International business in the global economy Objectives Once you have completed this module you should be able to: understand the broad economic concepts for businessunderstand the concepts of international business, international trade and investmentrealise the reasons for firms’ internationalisation strategiesanalyse the importance of international business within the global economyoutline and describe the evolution of international business and the modern firmdistinguish between globalisation of production and globalisation of marketlearn about an organising framework for market globalisationknow the dimensions and drivers of market globalisationexplain the consequences of globalisationexplore the impacts of globalisation on developing countries Learning resources Textbook Cavusgil et al. 2020, International business, 5th ed., chapters 1 and 2 . Selected readings 1.1: Besanko et al. 2007, Economics of strategy, chapter 1. 1.2: Wild, J, Wild, KL & Han, JCY 2008, International business: the challenges of globalization, chapter 1. 1.3: Masson, P 2001, ‘Globalisation: facts and figures’, IMF Policy Discussion Paper PDP/01/04, IMF, Washington. 1.4: Krugman, P 1991, ‘Myths and realities of US competitiveness’. 1.5: The Economist 1996, ‘The C-word strikes back’. Additional resources Besanko et al. 2007, Economics of strategy, primer. Brittan, L 1998, ‘Globalisation vs sovereignty? The European response’, The 1997 Rede lecture and related speeches, Cambridge University Press, Cambridge. Hak-Min, K 1999, Globalisation of International Financial Market: causes and consequences, Ashgate Publishing Limited, Hants. Layton et al. 2012, Economics for today, chapters 3, 5, 6, 7, 8 & 9. [strongly recommended] Pindyck & Rubinfeld 2009, Microeconomics, chapters 2 & 7. Sawyer & Sprinkle 2006, International economics, chapters 2 & 3. Note For understanding ‘economic concepts’ students are strongly advised to study any introductory economics textbook if the above mentioned textbooks are not available. Introduction This module provides some economic concepts for business and an introduction to international business. It provides the necessary backdrop against which you can think about international business strategy. It offers a very interesting historical perspective as well as the key concepts of international business, international trade and investment. Some emphasis is placed the differences between international business and domestic business. Here participants of international business, especially the multinational enterprise, will be introduced and discussed. Strategy is crucial for a firm to run effective business in the global economy. In this module you will see why firms pursue internationalisation strategies. You can also understand why you should study international business. The module will also review the evolution of international business and its importance in the global economy. Globalisation and its effects will also be extensively discussed. Economic concepts for businessDemand and supply Demand and supply analysis is fundamental to understand the market economy. The law of demand states that if other things remaining the same, an inverse relationship exists between the price of a good or service and quantity demanded in a defined time period. So the demand curve is downward-sloping from left to right. The horizontal summation of all individual demand curves in the market gives us the market demand curve. You should understand the distinction between change in quantity demanded and change in demand. The former occurs when price changes, and movement will be along the demand curve; on the other hand, the latter occurs when non-price determinant of demand changes, and there will be shift of the demand curve. The law of supply states that a direct relationship exists between the price of the good and quantity supplied, if other things remaining the same, in a defined time period. This is expressed as an upward-sloping curve from left to right. The horizontal summation of all individual supply curves in the market gives us the market supply curve. A change in the quantity supplied occurs due to price change only, and is reflected as a movement along the supply curve. A change in supply occurs due to changes of non-price determinants, and is reflected as a shift of the supply curve. We get market equilibrium when demand equal to supply. At this equilibrium point both the demand and supply curves intersect each other. At the equilibrium price, the quantity demanded is just equal to the quantity supplied; neither a surplus nor a shortage exists. A surplus is observed if price is above equilibrium, and a shortage is observed if the price is below equilibrium. The existence of surpluses and shortages induces prices to fall and rise, respectively (see Layton et al. 2012, chapter 3 for details). Price elasticity of demand and supply The price elasticity of demand is defined as the ratio of the percentage change in the quantity demanded of a product to a percentage change in its price. Basically it measures consumer responsiveness to a change in price. This measure of consumer responsiveness is indicated by a value, which is identified as the elasticity coefficient. The product has an elastic demand if the absolute value of the coefficient is greater than one; the product has an inelastic demand if the absolute value is less than one, and the product has a unitary elastic demand if it is equal to one. A product might also be perfectly elastic (horizontal demand curve) or perfectly inelastic (vertical demand curve). The degree of price elasticity of demand can also be realised by observing the relationship between the change in the price and the change in total revenue. An inverse relationship between the change in the price of the product and the change in total revenue exhibits that the product is elastic; a direct relationship exhibits that the product is inelastic. The degree of elasticity of a product depends on: the availability of substitutesthe share of a budget spent on the productthe amount of time under consideration. The price elasticity of supply is defined as the ratio of the percentage change in the quantity supplied of a product to a percentage change in its price. (See Layton et al. 2012, chapter 5; Pindyck & Rubinfeld 2009, chapter 2 for details.) Production costs A firm must have an idea about its revenues and costs. The firm’s profit is equal to revenues minus costs. In this section we will discuss costs. Total cost is equal to total fixed cost plus total variable cost. Average cost is equal to total cost divided by output produced. Marginal cost is the additional cost to the firm to produce an extra unit of output. (See Layton et al. 2012, chapter 6; Pindyck & Rubinfeld 2009, chapter 7 for details.) Here we will discuss four specific concepts: cost functions; long-run versus short-run costs; sunk costs and economic versus accounting costs. Total cost function The total cost function represents the relationship between firm’s total costs and the total amount of output it produces in a given period of time. Total cost function is an efficiency relationship. It shows the lowest possible total cost the firm would incur to produce a level of output, given the firm’s technological capabilities and the prices of factors of production, such as labour and capital. Fixed and variable costs Fixed costs remain constant as output increases. Building cost, general and administrative expenses and property taxes are examples of fixed costs. Variable costs increase as output increases. Direct labour costs and commission to salespeople are examples of variable costs. Average and marginal costs Average cost will vary with output. As output goes up, it may fall, rise, or remain constant. Economies of scale exist when average cost decreases as output increases. Diseconomies of scale exist when average cost increases as output increases. Constant returns to scale exists if average cost remains unchanged irrespective of output level. The following points are important for the relationship of average and marginal costs: When average cost is a decreasing function of output, marginal cost is less than average cost.When average cost is constant in output or at a minimum point, marginal cost is equal to average cost.When average cost is an increasing function of output, marginal cost is greater than average cost. Long-run versus short-run costs The short-run is known as the period of time in which the firm cannot adjust the size of its production facilities. There is an associated short-run average cost function for each plant size. These average cost functions include the annual costs of all relevant variable inputs (labour, materials) as well as the fixed cost of the plant itself (Besanko et al. 2007). The long-run is known as the period of time in which the firm can adjust the size of its production facilities optimally. The long-run average cost function is the lower envelope of the short-run average cost functions. It shows the lowest attainable average cost for any particular level of output. Sunk versus avoidable costs Some costs cannot be avoided, and thus must be incurred no matter what the decision is. These are called sunk costs. Avoidable costs are opposite of sunk costs that can be avoided if certain choices are made. A sunk cost is usually visible, but after it has been incurred it should always be ignored when making future economic decisions. For example, a specialised equipment has been purchased for a plant only, and it cannot be converted for alternative use. The expenditure on this equipment is a sunk cost. Because its opportunity cost is zero, it has no alternative use. Sunk cost and fixed cost are not the same. In particular, some fixed costs need not be sunk. Economic versus accounting costs The concept of accounting cost is grounded in the principle of accrual accounting, which emphasizes historical costs. Accounting statements – particularly income statements and balance sheets – are designed to serve an audience outside the firm. Economic costs are based on the concept of opportunity cost which states that the economic cost of deploying resources in a particular activity is the value of the best foregone alternative use of those resources. Therefore, accounting costs are not necessarily appropriate for decision making inside a firm. Business decisions require the measurement of economic costs (Besanko et al. 2007). Economic profit versus accounting profit Accounting profit is defined as the total revenue minus total explicit costs. Economic profit is total revenue minus explicit and implicit costs. Economists use the concept of economic profit to take economic decisions. Economic profit can be positive, zero or negative. Expressed as an equation: Economic profit = total revenue – total opportunity costs or Economic profit = total revenue – (explicit costs +implicit costs) (See Layton et al. 2012, chapter 6.) Note Total revenue (TR) is equal to price times quantity of output sold, PQ, and marginal revenue (MR) is the change in revenue resulting from a one-unit increase in output. Pricing and output decisions of a firm Perfect competition Perfect competition is the most competitive market structure which is characterised by a large number of small firms, a homogeneous product and very easy entry into, or exit from, the market. In perfect completion, a firm is a price taker. That is, the firm has no control over the price of the product it sells. Here market supply and demand conditions will determine price, and the firm makes only one decision – what quantity of output to produce that maximises profit. In the short run, a firm can earn positive profit or even can incur loss in this market structure. The firm maximises profit or minimises losses by producing the output where marginal revenue equals marginal cost. A perfectly competitive firm will shut down its production when the price is less than the average variable cost (AVC), as total loss will be fixed cost plus some of variable cost. A firm, however, will continue its production if price is more than the AVC, as by producing it can gain a portion of lost fixed cost. In the long run, a competitive firm earns only normal profit (zero economic profit). The freedom of free exit and entry eliminates positive economic profit or loss in the long run through the shifting of market supply curve and changing price (see Layton et al. 2012, chapter 7 for details). Monopoly It is a market of a single seller where the product is unique, and it is extremely difficult or impossible to enter into the market. In perfect completion, many firms constitute the industry; whereas in monopoly, a single firm is the industry. In this market structure, the seller is the price maker. The firm faces a downward sloping demand curve and therefore choose among price and output combinations along the demand curve. As with the perfectly competitive firm, a monopolist maximises profit by producing the quantity of output where MR = MC and charging the corresponding price on the elastic segment of its demand curve. A monopolist earns positive economic profit both in the short run and long run. A monopolist may also incur loss in the short run (see Layton et al. 2012, chapter 8 for details). Monopolistic competition and oligopoly Monopolistic competition is a market structure which is characterized by many small sellers, a differentiated product and easy market entry and exit. The monopolistic competitive firm is a price maker. The demand curve for a monopolistically competitive firm is less elastic (steeper) than for a perfectly competitive firm and more elastic (flatter) than for a monopolist. The monopolistically competitive firm, like firms in any market structure, maximises short-run profit by producing the output level where MR = MC. However, the monopolistically competitive firm, unlike a monopolist, will not earn an economic profit in the long run. Rather it, like a competitive firm, earns only a normal profit (zero economic profit). This is because short-run profits and easy entry attract new firms into the industry. Oligopoly is a market structure which is characterised by few sellers, either a homogeneous or a differentiated product and barriers to market entry. Here firms are mutually interdependent. Oligopolists drive market power from significant barriers to market entry. So like the monopolist, they can earn economic profit in the long run. However, price-output decision in an oligopoly market structure is not as simple as in monopoly or perfect competition where price is charged applying MR = MC rule. Here making price and output decisions is like playing a game of chess, or like a sporting game in which one player’s move depends on the anticipated reactions of the opposing player (Layton et al. 2012). Reading activity 1 Additional resources: Layton et al. 2012, chapters 3, 5, 6, 7, 8 & 9 Pindyck & Rubinfeld 2009, chapters 2 & 7 Besanko et al. 2007, primer.Make sure that you: understand the key economic concepts described in those chapters study the related figures/graphs and tables and draw key points from them. understand how prices and outputs are determined under each of the market structures. Exercise 1 Draw graphs to illustrate the difference between a decrease in quantity demanded and a decrease in demand for cut flowers. Give a possible reason for the change you have shown in each graph (end chapter Q.2, Layton et al. 2012). Exercise 1 Explain under what circumstances a firm in a competitive market will continue its production in the short run despite the fact that the firm is incurring loss. Illustrate graphically. Exercise 1 Graphically explain the short-run equilibrium of a firm under monopoly and monopolistic competition. International business In this section we will use a macro lens to introduce you some of the fundamental international business concepts. International business refers to the trade and investment activities by companies across national borders. Globalization of markets refers to ongoing economic integration and growing interdependency of countries worldwide. Stress the dramatic growth in world trade, which now exceeds some $10 trillion annually. There are two ways to invest internationally – passively (portfolio investment – financial assets) or actively (foreign direct investment – capital, technology, labor, land, plant and equipment). Also important are importing (global sourcing) – buying products/services from abroad and bringing them back to the home country. Exporting – manufacturing a product or service in one country and selling it to another. This section will address the broader questions of: Why firms go international?primarily to increase sales and profits!How international business is different from domestic businesscomplexity and risks (4)Who participates in international business? Multinational Enterprise (MNE)Small and Medium-sized Enterprise (SME)Born Global – entrepreneurial firm that is international from inceptionWhy you should study international businessCompetitive advantage – for you and your firm! Note International business is both a cause and a result of increasing national prosperity. Reading activity 1 Textbook: Cavusgil et al. 2020, chapter 1 ‘Introduction: what is international business?’ Exercise 1 Write down the answers to questions 1-11, 1-12, 1-15 and 1-16 of Cavusgil et al. 2020, page 58 (Test your comprehension AACSB: Reflective thinking skills). The evolution of the modern firm Reading activity 1 Selected reading 1.1: Besanko et al. 2007, chapter 1, ‘The evolution of the modern firm’. Exercise 1 Write notes comparing and contrasting the infrastructure for modern business with that of 1840 and 1910. Globalisation and the internationalisation of the firm ‘Globalisation is the trend toward greater economic, cultural, political, and technological interdependence among national institutions and economies’ (Wild et al. 2008, p. 6). This trend is characterised by denationalisation, where national boundaries are becoming less relevant. It is noted that globalisation is different from internationalisation, where entities are cooperating across national boundaries (Wild et al. 2008). Here we will focus on the business implications of globalisation. We will look at two areas of business in which globalisation is having profound effects – globalization of both production and markets. Globalisation of production Now many production activities are becoming global. The dispersal of production activities to locations that help a company achieves its cost-minimization or quantity – maximization objectives for a good or service is known as globalisation of production. This includes the sourcing of key production inputs (such as raw materials or products for assembly) and international outsourcing of services. Companies obtain several benefits from globalisation of production (see Wild et al. 2008, pp. 8–10 for details). Globalisation of markets ‘Globalisation of market refers to the gradual integration and growing interdependence of national economies’ (Cavusgil et al. 2020). Initially, though the term market globalisation was used by scholars to refer to the emergence of global markets for standardised products and services and the growth of world-scale companies that serve those markets, the term has in fact a broader meaning. It refers to the interconnectedness of national economies and the growing interdependence of buyers, producers, suppliers, and governments in different countries (Cavusgil et al. 2020). Globalization allows firms to view the world as one large marketplace for goods, services, capital, labour, and knowledge. Like the globalisation of production, market globalisation also offers companies several benefits. Why globalization is not a new phenomenon Early civilizations in the Mediterranean, Middle East, Asia, Africa, and Europe have all contributed to the growth of globalization. Ancient trade routes were the foundation for a high level of cross-cultural exchange of ideas that lead to the development of religion, science, economic activity, and government. Globalization evolved out of a common, shared international heritage of all civilizations, no matter where they developed, to reach out and touch one another. Exchange with others gave societies the opportunity to expand and grow. Phases of globalization Exhibit 2.1 of Cavusgil et al. (2020) summarizes the phases of globalization. Since the 1800s, in the evolution of market globalization has witnessed four distinct phases, each triggered by global events and technological discoveries: The First phase of globalization – 1830 to 1880The Second phase of globalization – 1900 to 1930The Third phase of globalization – 1948 to 1970sThe Fourth phase of globalization – 1980s to 2006The fifth phase of globalization- 2007 to present. An organizing framework for market globalisation Exhibit 2.2 of Cavusgil et al. (2020) presents the drivers, dimensions and consequences of market globalisation. This model distinguishes between: 1.the drivers or causes of globalisation2.the many dimensions or manifestations of globalisation3.(a)societal consequences of globalisation3.(b)firm-level consequences of globalisation which compel firms to proactively internationalize. The double arrows illustrate the interactive relationship between market globalization and its consequences. As market globalization intensifies, individual business enterprises are compelled to respond to challenges and exploit new advantages. Firms implementing internationalization proactively are more successful than those reactively engaging. Dimensions of market globalisation In the context of international business, market globalisation may be viewed simultaneously as: Consequences of economic, technological, and government trendsDrivers of economic, political, and social phenomenaDrivers and consequences of firm-level internationalization. Globalization of markets is a multifaceted phenomenon. Market globalization has following five dimensions or manifestations: Integration and interdependence of national economies.Rise of regional trading blocs and economic unions.Growth of global investment and financial flows.Convergence of consumer lifestyles and preferences.Globalization of production.Globalisation of services (See Cavusgil et al. 2020, pages 74-75 for details.) Drivers of market globalisation Among the causes of market globalisation, the following five drivers are particularly notable: Worldwide reduction of barriers to trade and investment.Market liberalization and adoption of free markets.Industrialization, economic development, and modernization.Integration of world financial markets.Advances in technology. (See Cavusgil et al. 2020, page 68 for details.) Technological advances as a driver of market globalisation Since the 1980s, the most important advances in technology have occurred in information technology, communications, the internet, manufacturing, and transportation. The twin trends transform national economies and promote outsourcing/ offshoring. For example – Information technology allows for more efficient adaptation to international markets as well as producing smaller lot sizes to target international niche markets. Emerging markets (technological leapfrogging) and consumers (reduced prices and greater selection) are the beneficiaries because of technological advancement. There is a delicate balance of job creation/unemployment when considering those who have lost their jobs to offshoring. China and India are the new beachheads of technological advances. Top management at Intel and Motorola, two of the world’s premier technology companies, agree that China is the future when it comes to technological progress. Innovation – societies and organizations innovate in various ways, including new product designs, new production processes, new approaches to marketing, and new ways of organizing or training. Among the industries most dependent on technological innovation are biotechnology, information technology, new materials, pharmaceuticals, robotics, medical equipment/devices, lasers and fiber optics, and electronics-based industries (Cavusgil et al. 2020). (See Cavusgil, et al. 2020, pages 69–73, how technological advances have had the greatest impact on information technology, communications, manufacturing and transportation, and how international business is being affected due to this impact.) Firm-level consequences of market globalisation: internationalization of the firm’s value chain The most significant implication of market globalisation for companies is that a purely domestic focus is no longer viable for firms in most industries.Market globalisation compels firms to internationalise their value chain, and adopt a global rather than a local focus.Value chain: The sequence of value-adding activities performed by the firm in the process of developing, producing, and marketing a product or a service.Globalization is the heightened ability of a firm to internationalize its value chain (reconfigure key value-adding activities), leading to greater international integration and cost efficiencies.The value chain concept is useful in international business because it helps clarify what activities are performed where in the world.Each value-adding activity is subject to internationalization – it can be performed in a foreign market instead of at home, sometimes with in collaboration with local business partners.Value chains vary in complexity and across industries and products.Exhibit 2.6 of Cavusgil et al. (2020) illustrates the typical value chain, underscoring the flexibility that firms have in reconfiguring their value-adding activities.Upstream activities = Research and development, procurement, and manufacturing.Downstream activities = Marketing, distribution, and sales and service.Exporting firms perform most ‘upstream’ value-chain activities (R&D and production) in the home market and most ‘downstream’ activities (marketing and after-sales service) abroad.Outsourcing – The value-adding activity is delegated to an external supplier, as opposed to being internalized within the company.Offshoring – Internationalizing the value chainExamples of Globalization – German car maker BMW launching a new factory in South Carolina; Jackson Mills, an aging textile plant, closed its doors and sourced textiles more cost-effectively, and of comparable quality, from suppliers in Asia. Both examples illustrate the relocation of key value-adding activities to the most advantageous global locations (Cavusgil et al. 2020). Societal consequences of market globalisation Positive consequences of market globalization: Cross-border trade and investment opened the world to innovations and progress while increasing performance standards, currently known as global benchmarking or world class. Negative consequences of market globalization: The transition to an increasingly single, global marketplace poses challenges to individuals, organizations and governments. Poverty is especially notable in Africa, Brazil, China and India where lower-income countries have not been able to integrate with the global economy as rapidly as others. Globalization has created countless new jobs and opportunities around the world, but it has also cost many people their jobs. Globalization generally has the following unintended consequences: loss of national sovereigntyoffshoring and the flight of jobseffect on the pooreffect on the natural environmenteffect on national culture. (See Cavusgil et al. 2017, pages 77–85 for details.) Globalisation and developing countries The impacts of globalisation on developed and developing countries are not the same. Brittan (1998) indicated that globalisation led to an increase in the wealth of developed countries without creating bigger poverty in the developing countries. Brittan cited the example of Asian countries where economic situation improved. The increased economic growth in Asian countries led to a reduction in the skewed distribution of income between developed and developing countries. Hak-Min (1992), however, differs from the view of Brittan, and opined that globalisation in the integrated world economy has led to industrial growth in a limited number of developed countries. With regard to effect of globalisation on income and income distribution Masson (2001) concluded that the developing countries that actively took part in the process of globalisation grew by 3.5% in the eighties and 5% in the nineties. The countries that did not actively take part in the process of globalisation did not realize any or just marginal growth rates after 1980. The countries that opened their economies grew at a faster rate than the developed countries. Therefore, it is not correct to argue that globalisation caused low and unequal distribution of income in developing countries. To explain the relationship between unemployment and globalisation, the opponents of globalisation argue that it will lead to higher level of unemployment in developing countries. Disagreeing with this proposition other economists opine that developed countries will be exporting jobs to the developing countries. So it is oversimplification to argue that the high levels of unemployment in developing countries are caused by globalisation (Brittan, 1998). Brittan argues that the demand for low skilled workers have declined due to technological developments. The international demand for skilled workers has increased. It is due to the fact that the specialised skilled worker is needed to compliment the advancement in technology. Reading activity 1 Textbook: Cavusgil et al. 2020, International business, chapter 2. Selected reading 1.2: Wild, Wild & Han, International business: the challenges, of globalization, chapter 1. Selected reading 1.3: Masson, P 2001, ‘Globalisation: facts and figures’, IMF Policy Discussion Paper PDP/01/04, IMF, Washington. Additional resources: Brittan, L 1998, ‘Globalisation Vs sovereignty? The European response’, The 1997 Rede lecture and related speeches, Cambridge University Press, Cambridge. Hak-Min, K 1999, Globalisation of International Financial Market: causes and consequences, Ashgate Publishing Limited, Hants. Exercise 1 Briefly answer to the following questions: Define globalisation. How does denationalisation differs from internationalisation? How does this current period of globalisation compare with the first age of globalisation Identify the arguments of those who say that globalisation creates jobs and boosts wages. What are the implications of globalisation for firm internationasation? What are the pros and cons of globalisation? How are developing countries being affected as a result of globalisation? Conclusion You have been introduced to some required economic concepts, interesting facts and issues relating to international business in this module. You are now well-grounded in the evolution and current status of international business in the global economy. You have considered globalisation that greatly affect international business. For every country, globalization brings opportunities and challenges. Domestic policies and firm’s appropriate strategy can help a lot to effectively face these challenges. You are now familiar with the participants of international business. Different types of participants play various role to facilitate international business. International trade is an important component of the world economy. Trade and location of business are also important questions in the strategy for international business. Should a business locate in a few targeted countries and export to others? Or should it aim to locate in all countries? Obviously the answer to this is ‘It depends’. Coca-Cola has a product and volume of sales in most markets that encourages it to locate in all countries, at least through joint ventures. Cable News Network (CNN) can operate out of centres based in a few countries and maintain roving news reporters in the rest. Reference list Brittan, L 1998, ‘Globalisation Vs sovereignty? The European response’, The 1997 Rede lect
