global business environment (0–10%)

Global Business Environment (0–10%)

8.1 Economic/Financial EnvironmentsTopics such as organization structures, types of international strategies, international strategic and tactical objectives, technology and global strategy, and forms of international business and marketing strategies are presented in this section.

(a) Organization Structures

Th e organization structure of the multinational corporation (MNC) evolves over time due to changes in economic policies, tax laws, government regulations, and political structures. Th e organizational structure of the MNC varies; each manager’s level has a varied degree of author-ity and responsibility.

MNCs are fi rms with signifi cant foreign direct investment assets. Th ey are characterized by their ability to derive and transfer capital resources worldwide and to operate facilities of produc-tion and penetrate markets in more than one country, usually on a global scale. Over the past 30 years, many writers have argued over the best name to use in referring to these companies. “Multinational enterprise” (MNE) has been a popular term because it refl ects the fact that many global fi rms are not, technically speaking, “corporations.” Th e terms “transnational corporation” and “supranational corpora tion” are often used within the United Nations system, where many internationalists argue that the operations and interests of the modern corporation “transcend” national boundaries.

One signifi cant trend in business during the last half of the twentieth century has been the global-ization of MNCs. At one time, MNCs were simply large do mestic companies with foreign opera-tions. Today, they are global companies. Th ey typically make de cisions and enter strategic alliances with each other without regard to national boundaries. Th ey move factories, technology, and capital to those countries with the most hospitable laws, the lowest tax rates, the most qualifi ed

8.1 Economic/Financial Environments 1

8.2 Cultural/Political Environments 14

8.3 Legal and Economic Concepts 22

8.4 Impact of Government Legislation and Regulation on Business 30

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8-2 Wiley CIA Exam Review 2013: Part 3, Internal Audit Knowledge Elements

workforce, or abundant natural resources. Th ey see market share and company per formance in global terms. Foreign sales and operations are extremely profi table for many multination als.

Mueller and his co-authors1 suggest fi ve common forms of organizations used by MNCs:

1. International divi sion/department2. Organization by product line3. Functional organization4. Geographic organi zation5. Global matrix organization

(See Exhibit 8.1.)

EXHIBIT 8.1 Common Forms of MNC Organizations

Common forms of Organization by product line

International division/department

Functional organization

Geographic organization

Global matrix organization

MNC organizations

Th e international division/department separates foreign operations from domestic operations. Th is international division is usually evaluated as an independent operation and compared with the domestic division. Organization by product line results in the integration of domestic and foreign operations and the evaluation of product lines based on worldwide results.

A company grouped by function (such as marketing, manufacturing, or accounting) is called a functional organization, and management maintains centralized control over the functions. An example is that the vice president for marketing or manufacturing at U.S. headquarters would be responsible for the marketing or manufacturing function worldwide. Th is structure is not com-mon but is popular among oil and coal companies whose products are homogeneous.

Geographic organization separates operations into geographic areas such as North America, Europe, and Asia. A company would use this form of structure when it has substantial foreign opera tions that are not dominated by a particular country or area of the world. U.S. MNCs do not use this form as often as European and Japanese MNCs do because U.S. MNCs are usually dominated by their domestic markets.

Th e global matrix organization blends two or more of the four forms just presented. An example is that the general manager of a German subsidiary will report to the vice president for world-wide product lines and to the area vice president for Europe. Th e matrix organization avoids the problems inherent in either integrating or separating foreign operations.

1 Gerhard G. Mueller, Helen Morsicato Gernon, and Gary K. Meek, Accounting: An International Perspective, 3rd ed. (Burr Ridge, IL: Irwin, 1994).

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Global Business Environment (0–10%) 8-3

(i) Information Flows and Organization Structures of MNCsTh e following list provides guidelines for information fl ows and organization structures of MNCs.

◾ Within the international division or department, information fl ows from subsidiaries to the vice president of the international division.

◾ In MNCs organized by product line, information fl ows from subsidiaries to the vice presi-dent of the product line.

◾ In an MNC organized by function, information fl ows from subsidiary to headquarters according to specifi c business function (i.e., marketing, manufacturing, or accounting).

◾ When MNCs are geographically organized, the subsidiary information is collected within a geographic area and then sent to headquarters.

◾ With the matrix form, information fl ows in two directions: from the subsidiary to the geographic location headquarters and by product line to MNC headquarters.

(ii) Models of Multinational BusinessAnother dimension to the organization of MNCs is the atti tude of headquarters management toward multinational business. Th ese attitudes can be classifi ed into three models: ethnocentric (home-country oriented), polycentric (host-country oriented), and geocentric (world oriented) (see Exhibit 8.2).

EXHIBIT 8.2 Models of MNCs

Models of MNCsPolycentric (host-country oriented)

Ethnocentric (home-country oriented)

Geocentric (world oriented)

An ethnocentric management thinks that home-country standards are superior and therefore applies them worldwide. Automakers are an example of the ethnocentric management model. A polycentric management assumes that host-country cultures are diff erent and, therefore, allows local subsidiaries or affi liates to operate autonomously. Standards for performance evalu-ation and control functions are determined locally. Pharmaceutical companies are an example of the polycentric model.

A geocentric management focuses on worldwide objectives and considers foreign subsidiaries as part of a whole. Standards for performance evaluation and control functions are determined both universally and locally. It is an ideal model where decisions are considered globally while, at the same time, individual subsidiaries are able to respond to the demands of host governments and the local customer. People of many diff erent nationalities serve on the board of directors and senior management teams. N.V. Philips and Unilever are good examples of the geocentric management model. “Th ink globally and act locally” is the basic tenet of corporations that are geocentrically managed.

Th e “host country” refers to that nation in which an MNC establishes a subsidiary in a local country. Th e “home country” (parent country) refers to that nation in which an MNC establishes a subsidiary in a foreign country.

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Th e attitudes of headquarters management also aff ect the location of decision making. Basically, three types of decision making may result: centralized, decentralized, and semicentralized or semidecentralized (see Exhibit 8.3).

EXHIBIT 8.3 Types of MNC Decision Making

Decentralized

Centralized

Semicentralized or decentralized

Types of MNC

decision making

If decision-making authority rests with headquarters, an MNC is said to be centralized. Even with this structure, an MNC generally does not make all decisions at one location but aims for a collaborative approach between headquarters and other business units.

If an MNC headquarters allows foreign subsidiaries to make important decisions, the corpora-tion is considered to be decentralized. Th is structure is more common when global diversity is considered. Managers of foreign subsidiaries are allowed a great deal of autonomy to plan, control, and evaluate their own operations at the local level.

Not all MNCs are purely centralized or decentralized. Often a mixture of organizations is neces-sary. Semicentralized or semidecentralized decision making arises when an MNC centralizes functions considered critical for success (e.g., research and development [R&D]) and decentralizes those that are less critical (e.g., marketing, production).

(b) Types of International Strategies

International fi rms typically develop their core strategy for the home country fi rst. Subsequently, they internationalize their core strategy through international expansion of activities and through adaptation. Eventually, they globalize their strategy by integrating op erations across nations. Th ese steps translate into four distinct types of strategies applied by international enterprises: (1) ethnocentric, (2) multidomestic, (3) global, and (4) transnational.

(i) Ethnocentric StrategyFollowing World War II, U.S. enterprises operated mainly from an ethnocentric perspec-tive. These companies produced unique goods and services, which they offered primarily to the domestic market. The lack of international competition offset the need of these enterprises to be sensitive to cultural differences. When these firms exported goods, they did not alter them for foreign consumption—the costs of alterations for cultural differences were assumed by the foreign buyers. In effect, this type of company had one strategy for all markets.

(ii) Multidomestic StrategyTh e multidomestic fi rm has a diff erent strategy for each of its foreign markets. In this type of strategy, “a company’s management tries to operate eff ectively across a series of worldwide positions with diverse product requirements, growth rates, competitive environments, and political risks. Th e company prefers that local managers do what is necessary to succeed in

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R&D, production, marketing, and distribution, but holds them responsible for results.”2 In essence, this type of corporation competes with local competitors on a market-by-market basis.

(iii) Global StrategyTh e global corporation uses all of its resources against its competition in a very integrated fashion. All of its foreign subsidiaries and divisions are highly interdependent in both operations and strategy. Th erefore, whereas in a multidomestic strategy, the managers in each country react to competition without considering what is taking place in other countries, in a global strategy, competitive moves are integrated across nations. Th e same kind of move is made in diff erent countries at the same time or in a systematic fashion. For example, a competitor is at tacked in one nation in order to exhaust its resources for another country, or a competitive attack in one nation is countered in a diff erent country—in that instance, the counterattack in a competi tor’s home market is a parry to an attack on one’s home market.

Th e advantages of the global strategy would negate the disadvantages of the multidomestic strategy, and the disadvantages of the global strategy would be negated by the advantages of the multidomestic strategy.

ADVANTAGES AND DISADVANTAGES OF GLOBAL STRATEGY

Advantages(Multidomestic strategy does not provide these advantages.) ◾ By pooling production or other activities for two or more nations, a fi rm can increase the benefi ts

derived from economies of scale.

◾ A company can cut costs by moving manufacturing or other activities to low-cost countries.

◾ A fi rm that is able to switch production among diff erent nations can reduce costs by increasing its bargaining power over suppliers, workers, and host governments.

◾ By focusing on a smaller number of products and programs than those under a multidomestic strategy, a corporation is able to improve both product and program quality.

◾ Worldwide availability, serviceability, and recognition can increase preference through reinforcement.

◾ The company is provided with more points from which to attack and counterattack competition.

Disadvantages (Multidomestic strategy can reduce these disadvantages.)

◾ Through increased coordination, reporting requirements, and added staff , substantial management costs can be incurred.

◾ Overcentralization can harm local motivation and morale, thus reducing the fi rm’s eff ectiveness.

◾ Standardization can result in a product that does not totally satisfy any customers.

◾ Incurring costs and revenues in multiple countries increases currency risk.

◾ Integrated competitive moves can lead to the sacrifi cing of revenues, profi ts, or competitive positions in individual countries—especially when the subsidiary in one country is told to attack a global competitor in order to convey a signal or divert that competi tor’s resources from another nation.

2 Jack Craig, Multinational Cooperatives: An Alternative for World Development (Saskatoon, Saskatchewan, Canada: Western Producers Prairie Books, 1976).

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(iv) Transnational StrategyTh e transnational strategy provides for global coordination (like the global strategy) and, at the same time, it allows local autonomy (like the multidomestic strategy). Nestlé, the world’s largest food company, headquartered in Switzerland, follows this strategy. Th e challenges managers of transnational corporations face are to identify and exploit cross-border synergies and to balance local demands with the global vision for the corporation. Building an eff ective transnational organization requires a corporate culture that values global dissimilarities across cultures and markets.

KEY CONCEPTS TO REMEMBER: Profi le of Transnational Enterprises

◾ A transnational enterprise is an MNC doing business globally to take advantage of tax incentives and to develop collaborative relations with foreign trading fi rms. Dr. Jack Craig of Canada’s York Universitya summarized the evolution of transnational enterprises as follows: from ethnocentric to polycentric to geocentric, and from profi t-oriented and investor-oriented fi rms to joint ventures to mixed orientations.

◾ From ethnocentric with complex organization in the home country; centralized decision making in headquarters evaluation and control of performance based on the home-country standards; communication fl ow outward to subsidiaries in host countries that have simpler organizations; ownership and recruitment of key management largely of home nationality.

◾ To polycentric with varied and independent organization; less headquarters authority and decision making; evaluation and control determined locally; wide variations in performance management and standards depending on local cultures; limited communication to/from headquarters and among subsidiaries; ownership, key management, and recruitment from host country.

◾ To preferred geocentric with increasingly complex, interdependent organization; seeking a collaborative approach between and among headquarters/subsidiaries; uses standards for evaluation and control that are both universal and local; international and local executives rewarded for reaching both local and worldwide objectives; ownership, key management, and recruitment is cosmopolitan—to develop the best person anywhere is the major criterion.

◾ From profi t-oriented and investor-owned corporations with direct investments in foreign subsidiaries and joint ventures or consortia, to mixed orientations (government-owned to service-owned cooperatives).

a Jack Craig, Multinational Cooperatives: An Alternative for World Development (Saskatoon, Saskatchewan, Canada: Western Producers Prairie Books), 1976.

(c) International Strategic and Tactical Objectives

Organizations generally establish two kinds of measurable objectives: strategic and tactical. Strategic objectives, which are guided by the en terprise’s mission or purpose and deal with long-term issues, associate the enterprise to its external environment and provide manage-ment with a basis for comparing performance with that of its competi tors and in relation to environmental demands. Examples of strategic objectives include to increase sales, to increase market share, to increase profi ts, and to lower prices by becoming an international fi rm. Tacticalobjectives, which are guided by the enterprise’s strategic objectives and deal with shorter-term issues, identify the key result areas in which specifi c performance is essential for the suc cess

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of the enterprise and aim to attain internal effi ciency. For example, they identify specifi cally how to lower costs, lower prices, increase output, capture a larger portion of the market, and penetrate an international market.

(d) Technology and Global Strategy

Technology has been at the root of the most dramatic changes oc curring in commerce today. It now enables organizations to integrate their systems, where changes in one part ripple throughout the system, causing shifts in the other parts. Therefore, no strategy has been left untouched. Technology has leveled the playing field for small firms, allowing them to compete successfully with large corporations in the same markets. With e-mail, videoconferencing, multimedia CD-ROMs, and networked databases, small businesses can emulate the marketing tactics of much larger companies—they can set up a home page on the World Wide Web right next door to Walmart. And electronic networks and the Internet have enabled organizations to decentralize business activities and to outsource activities to other organizations.

From a strategic viewpoint, technology has impacted international strategy in several important ways.

◾ Emphasis has moved from products to information and solutions. ◾ Products can be launched from commercialization tactics based on identifying specifi c customer needs.

◾ Relationships with customers have been made easier, which enhances product acceptance and minimizes costs due to redesign.

◾ Firms can now target specifi c products and services to specifi c customers. ◾ Technology supports the integration of engineering and commercialization to get the product to the customer in the least amount of time.

◾ Technology helps prevent midcourse corrections in product design, which usually result in higher costs and longer time to commercialize.

From a tactical viewpoint, current technology aids businesses in the commercialization of their products and services in numerous ways.

◾ E-mail enables fi rms to communicate rapidly and easily with customers, strategic partners, suppliers, distributors, and others around the globe. Th is lowers the costs of travel and speeds up response time.

◾ Videoconferencing allows enterprises to hold international strategic meetings without getting on an airplane.

◾ Networked databases provide organizations with online access to R&D information exist-ing around the globe.

◾ Internet access and laptop computers let employees work from virtually anywhere in the world, increasing effi ciency and bringing the organization closer to the customer.

◾ Satellite systems, which a fi rm can lease from a provider, allow organizations to receive broadcast messages from chain manufacturers that help move the product.

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◾ Laser color printers allow enterprises to quickly produce signs, banners, cards, price tags, and so on that look as good as those printed by a professional.

◾ Some industries have CD-ROM services that businesses can tie into on a regular basis to receive updated information of things such as equipment and supplies. Th is also makes it easier for a fi rm to quickly locate customer items that it normally does not carry in stock.

◾ Th e World Wide Web as a commercial tool is enabling smaller businesses to be on the same playing fi eld as larger businesses.

◾ Online databases have put information in the hands of anyone who chooses to access them.

One must bear in mind that technology is a tool used by strategists to improve business activities. It is not intended to replace personal contact with the customer, nor is it intended to replace a manager’s unique ability to take vast amounts of information and make sense of it in terms of strategy for the organization. It does make it easier for the manager to integrate all activities of the fi rm, automate routine tasks, and generally free up more time to focus on the fi rm’s strategy.

(e) Forms of International Business and Marketing Strategies

We classify international business into three categories: trade, intellectual property rights (trademarks, patents, and copyrights) and in ternational licensing agreements, and foreign direct investment. To the marketer, these broad categories describe three important methods for entering a foreign market. To the lawyer, they also represent the form of doing business in a foreign country and the legal relationship between parties to a business transaction. Each method brings a diff erent set of problems to the fi rm because the level of foreign penetration and entanglement in various countries is diff erent. Trade usually represents the least entangle-ment and, thus, the least political, economic, and legal risk, especially if the exporting fi rm is not soliciting business overseas or maintaining sales agents or inventories there. An investment in a plant and operations overseas usually represents the greatest market penetration and, thus, the greatest risk to the fi rm.

Considerable overlap occurs among these diff erent forms of doing business. A business plan for the production and marketing of a single product may contain elements of each form. To illustrate, a U.S. fi rm might purchase the rights to a trademark for use on an article of high-fashion cloth-ing made from fabric exported from China and assembled in off shore plants in the Caribbean for shipment to the United States and Europe. Here a business strategy encompasses elements of trade, licensing, and investment. For fi rms just entering a new foreign market, the method of entry might depend on a host of considerations, including the sophistication of the fi rm, its overseas experience, the nature of its product or services, its commitment of capital resources, and the amount of risk it is willing to bear.

(i) TradeTrade consists of the import and export of goods and services. “Exporting” is the term gener-ally used to refer to the process of sending goods out of a country, and “importing” is used to denote when goods are brought into a country. However, a more accurate defi nition is that exporting is the shipment of goods or the rendering of services to a foreign buyer located in a foreign country. Importing is then defi ned as the process of buying goods from a foreign sup-plier and entering them into the customs territory of a diff erent country. Every export entails an import, and vice versa.

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(A) Exporting Trade is often a fi rm’s fi rst step into international business. Compared to the other forms of international business (licensing and investment), trade is relatively uncomplicated. It provides the inexperienced or smaller fi rm with an opportunity to penetrate a new market, or at least to explore foreign market potential, without signifi cant capital investment and the risks of becoming a full-fl edged player (i.e., citizen) in the foreign country. For many larger fi rms, including MNCs, exporting may be an important portion of their business operations. Th e U.S. aircraft industry, for example, relies heavily on exports for signifi cant revenues.

Firms that have not done business overseas before should fi rst prepare an export plan, which can mean assembling an export team, composed possibly of management and outside advisors and trade specialists. Th eir plan should include the assessment of the fi rm’s readiness for export-ing, the export potential of its products or services, the fi rm’s willingness to allocate resources (including fi nancial, production output, and human resources), and the selection of its channels of distribution. Th e fi rm may need to modify products, design new packaging and foreign-language labeling, and meet foreign standards for product performance or quality assurance. Th e fi rm must also gauge the extent to which it can perform export functions in-house or whether these functions should best be handled indirectly through an independent export company. Export functions include foreign marketing, sales and distribution, shipping, and handling international transfers of money.

Firms accept varying levels of responsibility for moving goods and money and for other export functions. Th e more experienced exporters can take greater responsibility for themselves and are more likely to export directly to their foreign customers. Firms that choose to accept less responsibility in dealing with foreign customers or in making arrangements for shipping, for example, must delegate many export functions to someone else. As such, exporting is generally divided into two types: direct and indirect.

At fi rst glance, direct exporting seems similar to selling goods to a domestic buyer. A prospective foreign customer may have seen a fi rm’s products at a trade show, located a par ticular company in an industrial directory, or been recommended by another customer. A fi rm that receives a request for product and pricing information from a foreign customer may be able to handle it routinely and export directly to the buyer. With some assistance, a fi rm can overcome most hurdles, get the goods properly packaged and shipped, and receive payment as anticipated. Although many of these onetime sales are turned into long-term business success stories, many more are not. A fi rm hopes to develop a regular business relationship with its new foreign customer. However, the problems that can be encountered even in direct export ing are considerable.

Many fi rms engaged in direct exporting on a regular basis reach the point at which they must hire their own full-time export managers and international sales specialists. Th ese people participate in making export-marketing decisions, including product development, pricing, packaging, and labeling for export. Th ey should take primary responsibility for dealing with foreign buyers, attending foreign trade shows, complying with government export and import regulations, ship-ping, and handling the movement of goods and money in the transaction. Direct exporting is often done through foreign sales agents who work on com mission. It also can be done by sell-ing directly to foreign distributors. Foreign distributors are independent fi rms, usually located in the country to which a fi rm is exporting, that pur chase goods for resale to their customers. Th ey assume the risks of buying and warehousing goods in their market and provide additional product support services. Th ese distributors usually service the products they sell, thus relieving the exporter of that responsibility. Th ey often train end users to use the product, extend credit to their customers, and bear responsibility for local advertising and promotion.

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Indirect exporting is used by companies seeking to minimize their involvement abroad. Lack-ing experience, personnel, or capital, they may be unable to locate foreign buyers or are not yet ready to be handling the mechanics of a transaction on their own. Th ere are several diff erent types of indirect exporting. Export trading companies, commonly called ETCs, are companies that market the products of several manufacturers in foreign markets. Th ey have extensive sales contacts overseas and experience in air and sea shipping. Th ey often operate with the assistance and fi nancial backing of large banks, thus making the resources and international contacts of the bank’s foreign branches available to the manufacturers whose products they market. ETCs are licensed to operate under the U.S. antitrust laws.

Export management companies (EMCs), however, are really consultants that advise manu-facturers and other exporters. Firms that cannot justify their own in-house export manag ers use them. Th ey engage in foreign market research, identify overseas sales agents, exhibit goods at foreign trade shows, prepare documentation for export, and handle language translations and shipping arrangements. As in direct exporting, all forms of indirect exporting can involve sales through agents or to distributors.

(B) Importing and Global Sourcing Here importing is presented from the perspective of the global fi rm for which importing is a regular and necessary part of their business. Global sourcing is the term commonly used to describe the process by which a fi rm attempts to lo cate and purchase goods or services on a worldwide basis. Th ese goods may include, for ex ample, raw materials for manufacturing, component parts for assembly operations, commodi ties such as agricultural products or minerals, or merchandise for resale.

(C) Government Controls over Trade: Tariff s and Nontariff Barriers Both importing and exporting are governed by the laws and regulations of the countries through which goods or services pass. Nations regulate trade in many ways. Th e most common methods are tariff s and nontariff barriers. Tariff s are import duties or taxes imposed on goods entering the customs territory of a nation. Tariff s are imposed for many reasons, including the collection of revenue, the protection of domestic industries from foreign competition, and political control (e.g., to provide incentives to import products from politically friendly countries and to discourage importing products from unfriendly countries).

Nontariff barriers are all barriers to importing or exporting other than tariff s. Nontariff barriers are generally a greater barrier to trade than are tariff s because they are more insidious. Unlike tariff s, which are published and easily understood, nontariff barriers are often disguised in the form of government rules or industry regulations and often are not understood by foreign compa-nies. Countries impose nontariff barriers to protect their national economic, so cial, and political interests. Imports might be banned for health and safety reasons. Imported goods usually have to be marked with the country of origin and labeled in the local language so that consumers know what they are buying. One form of nontariff barrier is the technical barrier to trade, or product standard. Examples of product standards include safety stan dards, electrical standards, and environmental standards (e.g., German cars meeting U.S. emis sion standards not mandated in Europe). A quota is a restriction imposed by law on the num bers or quantities of goods, or of a particular type of good, allowed to be imported. Unlike tariff s, quotas are not internationally accepted as a lawful means of regulating trade except in some special cases. An embargo is a total or near-total ban on trade with a particular country, sometimes enforced by military action and usually imposed for political purposes. An internationally orchestrated embargo was used against Iraq after its invasion of Kuwait in 1990. A boycott is a refusal to trade or do business with certain fi rms, usually from a particular coun try, on political or other grounds.

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Tariff s and nontariff barriers have a tremendous infl uence on how fi rms make their trade and investment decisions. Th ese decisions, in turn, are refl ected in the patterns of world trade and the fl ows of investment capital.

(D) Trade Liberalization and the World Trade Organization Trade liberalization refers to the eff orts of governments to reduce tariff s and nontariff barriers to trade. In the twentieth century, the most important eff ort to liberalize trade came with the international acceptance of the GeneralAgreement on Tariff s and Trade (GATT). Th is is an agreement between nations, fi rst signed in 1947 and continually expanded since that time, that sets the rules for how na tions will regulate international trade in goods and services. In 1995, the Geneva-based World Trade Organization (WTO), was created to administer the rules and to assist in settling trade disputes between its member nations. All WTO nations are entitled to normal trade relations with one another. Th is is referred to as most favored nation (MFN) trading status. Th is means that a member country must charge the same tariff on imported goods, and not a higher one, as that charged on the same goods coming from other WTO member countries. Trade liberalization has led to increased economic development and an improved quality of life around the world.

Another type of restriction over trade is export control. An export control limits the type of product that may be shipped to any particular country. Th ese controls usually are imposed for economic or political purposes and are used by all nations of the world. For instance, high-tech computers might not be allowed to be shipped from the United States or Canada to another country without a license from the U.S. or Canadian government. Before signing a contract for the sale of certain products or technical know-how to a foreign customer, U.S. exporters must consider whether they will be able to obtain U.S. licensing for the shipment.

(ii) Intellectual Property Rights and International Licensing AgreementsIntellectual property (IP) rights are a grant from a government to an individual or fi rm of the exclusive legal right to use a copyright, patent, or trademark for a specifi ed time. Copyrights are legal rights to artistic or writ ten works, including books, software, fi lms, music, or to such works as the layout design of a computer chip. Trademarks include the legal right to use a name or symbol that identifi es a fi rm or its product. Patents are governmental grants to inventors assuring them of the exclusive legal right to produce and sell their inventions for a period of years. Copyrights, trademarks, and patents compose substantial assets of many domestic and international fi rms. As valuable assets, IP can be sold or licensed for use to others through a licensing agreement.

International licensing agreements are contracts by which the holder of IP will grant certain rights in that property to a foreign fi rm under specifi ed conditions and for a specifi ed time. Licensing agreements represent an important foreign market entry method for fi rms with mar-ketable IP. For example, a fi rm might license the right to manu facture and distribute a certain type of computer chip or the right to use a trademark on apparel such as blue jeans or designer clothing. It might license the right to distribute Hollywood movies or to reproduce and market word-processing software in a foreign market, or it might license its pat ent rights to produce and sell a high-tech product or pharmaceutical. U.S. fi rms have ex tensively licensed their property around the world and in recent years have purchased the technol ogy rights of Japanese and other foreign fi rms.

A fi rm may choose licensing as its market entry method because licensing can provide a greater entrée to the foreign market than is possible through exporting. A fi rm may realize many advan-tages in having a foreign company produce and sell products based on its IP instead of simply

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shipping fi nished goods to that market. When exporting to a foreign market, the fi rm must over-come obstacles, such as long-distance shipping and the resulting delay in fi lling orders. Exporting requires a familiarity with the local culture. Redesign of products or technology for the foreign market may be necessary. Importantly, an exporter may have to overcome trade re strictions, such as quotas or tariff s, set by the foreign government. Licensing to a foreign fi rm al lows the licensor to circumvent trade restrictions by having the products produced locally, and it allows entrance to the foreign market with minimal initial start-up costs. In return, the licensor might choose to receive a guaranteed return based on a percentage of gross revenues. Th is arrangement ensures payment to the licensor whether the licensee earns a profi t or not. Even though licensing agree-ments give the licensor some control over how the licensee utilizes its IP, problems can arise. For instance, the licensor may fi nd that it cannot police the licen see’s manufacturing or quality control process. Protecting itself from the unauthorized use, or pi racy, of its copyrights, patents, or trademarks by unscrupulous persons not party to the licensing agreement is also a serious concern for the licensor.

(A) Technology Transfer Th e exchange of technology and manufacturing know-how between fi rms in diff erent countries through arrangements such as licensing agreements is known as technology transfer. Transfers of technology and know-how are regulated by government control in some countries. Th is control is common when the licensor is from a highly industri alized country, such as the United States, and the licensee is located in a developing country, such as those in Latin America, the Middle East, or Asia. In their eff orts to industrialize, modernize, and develop a self-suffi ciency in technology and production methods, these countries often restrict the terms of licensing agreements in a manner benefi ting their own country. For instance, government regulation might require that the licensor introduce its most modern technology to the developing countries or train workers in its use.

(B) International Franchising Franchising is a form of licensing that is gaining in popularity worldwide. Th e most common form of franchising is known as a business operations fran chise, usually used in retailing. Under a typical franchising agreement, the franchisee is al lowed to use a trade name or trademark in off ering goods or services to the public in return for a royalty based on a percentage of sales or other fee structure. Th e franchisee usually obtains the franchiser’s know-how in operating and managing a profi table business and its other “secrets of success” (ranging from a “secret recipe” to store design to accounting methods). Franchising in the United States accounts for a large proportion of total retail sales. In foreign markets as well, franchising has been successful in fast food retailing, hotels, video rentals, convenience stores, photocopying services, and real estate services, to name but a few. U.S. fi rms have excelled in franchising overseas, making up the majority of new franchise operations worldwide. Th e prospects for future growth in foreign markets are enormous, especially in developing countries, such as those in Latin America. For instance, American fast food and retail franchises are common throughout Mexico City, Brazil, Eastern Europe, China, India and the former So viet Union.

(C) Some Legal Aspects of Franchising Franchising is a good vehicle for entering a foreign mar ket because the local franchisee provides capital investment, entrepreneurial commitment, and on-site management to deal with local customs and labor problems. However, many legal re quirements aff ect franchising. Franchising in the United States is regulated primarily by the Federal Trade Commission (FTC) at the federal level. Th e agency requires the fi ling of extensive disclosure statements to protect prospective investors. Other countries have also enacted new franchise disclosure laws. Some developing countries have restrictions on the amount of money that can

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be removed from the country by the franchiser. Moreover, some countries, such as China, also require government approval for franchise operations. Other countries might have restrictions on importing supplies (ketchup, bed linens, paper products, or what ever) for the operation of the business to protect local companies. However, more progressive developing countries are now abandoning these strict regulations because they want to wel come to their markets franchisers, their high-quality consumer products, and their managerial talent. Because of this more receptive attitude toward foreign fi rms, Mexico and Brazil have become home to many profi table new franchise operations.

(iii) Foreign Direct InvestmentTh e term foreign investment, or foreign direct investment, refers to the ownership and active control of ongoing business concerns, including investment in manu facturing, mining, farm-ing, assembly operations, and other facilities of production. A distinction is made between the home and host countries of the fi rms involved. Th e home country refers to that country under whose laws the investing corporation was created or is headquartered. For example, the United States is home to MNCs such as Ford, Exxon, and IBM, to name a few, but they operate in hostcountries throughout every region of the world. Of the three forms of international business, foreign investment provides the fi rm with the most involvement, and perhaps the greatest risk, abroad. Investment in a foreign plant is often a result of having had suc cessful experiences in exporting or licensing, and of the search for ways to overcome the disad vantages of those other entry methods. For example, by producing its product in a foreign country instead of exporting, a fi rm can avoid quotas and tariff s on imported goods, avoid currency fl uctuations on the traded goods, provide better product service and spare parts, and more quickly adapt products to local tastes and market trends. Manufacturing overseas for foreign markets can mean taking advantage of local natural resources, labor, and manufacturing economies of scale. Foreign investment in the United States is often called reverse investment. Most of the earlier foreign investment in the United States has come from the United Kingdom.

MNCs wishing to enter a foreign market through direct investment can structure their business arrangements in many diff erent ways. Th eir options and eventual course of action may depend on many factors, including industry and market conditions, capitalization of the fi rm and fi nancing, and legal considerations. Some of these options include the start-up of a new foreign subsidiary company, the formation of a joint venture with an existing foreign com pany, or the acquisition of an existing foreign company by stock purchase. For now, keep in mind that MNCs are usually not a single legal entity. Th ey are global enterprises that consist of any number of interrelated corporate entities, connected through extremely complex chains of stock ownership. Stock own-ership gives the investing corporation tremendous fl exibility when investing abroad.

Th e wholly owned foreign subsidiary is a “foreign” corporation organized under the laws of a foreign host country but owned and controlled by the parent corporation in the home country. Because the parent company controls all of the stock in the subsidiary, it can control manage-ment and fi nancial decision making.

Th e joint venture is a cooperative business arrangement between two or more companies for profi t. A joint venture may take the form of a partnership or corporation. Typically, one party will contribute expertise and another the capital, each bringing its own special resources to the venture. Joint ventures exist in all regions of the world and in all types of industries. Where the laws of a host country require local ownership or that investing foreign fi rms have a local partner, the joint venture is an appropriate investment vehicle. Local participation refers to the requirement that a

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share of the business be owned by nationals of the host country. Th ese requirements are gradually being reduced in most countries that, in an eff ort to attract more investment, are permitting wholly owned subsidiaries. Many American companies do not favor the joint venture as an investment vehicle because they do not want to share technology, expertise, and profi ts with another company.

Another method of investing abroad is for two companies to merge or for one company to acquire another ongoing fi rm. Th is option has appeal because it requires less know-how than does a new start-up and can be concluded without disruption of business activity.

8.2 Cultural/Political EnvironmentsIn this section, topics such as diff erent local/regional cultures, cross-cultural negotiations, and global mindsets are discussed.

(a) Diff erent Local/Regional Cultures

Because it is so diffi cult to defi ne precisely, many defi nitions of culture exist. “Culture” is the collective meaning a people put into their unique life-space. It is the pattern of attitudes, beliefs, customs, and traditions that generally expresses the way the average person in that place thinks and behaves.3 Culture gives people a sense of who they are, of belonging, of how they should behave, and of what they should be doing. Culture is a distinctly human capacity for adapting to circumstances and transmitting this coping skill and knowledge to subsequent generations. Culture itself is an attempt, consciously or unconsciously, by a people to transmit to future genera-tions their acquired wisdom and insight relative to their knowledge, beliefs, customs, traditions, morals, law, art, communication, and habits.

As mentioned earlier, culture provides a people with identity. Harris and Moran summarized characteristics of culture into 10 categories:

1. Sense of self and space2. Communication and language3. Dress and appearance4. Food and feeding habits5. Time consciousness6. Relationships7. Values and norms8. Beliefs and attitudes9. Mental process and learning

10. Work habits and practices

Corporate culture aff ects how an organization copes with competition and change, whether in terms of technology, economics, or people. Th e work culture stimulates or constricts the

3 Philip R. Harris and Robert T. Moran, Managing Cultural Diff erences, 3rd ed. (Houston: Gulf Publishing, 1991).

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energies of personnel, whether through slogans and myths or taboos. Today management is more cognizant of its customs and traditions, rules and regulations, policies and procedures—such components of culture are being used to make work more enjoyable, to increase productivity, and to meet customer needs and competitive challenges.

(i) Eff ects of CulturesPersons of dissimilar backgrounds usually require more time than those of the same culture to be come familiar with each other, be willing to speak openly, share suffi ciently in common ideas, and understand one another.

Th erefore, education and training of global leaders must include formal learning in the various cultural dimensions. With the globalization of business, managers and leaders need to become more transnational and transcultural in their thinking, planning, and involvement with people.

Culture also aff ects high-technology exporters and their share of the world market. For example, European fi rms view technological innovation as a danger with problems rather than an opportunity whereas the Americans and Japanese intuitively see the benefi ts of new technology. Unless such cul tural handicaps are countered, Europe may not be able to take full advantage of some emerging markets.

Diff erences in customs, behavior, and values result in problems that can be managed only through eff ective cross-cultural communication and interaction. When people have misunderstandings or commit “errors” when working with persons from diff erent cultures, they are often unaware of any problem. Cross-cultural mistakes result when we fail to recognize that persons of other cultural back grounds have diff erent goals, customs, thought patterns, and values from our own. Diff erences do not necessarily mean barriers; they can become bridges to understanding and enrichment of human lives.

(ii) Global Manager’s DilemmaGlobal managers operating transnationally are commonly faced with the following situation: In one country something is a lawful or accepted practice, and elsewhere it is illegal. Bribes, for example, may be a common way of doing business to ensure service in the host-country culture but quite illegal in the home-country culture.

Advances in mass media, transportation, and travel are breaking down the traditional barriers among groups of peoples and their diff ering cultures, so that a homogenization process is under way. Global managers should be alert to serving this new community in human needs and markets with strategies that are transnational.

Global planning requires not only an eff ective international management information system but input from a variety of locals at diff erent levels of sophistication. Even when there are apparent simi larities of people in geographic regions, cultural diff erences may require alteration of strategic market planning. For example, North American companies and unions discovered this in Canada when they tried to treat their operations in Canada as mere U.S. extensions. Europeans realized this in Bolivia and Argentina where political and social conditions altered a common cultural heritage.

(iii) Regional CulturesEven in the United States, there are cultural diff erences between the South and the North and between the East and the West. Food habits, language, accent, pace of life, work attitudes, and values are diff erent.

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Culture aff ects decision making too. Robert Doktor,4 a professor at the University of Hawaii, contrasted Japanese chief executive offi cers (CEOs) with their American counterparts and dis-covered signifi cant diff erences in the way each group thinks and solves problems. Th e Japanese interviewed, for instance, spent most of their time with their people—they tended to engage in fewer work activities, but for a longer duration than their Western colleagues. Doktor concluded that Japanese CEOs go about problem solving in a more planned and orderly manner indica-tive of left-hemisphere dominance, fulfi lling their role in ways quite opposite from what other researchers discovered about American executives.

(iv) Global Communication InsightsAll behavior is communication because all behavior contains a message, whether intended or not. Communication is not static and passive; rather it is a con tinuous and active process with-out beginning or end. A communicator is not simply a sender or a receiver of messages but can be both at the same time. Culture poses communication problems be cause there are so many variables unknown to the communicators. As the cultural variables and diff erences increase, the number of communication misunderstandings increases.

Let us look at few examples of communication insights in a global context.

◾ Th e American manager who gives a gift of yellow fl owers in France or white fl owers in Japan has communicated something but probably not that which was intended. In France, yel low fl owers suggest infi delity; white fl owers are given at funerals in Japan to indicate sympathy.

◾ Th e American manager who has sharply disagreed with a Saudi Arabian in the presence of others has committed an “impoliteness” in the Arab world that is diffi cult to remedy.

◾ During an evening meal, a business conversation with a French manager in France may be very inappropriate.

◾ Space is also a factor in the communication process. Th e United States is a noncontact soci ety and requires distance between people during a conversation. Many cultures, such as Latin American and Middle Eastern, are contact societies and require relatively close physical proximity to others during a conversation. Between males, touching is common and handshakes are frequent and last throughout a litany of greetings.

◾ Most persons use their hands when speaking to punctuate the fl ow of conversation, refer to objects or persons, and mimic or illustrate words or ideas. Often gestures are used in place of words. Generally, Japanese speakers use fewer words and fewer gestures than American speakers; French use more of both, and Italians much more.

(v) High- and Low-Context CommunicationsAnthropologist Edward Hall5 makes a vital distinction between high- and low-context cultures and how the matter of context impacts communications. A high-context culture uses high-context communications—that is, information is either in the physical context or internalized in the person. Japan, Saudi Arabia, and Africa are examples of cultures engaged in high-context communications, as are the Chinese and Spanish languages. However, a low-context culture

4 Ibid. Robert Doktor was mentioned in this book without any specifi c reference to Doktor.5 E. T. Hall and M. R. Hall, Understanding Cultural Diff erences: Keys to Success in West Germany, France, and the United States (Yarmouth, ME: Intercultural Press), 1990.

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employs low-context communications—most information is contained in explicit codes, such as words. North American cultures engage in low-context communi cations, whether in Canada or the United States, and English is a low-context language.

In the communication process, a low-context culture places meaning in the exact verbal de scription of an event. Individuals in such a culture rely on the spoken word. Th e common state ment that typifi es this idea is “Say what you mean.” However, in the high-context culture, much of the mean-ing is not from the words but is internalized in the person. Meaning comes from the environment and is looked for in the relationships between the ideas expressed in the communica tion process. High-context cultures tend to be more human-oriented than low-context cultures. Th e extended family concept fi ts into the high-context culture.

During negotiations or when working with Japanese and Latin Americans, they are looking for meaning and understanding in what is not said—in the nonverbal communication or body lan-guage, in the silences and pauses, in relationships and empathy. North Americans place emphasis on sending and receiving accurate messages directly, usually by being articulate with words. Spe-cifi cally, Japanese communicate by not stating things directly, while Americans usually do just the opposite and spell it all out.

(vi) General Characteristics of the Emerging Work CultureHarris’s research6 identifi ed 10 general characteristics of the emerging work culture. Workers at all levels in the future will generally manifest or seek more

1. Enhanced quality of work life.2. Autonomy and control over their work space.3. Organizational communication and information orientation.4. Participation and involvement in the enterprise.5. Creative organizational norms or standards.6. High performance and improved productivity.7. Emphasis on new technology utilization.8. Emphasis on R&D.9. Emphasis on entrepreneurialism.

10. Informal and synergistic relationships.

(vii) Cultural Awareness Learning ProgramTh e aim of the Canadian International Development Agency’s training program is to instill seven skills that could be off ered as the objectives of all cultural awareness learning. Th ese skills can be applied to understand people, whether they are local, regional, or international. Th ese skills are listed next.

1. Communicate respect to transmit (both verbally and nonverbally) positive regard,encouragement, and sincere interest.

6 Ibid.

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2. Be nonjudgmental to avoid moralistic, value-laden, evaluative statements and to listenin such a way that the other can fully share and explain itself.

3. Personalize knowledge and perceptions to recognize the infl uence of one’s ownvalues, perceptions, opinions, and knowledge on human interaction and to regard suchas relative, rather than absolute, for more tentative communications.

4. Display empathy to try to understand others from their point of view, attempt to putoneself into the other’s life space, and feel as they do about the matter under consideration.

5. Practice role fl exibility to be able to get a task accomplished in a manner and time frame appropriate to the learner or other national and be fl exible in the process for getting jobsdone, particularly with reference to participation and group maintenance or morale.

6. Demonstrate reciprocal concern to truly open up a dialogue, take turns talking, sharethe in teraction responsibility, between groups, and promote circular communication.

7. Tolerate ambiguity to be able to cope with cultural diff erences, try to accept a degree offrustration, and deal with changed circumstances and people.

Th ese seven skills are associated with eff ective managing and transferring knowledge in a diff er-ent culture. Th e degree to which managers and auditors possess these skills marks their potential eff ectiveness in working in a multicultural environment.

(b) Cross-Cultural Negotiations

Negotiating across cultures is far more complex than negotiating within a culture because foreign negotiators have to deal with diff ering negotiating styles and cultural variables simultaneously. In other words, the negotiating styles that work at home generally do not work in other cultures. As a result, cross-cultural business negotiators have one of the most complicated business roles to play in organizations. Th ey are often thrust into a foreign society consisting of what appears to be hostile strangers. Th ey are put in the position of negotiating profi table business relationships with these people or suff ering the negative consequences of failure. And quite often they fi nd themselves at a loss as to why their best eff orts and intentions have failed them.

(i) How to Avoid Failure in International NegotiationsNegotiators in a foreign country often fail because local counterparts have taken more time to learn how to overcome the obstacles normally associated with international/cross-cultural negotiations. Failure may occur because of time and/or cost constraints. For example, a negotia-tor may be given to a short period of time to obtain better contract terms than were originally agreed to in a country where negotiations typically take a long time. A negotiator may think what works in the home country is good enough for the rest of the world, but it is far from the truth. In fact, strategies that fail to take into account cultural factors are usually naive or misconceived. Typically, the obstacles to overcome include

◾ Learning the local language, or at least being able to select and use an eff ective language translator.

◾ Learning the local culture, including how the culture handles confl ict, its business prac-tices, and its business ethics, or at least being able to select and use an eff ective cultural translator.

◾ Arriving well prepared for the negotiations. Along with the prior points, the negotiator must have a thorough knowledge of the subject matter being negotiated.

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Eff ective cross-cultural negotiators understand the cultural diff erences existing among all par-ties involved, and they know that failure to understand the diff erences serves only to destroy potential business success.

(ii) How Much Must One Know about the Foreign Culture? Realistically, it is nearly impossible to learn everything about another culture, although it may be possible if one lives in the culture for several years. Th e reason for this is that each culture has developed, over time, multifaceted structures that are much too complex for any foreigner to understand totally. Th erefore, foreign negotiators need not have total awareness of the foreign culture; they do not need to know as much about the foreign culture as the locals, whose frames of reference were shaped by that culture. However, they will need to know enough about the culture and about the locals’ negotiating styles to avoid being uncomfortable during (and after) negotiations. Besides knowing enough to not fail, they also need to know enough to win. For example, in negotiations between Japanese and Ameri can businesspeople, Japanese negotiators have sometimes used to their advantage their knowledge that Americans have a low tolerance for silence.

In other words, in order for negotiation to take place, foreigners must at least recognize those ideas and behaviors that the locals intentionally put forward as part of the negotiation process—and the locals must do the same for the foreigners. Both sides must be capable of interpreting these behaviors suffi ciently to distinguish common from confl icting positions, spot movement from positions, and respond in ways that sustain communication. Ultimately, cross-cultural negotiators must determine their counterparts’ personal motivations and agendas and adapt the negotiation style to them.

Th e purpose of the previous discussion is to develop a cross-cultural negotiating process. Th e process includes both strategy and tactics. Strategy refers to a long-term plan, and tactics refers to the actual means used to implement the strategy.

(iii) Strategic Planning for International NegotiationsStrategic planning for international negotiations involves fi ve stages:

1. Preparation for face-to-face negotiations2. Determining the settle ment range3. Determining where the negotiations should take place4. Deciding whether to use an individual or a group of individuals in the negotiations5. Learning about the country’s views on agreements/contracts

Tactical planning for international negotiations involves determining how to obtain leverage, use delay tactics, and deal with emotions.

(iv) Ethical ConstraintsBusiness ethics and corporate social responsibility place constraints on ne gotiators. For example, a negotiator’s ethical concerns for honesty and fair dealings, regardless of the power status of negotiating parties, will aff ect the outcome. Th ere is no global standard or view of what is ethi-cal or unethical behavior in business transactions—what is viewed as unethical behavior in one

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culture may be viewed as ethical in another culture, and vice versa. For instance, if a negotiator on one side pays off an infl uential decision maker on the other side to obtain a fa vorable decision, it would be an unethical business practice in some cultures (and illegal in the United States), but it would be quite acceptable in other cultures.

(v) International Management TheoriesTh eory Z, coined by William Ouichi,7 refers to a Japanese style of management that is charac-terized by long-term employment, slow promotions, consider able job rotation, consensus-style decision making, and concern for the employee as a whole.

Th eory T and Th eory T+ are complementary theories based on these Southeast Asian assumptions:

◾ Work is a necessity but not a goal itself. ◾ People should fi nd their rightful place in peace and harmony with their environment. ◾ Absolute objectives exist only with God. ◾ In the world, persons in authority positions represent God, so their objectives should be followed.

◾ People behave as members of a family and/or group, and those who do not are rejected by society.

(c) Global Mindsets

Cultural forces represent another important concern aff ecting international human resources (HR) management. In addition to organizational culture, national cultures also exist. Culture is composed of the societal forces aff ecting the values, beliefs, and actions of a distinct group of people. Cultural diff erences certainly exist between nations, but signifi cant cultural diff erences exist within countries also. One only has to look at the confl icts caused by religion or ethnicity in Central Europe and other parts of the world to see the importance of culture in international organizations. Convincing individuals from diff erent ethnic or tribal backgrounds to work together may be diffi cult in some parts of the world.

Geert Hofstede8 conducted research on more than 100,000 IBM employees in 53 countries, and he defi ned these fi ve dimensions useful in identifying and comparing culture:

1. Power distance2. Individualism3. Masculinity/femininity4. Uncertainty avoidance5. Long-term orientation

7 W. G. Ouichi and A.M. Jaeger, “Made in America under Japanese Management,” Harvard Business Review (September–October 1974). 8 Geert Hofstede, Cultural Consequences: International Diff erences in Work-Related Values (Beverly Hills, CA: Sage, 1984).

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Th e dimension of power distance refers to the inequality among the people of a nation. In coun-tries such as Canada, the Netherlands, and the United States, there is less inequality than in such countries as France, Mexico, and Brazil. As power distance scores increase, there is less status and authority diff erence between superiors and subordinates.

One way in which diff erences on this dimension aff ect HR activities is that the reactions to man agement authority diff er among cultures. A more autocratic approach to managing is more common in many countries, while in the Netherlands and the United States, there may be more use of employee participation in decision making.

Another dimension of culture identifi ed by Hofstede is individualism, which is the extent to which people in a country prefer to act as individuals instead of members of groups. On this dimension, people in some Asian countries tend to be less individualistic and more group oriented, whereas those in the United States are more individualistic. An implication of these diff erences is that more collective action and less individual competition are likely in those countries that deemphasize individualism.

Th e cultural dimension masculinity/femininity refers to the degree to which “masculine” val-ues prevail over “feminine” values. Masculine values identifi ed by Hofstede were assertiveness, performance orientation, success, and competitiveness; feminine values included quality of life, close personal relationships, and caring. Respondents from Japan had the most masculinity, while those from the Netherlands had more femininity-oriented values. Diff erences on this dimension may be tied to the role of women in the culture. Considering the diff erent roles of women and what is “acceptable” for women in the United States, Saudi Arabia, Japan, and Mexico suggests how this dimension might aff ect the assignment of women expatriates to managerial jobs in the various countries.

Th e dimension of uncertainty avoidance refers to the preference of people in a country for structured rather than unstructured situations. A structured situation is one in which rules can be es tablished and there are clear guides on how people are expected to act. Nations focusing on avoiding uncertainty, such as Japan and France, tend to be more resistant to change. In contrast, people in places such as the United States and Great Britain tend to have more “business energy” and to be more fl exible.

A logical use of diff erences in this factor is to anticipate how people in diff erent countries will react to changes instituted in organizations. In more fl exible cultures, what is less certain may be more intriguing and challenging, which may lead to greater entrepreneurship and risk taking than in the more “rigid” countries.

Th e dimension of long-term orientation refers to values people hold that emphasize the future, as opposed to short-term values, which focus on the present and the past. Long-term values include thrift and persistence, while short-term values include respecting tradition and fulfi ll-ing social obligations. Hofstede developed this dimension a decade after his original studies on dimension. A long-term ori entation was more present in Japan and India, while people in the United States and France tended to have more short-term orientations.

Diff erences in many other facets of culture could be discussed. But it is enough to understand that international HR managers and professionals must recognize that cultural dimensions diff er from country to country and even within countries. Th erefore, the HR activities appropriate in one culture or country may have to be altered to fi t appropriately into another culture or country.

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8.3 Legal and Economic ConceptsTopics such as contracts and key economic indicators are discussed in this section.

(a) Contracts

(i) Defi nition of a ContractContracts are governed by state common law. A contract is a binding agreement that the courts will enforce. It is a promise or a set of promises for the breach of which the law gives a remedy, or the performance of which the law in some way recognizes a duty. A promise manifests or demonstrates the intention to act or to refrain from acting in a specifi ed manner.

Th ose promises that meet all of the essential requirements of a binding contract are contractual and will be enforced. All other promises are not contractual, and usually no legal remedy is avail-able for a breach of, or a failure to properly perform, these promises. Th e remedies provided for breach of contract include compensatory damages, equitable remedies, reliance damage, and restitution. Th us, a promise may be contractual (and therefore binding) or noncontractual. In other words, all contracts are promises, but not all promises are contracts.

(ii) Requirements of a ContractTh e four basic requirements of a contract include (1) mutual assent, (2) consideration, (3) legality of object and subject matter, and (4) capacity (competent parties).

◾ Mutual assent. Th e parties to a contract must manifest by words or conduct that they have agreed to enter into a contract. Th e usual method of showing mutual assent is by off er and acceptance. An off er is a proposal or expression by one person that he is willing to do something for certain terms. A contract does not exist until the off er is formally accepted, either verbally or in written form. Th e off er and acceptance have to match. If they match, there is an agreement leading up to a contract. If they do not, it is more like a negotiation, to which someone responds with a counteroff er rather than an acceptance, which continues until both parties reach an agreement, or a meeting of the minds.

◾ Consideration. Each party to a contract must intentionally exchange a legal benefi t or incur a legal detriment as in inducement to the other party to make a return exchange. Consideration is a form of “mutual obligation.” In the business world, mutual promises in a contract of sale, whether express or implied, are generally suffi cient consideration.

◾ Legality of object and subject matter. Th e purpose of a contract must not be criminal, tortious, or otherwise against public policy. If the purpose is illegal, the resulting contract is null and void. Th e performance of a party in regard to the contract must not be an unlawful act if the agreement is to be enforceable. However, if the primary purpose of a contract is legal, but some terms contained within the agreement are not, then the contract may or may not be itself be illegal, depending on the seriousness of the illegal terms and the degree to which the legal and illegal terms can be separated.

◾ Capacity (competent parties). Th e parties to a contract must have contractual capacity. Certain persons, such as adjudicated incompetents, have no legal capacity to contract, while others, such as minors, incompetent persons, and intoxicated persons, have limited capacity to contract. All others have full contractual capacity. Th e parties can be principals or qualifi ed agents. Th e parties cannot engage in any fraudulent activities. Th e use of force

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or coercion to reach an agree ment is not acceptable in signing a contract because both parties must enter into the agreement on their own free will. Both parties must indicate a willingness to enter into the agreement and be bound by its terms.

In addition, although in a limited number of instances a contract must be evidenced in writing to be enforceable, in most cases an oral contract is binding and enforceable. Moreover, there must be an ab sence of invalidating conduct, such as duress, undue infl uence, misrepresentation, or mistake. A promise meeting all of these requirements is contractual and legally binding. However, if any require ment is unmet, the promise is noncontractual.

(iii) Classifi cation of ContractsContracts can be classifi ed according to various characteristics, such as method of formation, content, and legal eff ect. Th e standard classifi cations are listed next.

◾ Express or implied contracts ◾ Bilateral or unilateral contracts ◾ Valid, void, voidable, or unenforceable contracts ◾ Executed or executory contracts

Th ese classifi cations are not mutually exclusive. For example, a contract may be express, bilateral, valid, executory, and informal.

◾ Express and implied contracts. A contract formed by conduct is an implied or, more precisely, an implied-in-fact contract. In contrast, a contract in which the parties manifest assent in words is an express contract. Both are contracts, equally enforceable. Th e diff er-ence between them is merely the manner in which the parties manifest their assent.

◾ Bilateral and unilateral contracts. When each party is both a promisor (a person making a promise) and a promisee (the person to whom a promise is made), it is called a bilateral contract. A unilateral contract is one where only one of the parties makes a promise.

◾ Valid, void, voidable, and unenforceable contracts. A valid contract is one that meets all of the requirements of a binding contract. It is an enforceable promise or an agreement. A void contract is an agreement that does not meet all of the requirements of a binding contract. It has no legal eff ect and is merely a promise or agreement. An example is an agreement entered by a person whom the courts have declared incompetent. A contract that is neither void nor void able may nonetheless be unenforceable. An unenforceable contract is one for the breach of which the law provides no remedy. After the statutory time period has passed, a contract is referred to as unenforceable rather than void or voidable.

◾ Executed and executory contracts. A contract that has been fully carried out and com-pleted by all of the parties to it is an executed contract. By comparison, the term “execu-tory contract” ap plies to contracts that are still partially or entirely unperformed by one or more of the parties.

(iv) Other Types of ContractsTwo other types of contracts that occur in common include the doctrine of promissory estoppel and quasi contracts.

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(A) Doctrine of Promissory Estoppel In certain circumstances, the courts enforce noncontractual promises under the doctrine of promissory estoppel in order to avoid injustice. A noncontractual promise is enforceable when it is made under circumstances that should lead the promisor reasonably expect that the promisee, in reliance on the promise, would be induced by it to take defi nite and substantial action or to forbear, and the promisee does take such action or does forbear.

(B) Quasi Contracts A quasi (meaning “as if ”) contract is not a contract at all. A quasi contract is based on neither an express nor an implied in fact contract. Rather, a quasi contract is a contract implied in law, which is an obligation imposed by law to avoid injustice. Occasionally quasi contracts are used to provide a remedy when the parties enter into a void contract, an unenforceable contract, or a voidable contract that is avoided. In such a case, the law of quasi contracts will de termine what recovery is permitted for any performance rendered by the parties under the invalid, unenforceable, or invalidated agreements.

(b) Key Economic Indicators

(i) Nature of Key Economic IndicatorsBusiness conditions relate to business cycles. Decisions such as ordering inventory, borrowing money, increasing staff , and spending capital are dependent on the cur rent and predicted busi-ness cycle. For example, decision making in preparation for a recession, such as cost reduction and cost containment, is especially diff erent and diffi cult. Also, during a recession, de faults on loans can increase due to bankruptcies and unemployment.

Timing is everything when it comes to making good cycle-sensitive decisions. Managers need to make appropriate cutbacks prior to the beginning of a recession. Similarly, managers can-not get caught short during a period of rapid expansion. Economic forecasting is a necessity for predicting business cycles and swings. Trend analysis, economic surveys, opinions, and simulation techniques are useful to managers trying to stay abreast of the latest economic developments.

Businesses use economic forecasts in making investment and production decisions. When they foresee an economic downturn, inventories may be reduced. When prices are expected to rise quickly, they buy goods in advance and add to equipment and plant.

Statistical models are most successful when past circumstances can be used to predict future events. Economic models use historical data to develop predictive models. Current input to the model provides a meaningful production only if the important factors retain the same proportional signifi cance. During the energy crisis of the early 1970s, most economic models performed very poorly because key relationships had changed. Th us, predictive models improved once new historical patterns emerged.

Th e opposite of forecasting economic events is measuring economic events. Th is historical information is important in evaluating and providing information for predicting the future. Th e business cycle is the up-and-down movement of an economy’s ability to generate wealth. His-torical economic data show a clear pattern of alternating recessions and expansions. In between there have been peaks and troughs of varying magnitude and duration. Business cycles have a predictable structure but variable timing.

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(ii) Specifi c Types of Key Economic IndicatorsTh ree types of economic indicators are used in forecasting, including leading indicators, coinci-dent indicators, and lagging indicators (see Exhibit 8.4).

EXHIBIT 8.4 Key Economic Indicators

Key economic indicators

Leading indicators (change in advance ofother variables, e.g., capital goods purchases)

Coincident indicators (change at the same time asother variables change, e.g., inflation, unemployment)

Lagging indicators (change after the othervariables change, e.g., unemployment)

1. Leading indicators change in advance of other variables. Th ese are the least likely to beaccurate. However, they are the most useful for business planning, because they provideinfor mation for action. Example: Capital goods purchases are a leading indicator forrecession. Th e Consumer Price Index is often used in making plans for infl ation andwages because it is a leading economic indicator.

2. Coincident indicators change at the same time as other variables change. Example:Infl ation, unemployment, and consumer confi dence are coincident indicators.

3. Lagging indicators change after the other variables change. Th ese are more accurate,but the information is much less useful for decision making. Example: Unemploymentfi gures are lagging indicators of recession.

(iii) Other Types of Key Economic IndicatorsOther types of key economic indicators include gross national product (GNP), gross domestic product (GDP), net national product (NNP), consumer price index (CPI), and producer price index (PPI). Th ese are discussed below.

(A) Gross National Product and Gross Domestic Product A measure of the change in prices for all fi nal goods and services produced in the economy is the GNP price defl ator. Th is infl ation index can be used to estimate the infl ation rate on all goods and services over a recent time period.

Th e following list provides relationships among GNP, GDP, NNP, CPI, and PPI.

◾ Th e two main variables that contribute to increases in a nation’s real GDP are labor pro-ductivity and total worker hours.

◾ NNP is composed of the total market value of all fi nal goods and services produced in the economy in one year minus the capital consumption allowance.

◾ Th e basic source of improvements in real wage rates and in the standard of living is pro-ductivity growth.

◾ Under the income approach, GNP is measured as follows: Depreciation charges + Indirect business taxes + Wages, rents, interest, and profi ts.

◾ In the output (expenditures) approach to measuring a country’s GNP, it is calculated as follows: Consumption + Investments + Government purchases + Expenditures by foreigners.

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◾ When gross investment is less than depreciation, the capital stock of the economy is shrinking.

◾ An increase in the average hours worked per week of production workers would provide a leading indicator of a future increase in GNP.

◾ Th e sale of fi nal goods is included in the GNP, and the sale of intermediate goods is excluded from the GNP.

◾ GNP price defl ator is the price index for all fi nal goods and services used to adjust the money (or nominal) GNP to measure the real GNP.

(B) Consumer Price Index and Producer Price Index CPI is a statistic used to measure the changes in prices in a market basket of selected items. CPI is one factor in setting cost of living adjustments in a country. Critics of CPI argue that it overstates increases in the cost of living. Th is is due to the constant composition of the market basket of items whose prices are measured. Th e PPI measures the price of a basket of commodities at the point of their fi rst commercial sale.

Example: Application of CPI, Real Income, and Infl ation

Assume that in 1990, an internal auditor is making $40,000 per year. Five years later, his income has risen to $90,000, but the CPI has increased from 100 to 250. The real income (in 1990 prices) for the later year is calculated as follows:

The infl ation rate is (250 – 100)/250 = 150/250 = 0.60, that is, 60%.

Real income is nominal income minus infl ation rate, that is, 100% – 60% = 40%.

Therefore, real income is $90,000 × 0.40 = $36,000.

(iv) Methods of Measuring Economic PerformanceTh e basic goals of the public and private sectors are to achieve both the full employment of resources and a stable price level. Two major methods exist to measure economic performance of a country: unemployment and infl ation.

(A) Unemployment Th e key point is that the level of output depends directly on total or aggregate expenditures. A high level of total spending means that it will be profi table for the various industries to produce large outputs, and it will be profi table for various resource suppliers to be employed at high levels. Hence,

Total spending = Private sector spending + Public sector spending

Private sector spending alone is not enough to keep the economy at full employment. Th e gov-ernment’s obligation (public spending) is to augment private sector spending suffi cient enough to generate full employment. Government has two basic economic tools with which to accomplish public spending: spending programs and taxes. Specifi cally, government should increase its own spending on public goods and services on one hand and reduce taxes in order to stimulate pri-vate sector spending on the other. Unemployment results when either private sector spending or public sector spending does not measure up to expectations.

Th ere are four variations of unemployment: (1) full employment, (2) frictional unemployment, (3) cyclical employment, and (4) structural unemployment (see Exhibit 8.5).

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EXHIBIT 8.5 Four Variations of Unemployment

Four variations of unemployment

Full employment (does not mean 100%employment; inflation is demand-pull inflation)

Frictional unemployment (always exists, short-run unemployment, jobs and workers are available)

Cyclical employment (results from inadequate aggregate demand, is zero when full employment exists)

Structural unemployment (results from changes in technology, consumer preferences, location of industries)

Full employment means that all people 16 years of age or older are employed or are actively seeking employment or that cyclical unemployment is zero. Infl ation occurring during a period of full employment is most likely to be a demand-pull infl ation. In an economy that is near full employment, a decrease in the money supply is likely to decrease the price level.

TYPES OF EMPLOYMENT/UNEMPLOYMENT

◾ Full employment means that all people available to produce goods and services are employed.

◾ Frictional unemployment is short run and caused by people voluntarily changing jobs.

◾ Cyclical employment results from inadequate aggregate demand.

◾ Structural unemployment results from an economy’s failure to adjust to changes in technology, consumer preferences, or locations of industries.

Frictional unemployment will always exist in a dynamic economy. It is short-run unemploy-ment that is caused by people voluntarily changing jobs or by frictions that result from lack of knowledge about job opportunities and lack of labor mobility.

Th us, full employment means that only frictional unemployment exists. In other words, there is no cyclical or structural unemployment when the economy is operating at full employment. Th ere always will be some unemployment caused by workers changing jobs. Frictional unem-ployment occurs when both jobs and the workers qualifi ed to fi ll them are available. It is equal to about 5% or 6%.

Cyclical employment is unemployment that results from inadequate aggregate demand during the recession and depression phases of the business cycle.

Structural unemployment is unemployment that results from an economy’s failure to adjust completely and effi ciently to basic structural changes, such as changes in technology, changes in consumer preferences, and changes in the geographical locations of certain industries. It is equal to about 5% or 6%.

Structural changes prevent certain people from obtaining jobs because of their geographical location, race, age, inadequate education, or lack of training. People who are structurally unem-ployed often are referred to as the hard-core unemployed.

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(B) Infl ation and Defl ation If aggregate spending exceeds the full-employment output, the excess spending will have the eff ect of increasing the general price level. Th erefore, excessive aggregate spending is infl ationary. Government intervenes to eliminate the excess spending by cutting its own expenditures and by raising taxes so as to curtail private spending. Th e inverse relationship between unemployment and infl ation is embodied in the Phillips curve.

UNEMPLOYMENT AND INFLATION DILEMMA

◾ Total spending should increase to generate full employment.

◾ Excessive aggregate spending leads to infl ation.

◾ An increase in the price level would tend to decrease consumption.

Infl ation is a rise in the general level of prices; defl ation is a decline in the general level of prices. However, infl ation has been the prevailing condition in the United States in recent decades.

When prices rise, purchasing power, or the ability to buy goods and services, declines. If prices double, purchasing power is reduced to one-half of its previous level. Thus, inflation reduces the purchasing power of money. Inflation does not mean that the prices of all goods and services rise. Some prices rise, others fall, and some do not change at all, but, on the average, prices rise.

Th e basic cause of infl ation is spending in excess of what an economy can produce. If an economy has unemployed resources, an increase in aggregate demand tends to increase output and employ-ment a great deal and to increase prices only slightly. When an economy is fully employed, an increase in aggregate demand forces prices to increase sharply because resources are scarce and output cannot be increased.

(v) Types of Infl ationIn reality, there are seven types of infl ation, which are presented below (see Exhibit 8.6).

Cost-push inflation (production costs increase faster

Types of

Inflation

than productivity)

Demand-pull inflation (increase in aggregate demand,production costs cannot be increased)

Structural inflation (demand/cost increases to some,aggregate demand equals supply for the nation)

Profit-push inflation (profits increase before wagesincrease)

Hyper (pure) inflation (very small increase in output,if any)

Creeping inflation (a slow upward movement inprices, follows growth and full employment)

Bottleneck inflation (aggregate supply curve is steep)

EXHIBIT 8.6 Seven Types of Infl ation

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1. Cost-push infl ation is a rise in prices brought about by production costs increasing faster than productivity. Since labor is usually the largest cost of production, cost-push infl ationis often called wage-push infl ation. Th e expected impact is an increase in unemployment.

2. Demand-pull infl ation is a rise in prices that is caused by an increase in aggregatedemand when an economy’s resources are fully employed and production cannot beincreased. Th e ex pected impact is a decrease in unemployment.

3. Structural infl ation results when demand increases or costs increase in certain industries even though aggregate demand equals aggregate supply for the nation as a whole.

TYPES OF INFLATION

◾ Cost-push infl ation is caused by increase in wages and prices.

◾ Demand-pull infl ation is caused by increase in aggregate demand.

◾ Structural infl ation results when demand increases or cost increases in certain industries.

◾ Profi t-push infl ation occurs when corporate profi ts increase before wages increase.

◾ Hyperinfl ation or pure infl ation is a rise in prices with a very small increase in output.

◾ Creeping infl ation is a slow upward movement in prices over a period of several years.

◾ Bottleneck infl ation occurs when the aggregate supply curve is steep.

4. Profi t-push infl ation occurs when corporate profi ts increase before wages increase. Anin crease in corporate profi ts can result from increases in prices or from improvements inproduc tivity that reduce the labor cost per unit.

5. Hyperinfl ation or pure infl ation is a rise in prices with a very small, if any, increase inoutput.

6. Creeping infl ation is a slow upward movement in prices over a period of several years.Creeping infl ation is usually defi ned as a 1%, 2%, or 3% increase in the general price leveleach year. Creeping infl ation generally accompanies growth and full employment. Manyeconomists prefer creeping infl ation to price stability accompanied by unemploymentand lack of economic growth.

7. Bottleneck infl ation can be associated with an aggregate supply curve that is steep.

Before the redistribution eff ects of infl ation can be discussed, a distinction must be made between money income and real income. Money income is the amount of money or number of dollars a person receives for the work he or she does; real income is the amount of goods and services the money income will buy or the purchasing power of the money income. Real income is thus a function of money income and the prices of goods and services.

(vi) Eff ects of Infl ationIf nominal income increases faster than the price level, then real income will rise. Th ree classes of people generally suff er from infl ation, and three classes of people generally benefi t from infl ation.

1. Th ose who suff er are fi xed money income groups, creditors, and savers. Peoplewho have fi xed money incomes, or incomes that rise slower than prices, suff er from

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infl ation be cause their real income declines when prices increase faster than their money incomes in crease. Unanticipated infl ation will always adversely aff ect the wealth of lenders with fi xed rate mortgage loans. Low-fi xed-income individuals with no debts would likely suff er most adversely from infl ation. Infl ation reduces the value of a fi xed income.

VARIABLE INCOME VERSUS FIXED INCOME

◾ Individuals with variable incomes and debts gain from infl ation by paying them with dollars of lesser value than the amounts originally borrowed.

◾ Individuals with low fi xed income with no debts do not have the advantage enjoyed by middle- to upper-middle-class and rich individuals.

Creditors suff er from infl ation because the loans they make are paid back with dollars of less purchasing power than the dollars they lent. Savers suff er just like creditors, since the money people save declines in purchasing power as prices rise.

2. Th ose who benefi t are fl exible money income groups, debtors, and speculators.Flexible money income groups, or people whose incomes rise faster than prices rise,benefi t from infl ation because they experience an increase in their real incomes. Debtorsbenefi t because they pay off their loans with dollars that are “cheaper” (worth less) thanthe dollars they borrowed. Speculators—people who buy goods in anticipation ofmaking profi ts when prices change—can increase their real wealth if they borrow moneyto buy goods during infl ation.

It is interesting to note that infl ation redistributes wealth and income unevenly by penalizing some groups and bestowing benefi ts on other groups (assuming full employment). Infl ation is often called the cruelest tax because it penalizes those who are the most vulnerable to it. A higher infl ation rate generally results in higher nominal interest rates.

(vii) Nature of Defl ationDefl ation is a decrease in prices. Defl ation can be induced through contractionary monetary and fi scal policies. If defl ation occurs in the United States, it becomes cheaper for other countries to buy U.S. goods. Defl ation can arise automatically due to an excess of imports over exports.

8.4 Impact of Government Legislation and Regulation on BusinessTopics such as governmental legislation and regulation, government’s monitoring of environ-mental issues, specifi c trade legislation, and regulations such as tied aid practices and the U.S. Export-Import bank, and international laws such as World Trade Organization (WTO), North American Free Trade Agreement (NAFTA), and the European Union (EU) are discussed in this section.

Government impacts business in many ways. Th is impact is felt through regulations to control environment, labor practices, safety at workplace, product liability, import and export laws,

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banking practices, and other areas. Government also impacts business through depreciation laws and tax credits to control in vestment levels in the economy by the private sector. Using fi scal and monetary policies, government controls employment, production, infl ation, interest rates, government spending, and money supply in the economy.

For example, the Consumer Product Safety Commission enforces the Consumer Product Safety Act, which covers safety of any consumer product not addressed by other regulatory agencies. Th e Food and Drug Administration enforces laws and develops regulations to prevent distribution and sale of adulterated foods, drugs, cosmetics, and hazardous consumer products. Th e manu-facturer is usually liable for dangerous and unsafe products. Government laws and regulations can appear as a constraint on business behavior. Another way to view them is as an opportunity to provide safer and more effi cient products to consumers. Events such as deregulation in the airlines and telecommunications industries have helped both producers and consumers alike.

(a) Governmental Legislation and Regulation

Governmental legislation and regulation includes both state and federal government. Th e scope of state regulation includes pricing by public utility compa nies while the scope of federal regulation covers price fi xing, deceptive pricing, price discrimination, and promotional pricing. Examples include:

◾ Sherman Antitrust Act ◾ Clayton Act ◾ Federal Trade Commission Act ◾ Robinson-Patman Act ◾ Wheeler-Lea Act ◾ Celler Antimerger Act

Th ese federal statutes when combined with state legislation intend to promote and preserve competi tion in a free enterprise system and to prevent monopoly power. Th ese acts cover inter-state commerce among the several states but not intrastate activity. All states have antitrust stat utes applicable to intrastate activity.

(i) Sherman ActTh e Sherman Act of 1880 is the primary, fi rst tool of antitrust enforcement. Th e act declared illegal any combination, contract, or conspiracy in restraint of trade made among the states or with foreign countries. Th e act also made it illegal to monopolize, attempt to monopolize, or conspire to monopolize any portion of interstate commerce or any portion of trade with foreign nations. However, the Sherman Act did not state exactly what types of action were pro hibited. Two substantial provisions as defi ned in Sections 1 and 2 of the act are described next.

Section 1 states: “Every contract, combination in the form of trust or otherwise, or conspiracy, in restraint of trade or commerce among the several States, or with foreign nations, is declared to be illegal.”

Section 1 is concerned with contract, combination, and conspiracies in restraint of trade. Two or more persons working together (i.e., combination) to fi x prices or divide market to achieve the

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anticompetitive results, for example, constitute a violation of the act. Conspiracy is concerned with the conduct of an individual fi rm (e.g., predatory pricing) to create or maintain a monopoly.

Restraint of trade consists of horizontal and vertical types. A horizontal restraint is an agree-ment among competitors, such as manufacturers, retailers, or wholesalers. Examples of horizon-tal restraints include division of markets, price fi xing, group boycotts, and exchange of market information. A vertical restraint is an agreement between persons standing in a buyer–seller relationship (a manufacturer and a retailer in the same line of products). Examples of vertical restraint include resale price maintenance, location, territory, and customer restrictions, tying arrangements, and exclusive dealing contracts.

Section 2 states: “Every person who shall monopolize, or attempt to monopolize, or combine or conspire with any other person or persons, to monopolize any part of the trade or commerce among the several States, or with foreign nations, shall be deemed guilty of a felony.”

Th e wording of the act is too broad and general and leaves much discretion to federal courts for interpretation. Th ese two sections complement each other in achieving the goal of preventing monopoly and anticompetitiveness. Th e Sherman Act requires proof of actual and substantial anticompetitive eff ect.

Labor unions, agricultural cooperatives, fi sherman’s organizations, and export trade as sociations enjoy limited antitrust exemption.

VIOLATIONS OF THE SHERMAN ACT

Violations of both Sections 1 and 2 are felonies punishable by imprisonment of up to three years and fi nes up to $100,000, or both, for individuals and fi nes up to $1 million for corporations. Civil actions are more common than criminal proceedings.

Approximately 75% of civil suits are settled through consent decrees (a compromise between the government and the defendant). The Sherman Act also contains the seldom-used forfeiture remedy, where the property may be seized.

Conduct that would violate the Sherman Act in the absence of union involvement is not immu-nized by the participation of the union. For example, a union may not band together with a nonla-bor party, such as a contractor or manufacturer, to achieve a result forbidden by the antitrust laws.

(ii) Clayton ActTh e Clayton Act of 1914 was designed to strengthen and clarify the provisions of the Sherman Act. It defi nes specifi cally what constitutes monopolistic or restrictive practices, whereas the Sherman Act does not.

Th e Clayton Act makes price discrimination illegal unless it can be justifi ed because of diff erences in costs. Th e act prohibits the use of exclusive or tying contracts when their use “substantially lessens competition or tends to create a monopoly.” Exclusive or tying contracts are contracts in which the seller agrees to sell a product to a buyer on the condition that the buyer will not purchase products from the seller’s competitors. Th e Clayton Act also makes intercorporate stockhold-ings illegal if they tend to greatly reduce competition or to create a monopoly. In addi tion, the Clayton Act makes interlocking directorates (having the same individual on two or more board

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of directors) illegal if the corporations are competitive and if at least one of the corporations is of a certain minimum size.

Four provisions (sections 2, 3, 7, and 8) that are of importance are listed next.

◾ Section 2 prohibits certain types of price discrimination. ◾ Section 3 prohibits certain sales made on condition that the buyer not deal with the seller’s competitors.

VIOLATIONS OF THE CLAYTON ACT

No criminal sanctions are imposed for violations of the Clayton Act. Private remedies and legal and equitable relief are available. Legal relief is a private action for money damages.

In a private action, the plaintiff must ordinarily prove both the existence of an antitrust violation and damages resulting from that violation.

◾ Section 7 prohibits certain corporate mergers. ◾ Section 8 prohibits a person serving on the board of directors of two competing companies (an “interlocking directorate) if one or both companies are larger than a given size.

Th e goal of the Clayton Act is to curb anticompetitive practices in their incipiency. Under the act, simply showing a probable, rather than actual, anticompetitive eff ect would be enough cause for a violation of the act. Th is means that the Clayton Act is more sensitive to anticompetitive practices than the Sherman Act.

Th e scope of the Clayton Act in mergers includes both asset and stock acquisitions. Th e act now covers both mergers between actual competitors and vertical and conglomerate mergers having the requisite anticompetitive eff ect.

RULES OF MERGERS

◾ A horizontal merger is one between former competitors.

◾ A vertical merger occurs when a fi rm acquires a supplier or customer.

◾ If a business acquires a supplier, it is said to vertically integrate backward, or upstream.

◾ If a business acquires a customer, it is said to vertically integrate forward, or downstream.

◾ A conglomerate merger involves parties who were neither former competitors nor in the same supply chain.

(iii) Federal Trade Commission ActLike the Clayton Act, the Federal Trade Commission Act was designed to prevent abuses and to sustain competition. Th e act de clared as unlawful “unfair methods of competition in commerce.”

Th e act also established the Federal Trade Commission (FTC) in 1914 and gave it the power and the resources to investigate unfair competitive practices. Th e act authorizes the FTC to issue

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cease-and-desist orders prohibiting “unfair methods of competition” and “unfair or deceptive acts or practices.” Th ese orders provide injunctive relief by preventing or restraining unlawful conduct. One of the goals of the FTC is to enforce antitrust laws and to protect consumers.

VIOLATIONS OF THE FTC ACT

No criminal sanctions are imposed for violations of the FTC Act. Most FTC investi gations are settled by a consent order procedure.

Although no criminal sanctions or private damage remedies are imposed for FTC act violations, a $10,000-per-day civil penalty is imposed for violating cease-and-desist orders.

Th e FTC has a dual role in prohibiting unfair methods of competition and anticompetitive prac-tices. Th e FTC Act supplements the Sherman and the Clayton Acts. Th e FTC protects consum ers who are injured by practices such as deceptive advertising or labeling without regard to any eff ect on competitors.

Although not explicitly empowered to do so, the FTC frequently enforces the Sherman Act indi-rectly and enjoins conduct beyond the reach of either the Sherman or Clayton Acts.

(iv) Robinson-Patman ActIn 1936, Congress passed the Robinson-Patman Act, which amends the Clayton Act to protect small com petitors. It is often called the chain store act. Th e Robinson-Patman Act amends the price discrimination section of the Clayton Act. It was aimed at protecting independent retailers and wholesalers from “unfair discriminations” by large chain stores and mass distributors, which were supposedly obtaining large and unjustifi ed price discounts because of their purchasing power and bargaining position.

Both the Department of Justice and the FTC can proceed against violators of the Robinson-Patman Act. Th e act prohibits price discrimination (where a seller charges one buyer more than another for the same product). It makes it unlawful for sellers to grant concessions to buyers unless concessions are granted to all buyers on terms that are proportionally equal. Th e act reaches the quantity discount, a major form of price discrimination.

Th e Robinson-Patman Act made it illegal:

◾ To discriminate by granting unjustifi ed quantity discounts that greatly reduce competition or tend to create a monopoly among sellers or buyers.

◾ To pay brokerage fees if no broker is involved in a transaction. ◾ To grant or obtain larger discounts than those available to competitors who purchase the same goods in the same amounts.

◾ For sellers to grant concessions to buyers unless concessions are created to all buyers on terms that are proportionally equal.

Th e act applies only to sales, not to leases, agency/consignment arrangements, licenses, or refus-als to deal (selling to one fi rm while refusing to deal with another). Th e scope of the Robinson-Patman Act applies to tangible personal property (commodities) and in the sale of services or in tangibles, such as advertising.

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VIOLATIONS OF THE ROBINSONPATMAN ACT

To violate the statute, the discrimination in price must be “between diff erent purchasers.” A mere show-ing of diff erent prices charged is enough to violate.

A mere showing that competing buyers were charged diff erent prices is generally suffi cient to establish a prima facie Robinson-Patman Act violation. Proof of a prima facie case of price dis-crimination does not necessarily result in a liability.

Th e seller may avoid the consequences of the discrimination by proving one of three defenses: (1) the “cost justifi cation” defense, (2) the “meeting competition” defense, and (3) the “changing conditions.” Th e burden of proving a defense is on the discriminating seller.

(v) Wheeler-Lea ActIn 1938, the Wheeler-Lea Act was passed as an amendment to the FTC Act. Th e Wheeler-Lea Act makes “unfair or deceptive acts or practices” in interstate commerce illegal; thus, it is designed to protect consumers rather than competitors. With the passage of this act, the FTC has the authority to prohibit false and misleading advertising and product misrepresentation.

(vi) Celler Antimerger ActTh e Celler Antimerger Act of 1950 also amended the Clayton Act by making it illegal for a cor-poration to acquire the assets, as well as the stock, of a competing corporation if the eff ect is to greatly reduce competition or to tend to create a monopoly.

(b) Government’s Monitoring of Environmental Issues

The U.S. Environmental Protection Agency (EPA) protects and enhances the environment today and for future generations to the fullest extent possible under the laws enacted by the U.S. Congress. The agency’s mission is to control and abate pollution in the areas of air, water, solid waste, pesticides, radiation, and toxic substances. Its mandate is to mount an integrated, coordinated attack on environmental pollution in cooperation with state and local governments.

Th e Council on Environmental Quality was established within the Executive Offi ce of the Presi-dent by the National Environmental Policy Act of 1969 to formulate and recommend national policies to promote the improvement of the quality of the environment.

Th e council:

◾ Develops and recommends to the president national policies that further environ mental quality.

◾ Performs a continuing analysis of changes or trends in the national environment. ◾ Reviews and reappraises programs of the federal government to determine their contribu-tions to sound environmental policy.

◾ Conducts studies, research, and analysis relating to ecological systems and envi ronmental quality.

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◾ Assists the president in the preparation of the annual environmental quality report to the Congress.

◾ Oversees implementation of the National Environmental Policy Act.

(i) Air and RadiationTh e air activities of the EPA include:

◾ Development of national programs, technical policies, and regulations for air pollution control. ◾ Enforcement of standards. ◾ Development of national standards for air quality, emission standards for new stationary and mobile sources, and emission standards for hazardous pollutants.

◾ Technical direction, support, and evaluation of re gional air activities. ◾ Provision of training in the fi eld of air pollution control.

Related activities include technical assistance to states and agencies having radiation protection programs, including radon mitigation programs, and a national surveillance and inspection program for measuring radiation levels in the environment.

(ii) WaterTh e EPA’s water quality activities represent a coordinated eff ort to restore the nation’s waters. Th e functions of this program include:

◾ Development of national programs, technical policies, and regulations for water pollution control and water supply, ground water protection, marine and estuarine protection.

◾ Enforcement of standards. ◾ Water quality standards and effl uent guidelines development. ◾ Technical direction, support, and evaluation of regional water activities. ◾ Development of programs for technical assistance and technology transfer. ◾ Provision of training in the fi eld of water quality.

(iii) Solid Waste and Emergency ResponseTh e Offi ce of Solid Waste and Emergency Response provides policy, guidance, and direction for the agency’s hazardous waste and emergency response programs. Th e functions of these programs include:

◾ Development of policies, standards, and regulations for hazardous waste treatment, stor-age, and disposal.

◾ National management of the Superfund toxic waste cleanup program. ◾ Development of guidelines for the emergency preparedness and “community right-to-know” programs.

◾ Development of guidelines and standards for underground storage tanks. ◾ Enforcement of applicable laws and regulations.

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◾ Analysis of technologies and meth ods for the recovery of useful energy from solid waste. ◾ Provision of technical assistance in the development, management, and operation of waste management activities.

(iv) Pesticides and Toxic SubstancesTh e Offi ce of Pesticides and Toxic Substances is responsible for:

◾ Developing national strategies for the control of toxic substances. ◾ Directing the pesticides and toxic substances enforcement activities. ◾ Developing criteria for assessing chemical substances, standards for test protocols for chemicals, rules, and procedures for industry reporting and regulations for the control of substances deemed to be hazardous to man or the environment.

◾ Evalu ating and assessing the impact of existing chemicals, new chemicals, and chemicals with new uses to determine the hazard and, if needed, develop appropriate restrictions.

Additional activities include control and regulation of pesticides and reduction in their use to ensure human safety and protection of environmental quality. Th is includes:

◾ Establishing tolerance levels for pesticides that occur in or on food. ◾ Monitoring pesticide residue levels in food, humans, and nontarget fi sh and wildlife and their environments.

◾ Investiging pesticide accidents.

Th e Offi ce of Pesticides and Toxic Substances also coordinates activities under its statutory res-ponsibilities with other agencies for the assessment and control of toxic substances and pesticides.

(c) Specifi c Trade Legislation and Regulations

(i) Tied Aid Practices“Tied aid” refers to foreign assistance that is linked to the purchase of exports from the country extending the assistance. Tied aid can consist of foreign aid grants alone, grants mixed with com-mercial fi nancing or offi cial export credits (mixed credits), or concessional (low-interest-rate) loans.

MIXED CREDITS

Mixed credits are a combination of subsidized loans and commercial loans that, in eff ect, subsidize the purchase of a country’s exports.

Competitors’ tied aid practices are of concern to the United States because U.S. exporters can be put at a competitive disadvantage in bidding on overseas projects when competitor countries make tied aid available. Th e eff ect is the same for any exporting country.

Th e Organization for Economic Cooperation and Development (OECD) is a forum for monitor-ing economic trends and coordinating economic policy among its 24 member countries, which include the economically developed free market democracies of North America, Western Europe,

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and the Pacifi c. Negotiators representing countries in the OECD have agreed to curb the use of tied aid for commercial purposes and are taking steps to reduce the use of mixed credits.

(ii) U.S. Export-Import BankExports play a vital role in any economy by creating jobs and generating economic growth. Most industrialized nations have programs to help companies export—that is, sell their products abroad. Th ese programs, collectively referred to as export promotion, include off ering business coun-seling and training and giving representational assistance as well as providing market research information, trade fair opportunities, and export fi nancing assistance. Th ese programs can play an important role in increasing the exports of a country’s goods and services in sectors of the economy in which it is competitive.

BUDGET DEFICIT

Budget defi cit reduction and liberalized trade are important to the long-term health of any economy.

Th e U.S. Export-Import Bank (Eximbank) is one of 10 federal government agencies that off er programs to assist exporters. Th e Eximbank off ers a wide range of export fi nancing assistance, including direct loans, loan guarantees, and export insurance covering credit and political risks. Credit risk is the probability that a loan will not be repaid by a foreign country. Political risk is the probability that a foreign country’s political system is unstable. Although the Eximbank was created to facilitate the fi nancing of both U.S. exports and imports, it has been used almost exclusively to fi nance U.S. exports.

Th e Eximbank is required to counter competitors’ use of tied aid and mixed credits. In 1986, the U.S. Congress authorized the Eximbank to create a war chest fund as a means of overmatching or outbidding other countries that have repeatedly used tied aid and mixed credits to increase their exports. However, war chest funds have not been used extensively.

Th e export promotion programs are eff ective when:

◾ U.S. fi rms lack export awareness because markets have failed to give the right information to producers who otherwise would export.

◾ U.S. businesses are aware of export opportunities but need additional technical assistance to consummate export sales.

◾ U.S. fi rms need representational assistance from the U.S. government in opening doors overseas. ◾ U.S. businesses need competitive fi nancing, loan guarantees, or insurance to close an ex port deal.

KEY CONCEPTS TO REMEMBER: Imports and Exports

◾ Import quotas diff er from tariff s. Quotas discriminate on the basis of quantity whereas tariff s directly increase prices.

◾ GNP will fall following an increase in imports.

◾ A defi cit in the balance of payments occurs when imports exceed exports.

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(iii) Methods, Restrictions, and Barriers of International TradeA country will have a trade defi cit when it consumes more than it produces and imports the dif-ference from other countries. A country will become a debtor nation when there is a huge trade defi cit and when it borrows to fi nance the do mestic budget defi cit.

A country should strike a balance between the national savings rate and the budget defi cit, spe-cifi cally by reducing the defi cit without endangering long-term economic growth. An imbalance is created when the savings rate is declining and the budget defi cit is increasing. Th e national savings rate should be suffi cient to meet the needs of both private sector investments and gov-ernment borrowing. A country should focus on long-term investment as a way to enhance its competitiveness in the global marketplace.

A government’s economic policies require a diffi cult balancing of domestic goals with international economic objectives and constraints. For example, at the macroeconomic level, a government may adopt policies that:

◾ Support private sector investment by keeping the cost of capital at reasonable levels.◾ Support rising productivity in the private sector by improving infrastructure and a better-

educated and trained labor force. ◾ Encourage private sector fi rms to improve their own goals, policies, and management

control and information systems as their critical contribution to enhancing their country’s competitiveness.

(A) Methods of Restricting Trade Tariff s, import quotas, and domestic content laws are methods used to restrict foreign trade (see Exhibit 8.7).

EXHIBIT 8.7 Methods of Restricting Trade

Methods of restricting trade

Tariffs

Import quotas

Domestic content laws

Tariff s A tariff is a tax imposed on imported goods, usually as a percentage of the product’s value. Import duties, or tariff s, have been a source of government revenue far longer than income and value-added taxation (VAT). Goods entering a country are taxed at an ad valorem (percentage of value) basis. Many foreign countries prefer to use tariff s since it is relatively easy to check and control as goods come through designated ports.

Another popularity of tariff s is its incentive feature to relocate manufacturing production facili-ties and be competitive. If an American fi rm exporting to Brazil fi nds that its products are priced much higher in Brazil because of tariff s, it may build a manufacturing plant in Brazil to produce for the Brazilian market. Th is strategy has dual benefi ts: It not only avoids the tariff s to be paid but also makes the American fi rm’s products more competitive in Brazil.

Th e imposition of a tariff against an imported good raises its cost relative to what it would have been in the tariff ’s absence. Importers, therefore, need to charge a higher price to their customers. As a consequence, tariff s tend to worsen an imported product’s competitive position compared with similar items produced domestically.

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Because of high prices of imported goods due to tariff s, more sales will go to local manufacturers. Th us, tariff s off er a degree of market protection to local sellers whose life has been made competi-tively diffi cult by imports in their markets. For this reason, when imports become an important factor in a market, domestic manufacturers frequently ask the government for tariff protection. Th e usual argument is that imports are injuring the local industry and causing unemployment.

Import Quotas A quota is simply a quantitative restriction applied to imports. Under GATT, import quotas are supposed to be banned, but there are so many exceptions that the ban is not that useful. In fact, as tariff s have been reduced as an instrument of protection, the tendency has been to replace them with quotas.

Domestic Content Laws Another way many countries have attempted to ensure the participa tion of domestic producers has been through domestic content laws. Th ese laws stipulate that when a product is sold in the marketplace, it must incorporate a specifi ed percentage of locally made components. Th ese laws must meet local content requirements.

KEY CONCEPTS TO REMEMBER: Trade

◾ Consumption taxes on imported goods are an example of a tariff .

◾ Import tariff s have the same economic eff ect as a consumption tax plus a production subsidy. A direct eff ect of imposing a protective tariff on an imported product is lower domestic consumption of the item.

◾ The merchandise trade balance (or balance of trade) does not refl ect capital outfl ows.

◾ The point price elasticity of demand for imports will become larger following an increase in import prices.

◾ A nation experiencing chronic trade defi cits might consider trade quotas. Unemployment and productivity rates will decline as a result of trade quotas.

◾ Increased total world output provides the best justifi cation for reducing trade barriers between nations.

◾ An embargo creates the most restrictive barrier to exporting to a country and often results from political actions. An embargo is a total ban on some kind of imports, which is an extreme form of import quota.

(B) Methods of International Trade Export promotion programs, trade agreements, and technology policies set the stage for international trade to occur.

Export Promotion Programs As each country’s economic advancement is dependent on its success in trading with other countries, the way that country promotes its exports will be of great importance. Th erefore, it is important to ensure that the funds allocated are being channeled into areas with the greatest potential returns. A budget for export promotion programs would be a good start. For a government to promote these programs requires good internal controls, program evaluation criteria, proper program accountability, and enhanced planning and decision making. Export promotion programs, export loans, credit guarantees, and insurance are some examples of promoting international trade.

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EXERCISE ON TRADE BARRIERS

The United States imposed many barriers to international trade during the 1920s and 1930s. The United States has become much less protectionist and has eliminated or lessened numerous former barriers to trade. In the last several years, as a result of increased foreign competition in some histori-cally strong U.S. industries, some observers have become concerned that the United States will extend protection to other industries.

Question: Describe the basic types of trade barriers.

Answer: The three basic types of trade barriers include tariff s, quotas, and other non tariff barriers. A tariff is an import tax that may be used as a source of revenue for the government. A quota is a physical or dollar value limitation on the volume of imports of a particular commodity. A quota generates no revenue for the government, but it generates monopoly profi ts for the protected industry. A quota also increases the burden of adjustment of prices relative to tariff s. Other nontariff barriers include an array of government practices and regulations that interfere with the free fl ow of goods between countries. Some of the most common nontariff barriers include: export subsidies and taxes, diff erences in product stan dards, domestic subsidies and aids, and dumping regulations and customs valuations proce dures.

Trade Agreements Two popular trade agreements are the WTO, formally known as GATT and NAFTA. Th e aim of U.S. trade negotiations is to remove foreign barriers to imports and unfair governmental incentives to exports, thus encouraging the free fl ow of international trade. Th e principal multinational trade regime has been the WTO, which requires the negotiations of concerned countries in liberalizing the trade and removing tariff s and other barriers—which is not an easy thing to accomplish. More is said about WTO later.

TRADE AGREEMENTS

A vigorous and eff ective system for monitoring and enforcing agreements is essential to avoid viola-tions, delaying tactics, and drawn-out dispute settlements.

Th e United States, Mexico, and Canada concluded negotiations and signed the NAFTA, which became eff ective in 1994. Th e most signifi cant aspect of NAFTA is that it binds Mexico’s market-oriented economic reforms to international obligations, thereby making these reforms more permanent. Although NAFTA will likely have only a modest net eff ect on the U.S. economy, much controversy re mains as to the scope and extent of social and economic adjustments that will be caused by its implementation, such as eff ects on employment, immigration, and the environment. More is said about NAFTA later.

Technology Policies Technology policies, the fi nancial market structures, and the business/government relationships of other nations will have greater signifi cance in the more closely integrated global marketplace.

Th e U.S. International Trade Commission furnishes studies, reports, and recom mendations involving international trade and tariff s to the president, the Congress, and other government agencies. In this capacity, the commission conducts a variety of investigations, public hearings, and research projects pertaining to the international policies of the United States.

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Question: For each type, describe the impact on the protectionist country (importer) im posing the barrier.

Answer: All of the trade barriers are designed to decrease the quantity of imported goods supplied either by increasing prices or directly restricting quantities causing subsequent price increases. A tariff works by raising prices and hence cutting the demand for imports while quotas restrict the supply of imports forcing prices up. The increase in price associated with a tariff does not directly benefi t the seller; it becomes a source of revenue for the importing country. The increase in price associated with a quota does not become a source of revenue for the importing country, but the benefi ts become the property rights of some participant in the market yielding monopoly profi ts. The degree of protection that is achieved is determined by the demand elasticity of the product and whether the exporting country imposes retaliatory trade barriers.

Question: Describe the impact on producer nations (exporter) facing the barrier.

Answer: Tariff s, quotas, and other nontariff barriers cause the volume of trade to de cline. Since products can no longer be exported as profi tably, prices will decline in the exporting country. Production will decrease in the exporting country resulting in a loss of income.

Question: Describe the impact on international trade in the year-end balance of pay ments be-tween the protectionist and the producer.

Answer: In the importing country, the balance of payments improves. In the exporting country, the balance of payments worsens.

Source: Institute of Internal Auditors, CIA Examination, Part IV, Question No. 42 (Altamonte Springs, FL: May 1986).

(iv) Theory of Comparative AdvantageIncreased total world output is a good argument for free trade between countries. Incentives exist for trade to develop along the lines of comparative advantage. Countries achieve comparative advantage in certain goods due to international diff erences in demand or supply.

Th e law of comparative advantage explains how mutually benefi cial trade can occur when one country is less effi cient than another county in the production of all commodities. Th e less effi -cient country should specialize in and export the commodity in which its absolute disadvantage is smallest and should import the other commodity.

Countries should specialize when they have their greatest absolute advantage or in their least absolute disadvantage. Th is rule is known as the law of comparative advantage. An absolute advan-tage is the ability to produce a good using less input than is possible anywhere else in the world.

Production of the good with the lower price expands, and the country with a lower relative price of a product has comparative advantage in that product. Th erefore, production and trade follow the line of comparative advantage. For trade to occur along the lines of comparative advantage, the relative wage ratio must lie between the extremes of the diff erences in relative productive advantages.

Th e HO theorem states that a country will have a comparative advantage in and therefore will export that good whose production is relatively intensive in the factor with which that country is relatively well endowed. For example, a country that is relatively capital-abundant compared with another country will have a comparative advantage in the good that requires more capital per worker to produce.

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EXAMPLES OF COMPARATIVE ADVANTAGE THEORY

Example 1

Country A Country B

Good X Good Y Good X Good Y

100 0 60 0

60 20 30 10

20 40 0 20

0 50

This table represents production possibilities for Country A and Country B for two goods, X and Y. Based on the principle of comparative advantage, Country B should produce Good X.

Example 2

Country A Country B

Cotton 3 12 labor hours per unit of output

Automobile 6 8

Note that Country A is four times (i.e., 12 to 3) more effi cient in the production of cotton relative to Country B. However, Country A is only 4/3 (i.e., 8/6) more effi cient in the production of automobiles relative to Country B. Because Country A’s greatest absolute advantage is in the production of cotton, it is said to have a comparative advantage in cotton. Because Country B’s least absolute disadvantage is in the production of automobiles, it is said to have a comparative advantage in automobiles.

Example 3Assume a simple economy consisting of only two nations, Nation A and Nation B. The countries pro-duce and consume only two products: rice and cars. The comparative costs of production in each country are

Nation A Nation B

Rice (per ton) 10,000 20,000

Cars 15,000 16,000

Given this cost structure and a fi xed supply of inputs, what can be said with respect to comparative advantage and international trade?

a. Nation B has a comparative advantage with respect to the production of cars and will export carsto Nation A.

b. Nation B has a comparative advantage with respect to rice and will export rice to Nation A.

c. Nation A has a comparative advantage with respect to cars and will export cars to Nation B.

d. There will be no overall advantage to international trade.

In a competitive environment, trade fl ows are determined by profi t-seeking fi rms. If a product is relatively cheap in one country, it will tend to be exported to those places where it is rela-tively expensive. Th is practice supports the assumption that trade will fl ow in the direction of comparative advantage. Each country exports its comparative-advantage good and imports its comparative-disadvantage good.

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WTO STRUCTURE

The agreement establishing the World Trade Organization would, for the fi rst time, create a formal organization encompassing all GATT disciplines. WTO membership would be open only to countries that agree to adhere to all of the Uruguay Round agree ments and submit schedules of market access commitments for industrial goods, agricultural goods, and services. As such, this agreement would resolve the free rider problem and permit members to cross-retaliate by suspending concessions un-der any of these agree ments when authorized to impose sanctions. Adherence to the four plurilateral agreements would not be mandatory.

Free Rider ProblemDue to the WTO’s MFN require ments, member countries that adhere to a given code and provide concessions in accordance with its obligations are required to accord the same benefi ts to all WTO members, including those countries that did not adhere to the code and thus do not reciprocate.

Inability to Cross-RetaliateWhen a WTO member country is authorized to impose sanctions against another member for violat-ing its obligations under a given code, it may only suspend concessions provided under that code. This restriction limits the plaintiff country’s options and may make it diffi cult for that country to devise an eff ective sanction.

Choice (a) is the correct answer. Nation B has a comparative advantage in cars because the within-country price comparison between cars and rice is lower for Nation B (16,000/20,000 = 0.8) than for Nation A (15,000/10,000 = 1.5). Nation A has an absolute advantage, but Nation B has the compara-tive advantage. Choice (b) is incorrect. Nation A has the compara tive advantage for rice because its cost relationship (10,000/15,000 = 0.667) is lower than in Nation B (20,000/16,000 = 1.25). Choice (c) is incorrect. Nation B has the comparative ad vantage for cars. Choice (d) is incorrect. Total output will be maximized when each nation specializes in the products in which it has the greatest comparative advantage.

(v) International LawsLaws regarding WTO, NAFTA, the EU, and other regional groups are discussed in this section.

(A) World Trade Organization Th e Final Act resulting from the Uruguay Round of negotiations of the GATT was signed in April 1994. Th e Final Act created a new WTO as a successor to GATT. WTO would bring all member countries under more of the multilateral trade disciplines.

Implementation of the Uruguay Round agreement is meant to:

◾ Further open markets by reducing tariff s worldwide by one-third. ◾ Improve GATT procedures over unfair trade practices. ◾ Broaden GATT coverage by including areas of trade in services, IP rights, and trade-related investment that previously were not covered.

◾ Provide increased coverage to the areas of agriculture, textiles and clothing, government procurements, and trade and the environment.

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The agreement also makes provision for improved cooperation with other multilateral organizations with responsibilities and concerns similar to WTO, such as the World Bank and International Monetary Fund (IMF) as well as the OECD. It also would establish within WTO a Trade Policy Review Board com-prised of the members. This review body would examine, on a regular basis, national trade policies and other economic policies aff ecting the international trading environment.

Agreement for Market Access Th e market access for goods agreement is a key part of the Uruguay Round’s overall goal of liberalizing international trade by further opening markets among WTO countries. It is essentially a tariff schedule that refl ects the concessions agreed on by WTO signatories. Th e main contribution of the market access agreements would be to signifi cantly lower, or eliminate, tariff and nontariff barriers and to expand the extent of tariff bindings on industrial products among WTO signatories. Th e global economic impact of this agreement is substantial.

Provisions for Subsidies and Countervailing Duties Subsidies essentially lower a producer’s costs or increase its revenues. Consequently, producers may sell their products at lower prices than their competitors from other countries. Subsidies to fi rms that produce or sell internationally traded products can distort international trade fl ows.

Th e United States has historically provided fewer industrial subsidies than most countries, and it has sought to eliminate trade-distorting subsidies provided by foreign governments.

Countervailing duty laws can address some of the adverse eff ects that subsidies can cause. Countervailing duties are special customs duties imposed to off set subsidies provided on the manufacture, protection, or export of a particular good.

Th e agreement would create for the fi rst time three categories of subsidies and remedies: (1) prohibited subsidies (the red light category); (2) actionable subsidies (the yellow light category); and (3) nonactionable subsidies (the green light category) (see Exhibit 8.8).

EXHIBIT 8.8 Categories of Subsidies

Categories of subsidies

Prohibited subsidies (red light)

Actionable subsidies (yellow light)

Nonactionable subsidies (green light)

Prohibited subsidies include subsidies to encourage exports, including de facto export subsidies, and subsidies contingent on the use of local content.

Actionable subsidies are domestic subsidies against which remedies can be sought if they are shown to distort trade. Trade distortion occurs if: subsidized imports cause injury to a domes-tic industry (e.g., depress prices or threaten to do so); subsidies nullify or impair benefi ts owed to another country under WTO (e.g., the benefi ts of bound tariff concessions); or subsidized products displace or impede imports from another country or another country’s exports to a third-country market.

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Th ere is also a special category of actionable subsidies that have a high likelihood of being trade distorting. Th ese subsidies are presumed to cause “serious prejudice” to the trade interests of other countries when either of the following conditions are met:

◾ Th e total ad valorem subsidization of a product exceeds 5% of the value of the fi rm’s or industry’s output of a product (calculate on the basis of cost to the subsidizing government).

◾ Subsidies are provided to forgive debts or subsidies cover a fi rm’s or an industry’s operat-ing losses.

In cases where serious prejudice is presumed, the burden is on the subsidizing government to demonstrate that serious prejudice did not result from the subsidy in question.

Nonactionable subsidies include those that are not “specifi c” (i.e., not limited to an en terprise or industry or group of enterprises or industries). Subsidies also are nonactionable if they involve certain government assistance: for research and precompetitive development activity, for disad-vantaged regions, or to adapt existing plants and equipment to new environmental requirements.

Provision for Antidumping Dumping is generally considered to be the sale of an exported product at a price lower than that charged for the same or a like product in the home market of the exporter. Th is practice is thought of as a form of price discrimination that can poten tially harm the importing nation’s competing industries.

Dumping may occur as a result of exporter business strategies that include:

◾ Trying to increase an overseas market share. ◾ Temporarily distributing products in overseas markets to off set slack demand in the home market.

◾ Lowering unit costs by exploiting large-scale production. ◾ Attempting to maintain stable prices during periods of exchange rate fl uctuations.

International trade rules, as defi ned by WTO, take political as well as economic concerns into account and view dumping and its potential harm broadly. Article VI of the WTO agree ment notes that the contracting parties recognize that dumping “is to be condemned if it causes or threatens material injury to an established industry in the territory of a contracting party or materially retards the establishment of a domestic industry.” Th e rules allow for the imposi tion of antidumping duties, or fees, to neutralize the injurious eff ect of these pricing practices.

Some trade economists view dumping as harmful only when it involves the use of “predatory” practices that intentionally try to eliminate competition and gain monopoly power in a market. Th ey believe that predatory dumping rarely occurs and that antidumping enforcement is a pro-tectionist tool whose cost to consumers and import-using industries exceeds the benefi ts to the industries receiving protection. Moreover, they believe that increased use of antidumping pro-tection eff ectively reduces the anticipated gains that trade liberalization through tariff reduction will realize for the national economy.

Provision for Safeguards A safeguard is a temporary import control or other trade restriction a country imposes to prevent injury to domestic industry caused by increased imports. Article

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19 of the current GATT agreement, known as the safeguard clause, allows contracting par ties to obtain emergency relief from import surges. It is designed to help the domestic indus tries adjust to an infl ux of fairly traded imports.

Th e new Safeguard Agreement would require that safeguard measures be limited to an eight-year period for developed countries and ten years for developing countries. It provides for suspending the automatic right to retaliate to a safeguard measure for the fi rst three years. However, it would maintain the requirement that safeguards be applied on an MFN basis rather than being applied selectively (applied to just the country or coun tries causing injury to the domestic industry).

Agreement on Trade-Related Aspects of IP Rights Th e World Intellectual Property Organizations (WIPO), a United Nations specialized agency, is a world body whose mission is to (1) promote the protection of IP rights throughout the world through co operation among countries and, where appropriate, in collaboration with international organi zations; and (2) ensure administrative cooperation among the IP unions. WIPO administers a number of international agreements on IP protection, including, in particular, the Berne Convention for the Protection of Literary and Artistic Works, which provides for copyright protection, and the Paris Convention for the Protection of In dustrial Property, which provides protection for patents, trademarks, and industrial designs and the repression of unfair competition.

According to U.S. offi cials, these conventions do not contain specifi c commitments in im portant areas. For example, the Paris Convention does not contain a required minimum length of time for patent protection or specify the subject matter to be covered by patents, and the Berne Con-vention does not provide copyright protection for newer creations, such as sound re cordings. Further, they do not provide for meaningful enforcement measures, an area long considered crucial by U.S. interests; the Industry Functional Advisory Committee on IP rights has pointed out that standards of protection are useless unless they are enforced.

Agreement on Trade in Services Service industries dominate the U.S. economy and are impor-tant contributors to U.S. exports. Th e U.S. service industry is also the world’s largest exporter of services. International trade in services takes place through various channels, including:

◾ Cross-border transactions, such as transmission of voice, video, data, or other information and the transportation of goods and passengers from one country to another.

◾ Travel of individual consumers to another country (e.g., services provided to nonresi dent tourists, students, and medical patients).

◾ Sales of services (e.g., accounting, advertising, and insurance) through foreign branches or other affi liates established in the consuming country.

◾ Travel of individual producers to another country (e.g., services provided to foreign clients by business consultants, engineers, lawyers, etc.).

Th e Uruguay Round meetings created General Agreement on Trade in Services (GATS), which is the fi rst multilateral, legally enforceable agreement covering trade and investment in the ser-vices sector.

Agreement on Trade-Related Investment Measures Th ere is consensus among many, primar ily developed, countries that foreign direct investment can have a favorable eff ect on a host country’s

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economy. Th e foreign direct investment can create jobs, increase tax revenues, and introduce new technologies. It also increases the host country wages and productivity and seems to have a net positive eff ect on the competitiveness of the host economy.

According to the U.S. Department of Commerce review of foreign direct investment, fi rms choose to expand their activities overseas for a variety of reasons. Th ese reasons include a desire to:

◾ Maintain profi tability while reducing prices when faced with lower competitors’ prices. ◾ Maintain an increased worldwide market share. ◾ Gain access to or retain access in an overseas market, especially in periods when trade restrictions are threatened.

◾ Exploit, and maintain control over, an advantage specifi c to a company, such as manage-ment, marketing, and/or technology, or a comparative advantage in producing in the foreign market.

◾ Im prove the company’s ability to meet the overseas market’s needs by providing a special prod uct design and/or service.

Th e WTO created trade-related investment measures (TRIMs), which have economic eff ects that are comparable to those of traditional instruments of commercial policy, such as quotas, tariff s, and subsidies. TRIMs exist in many forms. TRIMs include local content requirements (obliging an investor to purchase or use a specifi ed amount of inputs from local suppliers). Local content requirements are the most common form of TRIM and are used in an attempt to ensure that the investment increases local employment and develops physical and human capital. TRIMs also include trade-balancing requirements. TRIMs are placed on foreign direct investment by governments in an eff ort to: infl uence investment decisions such as sourcing, production, and market locations; increase the likelihood that the host nation will capture the benefi ts expected from the investment; and redistribute the investment benefi ts from the investor to the host country.

TRIMs can be implemented in diff erent ways. Th ey can be mandatory, that is, enforce able under domestic law or administrative rulings. An example of this type of mandatory TRIM would be a law that states that investors must include a certain percentage of local content in their pro-duction. In addition, TRIMs can be actions that are necessary for an inves tor to undertake in order to obtain some type of advantage (investment incentive)—a quid pro quo approach. For example, a host government might approach an investor with a proposal that allows the investor to receive a tax exemption in return for including a certain percentage of local content in the company’s production.

Agriculture Provisions of the Uruguay Round Th e Uruguay Round represented the fi rst time that WTO contracting parties undertook to substantially reform agricultural trade. Th e Punta del Este ministerial declaration recognized an urgent need to stabilize the world agri culture market and liberalize trade by reducing import barriers, discipling the use of direct and indirect subsidies that aff ect trade, and minimizing the adverse eff ect of sanitary and phyto sanitary regulations and barriers. Th e declaration recognized that other negotiating areas were likely to improve agricultural trade as well, such as eff orts to strengthen the dispute resolution process. Th e sanitary and phytosanitary regulations and barriers are measures taken to protect human, animal, or plant life or health.

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(B) North American Free Trade Agreement NAFTA, which went into eff ect on January 1, 1994, was intended to facilitate trade and investment throughout North America (United States, Canada, and Mexico). It incorporates features such as the elimination of tariff and nontariff barriers. NAFTA also supports the objective of locking in Mexico’s self-initiated, market-oriented reforms. By removing barriers to the effi cient allocation of economic resources, NAFTA was projected to generate overall, long-term economic gains for member countries—modest for the United States and Canada and greater for Mexico. For the United States, this is due to the relatively small size of Mexico’s economy and because many Mexican exports to the United States were already subject to low or no duties. Under NAFTA, intra-industry trade and coproduction of goods across the borders were expected to increase, en hancing specialization and raising productivity.

NAFTA also included procedures fi rst to avoid, and then to resolve, disputes between parties to the agreement. Separately, the three NAFTA countries negotiated and entered into two supple-mental agreements designed to facilitate cooperation on environment and labor matters among the three countries. NAFTA will create the largest free trade zone in the world, with 360 million peo ple and an annual gross national product totaling over $6 trillion dollars.

Major Provisions of NAFTA Major provisions are listed next.

◾ Rules of origin ◾ Import/export quotas and licenses ◾ Technical standards and certifi cation ◾ Escape clauses ◾ Telecommunications networks ◾ Cross-border trade in services ◾ Antidumping and subsidy laws ◾ Cross-subsidization ◾ Investments ◾ Performance requirements ◾ Right to convert and transfer local currencies ◾ Disputes ◾ IP rights ◾ Due process ◾ Temporary entry visas ◾ Side agreements

Rules of Origin NAFTA trade is subject to rules of origin that determine whether goods qualify for its tariff preferences. Th ese include goods wholly originating in the free trade area. A general waiver of the NAFTA rules of origin requirements is granted if their nonregional value consists of no more than 7% of the price or total cost of the goods. Regional value may be calculated in most cases either by a transaction value or a net cost method. Th e former avoids costly account-ing systems. Th e latter is based on the total cost of the goods less royalties, sales promotion,

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packing and shipping, and allowable interest. Either method will require manufacturers to trace the source of non-NAFTA components and main tain source records.

Import/Export Quotas and Licenses Import and export quotas, licenses, and other restric-tions will gradually be eliminated under NAFTA subject to limited rights to restrain trade—for example, to protect human, animal, or plant health or to protect the environment.

Technical Standards and Certifi cation Technical standards and certifi cation procedures for products are classic examples of nontariff trade barriers. Mutual recognition of professional li cense is encouraged (notably for legal consultants and engineers) but not made automatic. All three countries have agreed not to lower existing environmental or health and safety standards in order to attract investments and will attempt to “upwardly harmonize” them. Environmental impact statements for foreign investments are required.

Escape Clauses Escape clause rules and procedures are applicable to United States–Mexico trade under NAFTA. Th ese permit temporary trade relief against import surges subject to a right of compensation in the exporting nation.

Telecommunications and Networks Public telecommunications networks and services must be opened on reasonable and nondiscriminatory terms for fi rms and individuals who need the networks to conduct business.

Cross-Border Trade in Services Cross-border trade in services is subject to national treat ment, including no less favorable treatment than that most favorably given at federal, state, or local gov-ernment levels. Existing cross-border restraints on the provision of fi nancial services are frozen, and no new restraints may be imposed. Providers of fi nancial services in each NAFTA nation will receive both national and MFN treatment. Th is includes equality of competitive opportunity, which is defi ned as avoidance of measures that pose a disadvantage to foreign providers relative to domestic providers.

Various procedural transparency rules are established to facilitate the entry and equal opportunity of NAFTA providers of fi nancial services. Th e host nation may legislate reasonable prudential requirements for such companies and, under limited circumstances, protect its balance of pay-ments in ways that restrain fi nancial providers.

Antidumping and Subsidy Laws Antidumping and subsidy laws and countervailing duties are applicable. A special committee may be invoked if the opportunity for independent judi cial review on a dumping or subsidy determination has been denied.

Cross-Subsidization Cross-subsidization between public transport services is not prohib ited, nor are monopoly providers of public networks or services.

Investments Investment in the industrial and services sectors of the NAFTA nations is promoted through rules against nondiscriminatory and minimum standards of treatment that benefi t even non-NAFTA investors with substantial business operations in a NAFTA nation.

Performance Requirements Performance requirements—for example, specifi c export lev els, minimum domestic content, domestic sources preferences, trade balancing, technology trans-fer, and product mandates—are disallowed in all areas except government procurement, export promotion, and foreign aid.

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Senior management positions may not be reserved by nationality, but NAFTA states may require that a majority of the board of directors or committees thereof be of a designated na tionality of residence, provided this does not impair the foreign investor’s ability to exercise control.

Right to Convert and Transfer Local Currencies A general right to convert and transfer lo cal currency at prevailing market rates for earnings, sale proceeds, loan repayments, and other invest-ment transactions has been established. Direct and indirect expropriations of invest ments by NAFTA investors are precluded except for public purposes and if done on a nondis criminatory basis following due process of law. A right of compensation without delay at fair market value plus interest is created.

Disputes In the event of a dispute, a NAFTA investor may elect monetary (but not puni tive) damages through binding arbitration in the home state of the investor or pursue judicial remedies in courts of the host state.

Investment, dumping, and subsidy, fi nancial services, environmental-investment, and standards disputes are subject to special dispute resolution procedures. A right of consultation exists when one country’s rights are aff ected.

IP rights NAFTA mandates adequate and eff ective IP rights in all countries, including national treatment and eff ective internal and external environment rights.

For copyright, NAFTA obligates protection for computer programs, database, computer pro-grams, and sound recording rentals and a 50-year term of protection for sound recordings. For patents, NAFTA mandates a minimum 20 years of coverage of nearly all products and processes, including pharmaceuticals and agricultural chemicals. Compulsory licensing is limited, notably regarding pharmaceuticals in Canada. Service marks are treated equally with trademarks. Satellite signal poaching is illegal and trade secrets are generally protected. NAFTA details member states’ duties to provide damages, injunctive, antipi racy and general due process remedies in the IP fi eld.

Due Process An agreement exists that deals with general duty of legal transparency, fair ness, and due process regarding all laws aff ecting traders and investors with independent administrative or judicial review of governmental action. Generalized exceptions to the agreement cover actions to protect national security and national interests, such as public morals, health, national treasures, and natural resources, or to enforce laws against deceptive or anticompetitive practices, short of arbitrary discriminations or disguised restraints on trade.

Balance of payments trade restraints are governed by the rules of the International Monetary Fund (IMF). Taxation issues are subject to bilateral double taxation treaties, including a new one between Mexico and the United States.

Temporary Entry Visas Entry rights cover businesspersons, traders, investors, intracompany transferees, and 63 designated professionals. White-collar businesspersons only need proof of citizenship and documentation of business purpose to work in another NAFTA country for up to fi ve years. However, an annual limit of 5,500 additional Mexican professionals may temporarily enter the United States during the fi rst 10 years of NAFTA. Apart from these provisions, there is no common market for the free movement of workers.

Side Agreements Side agreements on labor and the environment commit each country to cre-ate environmental and labor commissions that monitor compliance with the adequacy and the

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enforcement of domestic law. Th ese commissions are empowered to receive complaints. Nego-tiations to resolve complaints would ensue. Absent a solution, an arbitral panel of experts from the three nations would be convened to evaluate the complaint.

Impacts and Implementation of NAFTA Assessment of NAFTA’s eff ects is a complex undertaking since the provisions last 10 to 15 years. While NAFTA is not yet fully im plemented, U.S. trade with NAFTA members has accelerated and is in accordance with pre-NAFTA expectations.

At the sector level, there are diverse impacts from NAFTA. Within sectors, these impacts may include increases or decreases in trade fl ows, hourly earnings, and employment. Economic effi -ciency may improve from this reallocation of resources, but it creates costs for certain sectors of the economy and labor force, including job dislocation.

In general, NAFTA or broader trade policies cannot be expected to substantially alter overall U.S. employment levels, which are determined largely by demographic conditions and macroeconomic factors such as monetary policy.

While there is wide conceptual agreement on how trade liberalization contributes to improve-ment in the standard of living through increased productivity and lower prices, estimating the extent to which NAFTA specifi cally furthers these goals presents a major empirical challenge. For example, there are no estimates of NAFTA’s direct impact on productivity. However, growth in shared production activity and two-way trade suggests that increases in sector specialization, a mechanism through which productivity may be improved, have occurred.

NAFTA’s system for avoiding and settling disputes among the member countries is a critical ele-ment of the agreement. Th e agreement includes mechanisms such as the establishment of com-mittees and working groups and an early consultation process to help the parties avoid disputes. Th ese mechanisms have helped the governments resolve important trade issues and have kept the number of formal dispute settlement cases relatively low.

Trade laws agreed to under NAFTA have helped members improve the transparency (openness) of their antidumping and countervailing duty administrative processes, thus re ducing the potential for arbitrariness in their application.

It is too early to determine what defi nitive eff ect the supplemental agreements will have on the North American environment and labor. However, some government and private sector offi cials have acknowledged that the two commissions created to im plement the agreements have been for several positive achievements to date.

(C) European Union Th e EU, often called the Common Market, is a suprana tional legal regime with its own legislative, administrative, treaty-making, and judicial procedures. To create this regime, 15 or more European nations have surrendered substantial sovereignty to the EU. EU law has replaced national law in many areas, and the EU legal system operates as an umbrella over the legal systems of the member states. EU law is vast and intri cate. Th e EU has an aggregate population exceeding 375 million and a GNP exceeding $7,000 billion. Th e EU is the largest market for exports from the United States.

Th e tasks of the EU include creation of an economic and monetary union with emphasis on price stability with the goal of establishing a Europe “without internal frontiers.”

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The Council, the Commission, the Parliament, the Court of Justice Th e Council consists of representatives of the ruling governments of the member states. Th e European Community Treaty requires the Council to act by a qualifi ed majority on some matters and with unanimity on others.

Th e Commission is independent of the member states. Its 20 commissioners are se lected by council appointment. Th ey do not represent member states or take orders from member state governments. Th e Commission is charged with the duty by acting only in the best interests of the EU and serves as the guardian of the treaties. Th e Commission largely maintains EU relations with GATT and WTO. It proposes and drafts EU leg islation and submits that legislation to the Council for adoption.

Th e Parliament historically played an advisory role. Th e European Parliament has the power to put questions to the Commission and the Council concerning EU aff airs. It also has the power, so far unused, to censure the Commission, in which event all commission ers are required to resign as a body. As a minimum, the Parliament has a right to be consulted and to give an “opinion” as part of the EU legislative process. Th e opinion is not binding on the Commission or Council.

Th e role of the Court of Justice is to ensure that, in the interpretation and application of the treaty, the law is observed. Fifteen justices (one from each state) make up the European Court of Justice. If a confl ict arises between EU law and the domestic law of a member state, the Court of Justice has held that the former prevails. When there is no confl ict, both EU law and domestic law can coexist.

Major Provisions of the European Union Th e major provisions of EU laws include: free movement of goods, of workers, of capital, and of payments; and establishment of a monetary system, a tax system, and trade rules with nonmember states.

Free Movement of Goods Th e treaty attempts to achieve free movement of goods by es tablishment of a Customs Union to eliminate, between the member states, customs duties and all other charges having “equivalent eff ect.” It has established a Common Customs Tariff with the outside world. Quantitative restrictions on imports between member states and mea-sures having an equivalent eff ect are also prohibited. Nontariff trade barriers are frequently the subject of intense negotiation within the EU and remain the most troublesome feature of the Customs Union.

Free Movement of Workers Th e treaty distinguishes the “free movement of workers” (blue-collar workers and artisans) from the “right of establishment” and “freedom to provide ser-vices.” Regarding free movement of workers, the treaty prohibits “any discrimination, based on nationality, between workers of the member states as regards employment, remuneration and other conditions of work and employment.” Free movement of self-employed persons and of services across member state boundaries is aided by the right of establish ment. Restric-tions on the freedom to provide services across borders without local establish ment are being abolished progressively.

Free Movement of Capital Th e treaty requires the removal of national restrictions on the free movement of capital belonging to persons of member states “to the extent necessary to insure the proper functions of the Common Market.”

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Free Movement of Payments Th e “free” movement of workers and capital should be dis-tinguished from the free movement of payments necessary to EU trade. Current payments are, as a rule, treated more liberally under Union law and indeed are essential to the free movement of goods and services in the Common Market.

Monetary System In movement toward a monetary Union, the member states have created the European Monetary System (EMS) and the European Exchange Rate Mechanism (ERM). Th e ERM is similar in concept and form to the currency basket, and allows limited fl uctua tions on national exchange rates from agreed parities.

Th e states have also established a joint credit facility for giving short- and medium-term fi nancial support to EMS currencies under pressure. Th e European Currency Unit (ECU) is the basis of defi nition of the basket parities. ECUs, although not a tangible currency, are used as the basis of settlement between banks within the EMS, for budgetary purposes, to calculate agricultural subsidies, and levy fi nes and penalties. ECUs are increasingly used as reference values in private transactions.

Tax System With considerable eff ort, the EU nations have adopted a common tax system called value-added taxation. But diff erent revenue needs and tax policies cause diff er ent levels of VAT to apply to like items in the various member states.

Th e tax frontiers will be eliminated by imposing VAT reporting and collection duties on import-ers and exporters using the “destination principle” on VAT rates.

Trade Rules Th e treaty requires member states to coordinate and implement a common com-mercial policy toward nonmember states. Th is policy is based on uniform principles regarding tariff and trade agreements, fi shing rights, export policy, and other matters of external concern to the EU.

WTO VERSUS NAFTA VERSUS EU

◾ Due to the WTO’s focus on reducing trade barriers, its provisions have more far-reaching long-term eff ects on the world economy than NAFTA or the EU.

◾ When there is a confl ict between WTO and NAFTA, the latter prevails.

◾ NAFTA is better streamlined politically, legislatively, and judicially than EU.

◾ Unlike the EU, there is no NAFTA Council of Ministers, Court of Justice, or Parliament.

◾ The EU Commission is more powerful than NAFTA’s Trade Commission.

◾ NAFTA goals and techniques are strikingly limited while they are strikingly ambi tious for the EU.

◾ NAFTA’s goals are more achievable than those of the EU due to the EU’s grand-scale nature.

◾ NAFTA’s treaty is for a limited duration (10 to 15 years) while the EU treaty is of unlimited duration. Any nation in NAFTA may withdraw on six months’ notice, and other nations can be admitted to the NAFTA.

◾ NAFTA’s economic integration can advance to greater degrees than that of the EU due to several, diff erent, complex nations involved in the EU.

◾ The EU has legal foundation while NAFTA has economic foundation.

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(D) Other Regional Groups Many nations are contemplating or have already formed regional eco-nomic integration to capture the economic gains and international negotiating strength that regionalization can bring. Some regions or groups are listed next.

◾ Several groups have been formed in Africa including UDEA, CEAO, and ECOWAS. Th e purpose is to establish a common customs and tariff approach toward the rest of the world and to formulate a common foreign investment trade.

◾ Regional groups have been established in Latin America and the Caribbean (CARICOM, CACM, LAFTA/LAIA). Th e Latin American Free Trade Association (LAFTA) had small success in reducing tariff s and developing the region through cooperative industrial sector programs. Th ese programs allocated industrial production among the participating states. In 1994, some 37 nations signed the Association of Caribbean States agreement with long-term economic integration goals.

◾ Gulf Cooperations Council (GCC) was formed among Bahrain, Kuwait, Oman, Qatar, Saudi Arabia, and United Arab Emirates with these objectives: of establishing freedom of movement, a regional armaments industry, common banking and fi nancial systems, a unifi ed currency policy, a customs union, a common foreign aid program, and a joint, international investment company, the Gulf Investment Corporation. Th e GCC has imple-mented trade and investment rules concerning tariff s on regional and imported goods, government con tracts, communications, transportation, real estate investment, freedom of movement of pro fessionals, and development of a Uniform Commercial Code. In 1987, the GCC entered into negotiations with the EU that resulted in a major 1990 trade and cooperation agreement.

◾ Th e Andean Common Market (ANCOM) was founded by Bolivia, Chile, Colombia, Ecua-dor, and Peru in 1969 primarily to counter the economic power of Argentina, Brazil, and Mexico and to reduce dependency on foreign capital. Later, Venezuela joined and Chile left the group. Th e ANCOM Commission has not been an activist on behalf of regional integration like the EU Commission. It mostly reacts to proposals put forth by the Junta, the administrative arm of ANCOM.

◾ Th e Association of South East Asian Nations (ASEAN) was formed in 1967 by Indonesia, Malaysia, the Philippines, Singapore, and Th ailand. Brunei joined in 1984, and Vietnam joined in 1995. Th e Bangkok Declaration establishing ASEAN as a cooperative association is a broadly worded document but with little supranational legal machinery to implement its stated goals.

◾ East Asian Integration, ranging from Japan in the north to Indonesia in the south, has formed Asia-Pacifi c Economic Cooperation (APEC) consisting of 18 Asian-Pacifi c nations includ ing the United States. East Asia, unlike Europe, has not developed a formal Com-mon Mar ket with uniform trade, licensing, and investment rules. Late in 1994, the APEC nations targeted free trade and investment for developed countries by the year 2010 and developing countries by the year 2020.

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OPTIONS FOR NATIONS

Nations in the world have options to consider prior to joining a group of countries for economic inte-gration. These options are listed next.

◾ Free trade areas. In free trade areas, tariff s, quotas, and other barriers to trade among participating states are reduced or removed while individual national trade barriers vis-à-vis third-party states are retained.

◾ Customs unions. Customs unions not only remove trade barriers among participating states; they also create common trade barriers for all participating states regarding third-party states.

◾ Common markets. Common markets go further than customs unions by providing for the free movement of factors of production (e.g., capital, labor, technology, and enterprise) among participating states.

◾ Economic communities. Economic communities build on common markets by introducing some harmonization of basic national policies related to the economy of the community (e.g., transport, taxation, corporate structure, monetary matters, and regional growth).

◾ Economic unions. Economic unions embrace a more or less complete harmonization of national policies related to the economy of the union (e.g., company laws, commercial treaties, social welfare, currencies, and governmental subsidies). Economic communities and economic unions are diff erent only in regard to the number and importance of harmonized national policies.

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