Introduction to International Business July 28, 2008 Discussion Section Foreign Direct Investment; Political Economy of FDI; Foreign Exchange; International Monetary System
Agenda • Chapters 3,4,5,6 in a nutshell • Tips for future assignment • Review Chapters 7 • Discussion Questions • Review Chapter 9, 10 • Discussion Questions • Q&A regarding the Midterm
Chapters 3,4,5,6 in a nutshell • Chapter 3: • What is culture? What are the determinants of culture? How does culture affect business? • Chapter 4: • What are ethical dilemmas? How do ethical dilemma’s arise? What are some of the standards used to evaluate ethics? Which ones are “straw men” arguments? • Chapter 5: • What are the theories that explain the observed pattern of international trade? • Chapter 6: • What are some of the instruments that governments use to restrict trade? What are some political and economic justifications for trade intervention? Are these justifications “justified”? How has the world trading system developed?
Review of Case Write-ups • (1) Include your name and student ID • (2) Please staple (rather than paperclip) • (3) Please email only if you cannot attend section (or put “DUPLICATE” in email header) • (4) Use header/footer to indicate name and page X of Y on every page • (5) Label your answers • (6) Answer EVERY question • (7) Grade statistics • Morning: Mean 15.12 Stdev 3.76 • Afternoon: Mean 11.92 Stdev 2.74
Common problems • (1) One-sided responses • E.g., the “Nike is evil” responses. If there is only one side to the issue, it is not an ethical dilemma. It is okay to conclude with one or the other side, but you need to consider both sides first. • (2) Generalities-No support for your claims • Saying Nike should blah blah blah without saying why • Assertions almost never carry as much weight as supported argumentation • (3) Failure to cite theories/ethical constructs in the text • The textbook is not intended to be used solely as a paperweight • (4) Personal opinion is not proper argument unless supported by reasoning (See (2)) • Goal of assignments is to assess whether you learned the material in class • (5) Lack of structure/organization • Run-on diatribes are hard to read • (6) Please dispense with irrelevant facts • Include only those facts to support your claim. Avoid making mistakes of facts.
Consider question 1: Composite of inferior answers • Should Nike be held responsible for the conditions at foreign factories that it does not own? • I think Nike should be held responsible. People need to be able to make enough money to live, work in a safe place, and a company should take care of its employees. Nike has a lot of financial power and it can terminate contracts when it wants to, and so it can force subcontractors to comply with local laws. Plus Nike is financially successful, so it has a philanthropic responsibility. Nike knows what is going on at foreign factories, so it cannot escape it’s responsibility. Nike is a world-famous company, and therefore each country has its own standards. Since Nike is world-famous, it should follow the standards of the country it is operating in.
What’s a better approach? • Nike should not be held responsible for working conditions in foreign factories it does not own. • Reason 1 with support and key terms in bold (e.g., Friedman Doctrine ); • Reason 2 with support and key terms in bold (e.g., naive immoralist). • Nike should be held responsible for working conditions in foreign factories it does not own. • Reason 1 with support and key terms in bold (e.g., Kantian Doctrine); • Reason 2 with support and key terms in bold (e.g., Justice Theory). • Conclusion • State your conclusion clearly and succinctly and apply appropriate reasoning cited above to support it.
How would this look written out? • Based on the traditional straw men arguments, it is easy to argue that Nike should not be held responsible. The cultural relativism argument posits that ethics and working conditions are a product of culture. Subcontractors are thus entitled to establish working conditions of their own and Nike, a foreign entity, cannot be responsible for different standards in another country. • Another such argument, the Friedman doctrine, posits that a firm’s only social responsibility is to increase profits and stay within the law. If Nike’s subcontractors stay within the law, Nike should only look for the most cost-effective subcontractor. • However, these arguments fail upon further inquiry. As Nike vets and approves subcontractors based on their overall ability to provide a service, the working conditions of the factories should be a component in their assessment of the subcontractor. As a multinational corporation, it possess the power to control resources and move its production facilities from country to country, affecting thousands of jobs and lives. According to the utilitarian framework, it therefore has a moral obligation to be socially responsible to the society it operates in because of the sheer number of workers it affects even when balanced against a potential increase in prices spread across consumers of its products. Moreover, Nike could follow valid principles of justice impartially using the “veil of ignorance,” a concept brought up by John Rawls. According to this theory, Nike should distribute economic goods (its vast resources and profits) more equitably with the workers of its foreign subcontractors by demanding better working conditions, even if it means greater costs to the company. • Vaishnavi Jayakumar (with slight modifications)
Chapter 7 Learning Goals • Be familiar with current trends regarding FDI in the world economy. • Understand the different theories of foreign direct investment. • Appreciate how political ideology shapes a government’s attitudes towards FDI. • Understand the benefits and costs of FDI to home and host countries. • Be able to discuss the range of policy instruments that governments use to influence FDI. • Articulate the implications for management practice of theory and government policies associated with FDI.
Chapter 7: Foreign Direct Investment • What is FDI? • FDI in the world economy • Trends; Direction of FDI; Source of FDI; Shift to Services • Form of FDI • Greenfield vs. Acquisitions and Mergers • Why undertake FDI? • Theories that explain WHY FDI occurs • Limitations of exporting and licensing • Internationalization theory • Theories that explain the patterns in FDI • Strategic behavior in in oligopoly competition; (Knickerkbocker’s“Multipoint Competition Theory) • Vernon’s “Product Life Cycle Theory” • The “Eclectic Paradigm” (combines the two sets of theories above) • Dunning: location-specific advantages; externalities
Chapter 7 Review continued • Political Ideology and FDI • Radical View • Free Market View • Pragmatic Nationalism • Government Response • Encourage/restrict outward FDI • Encourage/restrict inward FDI
Chapter 7 Critical Thinking Questions • In 2003, inward FDI accounted for some 78% of gross fixed capital formation in Ireland, but only 0.6% in Japan. What do you think explains this differences in FDI flows into the two countries?
Chapter 7 Critical Thinking Questions • Compare and contrast these explanations of FDI: internalization theory, Vernon's product life cycle theory, and Knickerbocker's theory of FDI. Which theory do you think offers the best explanation of the historical pattern of FDI? Why?
Chapter 7 Critical Thinking Questions • You are the international manager of a US business that has just invented a revolutionary new personal computer that can perform the same functions as existing PCs but costs only half as much to manufacture. Several patents protect the unique design of this computer. Your CEO has asked you to formulate a recommendation for how to expand into Western Europe. Your options are (a) to export from the US, (b) to license a European firm to manufacture and market the computer in Europe, and (c) to set up a wholly owned subsidiary in Europe. Evaluate the pros and cons of each alternative and suggest a course of action to your CEO.
Chapter 7 Critical Thinking Questions • Inward FDI is bad for (i) a developing economy and (ii) a developed economy and should be subjected to strict controls. Discuss.
Chapter 7 Critical Discussion Questions • Firms should not be investing abroad when there is a need for investment to create jobs at home. Discuss.
Chapter 7 Critical Thinking Questions • Do you think the successful conclusion of a multilateral agreement to liberalize regulations governing FDI will benefit the world economy? Why?
Chapter 9 Learning Goals • Be conversant with the functions of the foreign exchange market. • Understand what is meant by spot exchange rates. • Appreciate the role that foreign exchange rates play in insuring against foreign exchange risk. • Understand the different theories explaining how currency exchange rates are determined and their relative merits. • Be familiar with the merits of different approaches towards exchange rate forecasting. • Understand the differences between transaction, translation, and economic exposure, and what managers do to manage each type of exposure.
Chapter 9: The Foreign Exchange Market • What is the FOREX market for? • Currency conversion; insuring against foreign exchange risk (using spot exchange, forward exchange, or currency swaps) • Arbitrage in FOREX markets • Theories about how FOREX rates are determined • Price and exchange rates: law of one price; purchasing power parity; money supply and price inflation • Interest rates and exchange rates: Fisher Effect; International Fisher Effect • Investor psychology and bandwagon effects • Forecasting in FOREX markets • Efficient v. Inefficient Schools; Approaches • FOREX Exposures and Multinational Firms • Transaction, Translation, Economic
Example of a currency swap • For example, consider the US-based company ("Acme Tool & Die") that has raised money by issuing a Swiss Franc-denominated Eurobond with fixed semi-annual coupon payments of 6% on 100 million Swiss Francs. Upfront, the company receives 100 million Swiss Francs from the proceeds of the Eurobond issue (ignoring any transaction fees, etc.). They are using the Swiss Francs to fund their US operations. • [Why issue bonds in Swiss Francs? The only rationale for doing this is because there are investors with Swiss Franc funds who are looking to diversify their portfolios with US credits such as Acme's. They are willing to buy Acme's Eurobonds at a lower yield than Acme can issue bonds in the US. A Eurobond is any bond issued outside of the country in whose currency the bond is denominated.] • Because this issue is funding US-based operations, we know two things straightaway. Acme is going to have to convert the 100 million Swiss Francs into US dollars. And Acme would prefer to pay its liability for the coupon payments in US dollars every six months. • Acme can convert this Swiss Franc-denominated debt into a US dollar-like debt by entering into a currency swap with the First London Bank. • Acme agrees to exchange the 100 million Swiss Francs at inception into US dollars, receive the Swiss Franc coupon payments on the same dates as the coupon payments are due to Acme's Eurobond investors, pay US dollar coupon payments tied to a pre-set index and re-exchange the US dollar notional into Swiss Francs at maturity. • Acme's US operations generate US dollar cash flows that pay the US-dollar index payments. • First London Bank make Swiss-Franc denominated payments. • In essence, Acme and First London Bank have “swapped currencies”
Chapter 9 Critical Thinking Questions • The interest rate on South Korean government securities with one-year maturity is 4% and the expected inflation rate is 2%. The interest rate on U.S. government securities with one-year maturity is 7%, and the expected rate of inflation is 5%. The current spot exchange rate for Korean won is $1 = W1,200. Forecast the spot exchange rate one year from today. Explain the logic of your answer
Answer: • The international Fisher effect suggests that the exchange rate will change in an equal amount but in an opposite direction to the difference in nominal interest rates. Hence since the nominal interest rate is 3% higher in the US than in South Korea, the dollar should depreciate by 3% relative to the South Korean Won. Using the formula from the book: (S1 - S2)/S2 x 100 = i$ - iWon and substituting 7 for i$, 4 for iWon, and 1200 for S1, yields a value for S2 of $1=W1165.
Chapter 9 Critical Thinking Questions • Two countries, Great Britain and the United States, produce just one good: beef. Suppose the price of beef in the United States is $2.80 per pound and in Britain it is ₤3.70 per pound. • According to PPP theory, what should the dollar/pound spot exchange rate be? • Suppose the price of beef is expected to rise to $3.10 in the United States and to ₤4.65 in Britain. What should the one-year forward dollar/pound exchange rate be? • Given your answers to parts a and b, and given that the current interest rate in the United States is 10%, what would you expect the current interest rate to be in Britain?
Answer: • (a) According to PPP, the $/£ rate should be 2.80/3.70, or .76$/£. • (b) According to PPP, the $/£ one year forward exchange rate should be 3.10/4.65, or .67$/£. • (c) Since the dollar is appreciating relative to the pound, and given the relationship of the international Fisher effect, the British must have higher interest rates than the US. Using the formula (S1 - S2)/S2 x 100 = i£ - i$ we can solve the equation for i£, with S1=.76, S2=.67, i$ = 10, yielding a value of 23.4% for the British interest rates.
Chapter 9 Critical Thinking Questions • You manufacture wine goblets. In mid-June you receive an order for 10,000 goblets from Japan. Payment of ¥400,000 is due in December. You expect the yen to rise from the present rate of $1 = ¥130 to $1 = ¥100 by December. You can borrow yen at 6% a year. What should you do?
Answer • (1) The simplest solution would be to just wait until December, take the ¥400,000 and convert it at the spot rate at that time, which you assume will be $1=¥100. • In this case you would have $4,000 in mid-December. • (2) Forward Contract • If the current 180-day forward rate is lower than 100¥/$, then a forward contract might be preferable since it both locks in the rate at a better level and reduces risk. • If the rate is above ¥100/$, then whether you choose to lock in the forward rate or wait and see what the spot does will depend upon your risk aversion. • (3) Borrow Money • There is a third possibility also. You could borrow money from a bank that you will pay back with the ¥400,000 you will receive (400,000/1.03 = ¥388,350 borrowed), convert this today to US$ (388,350/130 = $2,987), and then invest these dollars in a US account. For this to be preferable to the simplest solution, you would have to be able to make a lot of interest (4,000 - 2,987 = $1,013), which would turn out to be an annual rate of 51% ((1,013/4000) * 2). If, however, you could lock in these interest rates, then this method would also reduce any exchange rate risk. What you should do depends upon the interest rates available, the forward rates available, how large a risk you are willing to take, and how certain you feel that the spot rate in December will be ¥100 = $1.
Chapter 9 Critical Thinking Questions • You are the CFO of a US firm whose wholly owned subsidiary in Mexico manufactures component parts for your US assembly operations. The subsidiary has been financed by bank borrowings in the United States. One of your analysts told you that the Mexican peso is expected to depreciate by 30 percent against the dollar on the foreign exchange markets over the next year. What actions, if any, should you take?
Answer • Your financing and operating capital are in dollars, yet many of your costs (labor) must be in peso. Your hard assets are all in peso, and their value will decline. On the other hand, if the peso depreciates, then your dollars will go further. So perhaps doing nothing is the best approach. If you are pretty sure that the peso will depreciate, then you may want to avoid any major peso-denominated costs that you can until after devaluation. That may mean holding back on shipments if possible, and you may want any dollar-denominated purchases made before the devaluation. You may want to move any peso-denominated major accounts into dollars before the devaluation.
Chapter 10 Learning Goals • Be familiar with the historical development of the modern global monetary system. • Describe the role played by the World Bank and the IMF in the international monetary system. • Be familiar with the differences between a fixed and a floating exchange rate system. • Know what exchange rate systems are used in the world today and why countries adopt different exchange rate regimes. • Understand the debate surrounding the role of the IMF in the management of financial crises. • Appreciate the implications of the global monetary system for currency management and business strategy.
Chapter 10: The International Monetary System • Different exchange rate regimes: • Fixed • Floating: pegged; dirty float • Fixed versus Floating Exchange Rates • Why choose floating exchange rates? • Monetary policy autonomy • Trade balance adjustments • Why choose fixed exchange rates? • Monetary discipline • Speculation • Uncertainty • Trade Balance Adjustment • Who is right?
Chapter 10: Critical Thinking Questions • Debate the relative merits of fixed and floating exchange rate regimes. From the perspective of an international business, what are the most important criteria in a choice between the systems? Which system is the more desirable for an international business?
Chapter 10: Critical Thinking Questions • Imagine that Canada, the United States, and Mexico decide to adopt a fixed exchange rate system. What would be the likely consequences of such a system for (a) international businesses and (b) the flow of trade and investment among the three countries?
Chapter 10: Critical Thinking Questions • Do you think the standard IMF policy prescriptions of tight monetary policy and reduced government spending are always appropriate for developing nations experiencing a currency crisis? How might the IMF change its approach? What would the implications be for international business?
About the Midterm • Unless you have made special arrangements, please show up at your own class time: If you are in the morning class, come to the morning exam, and if you are in the afternoon class, come to the afternoon exam. Each class receives a different version of the exam. If you come to the "wrong" exam (the one you're not enrolled in) WE WILL MAKE NO POSITIVE ADJUSTMENT TO YOUR SCORE EVEN IF THERE IS A DIFFERENCE IN AVERAGES BETWEEN THE TWO CLASSES. • The exams will be held in the same class room C230 from 10:30 a.m. to 1:00 p.m. for the morning class, and from 3:30 p.m. to 6:00 p.m. for the afternoon class • Please bring your own (green) scantron sheet if you have one. If not, we will provide one for you, but supplies are limited. • There is no need for a blue book. Please answer all short answers in the exam itself. • Please bring a number 2 pencil -- the scantron sheets will be graded electronically. If you use a pen, you will be marked 0 for all answers. Needless to say, bring an eraser. • You are allowed one sheet of notes and a language dictionary for the exam. • Sanny will be holding office hours from 1:30 p.m. to 3:00 p.m. at Cafe Strada (located on Bancroft X College Ave)
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