International business is a term used to collectively describe all commercial transactions (private and governmental, sales, investments, logistics,and transportation) that take place between two or more nations. Usually, private companies undertake such transactions for profit; governments undertake them for profit and for political reasons. It refers to all those business activities which involves cross border transactions of goods, services, resources between two or more nations. Transaction of economic resources include capital, skills, people etc. for international production of physical goods and services such as finance, banking, insurance, construction etc.
A multinational enterprise (MNE) is a company that has a worldwide approach to markets and production or one with operations in more than a country. An MNE is often called multinational corporation (MNC) or transnational company (TNC). Well known MNCs include fast food companies such as McDonald's and Yum Brands, vehicle manufacturers such as General Motors, Ford Motor Company and Toyota, consumer electronics companies like Samsung, LG and Sony, and energy companies such as ExxonMobil, Shell and BP. Most of the largest corporations operate in multiple national markets.
Areas of study within this topic include differences in legal systems, political systems, economic policy, language, accounting standards, labor standards, living standards, environmental standards, local culture, corporate culture, foreign exchange market, tariffs, import and export regulations, trade agreements, climate, education and many more topics. Each of these factors requires significant changes in how individual business units operate from one country to the next.
The conduct of international operations depends on companies' objectives and the means with which they carry them out. The operations affect and are affected by the physical and societal factors and the competitiveenvironment.
Operations
* Objectives: sales expansion, resource acquisition, risk minimization
Means
* Modes: importing and exporting, tourism and transportation, licensing and franchising, turnkeymanagement contracts, direct investment and portfolio investments. operations,
* Functions: marketing, global manufacturing and supply chain management, accounting, finance, human resources
* Overlaying alternatives: choice of countries, organization and control mechanisms
Physical and societal factors
* Political policies and legal practices
* Cultural factors
* Economic forces
* Geographical influences
Competitive factors
* Major advantage in price, marketing, innovation, or other factors.
* Number and comparative capabilities of competitors
* Competitive differences by country
There has been growth in globalization in recent decades due to the following eight factors:
* Technology is expanding, especially in transportation and communications.
* Governments are removing international business restrictions.
* Institutions provide services to ease the conduct of international business.
* Consumers know about and want foreign goods and services.
* Competition has become more global.
* Political relationships have improved among some major economic powers.
* Countries cooperate more on transnational issues.
* Cross-national cooperation and agreements.
Studying international business is important because:
* Most companies are either international or compete with international companies.
* Modes of operation may differ from those used domestically.
* The best way of conducting business may differ by country.
* An understanding helps you make better career decisions.
* An understanding helps you decide what governmental policies to support.
Managers in international business must understand social science disciplines and how they affect all functional business fields.
Tom Travis, the managing partner of Sandler, Travis & Rosenberg, PA. and international trade and customs consultant, uses the Six Tenets when giving advice on how to globalize one's business. The Six Tenets are as follows[3]:
1. Take advantage of trade agreements: think outside the border
* Familiarize yourself with preference programs and trade agreements.
* Read the fine print.
* Participate in the process.
* Seize opportunities when they arise.
2. Protect your brand at all costs
* You and your brand are inseparable.
* You must be vigilant in protecting your intellectual property both at home and abroad.
* You must be vigilant in enforcing your IP rights.
* Protect your worldwide reputation by strict adherence to labor and human rights standards.
3. Maintain high ethical standards
* Strong ethics translate into good business.
* Forge ethical strategic partnerships.
* Understand corporate accountability laws.
* Become involved with the international business self-regulation movement.
* Develop compliance protocols for import and export operations.
* Memorialize your company's code of ethics and compliance practices in writing.
* Appoint a leader.
4. Stay secure in an insecure world
* Security requires transparency throughout the supply chain.
* Participate in trade-government partnerships.
* Make the most of new security measures.
* Secure your data.
* Keep your personnel secure.
5. Expect the Unexpected
* The unexpected will happen.
* Do your research now.
* Address your particular circumstances.
6. All global business is personal
* Go to the source.
* Keep communications open.
* Keep the home office operational.
* Fly the flag at your overseas locations.
* Relate to offshore associates on a personal level.
* Be available to overseas clients and customers 24/7.
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The advantages of globalisation (an economic view):
The economic benefits that greater openness to international trade bring are:
♦ Faster growth: economies that have in the past been open to foreign direct investments have developed at a much quicker pace than those economies closed to such investment e.g. communist Russia
♦ Cheaper imports: this is down to the simple fact that if we reduce the barriers imposed on imports (e.g. tariffs, quota, etc) then the imports will fall in price
♦ New technologies: by having an open economy we can bring in new technology as it happens rather than trying to develop it internally
♦ Spur of foreign competition: foreign competition will encourage domestic producers to increase efficiency. Carbaugh (1998) states that global competitiveness is a bit like golf, you get better by playing against people who are better than you.
♦ Increase consumer income: multination will bring up average wage levels because if the multinationals were not there the domestic companies would pay less.
♦ Increased investment opportunities: with globalisation companies can move capital to whatever country offers the most attractive investment opportunity. This prevents capital being trapped in domestic economies earning poor returns.
Disadvantages of globalisation:
The negative drivers of globalisation included culture which is a major hold back of globalisation. An example of how culture can negatively affect globalisation can be seen in the French film industry. The French are very protective of this part of their culture and provide huge grants to help its development. As well as government barriers market barriers and cultural barriers still exist.
Also a negative aspect to a countries development is war e.g. tourism in Israel fell by 40% due to the latest violence. Corporate strategy can also be a negative driver of
globalization as corporation may try to locate in one particular area.
Another negative driver of globalisation is “local focus” or “localisation” as it is termed in Richard Douthwaite’s book “Short Circuit”. Douthwaite (1996) believes that globalisation can and should be reversed. He also believes that localisation is the way to do this. He defines localisation as “not meaning everything being produced locally but it means a better a balance between local, regional, national and international markets and thus bring less control to multinational corporations”. Another step to reverse globalisation would be for governments to club together to curb the power of multinational by negotiating new trade and treaties that would remove the subsidies powering globalisation and give local production a chance.
Douthwaite also states that the global economy is itself nothing less than a system of structural exploitation that creates hidden slaves on the other side of the world and also
that the North should allow the South to produce for itself and not just for us (North). So it can be seen that Douthwaite is very opposed to globalisation especially that part of it
exploited by multinational corporations.
Further arguments put forward against globalisation by Mr. Lawton include that it actually destroys jobs in wealthy advanced countries. This is due to the lower costs of wages in developing countries. Multinationals will move to areas of lower wage levels at the drop of a hat e.g. Fruit of the Loom. Also this ability to relocate has meant that wage levels of unskilled workers in developed countries has actually fallen relatively speaking. This is down to the fact that one now needs skill and knowledge in developed economies to survive.
Also there is the loss of sovereignty that globalisation brings. Many anti-globalisation believers state that nations are loosing their identity and selling their soul.
Then there are environmental factors of globalisation as described earlier. These are becoming more and more controversial.
Technology, though usually viewed as a positive aspect of globalisation, also has some negative points. Jeffry Sachs (The Economist, June 24th 2000) argues that technology is now what divides the world. Sachs states that 15% of the world’s population account for nearly all the world’s technological advances. This has to be a concern if developing economies are ever going to catch up. Many countries, almost 30% of the world’s population, are technologically excluded (this means not only that they do not innovate but also that they cannot adopt new technologies). In recent years some countries, such as Taiwan, South Korea and Israel, have become top rank innovators and with this their economies have flourished. This would indicate that perhaps the best way to tackle world poverty is to provide aid through education and technology.
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What are Various Theories of International Business?
International business is a broad term, collectively used to describe all commercial transactions (private, government and semi-government) that take place between two or more nations. International business is a newly coined term, but the concept is quite traditional. Actually, the term international business is derived from “international trade”.
In ancient days, producers of a country used to export their surplus production to neighboring countries and later with the further development of trade they started exporting goods to far off countries as well. This was the establishment of an era of “international trade”. With further developments, more competitors came into the international markets, as a result of which producers started marketing their goods at international levels; this was the time when “international trade” turned into “international marketing”.
With further advancements, producers started establishing their production facilities in foreign countries and the era of globalization arrived; this was the time when researchers coined the term “international business”. There are many thinkers who have worked in the field of international business and they have put forward various theories in order to justify the concept of international business. These theories collectively explain why business firms of one country should go to another country, although the industries of that country also produce the same goods and market them. So these theories explain the basis for international business.
Some of the most important theories of international business are given below-
The absolute advantage theory
Theories of International BusinessThe absolute advantage theory was given by Adam Smith in 1776; according to the absolute advantage theory each country always finds some absolute advantage over another country in the production of a particular good or service. Simply because some countries have natural advantage of cheap labour, skilled labour, mineral resources, fertile land etc. these countries are able to produce some specific type of commodities at cheaper prices as compared to others. So, each country specializes in the production of a particular commodity. For example, India finds absolute advantage in the production of the silk saris due to the availability of skilled workers in the field, so India can easily export silk saris to the other nations and import those goods in which other countries find absolute advantages.
But this theory is not able to justify all aspects of international business. This theory leaves no scope of international business for those countries that are having absolute advantage in all fields or for those countries that are having no absolute advantage in any field.
The comparative cost theory:
After 40 years of absolute advantage theory, in order to provide the full justification of international business David Richardo presented the Richardian model—comparative cost theory. According to the comparative cost theory, two countries should do business with each other if one country is having an advantage in the ability of producing one good relative to another good as compared to some other country’s relative ability of producing same goods. It can be well understood by taking an illustration-
If USA could produce 25 bottles of wine and 50 pounds of beef by using all of its production resources and France could yield 150 bottles of wine and 60 pounds of beef by using the same resources, then according to absolute advantage theory France finds clear advantage over USA in the production of both beef and wine. So, there should not be any business activity between the two countries. But this is not the case according to the comparative cost theory. Comparative cost theory suggests relative comparing of the beef and wine production. In relative comparing we can find that France sacrifices 2.5 bottles of wine for producing each pound of beef (150/60) and USA sacrifices 0.5 bottles of wine for producing each pound of beef (25/50). So, we can see that production of beef is more expensive in France as compared to USA. Comparative cost theory suggests USA to import wine from France instead of producing it and in similar manner theory suggests France to import beef from USA instead of producing it.
In this way, comparative cost theory well explains the driving forces behind international business.
Opportunity cost theory:
The opportunity cost theory was proposed by Gottfried Haberler in 1959. The opportunity cost is the value of alternatives which have to be forgone in order to obtain a particular thing. For example, Rs. 1,000 is invested in the equity of Rama News Limited and earned a dividend of six per cent in 1999, the opportunity cost of this investment is 10 per cent interest had this amount been deposited in a commercial bank for one year term.
Another example is that, India produces textile garments by utilizing its human resources worth of Rs. 1 billion and exports to the US in 1999. The opportunity cost of this project is, had India developed software packages by utilizing the same human resources and exported the same to USA in 1999, the worth of the exports would have been Rs. 10 billion. Opportunity cost approach specifies the cost in terms of the value of the alternatives which have to be foregone in order to fulfil a specific art.
Thus, this theory provides the basis for international business in terms of exporting a particular product rather than other products. The previous example suggests that it would be profitable for India to develop and export software packages rather than textile garments to the USA.
The vent for surplus theory
International trade absorbs the output of unemployed factors. If the countries produce more than the domestic requirements, they have to export the surplus to other countries. Otherwise, a part of the productive labor of the country must cease and the value of its annual produce diminishes.
Thus, in the absence of foreign trade, they would be surplus productive capacity in the country. The surplus productive capacity is taken by another country and in turn gives the benefit under international trade. According to this theory, the factors of production of developing countries are fully utilized. The unemployed labor of the developing countries is profitably employed when the surplus is exported.
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Balance of payment (BoP) is a statistical statement that summarizes, for a specific period, transactions between residents of a country and the rest of the world. BoP positions indicate various signals to businesses. BoP comprises current account, capital account and financial account.
and services, income and current transfers. In the capital account, transactions of capital transfers, capital acquisition and non-produced non-financial assets like buildings and patents are included, while in the financial account, transactions relating to financial assets and liabilities like portfolio investments and foreign exchange reserves are included.
However, the BoP account of most countries still classify transactions under two heads only—capital account and current account. In such a case, financial and capital accounts are treated as one. Transactions in BoP are recorded on a double-entry bookkeeping system that is, a transaction is recorded on each side—debit and credit of the BoP account.
There are many signals that the BoP account of a country gives out. For example, large current account transactions indicate towards openness of an economy. This was the case with India as reduction in trade restrictions and duties led to increase in both exports and imports after 1991. Also large capital account transactions may indicate well-developed capital markets of an economy.
Healthy BoP positions or surplus in capital and current account keeps confidence in the economy and among investors. However, healthy BoP positions may be different for different countries. For example, surplus in current account is often more important for developed countries than surplus in capital account as most of them have sufficient capital to fund their investments. On the other hand, developing countries like India may place more importance on capital account as reserves and funding for investment is crucial for them at present.
Large balances often attract foreign investors into an economy, thus bringing in precious foreign exchange. Often credit ratings are based on BoP positions, thereby affecting the flows of credit to businesses. Businesses can make predictions about exchange rates by studying BoP positions. A healthy BoP position can signal domestic currency appreciation, hence encouraging businesses to engage in future contracts accordingly. Also, the BoP position influences the decisions of policy makers, which are crucial for any business.
How does BoP influence economic policy?
The policies of a nation are highly affected and determined by the position and status of its BoP. While formulating or deciding any economic policy, BoP position and policy effect on BoP is given special consideration. While all the policies affect BoP, policies like tariff policy, those related to foreign flows etc affect it in greater magnitude.
Earlier, trade-related policies used to have special focus. But over the years the share of current account transactions in total BoP transactions has decreased. For example, in India its share was almost 60% in 1991-92, but reduced to around 44% in 2007-08. Also, mismatch has been much greater in capital account in recent years, which gave rise to India’s foreign exchange reserves. Over the years, these trends have forced policy makers to make policies keeping in mind foreign flows (capital) and effects of policies on them. However, policies at the same time could be held responsible for such flows.
To improve BoP positions countries have lately often leaned towards the capital account side. The trend has shifted from import substituting policies, that is, policies in which imports are discouraged by way of tariffs, quotas toward more of foreign inflows enhancing policies in the belief that such inflows may make a country crisis-proof and lead to investments that would increase productive capacity and also may increase exports that would earn foreign exchange in future.
However, BoP position in itself affects decisions of policy makers. Often, a deteriorating current account is supported by capital or financial account. A healthy BoP position often allows countries to open up their trade and to appropriate gains from it.
India’s BoP:
India presently has a deficit in its current account of BoP, which has increased substantially after reforms in 1991. In 1991-92, current account deficit was $1,178 million, which rose to $17,403 million in 2007-08, and accounted for $36,469 million for the last three quarters of 2008. After the reforms in 1991, India’s position of merchandise trade (exports and imports of goods) kept on deteriorating, but its position on invisibles (services, current transfers etc) improved during the period. However, one of the major factors for increasing current account deficit in the last few years has been a rising oil import bill. Some countries like Japan and Germany have current account surpluses, while the USA and UK have deficits.
India has done fairly well on the capital account side. In 2007-08 it had a capital account surplus of $108,031 million. In the same year it increased its foreign exchange reserves by $92,164 million, which provided stability to the economy. Foreign investments have increased manifold since 1991, peaking in 2007-08 to $44,806 million.
India’s overall current account and capital account deficit is $20,380 million for April–December 2008, which is expected to rise to a figure between $25 and 30 billion by the year ending March 31, 2009. There has been dip in reserves from $309,723 million in March 2008 to $253,000 million in March 2009. Reasons for this are portfolio flows from foreign institutional investors and the appreciation of the US dollar. But this may not pose a significant threat to the Indian economy and businesses because of large pool of reserves that are still providing enough cushion. However, some businesses like those related to equities and realty are hit when outflows from these sectors occur. Not only is there fall in asset prices and erosion of investment value, but economic activity also gets reduced in these sectors.
However, recent profitability/growth numbers have indicated signs of a revival. Also political change and expected stability might bring in foreign exchange and may improve India’s capital account position and reserves. This may lead to the appreciation of the Indian rupee and may affect exporters and importers accordingly. At the same time, reserves infuse stability into the system, which in turn has positive effects on businesses and investments
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Components of Balance of Payments:
Balance of Payments is generally grouped under the following heads
i) Current Account
ii) Capital Account
iii) Unilateral Payments Account
iv) Official Settlement Account.
Current Account
“The Current Account includes all transactions which give rise
to or use up national income.”
The Current Account consists of two major items, namely:
I) Merchandise exports and imports, and
ii) Invisible exports and imports.
Merchandise exports, i.e., the sale of goods abroad, are credit entries because all transactions giving rise to monetary claims on foreigners represent credits. On the other hand, merchandise imports , i.e., purchase of goods from abroad, are debit entries because all transactions giving rise to foreign money claims on the home country represent debits. Merchandise imports and exports form the most important international transaction of most of the countries .Invisible exports, i.e., sales of services, are credit entries and invisible imports, i.e. Purchases of services, are debit entries. Important invisible exports include the sale abroad of such services as transport, insurance, etc., foreign tourist expenditure abroad and income paid on loans and investments (by foreigners)in the home country form the important invisible entries on the debit side.
Capital Account:
The Capital Account consists of short- terms and long-term capital transactions A capital outflow represents a debit and a capital inflow represents a credit. For instance, if an American firm invests Rs.100 million in India, this transaction will be represented as a debit in the US balance of payments and a credit in the balance of payments of India. The payment of interest on loans and dividend payments are recorded in the Current Account, since they are really payment s for the services of capital. As has already been mentioned above, the interest paid on loans given by foreigners of dividend on foreign investments in the home country are debits for the home country, while, on the other hand, the interest received on loans given abroad and dividends on investments abroad are credits.
Unilateral Transfers Account:
Unilateral transfers is another terms for gifts. These unilateral transfers include private remittances, government grants ,disaster relief, etc. Unilateral payments received from abroad are credits and those made abroad are debits.
Official Settlements Accounts:
Official reserves represent the holdings by the government or official agencies of the means of payment that are generally accepted for the settlement of international claims Anonymous
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The balance of payments (BOP) is the place where countries record their monetary transactions with the rest of the world. Transactions are either marked as a credit or a debit. Within the BOP there are three separate categories under which different transactions are categorized: the current account, the capital account and the financial account. In the current account, goods, services, income and current transfers are recorded. In the capital account, physical assets such as a building or a factory are recorded. And in the financial account, assets pertaining to international monetary flows of, for example, business or portfolio investments, are noted. In this article, we will focus on analyzing the current account and how it reflects an economy's overall position. (For background reading, see What Is The Balance Of Payments?)
The Current Account :
The balance of the current account tells us if a country has a deficit or a surplus. If there is a deficit, does that mean the economy is weak? Does a surplus automatically mean that the economy is strong? Not necessarily. But to understand the significance of this part of the BOP, we should start by looking at the components of the current account: goods, services, income and current transfers.
1. Goods - These are movable and physical in nature, and in order for a transaction to be recorded under "goods", a change of ownership from/to a resident (of the local country) to/from a non-resident (in a foreign country) has to take place. Movable goods include general merchandise, goods used for processing other goods, and non-monetary gold. An export is marked as a credit (money coming in) and an import is noted as a debit (money going out).
2. Services - These transactions result from an intangible action such as transportation, business services, tourism, royalties or licensing. If money is being paid for a service it is recorded like an import (a debit), and if money is received it is recorded like an export (credit).
3. Income - Income is money going in (credit) or out (debit) of a country from salaries, portfolio investments (in the form of dividends, for example), direct investments or any other type of investment. Together, goods, services and income provide an economy with fuel to function. This means that items under these categories are actual resources that are transferred to and from a country for economic production.
4. Current Transfers - Current transfers are unilateral transfers with nothing received in return. These include workers' remittances, donations, aids and grants, official assistance and pensions. Due to their nature, current transfers are not considered real resources that affect economic production.
Now that we have covered the four basic components, we need to look at the mathematical equation that allows us to determine whether the current account is in deficit or surplus (whether it has more credit or debit). This will help us understand where any discrepancies may stem from, and how resources may be restructured in order to allow for a better functioning economy.
The following variables go into the calculation of the current account balance (CAB):
X = Exports of goods and services
M = Imports of goods and services
NY = Net income abroad
NCT = Net current transfers
The formula is:
CAB = X - M + NY + NCT
What Does It Tell Us?
Theoretically, the balance should be zero, but in the real world this is improbable, so if the current account has a deficit or a surplus, this tells us something about the state of the economy in question, both on its own and in comparison to other world markets.
A surplus is indicative of an economy that is a net creditor to the rest of the world. It shows how much a country is saving as opposed to investing. What this means is that the country is providing an abundance of resources to other economies, and is owed money in return. By providing these resources abroad, a country with a CAB surplus gives other economies the chance to increase their productivity while running a deficit. This is referred to as financing a deficit.
A deficit reflects an economy that is a net debtor to the rest of the world. It is investing more than it is saving and is using resources from other economies to meet its domestic consumption and investment requirements. For example, let us say an economy decides that it needs to invest for the future (to receive investment income in the long run), so instead of saving, it sends the money abroad into an investment project. This would be marked as a debit in the financial account of the balance of payments at that period of time, but when future returns are made, they would be entered as investment income (a credit) in the current account under the income section. (For more insight, read Current Account Deficits.)
A current account deficit is usually accompanied by depletion in foreign-exchange assets because those reserves would be used for investment abroad. The deficit could also signify increased foreign investment in the local market, in which case the local economy is liable to pay the foreign economy investment income in the future.
It is important to understand from where a deficit or a surplus is stemming because sometimes looking at the current account as a whole could be misleading.
Analyzing the Current Account:
Exports imply demand for a local product while imports point to a need for supplies to meet local production requirements. As export is a credit to a local economy while an import is a debit, an import means that the local economy is liable to pay a foreign economy. Therefore a deficit between exports and imports (goods and services combined) - otherwise known as a balance of trade deficit (more imports than exports) - could mean that the country is importing more in order to increase its productivity and eventually churn out more exports. This in turn could ultimately finance and alleviate the deficit.
A deficit could also stem from a rise in investments from abroad and increased obligations by the local economy to pay investment income (a debit under income in the current account). Investments from abroad usually have a positive effect on the local economy because, if used wisely, they provide for increased market value and production for that economy in the future. This can allow the local economy eventually to increase exports and, again, reverse its deficit.
So, a deficit is not necessarily a bad thing for an economy, especially for an economy in the developing stages or under reform: an economy sometimes has to spend money to make money. To run a deficit intentionally, however, an economy must be prepared to finance this deficit through a combination of means that will help reduce external liabilities and increase credits from abroad. For example, a current account deficit that is financed by short-term portfolio investment or borrowing is likely more risky. This is because a sudden failure in an emerging capital market or an unexpected suspension of foreign government assistance, perhaps due to political tensions, will result in an immediate cessation of credit in the current account.
Conclusion:
The volume of a country's current account is a good sign of economic activity. By scrutinizing the four components of it, we can get a clear picture of the extent of activity of a country's industries, capital market, services and the money entering the country from other governments or through remittances. However, depending on the nation's stage of economic growth, its goals, and of course the implementation of its economic program, the state of the current account is relative to the characteristics of the country in question. But when analyzing a current account deficit or surplus, it is vital to know what is fueling the extra credit or debit and what is being done to counter the effects (a surplus financed by a donation may not be the most prudent way to run an economy). On a separate note, the current account also highlights what is traded with other countries, and it is a good reflection of each nation's comparative advantage in the global economy.
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The Bretton Woods system:
Since the end of World War II, the U.S. dollar has enjoyed a unique and powerful position in international trade. But perhaps no more.
Before boarding a plane on Saturday to meet President George W. Bush, French President Nicolas Sarkozy proclaimed, "Europe wants it. Europe demands it. Europe will get it." The "it" here is global financial reform, and evidently Sarkozy won't have to wait long. Just hours after their closed-door meeting had finished, Bush and Sarkozy, along with European Commission President Jose Manuel Barroso, issued a joint statement announcing that a summit would be held next month to devise what Barroso calls a "new global financial order."
The old global financial order is, well, old. Established in 1944 and named after the New Hampshire town where the agreements were drawn up, the Bretton Woods system created an international basis for exchanging one currency for another. It also led to the creation of the International Monetary Fund (IMF) and the International Bank for Reconstruction and Development, now known as the World Bank. The former was designed to monitor exchange rates and lend reserve currencies to nations with trade deficits, the latter to provide underdeveloped nations with needed capital — although each institution's role has changed over time. Each of the 44 nations who joined the discussions contributed a membership fee, of sorts, to fund these institutions; the amount of each contribution designated a country's economic ability and dictated its number of votes.
In an effort to free international trade and fund postwar reconstruction, the member states agreed to fix their exchange rates by tying their currencies to the U.S. dollar. American politicians, meanwhile, assured the rest of the world that its currency was dependable by linking the U.S. dollar to gold; $1 equaled 35 oz. of bullion. Nations also agreed to buy and sell U.S. dollars to keep their currencies within 1% of the fixed rate. And thus the golden age of the U.S. dollar began.
For his part, legendary British economist John Maynard Keynes, who drafted much of the plan, called it "the exact opposite of the gold standard," saying the negotiated monetary system would be whatever the controlling nations wished to make of it. Keynes had even gone so far as to propose a single, global currency that wouldn't be tied to either gold or politics. (He lost that argument).
Though it came on the heels of the Great Depression and the beginning of the end of World War II, the Bretton Woods system addressed global ills that began as early as the first World War, when governments (including the U.S.) began controlling imports and exports to offset wartime blockades. This, in turn, led to the manipulation of currencies to shape foreign trade. Currency warfare and restrictive market practices helped spark the devaluation, deflation and depression that defined the economy of the 1930s.
The Bretton Woods system itself collapsed in 1971, when President Richard Nixon severed the link between the dollar and gold — a decision made to prevent a run on Fort Knox, which contained only a third of the gold bullion necessary to cover the amount of dollars in foreign hands. By 1973, most major world economies had allowed their currencies to float freely against the dollar. It was a rocky transition, characterized by plummeting stock prices, skyrocketing oil prices, bank failures and inflation.
It seems the East Coast might yet again be the backdrop for a massive overhaul of the world's financial playbook. U.N. Secretary-General Ban Ki-moon publicly backed calls for a summit before the new year, saying the agency's headquarters in New York — the very "symbol of multilateralism" — should play host. Sarkozy concurred, but for different reasons: "Insofar as the crisis began in New York," he said, "then the global solution must be found to this crisis in New York."
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Types of Investment Risk:
There are many types of risk that are caused by different factors, or which affect different investments to varying extents. Some factors affect most investments and are called systematic risks. Other risks, such as sector risks affect only a particular sector of the economy. Some risks are specific to a business or asset, and are called nonsystematic risks, or diversifiable risks, because such risks can be lowered by diversified investments.
Inflation risk is a systematic risk that lessens real returns due to the decreasing purchasing power of the returns. Although inflation negatively affects most investment returns, in some cases, currency inflation can yield higher returns, such as when it is sold short in a currency transaction.
Interest rate risk is a risk that lowers yields or returns due to changes in the prevailing interest rate. Interest rate risk can affect different securities in different ways. The price of bonds in the secondary market, for instance, varies inversely to interest rates—when interest rates rise, the price of bonds drops, and vice versa.
Business risk is any risk that can lower a business’s net assets or net income that could, in turn, lower the return of any security based on it. Some business risks are sector risks that can affect every company in a particular sector, while some business risks affect only a particular company. Higher mortgage rates can increase the business risk for real estate or construction companies, for instance. However, even similar businesses can have widely different risks depending on the quality of management and the resources that are available to the business.
Financial risk is the risk that a business will not be able to make payments due to its debt load. Interest and principal must be paid on borrowed money—failure to make payments can force the business into bankruptcy. A business with large amounts of debt relative to income does not have much reserve for unexpected expenses or lower income, and can fail if the economy sours or if it encounters some other factor that lowers income or increases expenses.
Tax risk is the risk that a taxing authority will change tax laws that will affect an investment negatively. Higher taxes on investment income reduce real returns and can lower the prices of investments in the secondary markets. Higher taxes on businesses will lower their net income, which will usually lower its stock price, and may lower its bond prices in the secondary market if their credit rating is lower as a result of the lower income.
Market risk is the risk that market conditions can negatively impact investment returns. For instance, the prices of securities are dependent on general supply and demand that fluctuates independently of any security in particular. Market risk is generally dependent on economic conditions, such as inflation, consumer sentiment, or credit availability.
Although market risk affects most investments, some investments are affected more than others. How much an investment is affected by market risk is measured by its price volatility, especially in its relationship to an index of similar investments. For instance, some stocks rise higher when the market rises, or falls lower, when the market drops. Sometimes an investment may be countercyclical to other similar financial instruments. Thus, some stocks rise when the general market falls and vice versa. Often, the market movement is measured by a broad index, such as the S&P 500 Stock Index.
Event risk is the risk of an event that can have an impact on the potential return of an investment. Generally, event risk is risk that affects a single company and its securities, such as the loss of a major lawsuit or an accounting scandal. Sometimes event risk can affect a number of securities, such as the political risk that a country will do something that will drive down the prices of any securities issued by companies located in there, such as increasing taxes, discouraging foreign investment, or in extreme cases, nationalizing the companies without proper compensation.
Finally, there is liquidity risk, which is the risk that an investment cannot be sold quickly for a reasonable price. Real estate, for instance, is an illiquid investment because it takes considerable time to sell unless it is sold below market value.
These are the general risks that affect virtually every investment. There are, however, other risks that affect specific types of investments.
A multinational enterprise (MNE) is a company that has a worldwide approach to markets and production or one with operations in more than a country. An MNE is often called multinational corporation (MNC) or transnational company (TNC). Well known MNCs include fast food companies such as McDonald's and Yum Brands, vehicle manufacturers such as General Motors, Ford Motor Company and Toyota, consumer electronics companies like Samsung, LG and Sony, and energy companies such as ExxonMobil, Shell and BP. Most of the largest corporations operate in multiple national markets.
Areas of study within this topic include differences in legal systems, political systems, economic policy, language, accounting standards, labor standards, living standards, environmental standards, local culture, corporate culture, foreign exchange market, tariffs, import and export regulations, trade agreements, climate, education and many more topics. Each of these factors requires significant changes in how individual business units operate from one country to the next.
The conduct of international operations depends on companies' objectives and the means with which they carry them out. The operations affect and are affected by the physical and societal factors and the competitiveenvironment.
Operations
* Objectives: sales expansion, resource acquisition, risk minimization
Means
* Modes: importing and exporting, tourism and transportation, licensing and franchising, turnkeymanagement contracts, direct investment and portfolio investments. operations,
* Functions: marketing, global manufacturing and supply chain management, accounting, finance, human resources
* Overlaying alternatives: choice of countries, organization and control mechanisms
Physical and societal factors
* Political policies and legal practices
* Cultural factors
* Economic forces
* Geographical influences
Competitive factors
* Major advantage in price, marketing, innovation, or other factors.
* Number and comparative capabilities of competitors
* Competitive differences by country
There has been growth in globalization in recent decades due to the following eight factors:
* Technology is expanding, especially in transportation and communications.
* Governments are removing international business restrictions.
* Institutions provide services to ease the conduct of international business.
* Consumers know about and want foreign goods and services.
* Competition has become more global.
* Political relationships have improved among some major economic powers.
* Countries cooperate more on transnational issues.
* Cross-national cooperation and agreements.
Studying international business is important because:
* Most companies are either international or compete with international companies.
* Modes of operation may differ from those used domestically.
* The best way of conducting business may differ by country.
* An understanding helps you make better career decisions.
* An understanding helps you decide what governmental policies to support.
Managers in international business must understand social science disciplines and how they affect all functional business fields.
Tom Travis, the managing partner of Sandler, Travis & Rosenberg, PA. and international trade and customs consultant, uses the Six Tenets when giving advice on how to globalize one's business. The Six Tenets are as follows[3]:
1. Take advantage of trade agreements: think outside the border
* Familiarize yourself with preference programs and trade agreements.
* Read the fine print.
* Participate in the process.
* Seize opportunities when they arise.
2. Protect your brand at all costs
* You and your brand are inseparable.
* You must be vigilant in protecting your intellectual property both at home and abroad.
* You must be vigilant in enforcing your IP rights.
* Protect your worldwide reputation by strict adherence to labor and human rights standards.
3. Maintain high ethical standards
* Strong ethics translate into good business.
* Forge ethical strategic partnerships.
* Understand corporate accountability laws.
* Become involved with the international business self-regulation movement.
* Develop compliance protocols for import and export operations.
* Memorialize your company's code of ethics and compliance practices in writing.
* Appoint a leader.
4. Stay secure in an insecure world
* Security requires transparency throughout the supply chain.
* Participate in trade-government partnerships.
* Make the most of new security measures.
* Secure your data.
* Keep your personnel secure.
5. Expect the Unexpected
* The unexpected will happen.
* Do your research now.
* Address your particular circumstances.
6. All global business is personal
* Go to the source.
* Keep communications open.
* Keep the home office operational.
* Fly the flag at your overseas locations.
* Relate to offshore associates on a personal level.
* Be available to overseas clients and customers 24/7.
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The advantages of globalisation (an economic view):
The economic benefits that greater openness to international trade bring are:
♦ Faster growth: economies that have in the past been open to foreign direct investments have developed at a much quicker pace than those economies closed to such investment e.g. communist Russia
♦ Cheaper imports: this is down to the simple fact that if we reduce the barriers imposed on imports (e.g. tariffs, quota, etc) then the imports will fall in price
♦ New technologies: by having an open economy we can bring in new technology as it happens rather than trying to develop it internally
♦ Spur of foreign competition: foreign competition will encourage domestic producers to increase efficiency. Carbaugh (1998) states that global competitiveness is a bit like golf, you get better by playing against people who are better than you.
♦ Increase consumer income: multination will bring up average wage levels because if the multinationals were not there the domestic companies would pay less.
♦ Increased investment opportunities: with globalisation companies can move capital to whatever country offers the most attractive investment opportunity. This prevents capital being trapped in domestic economies earning poor returns.
Disadvantages of globalisation:
The negative drivers of globalisation included culture which is a major hold back of globalisation. An example of how culture can negatively affect globalisation can be seen in the French film industry. The French are very protective of this part of their culture and provide huge grants to help its development. As well as government barriers market barriers and cultural barriers still exist.
Also a negative aspect to a countries development is war e.g. tourism in Israel fell by 40% due to the latest violence. Corporate strategy can also be a negative driver of
globalization as corporation may try to locate in one particular area.
Another negative driver of globalisation is “local focus” or “localisation” as it is termed in Richard Douthwaite’s book “Short Circuit”. Douthwaite (1996) believes that globalisation can and should be reversed. He also believes that localisation is the way to do this. He defines localisation as “not meaning everything being produced locally but it means a better a balance between local, regional, national and international markets and thus bring less control to multinational corporations”. Another step to reverse globalisation would be for governments to club together to curb the power of multinational by negotiating new trade and treaties that would remove the subsidies powering globalisation and give local production a chance.
Douthwaite also states that the global economy is itself nothing less than a system of structural exploitation that creates hidden slaves on the other side of the world and also
that the North should allow the South to produce for itself and not just for us (North). So it can be seen that Douthwaite is very opposed to globalisation especially that part of it
exploited by multinational corporations.
Further arguments put forward against globalisation by Mr. Lawton include that it actually destroys jobs in wealthy advanced countries. This is due to the lower costs of wages in developing countries. Multinationals will move to areas of lower wage levels at the drop of a hat e.g. Fruit of the Loom. Also this ability to relocate has meant that wage levels of unskilled workers in developed countries has actually fallen relatively speaking. This is down to the fact that one now needs skill and knowledge in developed economies to survive.
Also there is the loss of sovereignty that globalisation brings. Many anti-globalisation believers state that nations are loosing their identity and selling their soul.
Then there are environmental factors of globalisation as described earlier. These are becoming more and more controversial.
Technology, though usually viewed as a positive aspect of globalisation, also has some negative points. Jeffry Sachs (The Economist, June 24th 2000) argues that technology is now what divides the world. Sachs states that 15% of the world’s population account for nearly all the world’s technological advances. This has to be a concern if developing economies are ever going to catch up. Many countries, almost 30% of the world’s population, are technologically excluded (this means not only that they do not innovate but also that they cannot adopt new technologies). In recent years some countries, such as Taiwan, South Korea and Israel, have become top rank innovators and with this their economies have flourished. This would indicate that perhaps the best way to tackle world poverty is to provide aid through education and technology.
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What are Various Theories of International Business?
International business is a broad term, collectively used to describe all commercial transactions (private, government and semi-government) that take place between two or more nations. International business is a newly coined term, but the concept is quite traditional. Actually, the term international business is derived from “international trade”.
In ancient days, producers of a country used to export their surplus production to neighboring countries and later with the further development of trade they started exporting goods to far off countries as well. This was the establishment of an era of “international trade”. With further developments, more competitors came into the international markets, as a result of which producers started marketing their goods at international levels; this was the time when “international trade” turned into “international marketing”.
With further advancements, producers started establishing their production facilities in foreign countries and the era of globalization arrived; this was the time when researchers coined the term “international business”. There are many thinkers who have worked in the field of international business and they have put forward various theories in order to justify the concept of international business. These theories collectively explain why business firms of one country should go to another country, although the industries of that country also produce the same goods and market them. So these theories explain the basis for international business.
Some of the most important theories of international business are given below-
The absolute advantage theory
Theories of International BusinessThe absolute advantage theory was given by Adam Smith in 1776; according to the absolute advantage theory each country always finds some absolute advantage over another country in the production of a particular good or service. Simply because some countries have natural advantage of cheap labour, skilled labour, mineral resources, fertile land etc. these countries are able to produce some specific type of commodities at cheaper prices as compared to others. So, each country specializes in the production of a particular commodity. For example, India finds absolute advantage in the production of the silk saris due to the availability of skilled workers in the field, so India can easily export silk saris to the other nations and import those goods in which other countries find absolute advantages.
But this theory is not able to justify all aspects of international business. This theory leaves no scope of international business for those countries that are having absolute advantage in all fields or for those countries that are having no absolute advantage in any field.
The comparative cost theory:
After 40 years of absolute advantage theory, in order to provide the full justification of international business David Richardo presented the Richardian model—comparative cost theory. According to the comparative cost theory, two countries should do business with each other if one country is having an advantage in the ability of producing one good relative to another good as compared to some other country’s relative ability of producing same goods. It can be well understood by taking an illustration-
If USA could produce 25 bottles of wine and 50 pounds of beef by using all of its production resources and France could yield 150 bottles of wine and 60 pounds of beef by using the same resources, then according to absolute advantage theory France finds clear advantage over USA in the production of both beef and wine. So, there should not be any business activity between the two countries. But this is not the case according to the comparative cost theory. Comparative cost theory suggests relative comparing of the beef and wine production. In relative comparing we can find that France sacrifices 2.5 bottles of wine for producing each pound of beef (150/60) and USA sacrifices 0.5 bottles of wine for producing each pound of beef (25/50). So, we can see that production of beef is more expensive in France as compared to USA. Comparative cost theory suggests USA to import wine from France instead of producing it and in similar manner theory suggests France to import beef from USA instead of producing it.
In this way, comparative cost theory well explains the driving forces behind international business.
Opportunity cost theory:
The opportunity cost theory was proposed by Gottfried Haberler in 1959. The opportunity cost is the value of alternatives which have to be forgone in order to obtain a particular thing. For example, Rs. 1,000 is invested in the equity of Rama News Limited and earned a dividend of six per cent in 1999, the opportunity cost of this investment is 10 per cent interest had this amount been deposited in a commercial bank for one year term.
Another example is that, India produces textile garments by utilizing its human resources worth of Rs. 1 billion and exports to the US in 1999. The opportunity cost of this project is, had India developed software packages by utilizing the same human resources and exported the same to USA in 1999, the worth of the exports would have been Rs. 10 billion. Opportunity cost approach specifies the cost in terms of the value of the alternatives which have to be foregone in order to fulfil a specific art.
Thus, this theory provides the basis for international business in terms of exporting a particular product rather than other products. The previous example suggests that it would be profitable for India to develop and export software packages rather than textile garments to the USA.
The vent for surplus theory
International trade absorbs the output of unemployed factors. If the countries produce more than the domestic requirements, they have to export the surplus to other countries. Otherwise, a part of the productive labor of the country must cease and the value of its annual produce diminishes.
Thus, in the absence of foreign trade, they would be surplus productive capacity in the country. The surplus productive capacity is taken by another country and in turn gives the benefit under international trade. According to this theory, the factors of production of developing countries are fully utilized. The unemployed labor of the developing countries is profitably employed when the surplus is exported.
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Balance of payment (BoP) is a statistical statement that summarizes, for a specific period, transactions between residents of a country and the rest of the world. BoP positions indicate various signals to businesses. BoP comprises current account, capital account and financial account.
and services, income and current transfers. In the capital account, transactions of capital transfers, capital acquisition and non-produced non-financial assets like buildings and patents are included, while in the financial account, transactions relating to financial assets and liabilities like portfolio investments and foreign exchange reserves are included.
However, the BoP account of most countries still classify transactions under two heads only—capital account and current account. In such a case, financial and capital accounts are treated as one. Transactions in BoP are recorded on a double-entry bookkeeping system that is, a transaction is recorded on each side—debit and credit of the BoP account.
There are many signals that the BoP account of a country gives out. For example, large current account transactions indicate towards openness of an economy. This was the case with India as reduction in trade restrictions and duties led to increase in both exports and imports after 1991. Also large capital account transactions may indicate well-developed capital markets of an economy.
Healthy BoP positions or surplus in capital and current account keeps confidence in the economy and among investors. However, healthy BoP positions may be different for different countries. For example, surplus in current account is often more important for developed countries than surplus in capital account as most of them have sufficient capital to fund their investments. On the other hand, developing countries like India may place more importance on capital account as reserves and funding for investment is crucial for them at present.
Large balances often attract foreign investors into an economy, thus bringing in precious foreign exchange. Often credit ratings are based on BoP positions, thereby affecting the flows of credit to businesses. Businesses can make predictions about exchange rates by studying BoP positions. A healthy BoP position can signal domestic currency appreciation, hence encouraging businesses to engage in future contracts accordingly. Also, the BoP position influences the decisions of policy makers, which are crucial for any business.
How does BoP influence economic policy?
The policies of a nation are highly affected and determined by the position and status of its BoP. While formulating or deciding any economic policy, BoP position and policy effect on BoP is given special consideration. While all the policies affect BoP, policies like tariff policy, those related to foreign flows etc affect it in greater magnitude.
Earlier, trade-related policies used to have special focus. But over the years the share of current account transactions in total BoP transactions has decreased. For example, in India its share was almost 60% in 1991-92, but reduced to around 44% in 2007-08. Also, mismatch has been much greater in capital account in recent years, which gave rise to India’s foreign exchange reserves. Over the years, these trends have forced policy makers to make policies keeping in mind foreign flows (capital) and effects of policies on them. However, policies at the same time could be held responsible for such flows.
To improve BoP positions countries have lately often leaned towards the capital account side. The trend has shifted from import substituting policies, that is, policies in which imports are discouraged by way of tariffs, quotas toward more of foreign inflows enhancing policies in the belief that such inflows may make a country crisis-proof and lead to investments that would increase productive capacity and also may increase exports that would earn foreign exchange in future.
However, BoP position in itself affects decisions of policy makers. Often, a deteriorating current account is supported by capital or financial account. A healthy BoP position often allows countries to open up their trade and to appropriate gains from it.
India’s BoP:
India presently has a deficit in its current account of BoP, which has increased substantially after reforms in 1991. In 1991-92, current account deficit was $1,178 million, which rose to $17,403 million in 2007-08, and accounted for $36,469 million for the last three quarters of 2008. After the reforms in 1991, India’s position of merchandise trade (exports and imports of goods) kept on deteriorating, but its position on invisibles (services, current transfers etc) improved during the period. However, one of the major factors for increasing current account deficit in the last few years has been a rising oil import bill. Some countries like Japan and Germany have current account surpluses, while the USA and UK have deficits.
India has done fairly well on the capital account side. In 2007-08 it had a capital account surplus of $108,031 million. In the same year it increased its foreign exchange reserves by $92,164 million, which provided stability to the economy. Foreign investments have increased manifold since 1991, peaking in 2007-08 to $44,806 million.
India’s overall current account and capital account deficit is $20,380 million for April–December 2008, which is expected to rise to a figure between $25 and 30 billion by the year ending March 31, 2009. There has been dip in reserves from $309,723 million in March 2008 to $253,000 million in March 2009. Reasons for this are portfolio flows from foreign institutional investors and the appreciation of the US dollar. But this may not pose a significant threat to the Indian economy and businesses because of large pool of reserves that are still providing enough cushion. However, some businesses like those related to equities and realty are hit when outflows from these sectors occur. Not only is there fall in asset prices and erosion of investment value, but economic activity also gets reduced in these sectors.
However, recent profitability/growth numbers have indicated signs of a revival. Also political change and expected stability might bring in foreign exchange and may improve India’s capital account position and reserves. This may lead to the appreciation of the Indian rupee and may affect exporters and importers accordingly. At the same time, reserves infuse stability into the system, which in turn has positive effects on businesses and investments
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Components of Balance of Payments:
Balance of Payments is generally grouped under the following heads
i) Current Account
ii) Capital Account
iii) Unilateral Payments Account
iv) Official Settlement Account.
Current Account
“The Current Account includes all transactions which give rise
to or use up national income.”
The Current Account consists of two major items, namely:
I) Merchandise exports and imports, and
ii) Invisible exports and imports.
Merchandise exports, i.e., the sale of goods abroad, are credit entries because all transactions giving rise to monetary claims on foreigners represent credits. On the other hand, merchandise imports , i.e., purchase of goods from abroad, are debit entries because all transactions giving rise to foreign money claims on the home country represent debits. Merchandise imports and exports form the most important international transaction of most of the countries .Invisible exports, i.e., sales of services, are credit entries and invisible imports, i.e. Purchases of services, are debit entries. Important invisible exports include the sale abroad of such services as transport, insurance, etc., foreign tourist expenditure abroad and income paid on loans and investments (by foreigners)in the home country form the important invisible entries on the debit side.
Capital Account:
The Capital Account consists of short- terms and long-term capital transactions A capital outflow represents a debit and a capital inflow represents a credit. For instance, if an American firm invests Rs.100 million in India, this transaction will be represented as a debit in the US balance of payments and a credit in the balance of payments of India. The payment of interest on loans and dividend payments are recorded in the Current Account, since they are really payment s for the services of capital. As has already been mentioned above, the interest paid on loans given by foreigners of dividend on foreign investments in the home country are debits for the home country, while, on the other hand, the interest received on loans given abroad and dividends on investments abroad are credits.
Unilateral Transfers Account:
Unilateral transfers is another terms for gifts. These unilateral transfers include private remittances, government grants ,disaster relief, etc. Unilateral payments received from abroad are credits and those made abroad are debits.
Official Settlements Accounts:
Official reserves represent the holdings by the government or official agencies of the means of payment that are generally accepted for the settlement of international claims Anonymous
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The balance of payments (BOP) is the place where countries record their monetary transactions with the rest of the world. Transactions are either marked as a credit or a debit. Within the BOP there are three separate categories under which different transactions are categorized: the current account, the capital account and the financial account. In the current account, goods, services, income and current transfers are recorded. In the capital account, physical assets such as a building or a factory are recorded. And in the financial account, assets pertaining to international monetary flows of, for example, business or portfolio investments, are noted. In this article, we will focus on analyzing the current account and how it reflects an economy's overall position. (For background reading, see What Is The Balance Of Payments?)
The Current Account :
The balance of the current account tells us if a country has a deficit or a surplus. If there is a deficit, does that mean the economy is weak? Does a surplus automatically mean that the economy is strong? Not necessarily. But to understand the significance of this part of the BOP, we should start by looking at the components of the current account: goods, services, income and current transfers.
1. Goods - These are movable and physical in nature, and in order for a transaction to be recorded under "goods", a change of ownership from/to a resident (of the local country) to/from a non-resident (in a foreign country) has to take place. Movable goods include general merchandise, goods used for processing other goods, and non-monetary gold. An export is marked as a credit (money coming in) and an import is noted as a debit (money going out).
2. Services - These transactions result from an intangible action such as transportation, business services, tourism, royalties or licensing. If money is being paid for a service it is recorded like an import (a debit), and if money is received it is recorded like an export (credit).
3. Income - Income is money going in (credit) or out (debit) of a country from salaries, portfolio investments (in the form of dividends, for example), direct investments or any other type of investment. Together, goods, services and income provide an economy with fuel to function. This means that items under these categories are actual resources that are transferred to and from a country for economic production.
4. Current Transfers - Current transfers are unilateral transfers with nothing received in return. These include workers' remittances, donations, aids and grants, official assistance and pensions. Due to their nature, current transfers are not considered real resources that affect economic production.
Now that we have covered the four basic components, we need to look at the mathematical equation that allows us to determine whether the current account is in deficit or surplus (whether it has more credit or debit). This will help us understand where any discrepancies may stem from, and how resources may be restructured in order to allow for a better functioning economy.
The following variables go into the calculation of the current account balance (CAB):
X = Exports of goods and services
M = Imports of goods and services
NY = Net income abroad
NCT = Net current transfers
The formula is:
CAB = X - M + NY + NCT
What Does It Tell Us?
Theoretically, the balance should be zero, but in the real world this is improbable, so if the current account has a deficit or a surplus, this tells us something about the state of the economy in question, both on its own and in comparison to other world markets.
A surplus is indicative of an economy that is a net creditor to the rest of the world. It shows how much a country is saving as opposed to investing. What this means is that the country is providing an abundance of resources to other economies, and is owed money in return. By providing these resources abroad, a country with a CAB surplus gives other economies the chance to increase their productivity while running a deficit. This is referred to as financing a deficit.
A deficit reflects an economy that is a net debtor to the rest of the world. It is investing more than it is saving and is using resources from other economies to meet its domestic consumption and investment requirements. For example, let us say an economy decides that it needs to invest for the future (to receive investment income in the long run), so instead of saving, it sends the money abroad into an investment project. This would be marked as a debit in the financial account of the balance of payments at that period of time, but when future returns are made, they would be entered as investment income (a credit) in the current account under the income section. (For more insight, read Current Account Deficits.)
A current account deficit is usually accompanied by depletion in foreign-exchange assets because those reserves would be used for investment abroad. The deficit could also signify increased foreign investment in the local market, in which case the local economy is liable to pay the foreign economy investment income in the future.
It is important to understand from where a deficit or a surplus is stemming because sometimes looking at the current account as a whole could be misleading.
Analyzing the Current Account:
Exports imply demand for a local product while imports point to a need for supplies to meet local production requirements. As export is a credit to a local economy while an import is a debit, an import means that the local economy is liable to pay a foreign economy. Therefore a deficit between exports and imports (goods and services combined) - otherwise known as a balance of trade deficit (more imports than exports) - could mean that the country is importing more in order to increase its productivity and eventually churn out more exports. This in turn could ultimately finance and alleviate the deficit.
A deficit could also stem from a rise in investments from abroad and increased obligations by the local economy to pay investment income (a debit under income in the current account). Investments from abroad usually have a positive effect on the local economy because, if used wisely, they provide for increased market value and production for that economy in the future. This can allow the local economy eventually to increase exports and, again, reverse its deficit.
So, a deficit is not necessarily a bad thing for an economy, especially for an economy in the developing stages or under reform: an economy sometimes has to spend money to make money. To run a deficit intentionally, however, an economy must be prepared to finance this deficit through a combination of means that will help reduce external liabilities and increase credits from abroad. For example, a current account deficit that is financed by short-term portfolio investment or borrowing is likely more risky. This is because a sudden failure in an emerging capital market or an unexpected suspension of foreign government assistance, perhaps due to political tensions, will result in an immediate cessation of credit in the current account.
Conclusion:
The volume of a country's current account is a good sign of economic activity. By scrutinizing the four components of it, we can get a clear picture of the extent of activity of a country's industries, capital market, services and the money entering the country from other governments or through remittances. However, depending on the nation's stage of economic growth, its goals, and of course the implementation of its economic program, the state of the current account is relative to the characteristics of the country in question. But when analyzing a current account deficit or surplus, it is vital to know what is fueling the extra credit or debit and what is being done to counter the effects (a surplus financed by a donation may not be the most prudent way to run an economy). On a separate note, the current account also highlights what is traded with other countries, and it is a good reflection of each nation's comparative advantage in the global economy.
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The Bretton Woods system:
Since the end of World War II, the U.S. dollar has enjoyed a unique and powerful position in international trade. But perhaps no more.
Before boarding a plane on Saturday to meet President George W. Bush, French President Nicolas Sarkozy proclaimed, "Europe wants it. Europe demands it. Europe will get it." The "it" here is global financial reform, and evidently Sarkozy won't have to wait long. Just hours after their closed-door meeting had finished, Bush and Sarkozy, along with European Commission President Jose Manuel Barroso, issued a joint statement announcing that a summit would be held next month to devise what Barroso calls a "new global financial order."
The old global financial order is, well, old. Established in 1944 and named after the New Hampshire town where the agreements were drawn up, the Bretton Woods system created an international basis for exchanging one currency for another. It also led to the creation of the International Monetary Fund (IMF) and the International Bank for Reconstruction and Development, now known as the World Bank. The former was designed to monitor exchange rates and lend reserve currencies to nations with trade deficits, the latter to provide underdeveloped nations with needed capital — although each institution's role has changed over time. Each of the 44 nations who joined the discussions contributed a membership fee, of sorts, to fund these institutions; the amount of each contribution designated a country's economic ability and dictated its number of votes.
In an effort to free international trade and fund postwar reconstruction, the member states agreed to fix their exchange rates by tying their currencies to the U.S. dollar. American politicians, meanwhile, assured the rest of the world that its currency was dependable by linking the U.S. dollar to gold; $1 equaled 35 oz. of bullion. Nations also agreed to buy and sell U.S. dollars to keep their currencies within 1% of the fixed rate. And thus the golden age of the U.S. dollar began.
For his part, legendary British economist John Maynard Keynes, who drafted much of the plan, called it "the exact opposite of the gold standard," saying the negotiated monetary system would be whatever the controlling nations wished to make of it. Keynes had even gone so far as to propose a single, global currency that wouldn't be tied to either gold or politics. (He lost that argument).
Though it came on the heels of the Great Depression and the beginning of the end of World War II, the Bretton Woods system addressed global ills that began as early as the first World War, when governments (including the U.S.) began controlling imports and exports to offset wartime blockades. This, in turn, led to the manipulation of currencies to shape foreign trade. Currency warfare and restrictive market practices helped spark the devaluation, deflation and depression that defined the economy of the 1930s.
The Bretton Woods system itself collapsed in 1971, when President Richard Nixon severed the link between the dollar and gold — a decision made to prevent a run on Fort Knox, which contained only a third of the gold bullion necessary to cover the amount of dollars in foreign hands. By 1973, most major world economies had allowed their currencies to float freely against the dollar. It was a rocky transition, characterized by plummeting stock prices, skyrocketing oil prices, bank failures and inflation.
It seems the East Coast might yet again be the backdrop for a massive overhaul of the world's financial playbook. U.N. Secretary-General Ban Ki-moon publicly backed calls for a summit before the new year, saying the agency's headquarters in New York — the very "symbol of multilateralism" — should play host. Sarkozy concurred, but for different reasons: "Insofar as the crisis began in New York," he said, "then the global solution must be found to this crisis in New York."
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Types of Investment Risk:
There are many types of risk that are caused by different factors, or which affect different investments to varying extents. Some factors affect most investments and are called systematic risks. Other risks, such as sector risks affect only a particular sector of the economy. Some risks are specific to a business or asset, and are called nonsystematic risks, or diversifiable risks, because such risks can be lowered by diversified investments.
Inflation risk is a systematic risk that lessens real returns due to the decreasing purchasing power of the returns. Although inflation negatively affects most investment returns, in some cases, currency inflation can yield higher returns, such as when it is sold short in a currency transaction.
Interest rate risk is a risk that lowers yields or returns due to changes in the prevailing interest rate. Interest rate risk can affect different securities in different ways. The price of bonds in the secondary market, for instance, varies inversely to interest rates—when interest rates rise, the price of bonds drops, and vice versa.
Business risk is any risk that can lower a business’s net assets or net income that could, in turn, lower the return of any security based on it. Some business risks are sector risks that can affect every company in a particular sector, while some business risks affect only a particular company. Higher mortgage rates can increase the business risk for real estate or construction companies, for instance. However, even similar businesses can have widely different risks depending on the quality of management and the resources that are available to the business.
Financial risk is the risk that a business will not be able to make payments due to its debt load. Interest and principal must be paid on borrowed money—failure to make payments can force the business into bankruptcy. A business with large amounts of debt relative to income does not have much reserve for unexpected expenses or lower income, and can fail if the economy sours or if it encounters some other factor that lowers income or increases expenses.
Tax risk is the risk that a taxing authority will change tax laws that will affect an investment negatively. Higher taxes on investment income reduce real returns and can lower the prices of investments in the secondary markets. Higher taxes on businesses will lower their net income, which will usually lower its stock price, and may lower its bond prices in the secondary market if their credit rating is lower as a result of the lower income.
Market risk is the risk that market conditions can negatively impact investment returns. For instance, the prices of securities are dependent on general supply and demand that fluctuates independently of any security in particular. Market risk is generally dependent on economic conditions, such as inflation, consumer sentiment, or credit availability.
Although market risk affects most investments, some investments are affected more than others. How much an investment is affected by market risk is measured by its price volatility, especially in its relationship to an index of similar investments. For instance, some stocks rise higher when the market rises, or falls lower, when the market drops. Sometimes an investment may be countercyclical to other similar financial instruments. Thus, some stocks rise when the general market falls and vice versa. Often, the market movement is measured by a broad index, such as the S&P 500 Stock Index.
Event risk is the risk of an event that can have an impact on the potential return of an investment. Generally, event risk is risk that affects a single company and its securities, such as the loss of a major lawsuit or an accounting scandal. Sometimes event risk can affect a number of securities, such as the political risk that a country will do something that will drive down the prices of any securities issued by companies located in there, such as increasing taxes, discouraging foreign investment, or in extreme cases, nationalizing the companies without proper compensation.
Finally, there is liquidity risk, which is the risk that an investment cannot be sold quickly for a reasonable price. Real estate, for instance, is an illiquid investment because it takes considerable time to sell unless it is sold below market value.
These are the general risks that affect virtually every investment. There are, however, other risks that affect specific types of investments.
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