running information technology departments for many organiza- comparative advantage (Blinder, 2006).
tions. India's workforce tends to be skilled and refined so that its
current services include engineering, research and development, Comparative Advantage
aircraft design, as well as microchip development (Dolan, 2006). Comparative advantage is a fundamental economic theory that
explains why it is beneficial for two parties — whether they are
In addition to jobs being transferred to India, jobs are also being countries, regions or businesses, to trade their goods and ser-
offshored from India to other countries. Many staffing agencies vices. A key factor in determining comparative advantage is how
based in India are establishing offices in other countries where readily the two regions can produce different goods that will sub-
offshore markets are emerging. Outsourcing work to an orga- sequently be traded. The concept of comparative advantage is
nization that subsequently outsources the work to a company the basis for a business or region to choose a good or service to
in another country is referred to as the global delivery model. specialize in producing. If the US can produce certain goods or
Understanding this model enables a company to seek locations services at lower cost than a foreign country, and if the foreign
 ​​​Offshoring​ 95

country can produce other goods and services at a lower cost tries have historically had more robust entitlement programs.
than the United States both countries may gain from trading each At the same time, these programs are expensive and the ques-
others' relatively inexpensively produced goods and services tion remains as to whether those nations will be able to afford
(Blinder, 2006). additional social programs (Blinder, 2006). While there are chal-
lenges facing the U.S. and other wealthy nations, the practice of
For example, Great Britain once held a comparative advantage transferring jobs to developing nations will continue as multina-
in the manufacturing of textiles, but that advantage eventually tional companies seek skilled workers and new markets.
shifted to New England, and with that, jobs were transferred to
the United States. However, China and other low wage countries In addition, offshoring has been concentrated in a few regions
now enjoy a comparative advantage in textile manufacturing, of countries where jobs have been transferred. Because of this
and jobs that were once considered "American" have been off- concentration, wages have been escalated and there is a high
shored to these countries. Further, technological innovations that turnover rate as employees move from one offshored job to
have arisen in the information age have had a significant impact another. Therefore, the determination of where to transfer jobs
on comparative advantage and in determining which goods and is no longer driven by solely by wages. Today, businesses also
services can be traded internationally. Traditionally, any manu- need to consider wage inflation trends, future labor supplies
factured good was considered tradable. Manufactured goods are and recruitment costs (Farrell, 2006). Companies seeking to
goods that have been processed in any way, and these include offshore jobs will require access to suitable workers or profes-
intermediate and industrial goods as well as final goods. On the sionals. These are individuals who are university graduates, have
other hand, anything such as services or real estate was thought a number of years of experience, language skills, and technical
of as non-tradable (Blinder, 2006). knowledge.

Results of Improving Technologies Moreover, these individuals will need to be capable of interact-
Because of the digitalization of information and vast improve- ing in a corporate environment. In this regard, the availability
ments in telecommunications, however, many services that were of suitable workers varies widely from country to country, and
considered non-tradable can now be delivered electronically a country that has a large and accessible pool of suitable work-
around the globe. This is especially relevant for customer ser- ers will enjoy a comparative advantage in attracting offshored
vice, call service, technological and laboratory functions. The jobs. While India has been a primary location for offshoring,
continued shift toward personal services in wealthy nations will such countries as South Africa, Morocco, and countries in East-
require economic and social adjustments. One potential result of ern Europe are emerging as markets for outsourcing. Moreover,
this trend will be that more people seek positions in the personal as the world’s economies continue to integrate because of the
services, and this will cause the wages in these fields to decline. forces of globalization, offshoring will continue to be a reality. In
Also, wealthy nations will be required to reallocate workers addition, many multinational corporations are seeking to create
form one personal service field to another, and this will require 24/7 development cycles, gain access to new markets, and better
retraining of vast numbers of people (Blinder, 2006). proximity to new customers (Wadhwa, 2006).

The necessary adjustments that will be required of the wealthy

nations will put pressure on those societies to adapt. The United Viewpoints
States, for example, currently enjoys a comparative advantage in
non-tradable services due to its well-established health and edu- Evolution of Free Trade & its Effect on Offshoring
cation services, professional and business services and leisure The challenges that offshoring poses to wealthy nations like the
and hospitality services. However, the United States will need U.S. as well as developing nations are numerous. For the United
to reorganize its workforce in order to maintain this advantage. States, multinational companies will continue to outsource and
There could be changes that result in the country having more this will have a fundamental effect on the nation's economy as
divorce lawyers than contract lawyers, since the latter is the type well as the structure of its labor markets. As mentioned above,
of service that could be vulnerable to offshoring. In health ser- the United States has shifted away from a manufacturing-based
vices, while internists will still be needed, many companies have economy to a service-based economy. The initial transfer of
begun offshoring radiology positions. These transformations, in manufacturing jobs actually began decades ago and this trend
turn, will require changes in the country's educational system was accelerated by the evolution of free trade. This is particu-
in order to prepare workers for jobs that will continue to exist larly evidenced by the implementation of the North American
(Blinder, 2006). Free Trade Agreement (NAFTA) in the 1990s.

Further, as more impersonal services are offshored, there will NAFTA is a free trade agreement entered into among the United,
be a need for trade adjustment assistance in the form of social States, Canada and Mexico that essentially eliminated duties
safety nets such as unemployment compensation, job retraining, on various goods and products that were already being traded
pensions and public assistance. In this regard, the United States among these three nations. In short, NAFTA resulted in the
is not as prepared as nations in Western Europe since those coun- transfer of certain manufacturing jobs to Mexico (Field 2004).
96 ​​​Offshoring​

Another significant development in free trade was the relation- also one day be offshored. Another area where America enjoys
ship between the United States and China and the establishment a comparative advantage is in the financial services sector,
of the World Trade Organization in 1995. This organization but advances in technology may have an impact here as well
was established by the Uruguay Round of agreements under (Blinder, 2006).
the General Agreement on Tariffs and Trade. After China was
admitted into the WTO, there was an increase in trade between In the final analysis, offshoring will continue to evolve and as
China and the U.S. and a number of manufacturing jobs were it does it will present other challenges to the US economy. The
also outsourced by US-based multinationals to companies in educational system will need to focus on training workers for
China (Bury, 2004). jobs in the personal services sector. Moreover, other factors like
influx of workers from Mexico and Central America is present-
As these trends continue to develop, the US economy contin- ing challenges for US workers who have previously filled those
ues to transfer to a service-based economy that will increasingly roles because migrant workers are performing these functions
focus on personal services rather than impersonal services. At for lower wages. Finally, as the world's economies continue to
the same time, there will continue to be a need for low skilled integrate, there will be a need for people in the United States
workers, and this especially will be the case in the hospitality, to develop stronger foreign language skills. Many of the highly
construction and agriculture industries. This has and will con- skilled workers in India and China can speak English, and in
tinue to contribute to an influx of migrant workers to the United some of the emerging offshoring markets in Eastern Europe,
States from Mexico and Central America. (Quan, 2005). many of the highly skilled workers are fluent in a number of
languages. The question remains as to how well equipped our
Challenges Faced by the United States society is to meet these challenges.
As the economy has continued to evolve, the types of service
based jobs that will remain in the United States (and other
wealthy nations) will be personal service jobs that require face- Terms & Concepts
to-face contact. At the same time, more and more impersonal
service jobs, like customer service jobs, and medical and infor- Comparative Advantage: That strong suit which makes us indi-
mation technology will be transferred abroad. These trends vidual and unique; can be natural or man-made.
will affect wages in the United States. as labor is reallocated
(Farrel, 2006). Moreover, as technological advances continue, Direct Foreign Investment: An ownership interest of 10 per-
the types of service positions that can be offshored will continue cent by a domestic organization in the business of a company in
to change. In this regard, some economists have expressed con- another country.
cern that America's ability to compete, especially as it relates to
research and development, will be challenged. GATT: The General Agreement on Tariffs and Trade originally
entered into among many western nations in 1947 for the pur-
In order for America to maintain a competitive edge, it will need pose of eliminating barriers to world trader.
to keep critical research and development functions onshore.
For example, there will be a continued need for well educated Global Delivery Model: The concept of outsourcing work to an
engineers. China and India have a large supply of entry level organization that subsequently outsources the work to a com-
engineers, and many US-based multinationals will continue to pany in another country.
outsource engineering jobs to these countries. At the same time,
other companies are tapping into this talent pool by bringing Impersonal Services: Those that can be easily sent and received
people from India and China to work in information technol- electronically.
ogy divisions of US-based companies. However, American
workers do have certain advantages that can help to retain these Multinationals: A company that is headquartered in one coun-
highly skilled jobs. These advantages include their communica- try and that has established divisions of subsidiaries in a foreign
tion skills, understanding of the market, education and training country.
and creativity. In this regard, it can be said that having a highly
skilled work force along with these aforementioned qualities NAFTA: The North American Free Trade Agreement entered
gives America a comparative advantage with respect to personal into among the U.S., Canada and Mexico that eliminated trade
services sector jobs (Wadhwa, 2006). barriers and contributed to the outsourcing of manufacturing
jobs.
As it has been the case with other jobs, however, technologi-
cal advances may transform certain personal service jobs into Offshoring: The shifting of jobs from wealthy nations to devel-
impersonal service positions that can be delivered electronically oping nations.
throughout the world. For example, while radiology positions
have already been subjected to offshoring, other positions in the Outsourcing: The purchase of inputs or services by one business
healthcare services sector, such as medical lab technicians may from another.
 ​​​Offshoring​ 97

Personal Services: Services that require face-to- face contact or Jensen, P., & Pedersen, T. (2012). Offshoring and international
human interaction. competitiveness: Antecedents of offshoring advanced
tasks. Journal of the Academy of Marketing Science,
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seeing the agreements of the Uruguay Round of free trade talks. Massini, S., Perm-Ajchariyawong, N., & Lewin, A. Y. (2010).
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98 ​​​Offshoring​

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EBSCO Online Database Business Source Premier. http:// 42996&site=ehost-live

Edited by Richa S. Tiwary, PhD, MLS

Dr. Richa S. Tiwary holds a doctorate in Marketing Management with a specialization in consumer behavior from Banaras Hindu Uni-
versity, India. She earned her second masters degree in library sciences with dual concentration in information science & technology,
and library information services from the Department of Information Studies, University at Albany-SUNY.