international trade theory fdi and foreign exchange market

7/28/2019 International Trade Theory Fdi and Foreign Exchange Market

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Unit 2

International trade theory, FDI andForeign Exchange Market


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Objetives

1. Examine Porters and other theories related to trade flows between nations.

2. Analyze the implications that international trade holds in business practices andmanagement.

3. Be familiar with current trends regarding FDI in the world economy.

4. Understand the benefits of FDI for the home and host country.

5. Define the terms foreign exchange market and exchange rate.

6. Understand the functions of foreign exchange market and currency conversion.

7. Analyze the implications of foreign exchange exposure.


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International Trade Theory

Free trade. Trade theory shows why it is beneficial for a country.

International trade allows a country

Easy to explain.

Mercantilist philosophy.

Smith, Ricardo, and Heckscher-Ohlin promote unrestricted free trade

New trade theory and Porters theory of national competitive advantage.


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What Is Mercantilism?

Mercantilism suggests that the best interest to export more than it

imports.

Mercantilism views trade as a zero-sum game - one in which a gain by one

country results in a loss by another

What Is Smiths Theory Of Absolute Advantage?

The country has an absolute advantage.


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Is Unrestricted Free Trade

Always Beneficial?

Unrestricted free trade is beneficial, but the gains may not be as great asthe simple model of comparative advantage would suggest.

Opening a country to trade could increase.

Could A Rich Country Be Worse Off With Free Trade?

Paul Samuelson, the dynamic gains from trade may not always be

beneficial.

The ability to offshore services jobs.

Protectionist measures could create a more harmful situation than free

trade.


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What Is The

Heckscher-Ohlin Theory?

Eli Heckscher and Bertil Ohlin - comparative advantage arises from

differences in national factor endowments the extent to which a country

is endowed with resources like land, labor, and capital.

Does The Heckscher-Ohlin Theory Hold?

Wassily Leontief theorized that since the U.S. was relatively abundant in

capital compared to other nations, the U.S. would be an exporter of capital

intensive goods and an importer of labor-intensive goods.

However, he found that U.S. exports were less capital intensive than U.S.

imports

Since this result was at variance with the predictions of trade theory, it

became known as the Leontief Paradox


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What Is The

Product Life Cycle Theory?

Production facilities. As the market in the U.S. and other advanced nations matured, the

product would become more standardized, and price the main competitive

weapon.

Producers based in advanced countries.

If cost pressures were intense, developing countries would acquire a

production advantage over advanced countries.

Production became concentrated in lower-cost foreign locations.


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What Is New Trade Theory?

New trade theory suggests that the ability of firms to gain economies ofscale.

Through its impact on economies of scale, trade can increase the

variety of goods available to consumers and decrease the average cost

of those goods.

1. In those industries when output required to attain economies of scale

represents a significant proportion of total world demand, the global

market may only be able to support a small number of enterprises.

2. In those industries when output required to attain economies of scale

represents a significant proportion of total world demand, the global

market may only be able to support a small number of enterprises.


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What Is Porters Diamond

Of Competitive Advantage?

Michael Porter tried to explain why a nation achieves international

success in a particular industry and identified four attributes that

promote or impede the creation of competitive advantage.

1. Factor endowments - a nations position in factors of production

necessary to compete in a given industry.

2. Demand conditions - the nature of home demand for the industrysproduct or service.

3. Relating and supporting industries - the presence or absence of supplier

industries and related industries that are internationally competitive.

4. Firm strategy, structure, and rivalry - the conditions governing how

companies are created, organized, and managed, and the nature of

domestic rivalry.


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What Are The Implications

Of Trade Theory For Managers?

What Is The Balance Of Payments?

Is A Current Account Deficit Bad?

1. Location implications.

2. First-mover implications.

3. Policy implications.

Balance of payments accounts.

The current account records transactions that pertain to goods,services, and income, receipts and payments.

1. The capital account records one time changes in the stock of assets.

2. The financial account records transactions that involve the purchase orsale of assets.

Does current account deficit in the United States matter?

a current account deficit implies a net debtor

A dollar crisis could occur


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What Is The Source Of FDI?

Since World War II, the U.S. has been the largest source country for FDI.

Why Do Firms ChooseAcquisition Versus Greenfield Investments?

Most cross-border investment is in the form of mergers and acquisitions

rather than greenfield investments.

Firms prefer to acquire existing assets because.

Why Choose FDI?

1. Exporting - producing goods at home and then shipping them to the

receiving country for sale.

2. Licensing - granting a foreign entity the right to produce and sell the

firms product in return for a royalty fee on every unit that the foreign

entity sells.


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What Are The Theoretical

Approaches To FDI?

The radical view - the MNE is an instrument of imperialist domination and

a tool for exploiting host countries to the exclusive benefit of their

capitalist-imperialist home countries

The free market view- international production should be distributed

among countries according to the theory of comparative advantage

Pragmatic nationalism - FDI has both benefits (inflows of capital,

technology, skills and jobs) and costs (repatriation of profits to the homecountry and a negative balance of payments effect).

Recently, there has been a strong shift toward the free market stance

creating.


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BenefitsHostCountry

CostHost Country BenefitsHomeCountry

CostHomeCountry

Government

s Influence InternationalInstitutions Influence Managers

Resourcetransfereffects

Adverseeffects of FDIon competitionwithin the hostnation

Effect on thecapitalaccount

The homecountrysbalance ofpaymentscan suffer

Governmentscan encourageoutward FDI

1990s, there was noconsistent involvementby multinationalinstitutions

Consider what tradetheory implies aboutFDI

Employment

effects

Adverse

effects on thebalance ofpayments

Employment

effects

Employment

may also benegativelyaffected ifthe FDI

Governments

can restrictoutward/inward FDI

Today, the World Trade

Organization is changingthis by trying toestablish a universal setof rules designed topromote theliberalization of FDI

The direction of FDI

can be explainedthrough the location-specific advantagesargument associatedwith John Dunning

Balance ofpaymentseffects

Perceived lossof nationalsovereigntyand autonomy

Gains fromlearningvaluable skillsfrom foreign

markets

Governmentscan encourageinward FDI

An importantvariable in decisionsabout where tolocate foreign

production facilities


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What Is The Nature Of The

Foreign Exchange Market?

The foreign exchange market is a global network of banks, brokers, and

foreign exchange dealers connected by electronic communications systems.

The foreign exchange market.

The exchange rate is the rate at which one currency is converted into another

Events in the foreign exchange market affect firm sales, profits, and strategy

Importance

When Do Firms Use The Foreign Exchange Market?

The payments they receive for exports, the income they receive from foreigninvestments.

They must pay a foreign company for its products or services in its countrys

currency.

They have spare cash that they wish to invest for short terms in money markets.


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How Can Firms Hedge

Against Foreign Exchange Risk?

The foreign exchange market provides insurance to protect against foreign

exchange risk - the possibility that unpredicted changes in future exchangerates will have adverse consequences for the firm

A firm that insures itself against foreign exchange risk is hedging

To insure or hedge against a possible adverse foreign exchange rate

movement, firms engage in forward exchanges - two parties agree to

exchange currency and execute the deal at some specific date in the future

What Is The Difference Between Spot Rates And Forward Rates?

The spot exchange rate is the rate at which a foreign exchange dealer

converts one currency into another currency on a particular day. A forward exchange rate is the rate used for hedging in the forward

market.


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What Is A Currency Swap?

A currency swap is the simultaneous purchase and sale of a given amount

of foreign exchange for two different value dates.

Swaps are transacted.

How Are Exchange Rates Determined?

Exchange rates are determined by the demand and supply for differentcurrencies.

1. A countrys price inflation.

2. A countrys interest rate.

3. Market psychology.


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How Do Prices

Influence Exchange Rates?

Law of one price.

Purchasing power parity theory. A positive relationship exists between the inflation rate and the level of money

supply

When the growth in the money supply is greater than the growth in output,

inflation will occur

PPP theory suggests that changes in relative prices between countries will leadto exchange rate changes, at least in the short run

How Do Interest Rates Influence Exchange Rates?

International Fisher Effect.

In other words:

(S1 - S2) / S2 x 100 = i $ - i

Where i $ and i are the respective nominal interest rates in two countries

(in this case the US and Japan), S1 is the spot exchange rate at the beginning

of the period and S2 is the spot exchange rate at the end of the period.


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How Does Investor Psychology

Influence Exchange Rates?

Bandwagon effect.

Should Companies Use Exchange Rate Forecasting Services?

There are two schools of thought

1. Efficient market school.

2. Inefficient market school.

How Are Exchange Rates Predicted?

There are two schools of thought on forecasting

1. Fundamental analysis.

2. Technical analysis.

Are All Currencies Freely Convertible?

Freely convertible.

Externally convertible.

Nonconvertible.


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Capital flight.

Countertrade.

What Do Exchange Rates Mean For Managers?

1. Transaction exposure.

2. Translation exposure.

3. Economic exposure.

How Can Managers Minimize Exchange Rate Risk?

Lead strategy.

Lag strategy.


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Activities To be evaluated %

Forum: International trade theoryIs free trade fair? Why or why not?What are the potential costs of adopting a freetrade regime? Do you think governments shoulddo anything to reduce these costs? What?

Interventions: content,consistent with thediscussion topic andargument.

10%

Study Case: Management Focus on Cemex.Answer the following questions:

What value does Cemex bring to the hosteconomy? Can you see any drawbacks ofCemexs inward investment in an economy?Define a Greenfield Venture.Cemex has a strong preference for acquisitionsover Greenfield ventures as an entry mode.Why?

Structure, content,grammar, coherence,argument and analysis.

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Group work: Watch and discuss one of the

following videos:FDI in Sudanese Oil Changes SudaneseEconomy.U.S. Farmers respond to CAFTA.China: Changing the Yuan/Dolar.Write on one page document the outcomes ofyour discussion, and present them in avideoconference.

Structure, content,grammar, consistent withthe topic of the videoand argument.

10%

international trade theory fdi and foreign exchange market

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