International Business and Trade Jonnard Claude
International Business and Trade Jonnard Claude
International Business and Trade Jonnard Claude
Business
and Trade
Theory, Practice,
and Policy
Claude M. Jonnard
^.KF0RD PUBL|c library
658.049 J795i
Jonnard, Claude M
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DEMCO
I nternational
Business
and Trade
Theory, Practice,
and Policy
Claude M. Jonnard
Si
St. Lucie Press
Boca Raton Boston London New York Washington, D.C.
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Table of Contents
Preface . v
Acknowledgments . ix
About the Author . x
iii
iv International Business and Trade: Theory, Practice, and Policy
GLOSSARY . 267
v
VI International Business and Trade: Theory, Practice, and Policy
IX
About the Author
x
PART I
International Business
Theories and Concepts
CHAPTER 1
Corporate Challenges
INTRODUCTION
The major changes that have taken place in the last two centuries are
introduced, as are the challenges that will be facing globally oriented
businesses functioning as economic surrogates of society in the twenty-
first century.
3
4 International Business and Trade: Theory, Practice, and Policy
single country and prosper is probably over. Corporate growth and sur¬
vival today require a global perspective and strategy. The principles of
business behavior in a global environment are as important to master
today as economics, accounting, and mathematics if managers of eco¬
nomic enterprise are to succeed in this new arena of global competition,
interaction, and interdependence.
* World Bank, World Development Report, 1996, Table 4, pp. 194-195, Oxford Uni¬
versity Press, New York, 1996.
Corporate Challenges 7
The major challenge for the next 50 years. The major challenge for
the twenty-first century will probably be to support large and increasing
populations with enough resources and infrastructures to sustain eco¬
nomic growth and development without destroying the environment.
This can be translated into “people” issues such as food and energy,
shelter, healthcare, education, welfare and social services, transportation
and communications, production and distribution, money and banking,
and income and employment.
The smallest and largest countries of the world. The World Bank, in
its 1996 publication World Development Report, lists 209 countries. Some
are tiny, like Grenada with a population over slightly more than 92,000.
Some have large populations, like China and India (1.2 billion and 914
million, respectively, in 1997).*
A few countries cover vast territories and are demographically sparse
(Mongolia with 2.4 million), and a few countries (Indonesia with 190.4
million and the Netherlands with 15.4 million) occupy small land masses
and support very large populations. With the exception of the Nether¬
lands, whose population growth is relatively static (0.7%), most countries
have significantly increased their numbers since 1994. For example, as of
this writing, China has over two billion people, while India has reached
the one billion mark. It is probable that these two nations now account
for about 50% of the world’s population.*
Who is growing and who is not. Popular literature still talks about
“industrial” societies and “developing” countries. The World Development
Report classifies countries as low-income, middle-income, and high-in-
come economies. All areas with an annual per capita gross national
product (GNP) of more than $9,000 are included among the high-income
countries.
These societies account for about 20% of the world’s population and
are growing at an average of 0.5% annually. All other non-high-income
countries account for 80% and are growing at an average of 2 to 3%
annually, depending on the region. It is estimated that if current trends
persist, 90% of all people will be living in developing areas.
There is another dimension to high rates of population growth. In
many countries, over half of the total population is under 21 years of age.
If demographic trends continue, over half of the population of these
countries will be under the age of 16.
* World Bank, World Development Report, 1996, Tables 1 and la, pp. 188, 189, 222,
Oxford University Press, New York, 1996.
8 International Business and Trade: Theory, Practice, and Policy
The richest and the poorest. The five richest industrial countries in
terms of annual per capita GNP are (1997 figures) Switzerland ($40,000),
Japan ($36,000), Denmark ($29,000), Norway ($28,000), and the United
States ($27,000).
The five poorest countries are Rwanda ($80), Mozambique ($90),
Ethiopia ($100), Tanzania ($140), and Burundi ($160).
cases, the distance between the affluence of a small part of the global
village and the relative poverty of many of its parts remains great.
GLOBAL CHALLENGES
Corporate Responsibility
The charge to multinational corporations in this era seems to have evolved
to include three areas of responsibility that are much broader and com¬
plex than their nineteenth century focus on economic power and domi¬
nation for the sole benefit of their owners. John Rockefeller and Henry
Flagler grew their oil, real estate, and railroad empires without much
regard for the constituencies they served and the environments they
affected.
Things are different today. A large corporation today can be said to wear
a three-cornered hat that shelters all its constituencies. Each corner re¬
flects an area of critical responsibility.
Obligation to the stockholders. The first area of corporate endeavor
is to protect the interests of its stockholder owners by making its best
efforts to generate reasonably expected returns on their investment. This
is an important activity because not only must earnings be created to
meet stockholder expectations, but additional earnings must be forthcom¬
ing to help keep the business going and growing and to meet its two
other significant obligations or responsibilities.
Obligation to the human resources. The second area of responsibility
is to the employees, the human resources without which the enterprise
cannot exist. It is now generally recognized that companies have an
obligation to provide a safe and wholesome working environment, with
equal pay for equal work along with a compensation package that allows
human resources a commonly acceptable standard of living and a fair
opportunity for advancement.
Obligation to the community. The third area of responsibility is to the
communities that corporations serve through the production and sale of
their goods and services and in which they operate. The idea that busi¬
nesses can pollute environments and physically harm people is rapidly
becoming universally unacceptable. No argument is made for banning
noxious processes and driving under companies that produce important
10 International Business and Trade: Theory, Practice, and Policy
People Issues
The continued success of private multinational enterprise may depend
upon how well these nerve centers of economic activity address the basic
needs of all societies. Global business’s big challenge will be to success¬
fully meet those needs and still be able to turn a profit. The fundamental
problems that directly affect the individual, the community, and society
at large (to name a few constituencies) are education, food and energy,
healthcare, income and employment, money and banking, shelter, trans¬
portation and communications, and welfare and social services.
Education. The great majority of the world remains undereducated
and functionally illiterate. Existence of and access to college- and univer¬
sity-level programs are limited. On average, in most developing areas,
less than 5% of young people between the ages of 19 and 23 attend
college/university programs. By contrast, participation rates range from
30 to 70% in developed areas.* *
Food and energy. The industrialization of food production coupled
with advances in the agricultural sciences has enabled supplies to keep
pace with population growth. Yet food distribution and availability re¬
main problems in many areas where low-income societies are unable to
meet local demand through domestic production and cannot afford for¬
eign imports. Daily caloric intake remains under 2,000 calories in many
areas, compared to over 3,500 calories among the richer countries.**
Energy resource allocation also suffers uneven distribution. A full 75%
of all energy resources produced in any given year is consumed by that
25% of the world’s population which inhabits industrialized areas.
Healthcare. This remains an eyesore in many countries. Human lon¬
gevity in the richer areas reaches an average of 80 years in comparison
to 40 to 50 years in the poorest societies. Average life span is 39 years
in Guinea-Bissau, 42 years in Sierra Leone, and 48 years in Ethiopia.
Availability of physicians to the general population is also a good indi-
* World Bank, World Development Report, 1996, Table 7, p. 200, Oxford University
Press, New York, 1996.
* World Bank, World Development Report, 1992, Table 28, pp. 272, 273, Oxford
University Press, New York, 1992.
Corporate Challenges 11
* World Bank, World Development Report, 1992, Table 28, pp. 272, 273, Oxford
University Press, New York, 1992.
* World Bank, World Development Report, 1994, p. 6, Oxford University Press, New
York, 1994.
12 International Business and Trade: Theory, Practice, and Policy
Welfare and social services. Social security insurance and all sorts of
other social services and annuities which have been taken for granted for
so long among industrial nations barely exist in many developing areas.
There, the extended family is the major source of welfare and social
service for non-self-supporting individuals such the very young, the aged,
and the infirm. In the villages of many countries, such as India and
Bangladesh, for example, a young couple entering marriage learns that
they must rear as many as eight children or more if there are to be two
surviving offspring as the couple approaches old age. Each surviving
offspring would then be able to accept an aging parent into his or her
extended family.
Corporate Challenges
Turning problems into opportunities. Multinational businesses might, at
first blush, take the position that problems faced by much of the world
are too great to be resolved by the private sector and that they should
stick to the traditional bread-and-butter markets of the industrial coun¬
tries. However, the rush by large corporations to tap Third World markets
anywhere they may exist testifies to the fact that a potential exists for
both market share and profits.
Taking the long view. Investors and professional managers are taking
the long view that these new markets will some day be industrialized and
prosperous. It is therefore the responsibility of the multinationals to
maintain a presence in and to participate in the economic growth and
development of all emerging regions.
The environmental challenge. It is clear that the processes of eco¬
nomic change impact the environment. How long the planet can con¬
tinue to endure the battering of its infrastructure is a matter of argument.
There is nevertheless general agreement that technologies must be devel¬
oped and brought into play that will minimize environmental damage
and perhaps even repair damage already done. Hence, corporate actions
will have to balance stockholder enthusiasm and financial viability with
the need to operate environmentally friendly businesses.
The resource and technology challenge. There is a school of thought
that maintains that resources are finite. That may not be the case how¬
ever. The material resources employed in the distant past are no longer
utilized in the same manner today. Ships were once made of wood and
used human labor for locomotion. Today, they are made of plastic and
steel and are propelled by diesel fuel or nuclear energy. The plastics
industry itself is a testament to the creation of synthetic resources as a
Corporate Challenges 13
QUESTIONS
1.1 Describe and explain the ways in which the world has changed
since the end of the eighteenth century.
1.2 Describe and explain the ways in which the world has remained
basically unchanged since the end of the eighteenth century.
1.3 Explain the state as the “surrogate of society.” Will that change? if
so, to what? If not, why?
1.4 Explain what corporations, the state, and communities must do if the
private sector is to effectively wear its three-cornered hat.
INTRODUCTION
It is generally agreed that the main challenge of the twenty-first cen¬
tury will be to develop the infrastructures and economic enterprises
necessary to maintain large numbers of people in political order at
acceptable living standards without destroying the environment. Busi¬
ness, as society’s surrogate for economic progress, has a central role to
play in meeting this challenge. This is irrespective of whether it is
envisioned as an arm of government, seen as an independent force, or
sandwiched somewhere between state and private ownership. Three major
competing philosophies are reviewed in this chapter to see which ideas
are best suited to the management of society in the new century. Some
leading corporate philosophies are also analyzed to examine how the
business community sees itself blending into the emerging world order.
15
16 International Business and Trade: Theory, Practice, and Policy
Capitalism
This philosophy posits that societies should be less macro- and micromanaged
by governments. It suggests that more faith and reliance should be
placed in less regulated and controlled approaches to human affairs. The
conceptual basis of capitalist thinking can be traced from the seventeenth
and eighteenth century physiocrats and mercantilists through Adam Smith,
Thomas Malthus, and David Ricardo in the late 1700s and early 1800s to
John Stuart Mill in the mid-1800s and finally to Keynes in the 1900s.
These ideas call for a fundamental freedom of entrepreneurial action in
which the role of government is minimized except to encourage and
protect private sector economic activity.
Several neo-Malthusian and Darwinesque theories have emerged in
recent decades. They suggest that the key to organized and continued
economic growth and development may be through more “laissez-faire”
non-interventionist public policies in which the private sector is given
maximum latitude in determining the course of economic affairs. This
could even be at the expense of pulling away support systems from less
fortunate populations. Societies would self-manage their populations. Only
the best, the strongest, and the ablest would survive the bloodied and
bared fangs of this new economic liberalism.
Communism
Often called socialism, this philosophy perceives the tasks of economic
growth and development as the obligatory domain of government in
representing the state in discharging its responsibilities to the people
living within its borders. The factors of production are to be owned and
managed by the state through special government agencies to reach
prescribed goals such as full employment at a given standard of living.
Communist ideology is as old as capitalist philosophy. Karl Marx and
Friedrich Engels were its cardinal advocates in the nineteenth century,
although its ideas can be traced back through Hegel, Kant, and Hobbes
to Plato. It remains today a doctrine of sociopolitical order in many parts
of the world. The private sector may exist and indeed prosper, but only
in a manner subordinate to state policy.
Ethnocentric Corporations
These are large businesses whose equity base is usually concentrated in
a given geographic area (e.g., the United States). Corporate stockholders
and stockholder groups are mostly of a single national origin. Corporate
boards of directors also tend to reflect a particular national ethos. This
creates a strong inclination for top management to develop and imple-
18 International Business and Trade: Theory, Practice, and Policy
ment policies and programs that are skewed to the needs and wants of
the national community hosting the corporate center without giving the
same equal weight to international markets and opportunities.
Polycentric Corporations
These companies tend to organize themselves in a conglomerate mold
with far-flung and diversified operations in many different parts of the
world. The focus of effort is less upon the development of core busi¬
nesses to achieve overall market share and earnings and more on allo¬
cating bottom line responsibility to regional affiliates, whatever their
particular enterprise might be. The classic example is ITT (International
Telephone & Telegraph), which at one time simultaneously was in tele¬
communications, baked goods, the car rental business, and hotels.
Management control therefore tends to be more decentralized. Often,
equity ownership is spread out over several or many countries, as in the
cases of Royal Dutch Shell and Unilever.
A Philosophy of Business for the Twenty-First Century 21
Geocentric Corporations
These companies tend to organize themselves around a single decision¬
making center that regards the world as a single market to be ap¬
proached with a unified strategy that does not necessarily reflect the
interest or the image of a single national group or perspective.
The spirit of the geocentric executive is perhaps best captured by the
worlds of two people two centuries apart. Thomas Jefferson was reputed
to have said in 1806, “Merchants have no country. The mere spot they
stand on does not constitute so strong an attachment as that from which
they draw their gain.” In 1989, Gilbert Williamson, then president of the
National Cash Register Company, was quoted as saying, “I was asked the
other day about United States competitiveness and I replied that I don’t
think about it at all. We at NCR think of ourselves as a globally competi¬
tive company that happens to be headquartered in the United States.”
They are not committed to either home or host country nationals for any
particular position within their operations.
Thus, senior positions may or may not be reserved for home country
or host country nationals. It would not be unusual for the manager of
a U.S. geocentric corporation’s Singapore office to be a third-country
expatriate, say from Brazil. Implicit in this approach is the objective of
global best-source procurement. As in the case of polycentric companies,
home office training and indoctrination are provided. Being no fools,
geocentric companies also rely on key host country employees who are
qualified to reflect the needs of the local culture and are better con¬
nected with their society’s power structure.
home or host country brand and product managers and more on man¬
agers with global profit-and-loss responsibility to develop and implement
plans and budgets.
QUESTIONS
2.1 Describe and explain how resource development and management
theories and practices can differ among ethnocentric, polycentric,
and geocentric organizations.
26 International Business and Trade: Theory, Practice, and Policy
2.2 Describe and explain how the thrust and organization of a company’s
research and development effort can differ among ethnocentric,
polycentric, and geocentric organizations.
2.4 Describe and explain how marketing and sales differ among ethno¬
centric, polycentric, and geocentric organizations.
2.5 Describe and explain how finance and accounting differ among
ethnocentric, polycentric, and geocentric organizations.
INTRODUCTION
International business operations cover a range of activities from import-
export transactions to foreign direct investments and foreign portfolio
investments. Some of these operations are oriented toward the produc¬
tion and marketing of goods and services. Some are financially oriented
and deal with the cross-border movement of funds. The various forms of
cross-border activities in which large multinational corporations, along
with smaller companies, engage are reviewed in summary form in this
chapter.
These activities include merchandise importing and exporting (inter¬
national trade), contract manufacturing, licensing and franchising, turnkey
systems, management contracts, strategic alliances, and foreign direct
investments in joint ventures and wholly owned subsidiaries. They also
include foreign portfolio investments in stocks and bonds and a multi¬
tude of other financial transactions designed to maximize corporate after¬
tax profitability and return on invested assets.
A BREAKDOWN OF INTERNATIONAL
BUSINESS OPERATIONS
Corporations engage in any number of these activities not only to maxi¬
mize market opportunities and earnings, but also to capitalize on an array
27
28 International Business and Trade: Theory, Practice, and Policy
Exporting
Most smaller firms begin to sell their products internationally through
exporting. These firms may also typically import goods to complement
their product lines for sale in the home market. The export sale trans¬
action becomes the end unto itself, the objective being to record a sale
on company books for the same reason that motivates the domestic sales
force.
Sales eventually become revenues to cover costs and generate profits.
Companies may engage in importing for much the same reason, but here
the process is more subtle. Importing is a procurement function in which
the objective is not buying per se, but buying to meet local sales targets.
Importing has become a function to achieve a separate objective, whereas
exporting for many companies is both a function and a goal.
Most multinational corporations today no longer treat exporting as a
revenue-producing function in its own right. The cross-border movement
of merchandise is looked upon as one of several means to achieve
broader and more complex ends. Companies are more interested in
global market share targets, and exporting may or may not play a sig¬
nificant part in attaining them.
that they buy a product from an exporter means that they have title to
the item. This technically allows them to apply any markup or markdown
and to sell in any territory, which may end up being outside their specific
zone of operation. Court decisions in the United States and elsewhere
have tended to favor the rights of independent distributors and dealers
over those of manufacturers.
Contract Manufacturing
The best definition is by way of example. Cosmetics companies often
offer specialty soaps and facial cleansers as extensions to their lines of
perfume products. Many of these soap and detergent items are contracted
out to one or several of the major soapers, such as Colgate-Palmolive,
Procter & Gamble, or Unilever. Large aerospace companies like Boeing
often contract out parts and components to smaller machine shops in the
United States and abroad.
32 International Business and Trade: Theory, Practice, and Policy
Turnkey Systems
A turnkey project is an arrangement whereby a firm that specializes in
the design, construction, and start-up of a production facility contracts
with a foreign client to perform such service in exchange for a fee. Once
the firm has completed the project and trained the personnel to run it,
the new facility is then turned over to the client for full operation.
Turnkey projects are most common in the chemical, pharmaceutical,
petroleum, and metal-refining industries.
The main advantage of turnkey projects is that they are a way of
earning formidable returns on the asset of technological know-how with¬
out making a long-term investment. Another advantage is that in coun¬
tries where political and economic environments are often questionable,
a firm just constructs the facility, collects its money, and then leaves.
Therefore, it is not subject to any possible loss if the government and/
or economy undergoes adverse changes.
International Business Operations 33
Licensing
International licensing is an arrangement whereby a foreign licensee buys
the rights to manufacture another firm’s product in its country for a
negotiated fee. This fee is usually a distributed through royalty payment
based on units sold. The licensee puts up most of the capital necessary
to get the overseas operation going.
The advantage of licensing is that a firm does not have to bear the
development costs and risks associated with opening up a foreign mar¬
ket. It is a very attractive option for firms that lack the capital to develop
operations overseas. Additionally, licensing is also attractive when a firm
is unwilling to commit substantial financial resources to an unfamiliar or
a politically volatile foreign market.
On the negative side, there are three serious drawbacks to this mode
of entry. First, it does not give a firm the kind of control over manufac¬
turing, marketing, and strategy that is required to realize experience
curve and location economies. Licensing typically involves each licensee
setting up its own manufacturing operations, which severely limits a
firm’s ability to realize experience curve and location economies by
manufacturing its product in a centralized location.
The second disadvantage is that competing in a global market may
require a firm to coordinate strategic moves across countries by using
profits earned in one country to support competitive attacks in another;
however, the very nature of licensing severely limits a firm’s ability to do
this. A third problem is the potential loss of control of technological
know-how to foreign companies. For example, RCA Corporation once
licensed its color television technology to a number of Japanese firms
that quickly assimilated the technology and used it to enter the U.S.
market.
34 International Business and Trade: Theory, Practice, and Policy
Franchising
Franchising is similar to licensing, although it tends to involve much
longer term commitments than licensing. Whereas licensing is pursued
primarily by manufacturing firms, franchising is employed primarily by
service firms, such as McDonald’s and Hilton International. A franchising
agreement involves a franchisor selling limited rights for the use of its
brand name to a franchisee in return for a lump sum payment and a
share of the franchise’s profits. In contrast to most licensing agreements,
the franchise agrees to abide by strict rules as to how it conducts busi¬
ness. For example, when McDonald’s enters into a franchising agreement
with a foreign firm, it expects that firm to run its restaurant in a manner
identical to all the other McDonald’s locations worldwide.
The advantages of franchising as an entry mode are very similar to
those of licensing. Specifically, a firm is relieved of the costs and risks
of opening up a foreign market on its own. Instead, the franchise typi¬
cally assumes those costs and risks. Thus, using a franchising strategy, a
service firm can build up a global presence quickly and at a low cost.
The disadvantages of franchising are not as apparent in comparison
to licensing. Since franchising is used by service companies, there is no
reason to consider the need for coordination of manufacturing to achieve
experience curve and location curve economies. On the other hand,
franchising may inhibit a firm’s ability to take profits from one country
to support competitive attacks in another.
Quality control and consistency are other factors to be considered. For
example, when visiting the Paris Plilton, one would expect the same level
of service as at the Hilton’s Waldorf Astoria in New York. This is not
always the case, however. One way in which companies have addressed
quality control and consistency issues has been to establish management
subsidiaries in each country or region targeted for expansion. These
subsidiaries assume the responsibility of establishing and sometimes
managing franchises throughout their designated territory with full com¬
pliance to prescribed standards. Consequently, the combination of close
proximity and the smaller number of franchises to oversee helps provide
quality assurance.
Strategic Alliances
These are intercorporate agreements between two or more companies
designed to achieve various degrees of vertical and horizontal integration.
International Business Operations 35
Joint Ventures
Establishing a joint venture with a foreign firm has long been a popular
mode for entering new markets for two reasons. The first reason is that
many capital- and technology-intensive investment projects require the
resources of several different corporations in order to create the synergies
needed to make them successful. The second reason is that many host
nations encourage foreign investments to partner with local businesses in
an effort to guarantee partial ownership and full participation.
Typically, joint venture enterprises are formed as corporations whose
equity is divided among joint venture partners. They are, in a sense,
formally structured strategic alliances. Corporate partners share decision¬
making processes as well as the distribution of earnings.
There are two advantages to joint ventures. First, a firm is able to
benefit from a local partner’s knowledge of the host country operating
environment. For many U.S. firms investing abroad, their exposure has
generally involved providing technology and know-how, and some capi¬
tal, while the local partner has supplied the marketing expertise, knowl¬
edge, and business connections.
The second advantage is sharing the cost and risk, which are often
high when entering a new market. There are also instances where po¬
litical considerations make a joint venture the only feasible entiy mode.
For example, the only way American firms can set up operations in Japan
is if they can acquire a Japanese partner.
There are two major disadvantages to the use of joint ventures. First,
similar to licensing, a firm that enters into a joint venture risks losing
control of its technology to a joint venture partner. A second disadvan¬
tage is that a joint venture does not give a firm the tight and complete
control over operations that a subsidiary does. Hence, the completion of
experience curves, location economies, and economies of scale may take
longer. Nor does a joint venture give any specific partner the control that
might be needed to engage in coordinated global attacks against rivals.
Export trading companies (ETCs). Very large firms that are basically in¬
ternational traders whose principal sources of income are derived from
import-export sales activities. They tend to specialize in given industries
and commodities and are highly knowledgeable in their markets as well
as in the intricacies of international trade.
Importing. The act of bringing into the customs area of a country goods
made in another nation. Goods made in Brazil and shipped to the United
States would be classified as an import from Brazil to the United States.
Import of these same goods from Puerto Rico to the mainland United
States would be classified as a domestic transaction because the former
is part of the United States.
QUESTIONS
3.1 When would a company use an overseas (import) distributor and/
or dealer network? When would the use of import agents be appro¬
priate? What are some of the pitfalls in using either import distribu¬
tors or import agents? What are the alternatives when a company is
committed to exporting and not to manufacturing abroad?
3.2 Explain how smaller companies can gain by working through export
trading companies. Describe the advantages and disadvantages.
3.4 Explain exactly how a company would set up and manage a contract
manufacturing arrangement in another country.
3.5 Describe and explain the similarities and differences between strate¬
gic alliances and joint venture agreements.
3.6 Describe the pros and cons of turnkey arrangements, wholly owned
subsidiaries, and joint ventures.
CHAPTER 4
The Monetary System
INTRODUCTION
The monetary system that influences trade, investments, and even daily
private and public sector operations can be traced back to the early
nineteenth century. It evolved from the monetization of gold as a nation’s
holder of value in due course and coincided with the increasing use of
paper currency in the late eighteenth century. The themes of this chapter
are to show how the current monetary system developed into its current
form, how it affects all aspects of a company’s global activities, and what
shape the monetary system may take in the future.
41
42 International Business and Trade: Theory, Practice, and Policy
HISTORICAL BACKGROUND
Two Hundred Years of Scrip
With and Without Gold Backing
Before the Napoleonic wars, the general practice was for governments to
exchange gold and silver coins or bullion in exchange for goods and
services traded domestically and internationally. The so-called “coins of
the realm” were the monies minted by a ruling government and issued
sparingly to whoever provided goods and service to the reigning sover¬
eign. This practice helped establish the rule that the power to create and/
or mint money was a monopoly reserved for the central government.
This power is considered sacrosanct today by most nations as well as by
the United States.
Wariness concerning the use of gold as a medium of exchange to be
used directly in discharging financial obligations grew in the Napoleonic
era between 1800 and 1815 as continuing war made the movement of
monetary gold hazardous. Paper scrip (fiat money) backed by gold be¬
came a prudent alternative to the risky process of physically shipping the
precious metal across unsecure areas. These government-issued credit
notes, fully backed by gold held in government vaults, became legal
tender and gradually gained popular acceptance, eventually replacing
gold as the immediate holder of value in due course. For example, in
1821, the U.S. mint price was $20.67 per avoirdupois ounce. The British
pound, set at 53,17 shillings and 10.5 pence per troy ounce of gold, then
bought $4.87.
The current monetary system finds its roots in the gold standard, which
gained popularity among the world’s more powerful economies in the
early 1800s when they saw a need to cultivate a climate of stable ex¬
change rates for commonly traded currencies that were being printed on
paper. It was the first modern attempt by nations to create a universally
acceptable standard, namely gold, as backing for all major paper curren¬
cies in use at the time.
44 International Business and Trade: Theory, Practice, and Policy
The gold standard turned into the gold exchange standard in 1934.
That arrangement lasted until 1971, when the floating rate exchange rate
system was introduced. The era of floating rates continues today.
Central banks controlled their nations’ money supply in much the same
manner they do today. Hence, if country X had 16 ounces of gold and
“printed” 16 francs and country Y had 8 ounces of gold and “printed” 16
guilders, it meant that, relative to the price of gold, 1 franc was worth
46 International Business and Trade: Theory, Practice, and Policy
Most countries had discarded the gold standard by the early 1920s. World
trade and investments were growing so rapidly that the general sentiment
was that limiting economic growth and development to a state of nature
was no longer practical. The problem is that growth began to stagnate
in many parts of the world in the early 1920s. Growing protectionism
further hindered international cooperation to the point that, as the de¬
pression deepened after 1929, production, trade, and investments came
to a virtual standstill as prices fell precipitously on many goods and
services. Dwindling demand helped destroy the trading value of many
currencies that were no longer backed by gold, and there was a growing
perception that national monies had become debased.
The gold exchange standard started in 1934 with a unilateral decla¬
ration by the United States that it would buy back any U.S. dollars held
abroad by residents of other countries with gold at the officially posted
price of $35 per troy ounce. This was an effort by the United States to
shore up the dollar’s value by backing it directly with gold, thus giving
new life to the aging gold standard. The system was finally hammered
into place when the IMF was created in 1944.
The gold exchange standard preserved the traditional fixed exchange
rate system but made it more flexible. Exchange rates were now allowed
48 International Business and Trade: Theory, Practice, and Policy
This was the major change under the new system. The U.S. dollar be¬
came the currency of ultimate redemption and hence the world’s key
international reserve currency. The international understanding was that,
as the currency of ultimate redemption, the U.S. dollar was as good as
gold and could therefore be used as legal tender by the rest of the world.
The central banks of countries that joined the IMF allowed their currency
support processes to become coordinated by the IMF and thus subject
to more oversight than in the past.
Finally, it was possible for foreign exchange rates to fluctuate freely
within prescribed bands of a fixed exchange rate. The exchange rate was
no longer an inflexible price unyieldingly maintained by a central bank
until there was no choice but to mandate a change. The official foreign
exchange rate became a target to be supported, allowing daily movement
in cross-border currency prices. Those changes came to be viewed as a
barometer of what was going on in the world of international commerce
and as a guideline for central bank monetary policy.
When a national currency showed signs of short-term weakening,
namely that its price was falling toward a preset “floor,” central banks
along with the IMF would intervene by buying up quantities of the
weaker currency with stronger ones to bolster its price in international
currency markets. If a national currency moved toward a similarly preset
ceiling, the same process would occur in reverse. Central banks would
sell off the currency at lower prices to bring the foreign exchange rate
back down to the official level.
The gold exchange standard, with its variable fixed-exchange rate system,
ended in 1971, leaving all currencies to seek their own price level based
on global supply and demand. This system, which continues through the
present day, is called the floating rate system. Stability in international
currency markets is still maintained by the IMF and its network of central
banks. The system receives ad hoc support from the large private finan¬
cial institutions and multinational corporations, all of which have strong
vested interests in also maintaining global monetary stability.
A country facing high domestic and international demand for its goods
and services and whose government practices sound fiscal and monetary
management will usually find itself with a currency that is universally
acceptable, basically stable, and freely convertible. Such countries are
often called “hard currency” states.
A country whose goods and services are not in high demand, whose
economy tends to be highly inflationary, and whose political and eco¬
nomic policies lead to instability and unrest will generally find itself with
a low-demand currency and may come to be known as a “soft currency”
nation. This constitutes the great majority of countries.
Pegged Currencies
are pegged to either the U.S. dollar or the U.K’s pound sterling. The
Bahamian dollar is pegged to the U.S. dollar at a one-to-one ratio. This
means that the Bahamian dollar rises or falls along with the U.S. dollar
against all other currencies against which the latter floats.
Monetary Gold
The use of monetary gold was widespread until the 1970s. Countries
rarely use gold today to settle international payments. The prevailing
attitude, supported by the United States, is that economic growth and
development on an international scale should not be held hostage to a
state of nature. The United States does not back its own currency with gold,
either domestically or internationally, and the feeling is that other nations
do not need to do so either. Gold has been largely demonetized, except
for occasional gold auctions held by the IMF, and efforts to restore a gold
or gold exchange standard have thus far been unsuccessful.
Foreign Exchange
national accounts payables, that is, to pay for its imports and other
international obligations. That stock can be compared to a personal
checking or short-term savings account used to pay current expenses.
These foreign exchange reserves are held by private banks, central banks,
and other financial institutions.
Foreign exchange reserves are not always located in the nation where
they are claimed as assets. For example, U.S. banks often hold their
foreign exchange in overseas banks to make it easier for foreign-based
exporters that ship their goods to the United States to be paid on time.
This enables them to quickly settle foreign claims by debiting local
currency accounts in overseas banks. The same is true insofar as U.S.
exporters are concerned. They too expect on-time payment. Therefore,
foreign banks maintain dollar (their foreign exchange) deposits with U.S.
banks that can be conveniently debited to pay for U.S. exports.
Soft currency country. A countiy whose goods and services are not in
high demand, whose economy tends to be highly inflationary, and whose
political and economic policies lead to instability and unrest will gen-
54 International Business and Trade: Theory, Practice, and Policy
QUESTIONS
4.1 Describe and explain how the monetary system much of the trading
world knew in 1800 evolved into the prevailing system today.
4.2 Describe and explain, using specific examples, what a central bank
is and what its exchange control authority means. What distinctions
might be made between the U.S. Federal Reserve System, the Inter¬
national Monetary Fund, and the Bank of England?
4.3 You are the finance minister of country X, which is faced with a
huge trade and services deficit. Incoming foreign investments are
few and tourism is way down. Name and justify some options you
might exercise. (Cooking the books and leaving the country is not
one of them.)
4.4 Discuss the possibility and probability of the North American Free
Trade Association developing a single currency to cover Canada,
Mexico, and the United States. What steps might be taken to move
in that direction?
4.5 Discuss the merits of returning to a gold standard. What steps might
be taken to move in that direction?
INTRODUCTION
In this chapter, international trade, business, and investments are ana¬
lyzed from the perspective of the flow of cross-border exchange of
debits, credits, and payments among nations. These exchanges are re¬
corded in a country’s national accounts statistics, called “the balance of
payments.”
55
56 International Business and Trade: Theory, Practice, and Policy
Economic Transactions
Economists are interested in the notion of “equilibrium” wherein the
impact of given activities should be offset by the effects of others in order
to achieve and maintain harmony or a balance in international exchange.
They therefore tend to think of the BOP in terms of autonomous and
compensatory transactions. Autonomous transactions are those that occur
for market reasons (merchandise imports and exports and foreign invest¬
ments, shown on lines 2, 16, 43, and 56 of the Appendix) where players
have no idea of the economic ramifications of their actions. In country
A’s merchandise trade transactions (see preceding section), its export of
$2 million and import of $1 million would be called “autonomous.”
Indeed, all items from lines 1 through 32 of the Appendix are considered
autonomous in that sense.
Its $1 million merchandise trade deficit creates an economic imbal¬
ance (places it in a position of economic disequilibrium). The correction
of that imbalance takes place through a “compensatory” transaction that
somehow makes up for the deficit. When country A exercises some or
all of its options (see preceding section) in eliminating the transaction
disequilibrium, its economy (at least in terms of that singular activity) will
be back in balance. Hence, compensatory transactions are those that are
intended to restore equilibrium to a country’s BOP (see lines 34 and 49
of the Appendix). These compensatory activities may not cure deeper
rooted socioeconomic problems that lead to the initial disequilibrium like
country A’s merchandise trade deficit, but they will at least help in
“balancing the books.”
The fact that they actually do not fully bring the BOP back into a
bookkeeping equilibrium is due to errors and omissions. These creep
into the BOP’s computation for two reasons. First, it is still technically
impossible to capture all economic transactions that transpire among
nations. Second, central banks charged with the authority to participate
58 International Business and Trade: Theory, Practice, and Policy
Residency
Residency in a country is determined by physical domicile and not by
citizenship, although citizenship is often used by the governments of
many countries as prima facie evidence of residency. Residency refers to
an individual’s or a business’s physical domicile, or where one “lives” for
most of a calendar year. The term “most of the calendar year” is under¬
stood in many countries to mean more than 180 days or more than 270
days, depending on the type of tax treatment being sought. Hoffman
LaRoche (U.S.) is therefore a corporate resident of the United States
despite the fact that most of its voting stock is owned by its parent,
Hoffman LaRoche of Switzerland. A shipment from the U.S. subsidiary to
its Swiss parent would be treated as a merchandise export from the
United States on line 2 of the Appendix.
Business economists and finance executives who use the BOP as a tool
to determine a country’s sources and uses of funds will be more inter¬
ested in analyzing transactions from a cash flow or monetary perspective.
Instead of fitting economic activity among nations into autonomous and
compensatory headings, the designations current and capital accounts are
used. Lines 1 through 32 of the Appendix are included as part of a
country’s current account, and its credits and debits are reconciled under
“Memoranda” (line 70 of the Appendix). These transactions are under the
current account heading because they are treated as sales and purchases
in almost the same sense as they would be on a corporate income or
cash flow statement. All current account activity is also considered au¬
tonomous. A surplus in current account transactions represents a net
inflow of funds, while a deficit represents a net outflow of funds. Major
subsets of the U.S. current account position are listed below.
* The difference between the two figures results from the author’s rounding.
62 International Business and Trade: Theory, Practice, and Policy
QUESTIONS
5.1 You are the finance minister of a countiy with a BOP position that
indicates a huge net surplus of foreign portfolio investments. What
policy recommendations would you make and why?
5.5 Discuss with examples how monetaiy policy can be used to main¬
tain BOP equilibrium.
5.6 Discuss with examples how fiscal policy can be used to maintain
BOP equilibrium.
.
CHAPTER 6
Foreign Exchange and
Foreign Exchange Management
INTRODUCTION
The understanding and management of foreign exchange have become
a major preoccupation for multinational corporations. Essentially, foreign
exchange gains can mean extra profits for companies. Foreign exchange
losses can turn a profitable enterprise into a losing proposition.
Changes in cross-border currency prices occur continually throughout
the world. Some fluctuations are a result of rapid changes in the supply
and demand for specific currencies, such as U.S. dollars and Japanese
yen. Some currency price differentials are a function of time zone varia¬
tions. Sudden shifts in currency prices are often a consequence of un¬
certainty, fear, and speculation.
Over the long term, foreign exchange rates change as fundamental
economic relationships among countries change. The concept and opera¬
tion of the foreign exchange market and how companies manage their
foreign currency assets to minimize the risk of sustaining foreign ex¬
change losses are the focus of this chapter.
67
68 International Business and Trade: Theory, Practice, and Policy
Pegged Currencies
Some currencies which may tend to be “soft” are often “pegged” to hard
currencies to maintain their stability. A “pegged” currency, like the Ba¬
hamian dollar or the peso of the Dominican Republic, is linked to the
movement of a major “hard” currency, so that when the lead currency
floats up or down, the “pegged” money will also float in the same
direction in the same proportion. The problem is that “pegged” curren¬
cies often have little value in monetary markets outside of their link with
the lead currency.
* Foreign currency prices, cross rates, spot rates, and selected forward contracts and
currency futures are published in The Wall Street Journal. Currency prices for all
countries are published weekly in The Wall Street Journal. Currency prices are also
available in real-time quotes through the Internet.
Foreign Exchange and Foreign Exchange Management 69
prices.” Both mean the same. Two other terms often used are “spot rate”
and “forward rate.”
The spot rate for a currency is its foreign exchange price quoted for
immediate delivery. When one calls a bank’s currency trading desk for
a deutsche mark quote, the response will most likely be the spot price
(e.g., 1.50DM/U.S. dollar). This means that if no decision is made to trade
currencies (dollars for deutsche marks) at that time and the caller hangs
up and then tries an hour later, the foreign exchange rate may have
changed to 1.48DM/U.S. dollar. There would have been no commitment
by currency traders to execute an order at the old price.
Although it is defined as immediate, in practice, settlement actually
occurs two business days following the agreed-upon exchange date.
Thirty percent of all foreign exchange transactions are executed at the
spot rate.
The forward exchange rate is a foreign exchange rate quoted for future
delivery, which can be up to 180 days. Most forward rates rarely go
beyond 120 days. Using the deutsche mark example above, if the spot
rate is quoted at 1.50DM/U.S. dollar, then the 60-day forward rate might
hypothetically be quoted at 1.60DM/U.S. dollar.
Forward transactions come in two varieties: outright and swaps. For¬
ward outrights, are typically traded for the major volume currencies for
maturities of 30, 90, 120, 180, and 360 days. They represent 5% of all
foreign exchange transactions.
Forward swaps are the most common type of forward transaction,
comprising 60% of all foreign exchange transactions. In a swap transac¬
tion, two companies exchange currency immediately for an agreed-upon
length of time at an agreed exchange rate. At the end of the time period,
each company returns the currency to the former owner at the original
exchange rate with an adjustment for interest rate differences.
Forward contracts serve a variety of purposes, but their primary purpose
is to allow firms to lock in a rate of exchange on foreign currency funds
that may be needed in the future. This enables companies to avoid
potential foreign exchange losses on trades at times when prices on
desired currencies rise or fall.
70 International Business and Trade: Theory, Practice, and Policy
The foreign exchange prices on trades taking place at spot and for¬
ward rates are published daily in the business press of most countries
and are also available through the Internet and other specialized comput¬
erized services.
The other 5% of forward transactions occur in currency futures mar¬
kets. These trades take place in specific locations like the Philadelphia
Stock Exchange.
The Spread
Currency buying and selling commissions and transactions that take place
across different time zones create an ever-changing spread between buying
and selling prices and also impact the basic foreign exchange rate, de¬
pending on where in the world the trade is to occur. This knowledge
becomes handy for those who feel that better currency prices may be
had in places other than where they reside. With today’s information
technology, it becomes as easy to be a global currency trader as it is to
buy and sell stocks and bonds with a computer.
Forward Contract
Currency Futures
While the composition of IMF reserves, gold reserves, and SDRs may
change from time to time, they have little immediate impact on interna¬
tional trade. A change in a country’s quantity of foreign exchange re¬
serves (especially reserves of hard currencies) will affect imports and
exports right away.
If the U.S. stock of hard currency reserves declines, their prices will
quickly rise, which means that the dollar will start floating (devaluing)
down rapidly. This will make imports more expensive and, of course,
will make forward contracts more popular. Exporters, however, may
seize a short-term advantage because foreign importers will be able to
buy dollars at a cheaper price.
If the U.S. inventory of hard currency reserves rises, their prices may
actually drop, which means that the dollar will start floating up (up¬
valuing). This will make imports less expensive. Exporters will end up
at a disadvantage because the dollar will now be more expensive in
other importing countries.
Scenarios do not always play out as indicated above because of a
number of other variables that affect short-term foreign exchange prices,
not the least of which are current political and economic events. Flow¬
ever, for international traders of any size, heightened sensitivity to foreign
exchange fluctuations is essential for business survival and growth.
logistics, taxes, and other exogenous factors, the only variable left would
be inflation, and that would be assumed to have a nationally simulta¬
neous impact on costs, prices, wages, and salaries.
Therefore, without inflation, if the price of a moderate bottle of wine
in France is 30 French francs (FFr), then the exchange rate that equalizes
the purchasing parity would be
FFr 300/US$1.00
million. This part of the foreign exchange market is known as the inter¬
bank market. Brokers sometimes assist in the transfer of funds confiden¬
tially. The central banks of governments may participate in the foreign
exchange market in order to implement governmental policies regarding
the value of their currencies.
The market for foreign currencies is a worldwide market that is in¬
formal in structure. This means that there is no central pit, place, or floor.
The “market” is actually the thousands of telecommunications links be¬
tween financial institutions around the globe, and it is open 24 hours a
day. Although the foreign exchange market has no central location,
trading volume is concentrated in the United States, the United Kingdom,
and Japan.
The structure of the foreign currency market leads to some interesting
problems. Since there is no single exchange location or floor, there is no
one exchange rate.
--- = 5.8580
0.17071
76 International Business and Trade: Theory, Practice, and Policy
This means that if would take 60.95 Japanese yen to purchase 1 German
mark.
Foreign exchange reserves. The current U.S. position is over $270 billion.
This stock of foreign currencies is “quick” cash that importers access
through their banks in order to pay for goods purchased from other
countries.
Monetary gold reserves. These reserves still exist, but little or no gold has
been traded among nations since the early 1980s.
78 International Business and Trade: Theory, Practice, and Policy
Purchasing power parity theory. The formula for the purchasing power
parity theory is
Special drawing rights (SDRs). These special credits, created by the In¬
ternational Monetary Fund in 1969, were intended to expand the inter¬
national liquidity of fund member countries. However, members to date
have disagreed on the allocation methodology. The result is that although
SDRs are officially called “active” reserve assets, no SDRs have been
issued since 1981.
Spot rate. The spot rate for a currency is its foreign exchange price
quoted for immediate delivery.
QUESTIONS
6.1 The current spot rate for German deutsche marks into U.S. dollars
is 2.00DM/U.S. dollar. This year’s inflation rate for the United States
Foreign Exchange and Foreign Exchange Management 79
6.2 Discuss the circumstances under which the purchasing power parity
theory might and might not work well. Give specific examples.
6.3 Describe and explain the similarities and differences between spot
rates, forward and future rates, and the future spot rate.
6.4 Describe and explain the differences between how forward markets
and currency futures function.
6.5 Describe and explain how fixed exchange rates vary from pegged
exchange rates.
6.6 Describe and explain the role of central banking and foreign ex¬
change in international trade transactions.
'
PART II
International Trade and
Business Operations
CHAPTER 7
International Trade Practices:
The Parties
INTRODUCTION
In this chapter, the parties involved in the practice of international trade
and how they interface to create and complete an import-export trans¬
action are reviewed. This chapter also scans the operating environment
of international trade, introduces the major parties in an import-export
transaction, and explains their roles. The major parties are the exporter,
the importer, the freight forwarder, the customs broker, the bank, the
common carrier, and the insurer. There are others, depending on the
type of transaction, but these are the primary movers.
83
84 International Business and Trade: Theory, Practice, and Policy
until some agreement between the two parties indicates that title is to
be transferred from seller to buyer. The name of the foreign buyer
would be shown as the ultimate consignee, the party intended to receive
the goods and title to the compressor and from whom payment was
expected.
Most product manufacturers are also exporters. Multinational corpo¬
rations tend to export their output directly to a global network of affili¬
ates. These overseas companies may be dealers, distributors, or agents;
they can also be producers that buy for their own consumption and not
for resale.
When is an export an export? Whether the foreign customer is an
independent company, a wholly owned subsidiary, or something in
between is irrelevant to the import-export buyer/seller relationship. For
international trade transaction recording purposes, it is only important
that the exporter be a resident of one country and the importer be a
resident of another. An export sale is completed once title has passed
from exporter to importer, an invoice has been issued, an accounts
receivable established, and the transaction recorded in the international
accounts ledgers of the countries involved.
When is an export not an export? Consignment shipments are export
shipments with no title change from exporter to importer. There is only
a physical transfer of inventory from one country to another. A final
invoice is not cut, and no accounts receivable is created. Recording errors
frequently occur among nations because of mistakes made by the trading
community in appropriately labeling shipping documentation as either a
sale or a consignment.
Export trading company. An export trading company (ETC) is a
mercantile firm that buys from local supply sources and resells overseas.
These traders can be helpful to small manufacturing companies that are
not in a position to develop their own foreign markets. A U.S. company
that sells merchandise to an ETC is making a domestic sale. The ETC is
the exporter and shipper of record.
The Importer
The importer is the buyer or ultimate consignee. As stated above, its
name appears on all relevant documents which serve as evidence that an
export sale has taken place.
No strangers here. Exporters and importers are usually well known
to one another. This is especially true in the case of multinational com-
86 International Business and Trade: Theory, Practice, and Policy
parties, where a U.S. exporter’s foreign customer can be its own subsid¬
iary or a joint venture partner. Even small businesses are familiar to one
another multinationally through a web of credit checks and financial
references that today are available on a global basis.
"Arms-length" rule of law. Under the “arms-length” rule of law in the
United States and in most countries, buyers and sellers are considered
“unrelated” persons or residents for transaction purposes. Hence, a U.S.
exporter like Allied-Signal that ships goods to its wholly owned subsid¬
iary in Indonesia, Allied-Signal Indonesia, will be shown as the seller and
shipper of record, and Allied-Signal Indonesia will be the buyer and
ultimate consignee.
Importers have different shapes. Parties importing directly from an
exporter are not always those that plan to use or consume the items
purchased. They may be distributors or dealers that resell to consumers
or end users. Exporters thus have some choices in their overseas mar¬
keting strategies. They can target end users, they can sell their goods to
import distributors, or they can try to sell through import agents, who
function as local sales representatives. When selling through import agents,
title will probably not flow from exporter to agent; it will flow to the
agent’s customer when a sale in the foreign market is finally consum¬
mated by the agent.
of all import taxes and charges and arranging for the transport of the
goods to the buyer’s facility.
The customs broker represents the importer in much the same way
as the freight forwarder represents the exporter. Large customs brokers
and freight forwarders tend to be part of the same multinational transport
and customs services companies.
International Banks
International banks are designed to facilitate trade by helping exporters
and importers expedite the flow of documents and payments. It is im¬
portant that both the seller’s and the buyer’s banks have correspondent
relationships. This means that each bank may represent the other in
specified transactions.
The correspondent relationship. In effect, the exporter’s bank should
have power of attorney to act on behalf of the importer’s financial
institution. If there is no correspondent relationship, extra expenses and
delays can be expected.
For example, if an importer in Indonesia banks at Standard Bank and
an exporter banks at Citibank in the United States and both insist on
using their respective banks, then Citibank and Standard Bank will act as
correspondent banks for one another for this transaction, assuming they
already enjoy such a relationship.
In fact, most multinational banks like Citibank and Standard Bank
maintain correspondent banking affiliations with most major banks through¬
out the world. It would nevertheless be more convenient, faster, and
more cost effective for the buyer and seller to agree to use only one of
the two banks, as Citibank and Standard Bank both have banking sub¬
sidiaries in both countries.
If a correspondent relationship between the two banks is not pos¬
sible, either bank will usually locate a third-party bank with which both
original banks have a correspondent arrangement. Again, this situation
should be avoided because it increases processing costs and can create
delays.
Insurance
In-transit insurance is rarely legally required, but it makes good business
sense to have goods insured against loss and/or damage while moving
from one country to another. Further, many letters of credit specify that
marine insurance must be obtained and that a certificate of insurance
must be furnished along with other required documents before payment
can be made.
The general practice is to insure a shipment from the seller’s ware¬
house to the buyer’s warehouse. Either the exporter or the importer
should cover the goods with adequate insurance. This critical issue is
generally resolved during the negotiation stage of a sale.
Comprehensive and overall insurance coverage by the exporter will
lessen liability resulting from all sorts of unforeseen events, such as a
general average situation. This condition occurs when a vessel is dam¬
aged or lost at sea. Exporters, as charter parties, can become collectively
liable for repairs to or the replacement cost of the vessel unless it can
be shown that the goods were sold free on board (FOB factory), freight
along the outbound ship or vessel (FAS dock), or free on board vessel
(FOB vessel) “freight insurance collect,” with title changing before the
vessel left the port of embarkation.
Freight forwarders, customs brokers, carriers, and banks, in the inter¬
est of promoting trade and as a service to their clients, are usually in
an excellent position and more than willing to recommend reliable
insurers.
International Trade Practices: The Parties 89
while moving from one country to another. Further, many letters of credit
specify that marine insurance must be obtained and that a certificate of
insurance must be furnished along with other required documents before
payment can be made.
Trade in services. The export and import of services are growing rapidly
for the United States, but they remain far smaller than merchandise trade.
In 1995, $210.6 billion in services was exported in exchange for $142.2
billion in services imported. Services trade should continue to expand in
the future, but so will merchandise trade. The globalization of corporate
activities accelerates the cross-border interaction market forces, leading to
a greater exchange of all goods and services in order to achieve optimum
economies of scale, minimize costs, and maximize revenues. This ex¬
change takes place through international trade.
QUESTIONS
7.1 Why is exporting more actively supported by the U.S. government
than importing?
7.2 Why are imports in large quantity that lead to a merchandise trade
deficit sometimes regarded as being against a nation’s economic and
national interests?
INTRODUCTION
In this chapter, the legal environment of international business practices
is examined. Many questions concerning the rights and obligations of
those participating in cross-border transactions must be addressed before
committing time, energy, resources, and money to overseas ventures.
Important issues to consider are legal relationships created between buyers
and sellers through one-time-only transactions and ongoing distributor¬
ship and agency agreements, differences in the laws of individual nations
that affect commercial agreements, manufacturers’ rights and obligations
that emerge from product warranty and product liability claims, claims
relating to the protection of intellectual assets (i.e., patents, trademarks,
trade names, and copyrights), national employment protection laws, and
the protection of industrial property from seizure (expropriation).
91
92 International Business and Trade: Theory, Practice, and Policy
the better part of one year, usually defined as being at a location within
a national jurisdiction for longer than six months. There are exceptions
and variations to this general rule in many nations, and each jurisdiction
should be studied carefully by international taxation specialists and other
experts before committing a company to a course of action.
One-Time-Only Orders
Initial import-export transactions between sellers and buyers are often
accomplished on a one-time-only basis. These transactions are like trial
94 International Business and Trade: Theory, Practice, and Policy
Import Agents
Import agents are preferred by companies that consider maximum for¬
eign market control to be important. An agent (importer) functions in a
fiduciary relationship with a principal (the exporter). This means that the
importer may act based on the exporter’s express and/or implied instruc¬
tions. Goods imported on consignment through an agent means that
although the physical inventoiy has moved from the exporter’s ware¬
house to that of the import agent, title to the goods remains with the
exporter until the agent makes a sale. Title then passes directly from the
exporter to the agent’s customer. An export receivable is created at that
point.
The Legal Environment of International Business 95
Import Distributors
An import distributor, by definition, is an independent company that
buys and then resells goods for its own account. It assumes title to the
exporter’s goods on or before delivery of those goods to its warehouse.
As a general rule, title to the goods will pass to the buyer by the time
the goods clear customs.
Advantages. The advantages of an import distributorship are both
financial and legal. Once title passes from seller to buyer, a receivable
(a claim on the buyer’s assets) is established, and the clock starts ticking
toward the collection due date based on agreed-upon payment terms.
This title change removes the exporter from any liability regarding the
importer’s actions and behavior in the local market.
Another advantage is that distributorship arrangements can be on an
ad hoc basis without involving a term contract. Agency agreements normally
require a well-crafted document that spells out the understanding be¬
tween the parties. Distributorships that are not couched in a binding
contract can usually be terminated at will by either party, which is often
seen as an advantage by both parties.
Finally, a distributor, using its own finances, will be under greater
pressure to sell the exporter’s products than an agent that receives the
goods on a consignment basis and has made no financial commitment.
Disadvantages. These relate mainly to the exporter’s lack of marketing
and management control in view of the fact that the goods are now
owned by the distributor. Therefore, it is almost impossible for export
sellers to control distributor resale prices, even if clauses guaranteeing
that right are built into the distributorship agreement.
Where price is part of the overall product image, this can be a
problem. This disadvantage can be partially overcome if the exporter’s
product enjoys a high level of brand awareness among consumers or end
users through effective advertising and promotion in the local market.
While Coke, Pepsi, and GE may enjoy that curbside appeal, lesser names
may not enjoy the same reputation.
QUESTIONS
8.1 Describe and explain the characteristics, advantages, and disadvan¬
tages of an import distributorship.
8.3 Discuss some of the problems that the concept of residency can
create for a U.S.-based company and its overseas affiliates.
8.4 Discuss some of the problems that the “arms-length relationship” concept
can create for a U.S.-based company and its overseas affiliates.
CHAPTER 9
Product Warranty and
Product Liability Issues
INTRODUCTION
It is generally recognized throughout the world today that a producer of
goods has an obligation to offer satisfaction on defective products through
a product warranty. It is also the manufacturer’s general obligation to
make sure that the handling and use of those products cause no harm.
This obligation is global and is not limited to a product’s country of
manufacture. The various aspects of a company’s rights and obligations
in terms of product warranty and liability are discussed in this chapter.
PRODUCT WARRANTIES
These are promises by a manufacturer that its products will perform as
stated in published literature. They can be explicit or implicit. Warranties
are explicit when a manufacturer includes a written statement describing
what guarantees it offers in the event of product performance failure and
for how long a period of time those guarantees are good.
Warranty Disclaimers
Warranty disclaimers (e.g., “goods sold as is,” etc.) should be in writing.
If written warranties are not offered and if there are no written disclaim-
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100 International Business and Trade: Theory, Practice, and Policy
ers, then courts in many countries usually hold producers liable under
the principle of implied warranty. This means that a full warranty is in
force for a “reasonable” time.
Disclaimers have limited value. Disclaimers are generally issued by
exporters and/or their manufacturers that sell in areas where a dealer
network with after-sales service facilities does not yet exist. They are a
popular approach to a difficult problem and are viewed dimly by local
courts. These disclaimers are usually discounted by local courts, which
may apply their own time-honored rules of implied warranty.
Every sale is a potential claim. It would be preferable for a manu¬
facturer to make sure, prior to closing a sale with a foreign buyer, that
warranty service can be supplied. Any export sale has a chance of
becoming a warranty claim, and it is incumbent upon the U.S. seller to
make sure that the foreign customer is as protected as a domestic
consumer.
Be a broker if warranty service is impossible. It is possible for a
mercantile exporter (export trading company) to avoid warranty situa¬
tions altogether by expressly stating to all parties concerned that it is
functioning strictly in a brokerage capacity and not as part of the distri¬
bution chain.
Warranty breaches. This creates problems for exporters that do not
issue written warranty statements, especially if they are resellers. The
issue of what constitutes a “reasonable” time is always open to question,
thus exposing the maker of the product to litigation. It also opens the
exporter to the same lawsuit, as the latter would be considered to be part
of the producer’s global distribution chain.
In some areas, breach-of-warranty judgments are arbitrary, discrimina¬
tory, capricious, and rendered in absentia. They can lead to stiff fines and
even to prison sentences. In some cases, the exporter, which is often more
visible than the original manufacturer, will be held as the scapegoat.
Full warranty data should always be communicated. Complications
can arise when the manufacturer publishes a warranty but the warranty
documents and their contents are not forwarded and/or communicated
effectively to the foreign buyer and end user. This failure to make an
express warranty known to foreign customers forces local courts to treat
the case as if there were an implied warranty and perhaps even deceit
and fraud on the exporter’s part.
Advantages of express warranties. A well-detailed written warranty
statement by a seller defines the time frame within which the warranty
and warranty service are valid. It also defines the obligations of both the
Product Warranty and Product Liability Issues 101
seller and buyer, making it more difficult for foreign buyers and users to
lodge warranty claims long after products have been in use.
Importance of a warranty-competent overseas distributor or dealer
network. Manufacturers’ warranty statements should be conveyed to all
parties in the distribution chain, from the export resellers to the foreign
import distributors to the local dealers to the end users.
If no distributor or dealer network exists in a foreign country (often
a problem in developing areas), a decision not to sell may have to be
considered unless the manufacturer or the exporter is in a position to
provide on-site after-sales warranty services.
The need for a good foreign distributor/dealer network. The effective
execution of product warranty and more general after-sales service is the
key to overseas market survival and growth. This fact highlights the need
to build an experienced distributor network and a competent dealer
organization in foreign markets. The U.S. manufacturer, the U.S. exporter,
and the foreign customer will rely upon that network and organization
to provide a long-term mutually rewarding relationship.
PRODUCT LIABILITY
This thorny issue comes up when someone has been injured or property
has been damaged by the direct or indirect use of a product. Sometimes
a product liability situation can arise out of a warranty problem. Many
times, it happens because of the incorrect use of a product; sometimes
it occurs because a product falls on someone or something or breaks up
or explodes and destroys property and injures people.
QUESTIONS
9.1 Explain the differences between a warranty and a liability claim.
9.3 Discuss the different ways in which an exporter can minimize war¬
ranty and liability exposure.
CHAPTER 10
Protection of
Intellectual Assets
INTRODUCTION
This chapter explores the nature of intellectual assets and their impor¬
tance to companies doing business internationally. The protection of
these assets is growing in importance as goods and services are being
produced, marketed, and traded on a global scale.
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106 International Business and Trade: Theory, Practice, and Policy
Trade Name
This can be the name under which a business functions. The simple act
of initially registering a trade or business name at the city, county, or
state level for tax purposes protects the use of that name from infringe¬
ment by others without the consent of the business owner. However, this
protection is only statewide at best. Should the business ever contemplate
becoming a player in the national marketplace, the registration of its
trade name in Washington, D.C. would be appropriate. Once that is
done, trade name protection in other countries can be achieved through
a similar process.
Trademarks
These are the company and product logos and names that symbolically
describe a company’s goods and services, making them recognizable to
end users and consumers and distinguishable from those of the compe¬
tition. A trademark can be a word, symbol, drawing, or design or some
sort of combination of all these expressions which identify a product,
product line, service, or artistic creation as being proprietary to an indi¬
vidual or firm.
Trade names, once registered, can be considered in the same cat¬
egory as trademarks. Hence, the Coca-Cola Company is both a trade
name and trademark due to its unique shape and spelling. So too are
the words Coke and Diet Coke. The Coca-Cola Company and all its
products would not be where they are today were it not for the zeal and
jealousy with which corporate executives and their legal staffs guard
these assets globally.
Protection of Intellectual Assets 107
Copyrights
These are the word, shape, and symbol combinations that appear on
labels and packaging. They can be protected from infringement nation¬
ally and internationally by registering them in all markets where a com¬
pany plans to operate. As in the case of trademarks, there has been
progress over the years in simplifying the process of arranging for copy¬
right protection abroad. A number of bilateral treaties between the United
States and other individual countries have largely done away with the
tedious, time-consuming, and expensive country-hopping process.
Patents
These are inventions and unique innovations that a company possesses
which distinguish its products from all others. The patent itself is a
108 International Business and Trade: Theory, Practice, and Policy
Goodwill
Business executives normally think of assets in terms of cash, inventories,
accounts receivable, buildings, desks, motor vehicles, and a host of other
tangible items that have a purchase cost, a book value, and a discernible
market value. Business executives are also familiar with the notion of
goodwill as an asset, but small companies often tend to treat goodwill
in a casual manner, as if it is there but not worth much.
Goodwill can exist without intellectual assets. A company that has
survived for a number of years will have goodwill even if it holds no
registered patents, trademarks, trade names, or copyrights. This goodwill
is the accumulated appeal that a company enjoys with the trade, its
customers, and even with its competition.
Goodwill is a company's image. Corporate goodwill is encapsulated
in a corporate image and personality. Goodwill items are all those
attributes that give small and large companies recognition and appeal—
things to which companies can claim pride but no legal ownership.
These may include charitable acts and sponsorships, participation in
public works and education, and a reputation for fairness, prompt ser¬
vice, and product excellence, among many others. A company with a
high level of goodwill may find it easier to establish market share and
finance expansion. A company with limited goodwill may find market
access blocked and may experience difficulty obtaining necessary gov¬
ernment licenses and general acceptance of its goods and services.
110 International Business and Trade: Theory, Practice, and Policy
Goodwill. The accumulated appeal that a company enjoys with the trade,
its customers, and even with its competition.
Trade name. This can be the name under which a business functions.
The simple act of initially registering a trade or business name at the city,
county, or state level for tax purposes protects the use of that name from
infringement by others without the consent of the business owner.
QUESTIONS
10.1 Discuss the differences among the different types of patents for
which an inventor can apply.
10.5 Some argue that forcing poor countries to pay for technology that
has already made a profit for its owner is industrial piracy or
blackmail. Discuss this argument.
10.6 Discuss the efforts made to develop a global standard with regard
to the management of intellectual properties.
CHAPTER 11
International Trade Logistics
INTRODUCTION
The transportation environment is often ignored by business executives
in planning international business strategies for their companies. It is
frequently looked upon as a minor detail to be handled by freight
forwarders, banks, and customs agents and brokers. However, in-transit
shipping, insurance, documentation, and banking costs for moving goods
from one country to another can mean the difference between making
a profit and incurring a loss.
The specialized terminology used in international trade to define the
rights and obligations of all parties to a transaction is examined in this
chapter. In-transit insurance, without which the physical distribution of
goods internationally would be riskier than it is, is considered in detail.
Terminology
A shipment cannot be invoiced without clear knowledge that title has
passed. Unless an invoice can be issued, a receivable on the exporter’s
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114 International Business and Trade: Theory, Practice, and Policy
Sellers would like to unload title to their goods as soon as they leave
the loading dock, or at least once physical custody of the goods is
given up. Hence, they would prefer FOB factory selling terms be¬
cause in most instances that is where they lose physical control over
the merchandise.
Importers would naturally prefer to delay taking title until they actu¬
ally receive the goods, an excellent display of human nature. Somewhere
between the FOB factory selling point and the foreign buyer’s receiving
warehouse, both seller and buyer will agree on a point in place for
goods to change ownership. This point in place will be determined by
the shipping/selling terms in the seller’s invoice and other relevant docu¬
mentation. The payment terms, as spelled out in the drafts drawn by the
exporter, identify the time and place of payment but will have little to
do with merchandise title changes.
The shipping and selling terms in this section are known in the trade as
INCOTERMS, or international rules for the interpretation of trade terms.
They are excerpted from the International Chamber of Commerce, which
periodically updates the data as trade practices evolve.
Ex works (ex factory, ex mill, ex plantation, ex warehouse, etc.). “Ex
works” means that the seller’s only responsibility is to make the goods
available at its premises (i.e., works or factory). In particular, the seller
is not responsible for loading the goods on the vehicle provided by the
buyer, unless otherwise agreed. The buyer bears the full cost and risk
International Trade Logistics 115
involved in bringing the goods from the seller’s premises to the stated
destination. This represents the seller’s minimum obligation.
FOR/FOT (named departure point, sometimes called FOB factory).
FOR (free on rail) and FOT (free on truck) are synonymous, because the
word “truck” relates to the railway cars. They should only be used when
goods are to be carried by rail. The seller’s responsibility ends when the
goods are loaded upon the outbound truck. FOB always means “free on
board.”
FAS (named port of shipment). FAS means “free alongside ship.”
Under this term, the seller’s obligations are fulfilled when the goods have
been placed alongside the ship on the quay (wharf) or in lighters. This
means that the buyer has to bear all costs and risks of loss of or damage
to the goods from that moment. It should be noted that, unlike FOB, this
term requires the buyer to clear the goods for export.
FOB (named port of shipment). FOB means “free on board.” The
goods are placed on board a ship by the seller at a port of shipment
named in the sales contract. The risk of loss of or damage to the goods
is transferred from the seller to the buyer when the goods pass the ship’s
rail.
C&F (named port of shipment). C&F means “cost and freight.” The
seller must pay the costs and freight necessary to bring the goods to the
named destination, but the risk of loss of or damage to the goods, as well
as any cost increases, is transferred from the seller to the buyer when the
goods pass the ship’s rail in the port of shipment.
CIF (named port of destination). CIF means “cost, insurance, and
freight.” This term is the same as C&F but with the addition that the seller
has to procure marine insurance against the risk of loss of or damage to
the goods during the carriage. The seller contracts with the insurer and
pays the insurance premium. The buyer should note that under this term,
unlike “freight/carriage and insurance paid to,” the seller is only required
to cover insurance on minimum conditions.
Ex ship (named port of destination). “Ex ship” means that the seller
will make the goods available to the buyer on board the ship at the
destination named in the sales contract. The seller has to bear the full
cost and risk involved in bringing the goods there.
Ex quay (duty paid...named port). “Ex quay” means that the seller
makes the goods available to the buyer on the quay at the destination
named in the sales contract. The seller has to bear the full cost and risk
involved in bringing the goods there.
116 International Business and Trade: Theory, Practice, and Policy
There are two “ex quay” contracts in use: ex quay “duty paid” and ex
quay “duty (import taxes) on buyer’s account” in which the liability to
clear the goods for import is to be met by the buyer instead of the seller.
It is recommended that parties always use the full descriptions of
these terms (ex quay “duty paid” or ex quay “duty on buyer’s account”)
to avoid uncertainty as to who is to be responsible for the liability to
clear the goods for import.
If the parties decide that the seller should clear the goods for import
but that some of the costs payable upon the import of the goods should
be excluded, such as value-added taxes (VATs), the intent should be
made clear by adding words to this effect (e.g., “exclusive of VAT,” etc.).
Freight/carriage paid to... (named point of destination). Like C&F,
“freight/carriage paid to...” means that the seller pays the freight for the
carriage of the goods to the named destination. However, the risk of loss
of or damage to the goods, as well as any cost increases, is transferred
from the seller to the buyer when the goods have been delivered into
the custody of the first carrier and not at the ship’s rail.
This term can be used for all modes of transport, including multimodal
operations and container or “roll on-roll off” traffic by trailers and ferries.
When the seller has to furnish a bill of lading, waybill, or carrier’s receipt,
the seller duly fulfills this obligation by presenting such a document
issued by the person with whom the seller has contracted for carriage to
the named destination.
Freight/carriage and insurance paid to... (named point of destina¬
tion). This term is the same as “freight/carriage paid to...” but with the
addition that the seller has to procure transport insurance against the risk
of loss of or damage to the goods during the carriage. The seller con¬
tracts with the insurer and pays the insurance premium
Delivered at frontier (named place of delivery at frontier). “Delivered
at frontier” means that the seller’s obligations are fulfilled when the goods
have arrived at the frontier but before arrival at the customs border of
the countiy named in the sales contract.
This term is primarily intended to be used when goods are to be
carried by rail or road, but it may be used irrespective of the mode of
transport.
To avoid misunderstandings, it is recommended that parties contract¬
ing according to this trade term qualify the word “frontier” by indicating
the two countries separated by that frontier and also the named place of
delivery (e.g., “delivered at Franco-Italian frontier [Modane]”).
International Trade Logistics 117
INSURANCE
The thrust of this section is to discuss the importance of insurance in
international trade. Political and credit risk insurance is not at issue here.
International Trade Logistics 119
The concern is with hazard, casualty, and liability insurance which pro¬
tects both buyers and sellers in the event that something goes awry with
a shipment.
The general impression among many business executives is that if
their invoices read “FOB factory” or “freight and insurance collect,” they
have no responsibility for the goods beyond their warehouse loading
point. This view is misleading.
Insurance Coverage
Insurance coverage is generally offered on the basis of 110% of the CIF
value as indicated on the exporter’s invoices if the exporter is carrying
the insurance charges. The exporter prepays the insurance mainly on CIF
shipments.
Many exporters purchase a covering policy, called an “open cargo
policy,” on all shipments. This provides coverage even when importers
expressly state that they are insuring the goods. This might seem like
redundant coverage, but it helps to remember that there is no absolute
guarantee to exporters, whatever statements are made to the contrary by
their foreign buyers, that a viable insurance policy covering a shipment
in question in fact exists.
120 International Business and Trade: Theory, Practice, and Policy
passed since then, and whatever valid clauses may he contained in the
carrier’s contract of affreightment.
A carrier’s liability is limited under these circumstances to just an
obligation to move freight from one point to another and to be held
accountable for acts of gross negligence should that primary objective not
be achieved.
Marine risk insurance also protects goods while on shore against the
following:
Goods are generally insured for their CIF value plus 10%. That value
must be declared by the shipper. The coverage is against physical loss
only and excludes any kind of “loss of market” claim or claims caused
by delay, regardless of what caused the delay. The coverage also ex¬
cludes losses due to war, strikes, riots, and civil commotions, although
such insurance can be obtained for an additional premium.
122 International Business and Trade: Theory, Practice, and Policy
The following merchandise is not accepted for “all risks” insurance, and
special contracts must be requested. It is recommended that the exporter
negotiate directly with the insurer.
Open cargo policies are relatively expensive. They are underwritten and
sold on the basis of annual premiums, which can be broken down into
quarterly and even monthly payments. The amount of the premium is
determined by the nature of the items to be shipped, the mode of
transportation, and the geographical area of destination.
It goes without saying that explosive materials shipped to a war zone
will be subject to a very high insurance premium. On average, an annu¬
alized open cargo insurance policy may cost the exporter from 2 to 5%
of invoice value. It is worth planning ahead to build these costs into a
company’s export selling price structure. Whatever the costs, it is not
worth making a shipment without knowing conclusively that the goods
are adequately insured.
Shipping and selling terms. The language used in defining and determin¬
ing the time and place for goods to change ownership from seller to
buyer. It is important to pinpoint this ownership change, or change of
title, for insurance purposes. It is also important in determining when a
sale has been consummated for invoicing purposes. The shipping and
selling terms also help establish exporters’ and importers’ respective
obligations while the goods are in transit and beyond their physical
control.
QUESTIONS
11.1 Discuss the shipping/selling terms a company would use to relin¬
quish title as soon as possible and still pay the freight and insur¬
ance charges to a foreign customer’s point of receipt.
INTRODUCTION
The international banking system and documentation that must be pre¬
pared by international traders as shipments proceed to their destination
are described in this chapter. The paperwork, which includes the seller’s
commercial invoices, is commonly called “documentation.” Its accurate
and timely preparation and distribution (the collection process) will enable
importers to receive their goods and make it easier for exporters to
receive on-time payment.
SHIPPING DOCUMENTATION
A typical set of export shipping documents might include:
• Commercial invoices
• Shipper’s Export Declaration
• Sight or time draft
• Bill of lading or other transport document
• Certificate of origin
• Insurance policies or certificates
Documentation
These are legal documents describing the nature and value of a particular
shipment. They also identify the exporter and importer, along with the
125
126 International Business and Trade: Theory, Practice, and Policy
carrier, insurer, banks, and all other parties participating in the transac¬
tion. Without the proper documentation, obviously shipments cannot be
completed and payment cannot be rendered.
Commercial Invoices
These are the standard invoices a seller would normally issue upon
making a shipment to a domestic customer. They will probably be more
detailed in the sense that a more elaborate description of the goods
shipped, along with a more complete explanation of the shipping/selling
and payment terms, may have to be included to satisfy local customs
authorities abroad and to meet letter-of-credit conditions, other financial
requirements, as well as U.S. Customs regulations.
In some cases, the invoicing will have to be in both English and the
local language and may also have to bear a qualifying stamp from the
countiy’s consulate in the exporter’s region. Invoices are normally pre¬
pared by the seller.
The Draft
Certificate of Origin
This is not a special form and is not required by all countries. U.S. law
requires that commercial invoices and/or exporters’ declarations contain
a statement as to the origin of the goods. A few countries, however, do
have formal paperwork that must be completed to attest to the origin of
the goods and fair market prices.
Certificate of Insurance
This is written proof that goods being shipped internationally are insured
against theft, loss, or damage. Many orders covered by letter-of-credit
payment terms require the exporter to cover the shipment with insurance
while the goods are in transit. The requirement is waived in most other
cases. Some countries require the importer to buy insurance locally in
order to conserve scarce foreign exchange reserves.
Clean Collection
Documentary Collection
DRAFTS
A draft is a bill of exchange that is similar in many respects to a business
or personal check. It gives the banking system the necessary instructions
concerning who pays whom, how much, where, and when. A draft is a
written order by the drawer directing the drawee to make payment upon
sight of the instrument or at a determinable future date. Depending on
Documentary Drafts
These fall into two categories: sight drafts and time drafts. Both types are
used extensively in international trade. Sight drafts generally result in
faster payment and less risk to exporters. Time drafts give importers more
time to pay and therefore present more risk to exporters.
Sight Draft
If the draft is drawn at sight, the documents are released to the buyer
(drawee) upon payment of the draft. This term of settlement is referred
to as D/P (documents against payment) or CAD (cash against documents).
If the draft is a time draft (drawn to be payable 30, 60, 90, etc. days after
sight or date), the documents are released to the buyer upon acceptance
of the draft. This term of settlement is referred to as D/A (documents
against acceptance). Payment is to be made, at maturity of the draft, by
the acceptor of the draft. The accepted draft is called a trade acceptance.
Terms of settlement based on a time draft imply trust on the part of
the exporter. By agreeing to draw a time draft, the exporter is granting
credit terms to the importer. After the draft is accepted by the importer,
the exporter has only the importer’s promise to pay at the maturity date.
The collecting bank is not responsible for the payment at maturity of the
draft.
Despite the fact that many exporters persist in making open account
shipments, either on a freight collect or freight prepaid basis, this is not
a recommended practice. It is true that both buyer and seller may be in
frequent contact with one another, but the fact remains that they are
doing business across national borders. This can create difficulties, espe¬
cially when the importer is in a soft currency country which imposes
restrictions on the convertibility of local currency into dollars for trans¬
mittance back to the exporter.
On an open account shipment, the exporter might have to accept
payment in the importer’s currency or nothing at all. Operating through
a bank, the exporter will at least know that its collection documents will
be duly processed by the importing country’s central bank and that
payment will be made as dollars become available in the importing
countiy’s banking system. Thus, the great advantage of utilizing a formal
system of export documentation and routing it through a bank lies in a
fairly high assurance of payment.
Once the importer accepts the documents from its own correspondent
bank, even if the payment terms are for an extended time period, the
international banking channels through which the transaction has taken
place automatically seek to make a collection on behalf of the exporter.
This means that if the importer has funds deposited with its bank, its
account may be debited to satisfy the amount outstanding owed to the
exporter. If the funds on deposit are insufficient, the bank will press the
importer for the collection on behalf of the exporter.
documents agree with one another, the exporter may not get paid and/
or the importer may not receive its goods.
QUESTIONS
12.1 Describe the nature and purpose of an import license.
12.2 Discuss the pros and cons of clean collections and documentary
collections.
INTRODUCTION
This chapter focuses on the more popular payment terms used by com¬
panies in the export business. It also looks more closely at the role
played by the international banking system in providing an operating
environment that makes it easier for exporters to receive on-time pay¬
ment for their shipments.
There are risks with all payment terms except prepaid. There are even
risks with letter-of-credit transactions, as will be seen in the next chapter.
However, an interesting point to consider is that bad debts from interna¬
tional trade worldwide are much less than those from domestic sales,
despite the fact that most export sales involve the extension of trade
credit through extended payment terms.
PAYMENT TERMS
Payment terms do not normally determine when and where title to goods
changes hands. Payment terms establish who owes whom, how much,
when payment is to be made and received, through which intermediaries
(banks) payment is to be made, what currency is acceptable, and where
(which country, city, and bank) the payment is to be made. Where and
when a title change takes place is largely determined by the selling
terms, sometimes called shipping terms.
137
138 International Business and Trade: Theory, Practice, and Policy
necessary to move funds from the importer’s bank to the exporter’s bank
and have those funds converted into dollars in the process.
Data Verification
The two correspondent banks (the exporter’s and the importer’s) are
responsible for verifying that certain conditions specified in the documen¬
tation as previously agreed upon by the selling and buying parties are
met before the release of those documents. According to Chemical Bank,
the banks (and certainly not the exporters) are not responsible for:
Payment Terms
Without a draft, generically known as a bill of exchange, payment by
importer to exporter cannot be made, whatever the payment terms may
be. The draft contains all the instructions to the exporter’s bank and the
importer’s bank as to who pays whom, how much, where, and when.
Essentially, a draft is similar to a seller writing a check on behalf of
a buyer who has run out of checks. In lieu of the exporter executing a
draft, the importer would write a check in the local currency and send
it to the exporter in the United States.
This would result in a convoluted process in which the exporter
would have to submit the draft to the U.S. corespondent bank for collec¬
tion. The U.S. correspondent bank would route the draft back overseas
for conversion into dollars before being able to make a deposit to the
exporter’s account. This can create difficulties in the importer’s country,
because if no dollar (foreign exchange) has been set aside for the trans¬
action, the check in the local currency cannot legally be redeemed in
dollars.
An exporter would not as a matter of routine policy make a shipment
and have a draft issued unless guaranteed that the foreign exchange
(dollars) has been made available for the transaction.
Sight Draft
If a draft is drawn at sight, the documents are released to the buyer
(drawee) upon payment of the draft. This term of payment is often called
D/P (documents against payment) or CAD (cash against documents). It
means that the collecting bank will not release the shipping documents
to the importer until payment has been rendered.
Time Draft
Under these terms (a draft drawn to be payable 30, 60, 90, etc. days after
sight or date), the documents are released to the buyer upon acceptance
142 International Business and Trade: Theory, Practice, and Policy
Types of Collection
Clean Collection
This is a collection that involves only “financial” documents, including a
draft (also referred to as a bill of exchange), promissory note, or check.
The most common financial document is a draft. (See Chapter 12 for a
more detailed explanation.)
Documentary Collection
In a documentary collection, “commercial” (or shipping) documents are
transmitted. A financial document (draft) may be included as well. Under
a documentary collection, the exporter’s bank (remitting bank) foiwards
the documents and its instruction letter, which contains collection instruc¬
tions requested by the exporter, to the bank in the importer’s country
(the collecting bank). (See Chapter 12 for a more detailed explanation.)
Sight draft. If a draft is drawn at sight, the documents are released to the
buyer (drawee) upon payment of the draft. This term of payment is often
called D/P (documents against payment) or CAD (cash against docu¬
ments). It means that the collecting bank will not release the shipping
documents to the importer until payment has been rendered.
Time draft. Under these terms (a draft drawn to be payable 30, 60, 90,
etc. days after sight or date), the documents are released to the buyer
upon acceptance (signing) of the draft. This term of settlement is referred
to as D/A (documents against acceptance). Payment is to be made, at
maturity of the draft, by the acceptor of the draft. The accepted draft is
called a “trade acceptance.”
Financing Trade: Payments and Collections 145
QUESTIONS
13.1 Discuss the circumstances under which exporters would sell to
overseas customers on a time draft basis rather than offering sight
draft payment terms.
13.3 Discuss how factors other than the overseas customer’s credit may
impact the exporter’s payment terms.
13.5 Discuss the nature and purpose of a central bank’s import licensing
procedures.
/ V
CHAPTER 14
International Letters of Credit
INTRODUCTION
This chapter is about minimizing payment risk through the use of letters
of credit. It will also be shown that these documents can be used to
finance international trade.
147
148 International Business and Trade: Theory, Practice, and Policy
Irrevocable letter of credit. Most L/Cs that involve single orders with no
contracted repeat business are of this variety. The L/C is irrevocable by
the issuing bank. This means that neither the buyer nor the opening bank
can cancel the commitments made under the documents as long as the
seller (exporter) performs as specified in the L/C.
QUESTIONS
14.1 An exporter wants to ship a million-dollar piece of equipment to
a customer in Turkey and would like to give the customer 120-day
payment terms. The exporter would also like to be paid in U.S.
dollars as rapidly as possible. Using a specific example, explain
how a letter-of-credit arrangement might benefit both exporter and
importer.
14.2 Not all letters of credit are the same. Explain, using specific ex¬
amples, the differences among the various forms of letters of credit
available today.
14.3 Explain the ways in which letters of credit can be used to finance
an exporter’s transaction.
14.4 “A letter of credit is not money in the bank.” Explain this statement.
CHAPTER 15
Foreign Manufacturing
and Assembly
INTRODUCTION
This chapter discusses the use of turnkey systems, management contracts,
and contract manufacturing agreements as means of introducing high-
technology systems and/or goods produced in other countries expedi¬
ently and without long-term foreign direct investments.
TURNKEY AGREEMENTS
Turnkey agreements are most commonly used in emerging markets during
the design, procurement, assembly, and construction phases of a capital
project. Companies that have the critical skills needed to coordinate the
building of large capital projects (e.g., steel mills, petrochemical refining
and processing facilities, resort and housing developments, commercial
air terminals, etc.) become known as turnkey contractors.
155
156 International Business and Trade: Theory, Practice, and Policy
MANAGEMENT CONTRACTS
Management contracts are often instituted toward the last phase of a
turnkey agreement. The new facility has been turned over to the new
owner-operators, who find themselves temporarily without the experi¬
ence required to manage the project. A professional management com¬
pany may then be called in to operate, manage, and maintain the facility
and to train the local work force, until it becomes self-sustaining.
Foreign Manufacturing and Assembly 157
CONTRACT MANUFACTURING
Many companies that contract some or all of their production abroad are
small, have limited technology, and have few if any registerable or
patentable intellectual assets such as trade names, copyrights, and inven¬
tions. For these types of companies, contract manufacturing arrangements
with foreign producers can and do in fact provide viable alternatives to
making costly long-term investments.
However, contract manufacturing arrangements are also used by large
companies as a means of limiting their wholly owned production units
to the manufacture of what they consider to be their core product lines.
credit. Thus, the amount of tax paid to Belgium would not have to he
paid again to the United States.
Tax Ramifications
The disadvantage of the branch office concept for a small firm is mainly
financial by virtue of the branch office’s affiliation with the parent orga¬
nization. It is not separated from the parent and/or U.S. tax law. There¬
fore, its Belgian income is treated in the United States as part of the
parent’s worldwide income and is subject to federal income taxes. The
foreign tax credit helps reduce the tax burden a little, assuming a tax
treaty exists (there is one with Belgium), but some taxes may neverthe¬
less have to be paid.
Further, a branch office in many countries is not treated under the
same tax laws that apply to corporations and can have the effect of
creating needless additional tax burdens for the branch office in the
foreign market.
QUESTIONS
15.1 A small New Jersey manufacturer of industrial solvents that has
been successfully selling its products in Western Europe through
import distributors in the region’s major cities is about to be priced
out of the market by rising transport costs and high import taxes.
Discuss the following:
a. The main points to be negotiated between the New Jersey
company and a local contract filler somewhere in Western
Europe.
b. The organizational structure of the contract manufacturing ar¬
rangement in terms of the New Jersey company’s European
production and warehousing, its distribution, and the flow of
funds from transactions.
15.2 Describe and explain the nature, purpose, and structure of a turn¬
key project. Discuss its advantages and disadvantages for all parties
to the transaction.
CHAPTER 16
International Licensing
and Franchising
INTRODUCTION
In this chapter, the international transfer of technology and know-how
through arrangements called licensing and franchising agreements is
explored. These agreements are contracts by which owners of intellectual
property such as patents, trademarks, trade names, and copyrights are
able to temporarily rent, through a lease or license, their rights to those
assets to a licensee in return for a fee or royalty.
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164 International Business and Trade: Theory, Practice, and Policy
Intellectual Assets
As stated above, these are the patents, trademarks, trade names, and
copyrights that encompass a company’s technology, know-how, and
position in the market.
Business Name
The mere act of initially registering a trade or business name at the city,
county, or state level for tax purposes also protects against the infringe¬
ment of that name without the consent of the business owner. Should
a business ever contemplate becoming a player in the national market¬
place, trade name registration in Washington, D.C. would be appropriate.
Once that is done, it is possible to obtain trade name protection in other
countries through a similar process.
Copyrights
These are the word, shape, and symbol combinations that appear on
labels and packaging. They should be protected against infringement
International Licensing and Franchising 165
Patents
These are the inventions and unique innovations that a company pos¬
sesses which distinguish its products from all others. Market-oriented
companies like Coca-Cola, Nestle, and Disney do not rely as much on
patent protection as do product- and technology-oriented companies
such as Westinghouse, IBM, and Hewlett-Packard. Crossover businesses
like Microsoft depend on patent, trademark, trade name, and copyright
protection.
There are three types of patents: utility (product) patents, design
patents, and process patents. A product patent protects an invention and
the idea(s) behind the invention. Patents are also available for innova¬
tions that expand the use or application of the original device. Hence,
a four-legged seating element with a backrest, the whole thing being
called a “chair” and never having been in evidence before, could be
eligible for a product patent. Additional patents could be granted if arms
or rockers are subsequently added. The process by which the chair is
made, if sufficiently unique, might be eligible for a process patent.
It is more important to protect process patients than product patents,
mainly because the process governs the invention. When the Polaroid
camera was developed, it was covered by more than 300 distinct process
patents that took Eastman Kodak over 25 years to decipher. When Kodak
finally succeeded and introduced its own instant camera in time for the
U.S. bicentennial in 1976, it was saddled with a lawsuit that years later
cost it over $900 million, not including legal fees, to settle.
Know-How
This is the magic that makes a company live and prosper. It is the most
difficult of all intellectual properties to protect because it describes a
company’s valued human resources. Short of bringing back slavery, it is
virtually impossible to keep people from moving from company to com¬
pany, even in a small business environment.
All forms of employment contracts exist to keep valuable employees
from leaving with trade and technological secrets, and all leave much to
be desired. The situation becomes even murkier internationally, and
adding the extra element of industrial espionage to the problem defies
solution.
166 International Business and Trade: Theory, Practice, and Policy
FRANCHISING
Franchising is similar to licensing, although it tends to involve much
longer term commitments. Licensing is pursued primarily by manufactur¬
ing firms, whereas franchising is used more by more service-oriented
companies such as McDonald’s, Hertz, and hotel chains. Trade names,
trademarks, and copyrights are more often at issue than patents.
In a franchising agreement, a franchisor sells or leases limited rights
for the use of its name, know-how, and international advertising to a
franchisee in return for a lump sum payment, a royalty, and a share of
the franchise profits.
In contrast to many licensing agreements, the franchisee agrees to
abide by strict rules in the conduct of its business. When McDonald’s
enters into a franchising agreement with a foreign firm, it expects that
firm to run its restaurant in a manner that replicates the global corporate
image, beginning with its logo and extending to its menu and customer
service methodology. Small service companies will probably find fran¬
chise contracts more appropriate to their needs than straight licensing
agreements.
Advantages. The advantages of franchising as an entiy mode are very
similar to those of licensing. Specifically, a firm is relieved of the costs
and risks of opening up a foreign market on its own. Instead, the
franchisee typically assumes those costs and risks. Thus, by using a
franchising strategy, a service firm can build up a global presence quickly
and at a low cost.
Disadvantages. The disadvantages of franchising are not as apparent
in comparison to licensing. Because franchising is used mainly by non¬
manufacturing companies, not as much attention is paid to establishing
and maintaining quality and image standards on a universal level. Only
the largest franchises seriously consider the need for coordination of
manufacturing and services to achieve experience curve and location
curve economies.
International Licensing and Franchising 169
Know-how. The magic that makes a company live and prosper. It is the
most difficult of all intellectual properties to protect because it describes
a company’s valued human resources. Short of bringing back slavery, it
is virtually impossible to keep people from moving from company to
company, even in a small business environment.
QUESTIONS
16.1 Discuss how technology licensing agreements differ from fast-food
franchises.
16.4 Discuss the steps a company like Walt Disney might take to protect
its intellectual assets in countries like China.
'
.
CHAPTER 1 7
Strategic Alliances
INTRODUCTION
This chapter illustrates how businesses can use strategic alliances in an
international environment to mutual advantage.
Vertical Integration
The process of vertical integration establishes control over sources of
production (e.g., supplies, technology, financing, labor, and other re-
173
174 International Business and Trade: Theory, Practice, and Policy
Horizontal Integration
This process is intended to achieve market control through understand¬
ings or cooperation agreements designed to allocate and maintain market
share. Two or more companies that sell in the same market can therefore
agree to share the same sales force, the same marketing team, and pool
their advertising and promotion funds into a single budgeted campaign.
This is commonly done by beverage companies, restaurant chains, and
the entertainment industry. Companies are ready for a strategic alliance
when they come to believe that a measure of intercorporate cooperation
may result in synergies that will more quickly achieve mutual or recip¬
rocating objectives.
Organizational Structure
Having selected a partner, the alliance should be structured so that the
risk of losing technology and know-how to the other partner(s) is kept
to a minimum.
Alliances can be designed to limit technology transfers to those ex¬
clusively specified in protocol agreements. No transfers should be al¬
lowed unless they are formally included in licensing arrangements and
in fee-paid technical service contracts.
Contractual safeguards can be written into an alliance in the form of
restrictive covenants for employees in order to minimize “inside” raids on
intellectual properties such as patents, trademarks, trade names, copy¬
rights, and other “goodwill” assets by partners.
All partners to an alliance can agree in advance to exchange specified
skills and technologies in a mutual “open-house” atmosphere for a given
time frame.
The risk of malfeasance by an alliance partner can be reduced if a
firm extracts a significant credible commitment (cash in an escrow ac¬
count) from partners in advance.
Strategic alliance agreements will eventually be couched in any num¬
ber of structured and legally binding contracts, such as jointly financed
and/or managed research and development projects, contract manufac¬
turing, licensing and franchise arrangements, and protocol agreements
that provide the umbrellas for broad-based and long-term joint ventures.
Strategic Alliances 177
Management Style
Once a partner has been selected and an appropriate alliance strucftire
agreed upon, the task facing a firm is to maximize its benefits from the
alliance. As in all international business deals, an important factor is
sensitivity to cultural differences.
Many differences in management style are due to cultural differences.
Business executives, working closely with their counterparts in other
countries, need to make allowances and be flexible if cross-cultural
relationships are going to work for the mutual benefit of all parties
concerned. It goes without saying that a U.S. company can learn as much
if not more from a foreign affiliate than the overseas partner can learn
from its so-called American “mentor.”
The challenge of managing an international alliance successfully seems
to be building interpersonal relationships between the firms’ owners,
managers, and workers. The resulting friendships and collegiality help
build trust and create harmonious relations between the two firms.
Moreover, personal relationships foster an informal and often impor¬
tant line of communication between the partners by establishing a “par¬
allel” or unofficial management network. This network can be used to
address problems which may be difficult to express in a more formal
context.
Harmonization
Disputes occur in all human associations, and they invariably sprout up
in strategic alliances. The issue of whether one or another party is right
or wrong is irrelevant, and pursuing it to a conclusion too often results
in a “lose-lose” scenario for everyone, dooming the alliance to a prema¬
ture end.
It is unimportant for an intra-alliance dispute to have winners or
losers. It is more important to compromise the vested interests of the
alliance partners through some process of harmonization.
Binding arbitration by mutually agreed upon third parties is the usual
way in which arguments are handled in such situations. Internal commit¬
tees can also be established through a selection methodology that guar¬
antees impartiality in decision making. Whatever harmonization process
is jointly selected, it should be built into the basic agreement that sets
up the strategic alliance.
178 International Business and Trade: Theory, Practice, and Policy
QUESTIONS
17.1 Discuss the use of strategic alliances within the environment of
antitrust activity by governments to maintain open and competitive
markets.
17.2 Describe and explain, with specific examples, what horizontal in¬
tegration is.
1 7.3 Describe and explain, with specific examples, what vertical integra¬
tion is.
.
.
CHAPTER 18
Foreign Investments
INTRODUCTION
In this chapter, foreign direct investments in the form of joint ventures
and wholly owned subsidiaries (foreign subs) are examined. The objec¬
tive is to explore the decision-making process a company should con¬
sider before making an often irreversible long-term commitment in an¬
other country.
A Matter of Choice
Any company considering a direct foreign investment in which the plan
is to own an equity interest (voting common stock) in a foreign enter¬
prise will be faced with the choice of owning either all (wholly owned
181
182 International Business and Trade: Theory, Practice, and Policy
Equity Distribution
Joint ventures vaiy in their flexibility and participation by the stockholding
partners. There can be two principal partners, each owning 50% of the
voting common stock, or there can be several partners. The protocol joint
venture agreement can require an equal sharing of the enterprise’s capi¬
talization, or the partners may agree to another formula (e.g., one party
provides technology and scarce resources and the other(s) supplies labor,
management, land, and other needed assets).
184 International Business and Trade: Theory, Practice, and Policy
Earnings Distribution
Earnings distribution among the joint venture partners is generally but
not always determined by each participant’s contribution. As in owner¬
ship breakdown, distribution formulas vary. Two important factors which
influence dividend policy and distribution are local restrictions on remit¬
tances (more of a problem in developing areas, where foreign exchange
reserves may be limited) and issues of international taxation, not the least
of which is the impact of income tax holidays granted by host govern¬
ments to foreign direct investors.
venture in France for the purpose of producing and selling Skin Bracer
and Speed Stick deodorant in European markets.
The Mennen Company also parlayed initial import/export agreements
with distributors in Venezuela, Colombia, and elsewhere in Latin America
and the Caribbean first into licensing agreements and then into joint
venaire arrangements, many of which lasted until the 1994 acquisition of
Mennen by Colgate-Palmolive.
machine shop in the United States and then farmed out to small subs
abroad where labor and overhead costs are less and skills are high.
Yacht-chartering companies that maintain fleets of vessels in warm-
climate countries for the use of their clients from cold-weather locations
are generally small companies incorporated in Eastern Seaboard states.
Most of their offshore fleets are managed by foreign subsidiaries located
in any number of Caribbean or South Pacific countries.
The retail/wholesale outlets that market reproduction antiques and
fine art, the machine shops, and the yacht-chartering firms have five
qualities in common: they tend to be small, they must keep costs down
in order to survive, they serve niche markets in the United States and
abroad, quality control is critical, and superior service is of the essence.
If a small company is dependent on all five characteristics, the wholly
owned subsidiary route may be not merely a viable alternative—it may
be the only way to go.
Joint venture. A highly structured and formal strategic alliance that in¬
volves two or more partners. Sometimes the alliance is strictly voluntary,
but often it is mandated by the laws of the host country.
QUESTIONS
18.1 A large U.S.-based telecommunications company wants to become
a key player in China’s growing markets. It is interested in manu¬
facturing equipment for use in China as well as for export to other
countries. It also wants to offer general telecommunication services
to individuals, business, and government clients in China. Discuss
the possible entry strategies the company should consider.
INTRODUCTION
In this chapter, the regulatory environment of international trade and its
impact on the conduct of international business transactions are examined.
It is generally accepted that national governments have a responsibil¬
ity to guard their countries’ borders. They also have an obligation to raise
revenues in the form of taxes to fund their roles as governing bodies.
Finally, governments, in promoting and maintaining the common good of
the national communities they serve, participate in the regulation and
management of economic enterprise.
Large and small companies venturing out into business relationships
abroad that are unaware of these laws and government policies impact¬
ing trade and investments can suffer significant losses.
EXPORT RESTRICTIONS
Restrictions fall into three categories: export taxes, export quotas, and
national security restrictions. The United States is among the few coun¬
tries that impose a minimum of export restrictions.
Exporters are thus often caught by surprise when informed that there
may be a problem with the goods they wish to sell overseas. Unfortu¬
nately, they are sometimes brought to task only after the items have been
shipped and paid for.
191
192 International Business and Trade: Theory, Practice, and Policy
Export Quotas
Export quotas are restrictions on the quantity of product that can be
exported out of a country. The purpose of these quotas is to conserve
scarce resources by ensuring that enough stocks or inventories are re¬
tained to meet domestic needs before meeting foreign demand. The
United States imposes relatively few export quotas. Most are found levied
on costly and one-of-a-kind specialty products manufactured by the
chemical-processing industry for particular uses and customers, where
the intent was not to produce and sell for a general global market.
Trade Regulation and Restrictions 193
Export Taxes
Governments do not as a rule tax their own exports, because that re¬
duces their competitiveness in world markety U.S. taxes on exports have
not been an issue because of their rarity. There is also no internationally
accepted protocol for the creation and classification of export taxes, as
there is for import taxes (import tariffs or duties). In general, export taxes
are imposed by governments on an ad hoc basis not so much to prevent
exports but to generate revenue or to encourage value-adding changes
to a product before exportation.
Brazilian export taxes on coffee exports are a case in point. The
Brazilian government imposes low export taxes on many of its exports
merely as a mild revenue-producing medium to defray the costs of
maintaining port facilities.
However, the tax on green (unroasted) coffee exports is higher than
the tax on semi-roasted coffee beans. The intent is to encourage Brazilian
exporters to install processing facilities (to dry off and slightly roast the
beans before shipment) in distressed parts of port cities. The desired
result is to generate economic enterprise in economically depressed ar¬
eas, where unemployment is traditionally high.
IMPORT RESTRICTIONS
Import restrictions fall into three general categories: taxes, quotas, and
restrictions based on product standards or specifications. Taxes on im¬
ports are commonly known as import duties or import tariffs and are
“value-added” or “price-plus” almost by definition. Import quotas are a
restriction on the quantity of product that may be brought into a country.
Restrictions based on industiy-prescribed and government-sanctioned
standards and specifications can actually prevent any quantity of product
subject to such scrutiny from being imported.
194 International Business and Trade: Theory, Practice, and Policy
Import Taxes
Taxes on imports are value-added excise taxes and exist in three formats:
a percentage-based value-added tariff, a fixed-rate tariff, and a combina¬
tion percentage and fixed-rate tariff. The emphasis in the United States
is mostly on the first and second formats.
Single-Column Tariffs
Double-Column Tariffs
The United States, until its entry into the North American Free Trade
Association (NAFTA), was basically a double-column tariff country. It
imposed a “general” or “non-preferential” rate on imports originating in
countries with which it had no particularly special relationship (“Column
One”). It then placed a lower or a “preferential” rate on imports origi¬
nating in areas with which it enjoyed a “special” or MFN status (“Column
Two”).
Hence, if product X originated in a “Column One” country, it might
be subject to a 30% import levy; if that same product originated in a
“Column Two” nation with MFN status, like the United Kingdom, it might
hypothetically be subject to a 10% tax.
Triple-Column Tariffs
The United States, and many other industrial and industrializing countries
that have formed trade blocs such as NAFTA, MERCOSUR, and the
European Union (EU), operate under triple-column tariff systems. Some
can even be said to have four-column systems.
196 International Business and Trade: Theory, Practice, and Policy
Import Quotas
These restrictions on the quantity of product that can be imported from
overseas often create great difficulties for importers that depend entirely
on offshore sources for their supplies. The rationale for import quotas
stems from a desire to protect domestic producers from being over¬
whelmed by foreign competition. This is accomplished by dividing mar¬
ket share on an allocation basis.
The U.S. cotton quota imposes quantity limits on foreign cotton¬
growing countries to protect domestic growers and to allocate market
shares as fairly as possible to overseas producers. A problem arises when
countries export cotton-polyester blends to U.S. importers. All cotton and
Trade Regulation and Restrictions 197
Technical Restrictions
Technical restrictions are restrictions imposed by governments on imports
that allegedly do not meet local standards. Some are legitimately intended
to maintain high quality standards, but many are used as a means of
restricting imports, even when the superiority of the imported item can
be demonstrated. Europeans have historically made market entiy difficult
for U.S. telecommunications companies by insisting on technical specifi¬
cations that can be impossible to meet.
Restrictions based on a product’s standards and/or technical specifi¬
cations are used principally by competing industrial countries.
QUESTIONS
19.1 Discuss, with specific examples, the arguments for and against
import taxes.
19.2 Explain how import quotas function and how they can be used to
restrain trade among nations.
19.3 Explain, with examples, how import quotas can be used by high-
income countries as a political tool to control lower income trading
partners.
19.4 Describe and explain, with examples, the structure and rationale of
multiple-column tariff systems.
19.5 Describe and explain, with examples, the purpose of export quotas.
19.6 Describe and explain, with examples, the purpose of export taxes.
CHAPTER 20
Investment Restrictions
INTRODUCTION
In this chapter, the regulatory environment of international investments
and its impact on the conduct of international business transactions are
examined. Beyond governments’ responsibility to regulate trade is said to
lie an obligation to guide investments into areas of economic activity
seen necessary to promote economic growth and development. Govern¬
ments fulfill this obligation through a mix of fiscal (tax) and monetary
(interest rate and exchange control manipulation) policy.
INVESTMENT RESTRICTIONS
Today, countries impose restrictions on both outgoing and incoming
investments. They impose restrictions on the types of investments that
can be made, as well as investments made by overseas affiliates in third-
party nations. Both foreign direct investments and foreign portfolio in¬
vestments are impacted by government restrictions, many of which con¬
flict with one another.
199
200 International Business and Trade: Theory, Practice, and Policy
Bayer of Germany had its assets in the United States seized by federal
marshals in World War I, it lost its right to the use of the name “Bayer”
in the United States. It was not until 1995 that Bayer’s control and
ownership of the name were firmly re-established.
The U.S. assets of the General Analine & Film Corporation (GAF),
another German company, were expropriated at the outset of World War
II and never returned. Its equity was subsequently sold by the U.S.
government to American residents.
Expropriation or nationalization of foreign-owned assets such as plant
and equipment, inventories, accounts receivables, intellectual properties,
bank accounts, and private residences is common practice throughout the
world when nations begin dueling internationally. Properties may occa¬
sionally be restored, but most of the time they are not. The probability
of nationalization is one of the more important risk factors to be weighed
when engaging in cross-border enterprises.
These nations include Iran, Iraq, and Libya, with which trade and invest¬
ments, except under severely circumscribed instances, are prohibited by
the U.S. government. A persistent antagonistic relationship with these
states makes economic cooperation difficult and hazardous.
as the incoming investment creates a net economic benefit for the im¬
pacted region.
Investment Incentives
A 1996 law passed by the U.S. Congress tightened the general embargo
on doing business with Cuba. It is the latest in a series of laws enacted
by the government to prevent not only American-based companies but
all companies throughout the world from doing business with Cuba.
Many countries have protested that the law is arbitrary, capricious,
and discriminatory, as well as a possible violation of international law.
It is currently being contested within the World Trade Organization. A
ruling by that body is expected before the end of 1997.
It should be noted, however, that, viewed from the broader perspec¬
tive of international affairs over time, the law is no better or no worse
than the infamous “Arab embargo” against companies doing business
with Israel. The embargo had little effect and has proven over the years
to be an embarrassment.
"Conduct Unbecoming..."
The United States, like many countries, also attempts to legislate morality
and ethics. This was the intent of the Foreign Corrupt Practices Act
(FCPA), passed by the Congress in 1977 in the aftermath of the Watergate
era.
The FCPA, in amended form, remains on the books today. While it
condones “grease” payments by American executives to foreign function¬
aries to accelerate cargo clearance procedures and other clerical chores,
it imposes high criminal and civil penalties on the time-honored practice
of bribing foreign government officials in order to obtain a favorable
business decision.
Comments about the FCPA by international businesses have been
generally negative. The law has been accused of costing U.S. companies
billions of dollars in potential revenues due to prospects lost because of
an inability to bribe foreign government officials.
It is difficult to determine how much of this commentaiy is quanti¬
fiable fact and how much is hyperbole. In all fairness, attempts by foreign
residents to influence government decisions in the United States through
bribeiy would at the very least generate scandal, if not an official inquiry
followed by high-profile court action. The FCPA’s theme can best be
summarized as follows: Do not do abroad that which ought not to be
done at home!
QUESTIONS
20.1 The manager of the foreign subsidiary of a U.S.-based company
makes a sizable contribution to the election campaign of a local
politician in the host country. Discuss the situation in terms of a
possible violation of local law as well as the Foreign Corrupt
Practices Act.
INTRODUCTION
U.S. trade and investment policies have tended to encourage the nation
to export, import, invest overseas, and invite investments from abroad.
The general official attitude has been, since the country’s beginnings, that
trade and investments are good for the economy in an overall long-term
sense. This chapter analyzes U.S. government policies and programs
embodied in a number of tax laws that specifically support private sector
involvement in international trade and investments.
INTERNATIONAL TAXATION:
WHO PAYS TAXES TO WHOM?
Corporate residents of a country, like private residents, pay income taxes
and a number of other types of taxes, ranging from use and sales taxes
to property taxes. How much in total taxes is paid and to whom the taxes
are paid depend largely on where the business is located and where a
specific transaction takes place.
207
208 International Business and Trade: Theory, Practice, and Policy
personal 1040 income tax return. Different forms are needed to report
taxable foreign branch income, but the net effect is the same. Foreign
branch operating revenues are taxed as part of the U.S. company’s
worldwide earnings. If the U.S. company is a corporation, its foreign
branch earnings become part of its U.S. corporate tax return.
Tax Treaties
The U.S. government does not have tax treaties in place with all coun¬
tries. Further, each tax treaty is individually tailored as opposed to crafted
from a general template. Consequently, it is necessary for companies and
their tax specialists to have a working knowledge of the particulars of a
foreign countiy’s tax laws and the international taxation relations that
exist between that nation and the United States.
available, however, if no tax treaty exists between the tax haven and the
United States.
the payment of import taxes. They are used by small and large compa¬
nies to maintain a competitive cost and price advantage in U.S. and
overseas markets. This section examines FTZs, along with duty-free or in-
bond facilities, which exist to help importers and exporters reduce their
international transaction costs.
dise is intended for re-export, or they can pay all customs charges and
then apply for a refund of the taxes paid if the same goods are subse¬
quently re-exported. This process is known as a duty drawback. Finally,
the global trend toward import tax reduction under the continuing Gen¬
eral Agreement on Tariffs and Trade (GATT)/World Trade Organization
(WTO) accords is gradually rendering the FTZ concept obsolete.
Duty Drawbacks
It is also possible to apply for a refund of customs charges levied if the
imported merchandise is eventually re-exported. Companies often import
goods that are not originally intended for re-export, but as time passes,
the goods may ultimately be shipped to an overseas affiliate or customer.
Under existing law, companies have the right to apply for a “drawback”
or refund of the customs duties paid. The amount refunded is about 90
to 95% of the monies paid out, including customs brokerage fees.
trading agreements between the United States and major trading partners
like Canada and the GATT nations, was bitterly contested from the start.
The argument was that a DISC constituted an export subsidy prohibited
under the GATT.
In August of 1983, after much pressure from the GATT Council, the
administration submitted a proposal to replace the DISC with an offshore
entity known as a foreign sales corporation (FSC). Congress passed the
proposal in June 1984, and it was signed into law in July 1984. The first
major provision of the FSCA was to forgive the taxes on previously tax-
deferred DISC income, laying to rest forever the issue of the unrepaid
producers’ loans, along with all other unpaid taxes on now permanently
tax-deferred income,
ern Mariana Islands, and the U.S. Virgin Islands. Puerto Rico is not
included because of its special commonwealth status with the mainland.
Pricing Rules
Two pricing rules are used to determine the exempt income amount:
according to the rules that apply to foreign corporations with U.S. activi¬
ties. The portion of income from an FSC that utilized the safe-haven rules
will be subject to U.S. tax. The new rules treat this income as U.S. source
income connected with trade or business conducted through permanent
establishment of an FSC within the United States. By classifying the
income in this manner, it is subject to U.S. tax as normal business
income.
be treated as one for tax purposes. This election may be filed at any time
at least 90 days before the beginning of a new tax year. The election
requires the written consent of all stockholders, as they are all deemed
to have a vested interest in the management of the FSC.
Foreign Sales Corporation Act of 1983. This U.S. law provides a tax
incentive to corporations that conduct export operations from offices
based in offshore possessions such as the U.S. Virgin Islands and Guam.
Free trade zone (FTZ). A geographical enclosure within the customs area
of a country (that is to say, within the United States) into which goods
may be imported without the payment of import taxes.
Tax treaties and double taxation. All firms doing business in other coun¬
tries are vulnerable to double taxation unless a bilateral tax treaty is in
place. Foreign branch offices are most obviously affected because their
taxable income could be payable twice, in the host country and again in
the United States.
U.S. worldwide income rule. Under U.S. law, a resident of the United
States must pay taxes on all income earned in the United States and in
other countries. In other words, a U.S. resident must pay federal income
taxes on worldwide income.
224 International Business and Trade: Theory, Practice, and Policy
QUESTIONS
21.1 A large U.S.-based corporation is contemplating a long-term foreign
direct investment in the European Union region. Carefully plot the
organizational structure it should pursue in terms of the impact of
taxes on its activities.
21.2 Describe and explain, with examples, the nature of international tax
treaties and how they might affect a U.S. corporation doing busi¬
ness in many countries.
21.3 Describe and explain how a U.S. corporation might organize itself
to take advantage of the Foreign Sales Corporation Act.
21.4 Discuss how the concept of residency and the worldwide income
rule can impact the multinational organizational structure of U.S.
companies.
CHAPTER 22
U.S. Trade and Investment
Support Organizations
INTRODUCTION
In this chapter, the roles played by key U.S. government organizations
in assisting business in doing business overseas are examined. The focus
is on four support groups: the Overseas Private Investment Corporation,
the Export-Import Bank of the United States, the Small Business Admin¬
istration, and the United States Agency for International Development.
225
226 International Business and Trade: Theory, Practice, and Policy
Qualifications
Eligible enterprises include processing, manufacturing, storage, mining,
forestry, fishing, agricultural production, energy development, tourism,
hotel construction, equipment maintenance, and distributorship facilities.
OPIC generally does not provide financing for projects that involve housing
or infrastructure development.
OPIC Programs
OPIC’s direct loan and guarantee programs provide medium- and long¬
term funding and permanent capital to international investment projects
that involve significant equity and management participation by U.S.
companies. OPIC’s award of financing is based upon the economic,
technical, and financial soundness of a project. Project sponsors must
show an adequate cash flow to cover operational costs, to service all
debts, and to provide a return on investment.
Direct loans. Through direct loans, U.S. investors may obtain financing
for smaller projects. Loans for such projects typically range from $500,000
to a maximum of $6 million. Direct loans may only be used to finance
projects sponsored by or which significantly involve small businesses.
Loan guarantees. OPIC offers loan guarantees for larger projects, which
can involve small companies or major corporations. Loan guarantees
range from $2 million to as large as $50 million. Terms of direct loans
and loan guarantees generally provide for a final maturity of 5 to 12 years
following an appropriate grace period, during which only interest is
U.S. Trade and Investment Support Organizations 227
payable. The length of the grace period depends upon the time required
for the project to generate a positive cash flow.
Seed capital. OPIC may also provide capital for a project through
stock investments and the purchase of a project’s debentures convertible
to stock. These investments increase a project’s capital base, which helps
project sponsors obtain more debt capital to finance the project. OPIC’s
equity investments typically range from $250,000 up to $2 million, but
may be larger depending upon the particular project. U.S. companies of
any size are eligible to receive financial assistance under the equity invest¬
ment program. However, because equity investments usually involve greater
risk, OPIC is very careful in selecting which projects it will finance.
Coverage. OPIC policies can cover up to 90% of the investment in an
eligible project. It is OPIC’s policy to offer insurance only for new
investments that involve the expansion or modernization of an existing
plant or equipment or the acquisition of additional working capital to
expand an existing project. Eligible investors are citizens of the United
States; corporations, partnerships, and/or other organizations founded
under U.S. laws (and substantially owned by U.S. citizens); any state or
territoiy of the United States; or foreign businesses which are at least 95%
owned by sponsors eligible under the above requirements.
Pre-investment services. OPIC also offers pre-investment services to
assist U.S. companies in assessing foreign market potential. In 1996, OPIC
agreed to provide political risk insurance to a U.S. financial management
firm that intends to invest in a number of Soviet enterprises.
worried about the procedures that are in place. The loan requirements
used by OPIC are very similar to those of any bank doing business within
the United States.
The problem arises when a borrower defaults on a OPIC loan. Be¬
cause OPIC is a governmental agency, the taxpayers must suffer the loss.
Therefore, OPIC has come under much scrutiny for its risky loan practices.
Problems. One such investigation found that a huge shipment of
Israeli arms that ended up in the hands of the Medellin drug cartel was
apparently financed with $1.3 million in loans secured through OPIC.
The investigation showed that an alleged Antiguan melon farmer and
former Israeli soldier secured these funds supposedly for his melon farm,
but instead engineered an arms deal.
Origins
The Ex-Im Bank was established in 1934 by presidential order and was
reorganized in 1945. Its mission has changed over the years from sup¬
porting U.S. foreign-aid-financed exports through a system of credit and
political insurance programs to supporting private sector exports that
benefit the domestic economy.
The use of Ex-Im Bank financing has been influential in helping U.S.
firms to boost exports, especially to developing nations. At the same time,
its mission is to work with U.S. businesses in identifying, insuring, and
financing foreign direct investment projects that will both create jobs and
foster economic growth in the United States. In other words, an impor¬
tant criterion for Ex-Im Bank involvement is that a project must benefit
both the overseas country as well as the U.S. economy.
Objectives
The Ex-Im Bank’s mission is to create jobs through exports. It has several
programs available to assist both small and large U.S. companies engaged
U.S. Trade and Investment Support Organizations 229
Specific Programs
The Ex-Im Bank provides financing support for U.S. exporters through
working capital guarantees, export credit insurance, loan guarantees, and
direct loans.
goods and services for export. The Ex-Im Bank will process loan requests
for $833,334 and above. The Small Business Administration processes
loans for lesser amounts on behalf of small businesses.
The loan repayment guarantee transaction may be approved for a
single sale or a series of sales under a revolving line of credit. Its terms
are typically 12 months, but may be extended for a total of 2 years. Ex-
Im Bank requires that the borrower’s assets be secured, usually in the
form of inventory of exportable goods and/or accounts receivables on
goods or services already exported or other forms of collateral.
There is an up-front $100 application fee. The bank then charges the
guaranteed lender an up-front facility fee of 0.5% on the loan amount
and a quarterly usage fee of 0.25% on the disbursed amount.
The total cost of the loan is similar to the cost of a regular commercial
loan. This is because the funds are disbursed to the exporter not by the
Ex-Im Bank but by the private bank with which the exporter normally
deals. These Ex-Im Bank guaranteed loans are usually priced at the prime
rate plus 1 to 3% or more, depending upon the exporter’s credit rating.
Direct Loans
Direct loans provide foreign buyers with competitive fixed-rate financing
for their purchases in the United States. Ex-Im Bank’s loans and guaran¬
tees cover 85% of the contract price, with 100% of that portion financed.
The foreign buyer is required to make a 15% cash payment. The fees
charged by the Ex-Im Bank for its programs are based on the risk
U.S. Trade and Investment Support Organizations 233
$833,333, which represents the largest loan amount the SBA can cover
with a 90% guarantee.
In all the above cases, the SBA provides liquidity so that the guaranteed
portion of the loan can be traded in the secondaiy markets (i.e., between
investment banks and finance companies).
Eligibility
In order to be eligible for SBA assistance, firms must be for-profit orga¬
nized and fall within a standard size, based on the average number of
employees over the previous 12 months of operation or based on sales
averaged over a 3-year period. In manufacturing, a company is consid¬
ered a small business if it has less than 1,500 employees. (The usual
maximum for eligibility is 500 employees.) In the wholesale trades, a
small business is defined as having fewer than 100 employees. In ser¬
vices, average annual receipts may not exceed $14.5 million, depending
on the specific industry. In retailing, average annual receipts may not
exceed $21 million, again depending on the specific industry. In con¬
struction, average annual receipts may not exceed $17 million, depending
on the type of industry. In agriculture, average annual receipts may not
exceed $7 million, depending on the specific industry.
Loan terms depend on the use for which the proceeds are intended
and the ability of the business to repay. Working capital loans have
maturities of up to ten years. Fixed asset financing (i.e., purchase or
U.S. Trade and Investment Support Organizations 239
Importance to Business
Implementation of USAID programs is required by law to give priority to
small businesses, known in USAID parlance as “contractors.” Almost all
USAID programs involve the export of goods and services to developing
areas where U.S. economic assistance funds have been committed.
Once a development project has been articulated in the form of an
action plan with an approved budget (a low-cost housing and shopping
complex, for example), the entire program is put out for competitive
bids, with interested businesses invited to tender offers. The bidding
format is announced through government publications and SBA mailings
that circulate among small businesses, as it is government policy to give
preference to small and minority-owned firms. The payment terms on
these USAID contracts, once awarded, are always against an irrevocable
confirmed letter of credit. Payment can be made at the end of contract
performance, but veiy often is made on a percentage of completion
basis.
U.S. Small Business Administration (SBA). The SBA was created in 1953
as a federal agency to help small businesses raise operating capital. Over
the years, it has become the government’s major source of support for
small business and small business issues.
QUESTIONS
22.1 Describe and explain the functions of the Overseas Private Invest¬
ment Corporation, which has been around since 1969- Is it serving
any useful purpose today? Is it self-supporting? Should it be changed?
If so, to what? Should it be discontinued? If discontinued, should
something else take its place? If so, what?
22.2 Describe and explain the functions of the United States Agency for
International Development, which has been around since 1961. Is
it serving any useful purpose today? Is it self-supporting? Should it
be changed? If so, to what? Should it be discontinued? If discon¬
tinued, should something else take its place? If so, what?
INTRODUCTION
The trend toward international economic cooperation through the cre¬
ation of trade blocs, euphemistically called the “regionalization” of trade
and investments, is reviewed in this chapter. The roles played by inter¬
national organizations, such as the World Bank and the International
Monetary Fund, in assisting nations to grow their economies through
international trade and investments are also examined.
TRADE BLOCS
An awareness of the problems and opportunities presented by nations
forming trade blocs can go a long way in helping international businesses
to globally maximize market share and earnings. Nations often create
new and larger trading areas that are easier to penetrate than the tradi¬
tional single-nation market. An overview of trade blocs, how they work,
and how they are used to advantage by importers and exporters is
provided in this section.
245
246 International Business and Trade: Theory, Practice, and Policy
Economic Integration
The idea of economic integration is to merge the economic activities of
member countries to accelerate the processes of growth and develop¬
ment by maximizing market size, production capacity, and technological
advancement. Trade blocs are often seen as a stepping-stone on the path
toward economic integration. Trade blocs are also formed to protect
countries from what they may perceive as overwhelming foreign influ¬
ence and competition.
MERCOSUR
MERCOSUR (MERCOSUL in Brazilian Portuguese) is the South American
term for the “Southern Cone Common Market.” It is actually a free trade
association consisting of Argentina, Brazil, Paraguay, and Uruguay. Chile,
Bolivia, and a few other South American countries have expressed inter¬
est in joining MERCOSUR, which is probably one of the few trade
association success stories in Latin America and the Caribbean.
The region has had a long histoiy with FTAs. Two FTAs were formed
in I960: the Latin American Free Trade Association (LAFTA) and the
Central American Common Market (CACM). LAFTA included ten South
American nations (all the countries in the area with the exception of
Guyana, Surinam, and French Guyana) plus Mexico.
The CACM included all the Central American countries with the ex¬
ception of Belize and Panama. It discontinued operations in 1969- LAFTA
developed several subgroups, the most noteworthy of which was the
“Andean Six,” which included Venezuela, Colombia, Ecuador, Peru, Chile,
and Bolivia. LAFTA was reconstituted in the 1980s as the Latin American
Integration Association (LALA). This ten-member group included the original
LAFTA countries except for Mexico.
The early shortcomings experienced by Latin American countries may
be due to the fact that their integration plans were too ambitious.
MERCOSUR appears to be successful because it follows a go-slow pattern
of development, with the more limited goal becoming an effective free
trade association before becoming a customs union and eventually a
common market.
Operating on the same premise as MERCOSUR are the relatively new
free trade accords negotiated between Venezuela and Colombia. The
goal there is also to grow into an FTA before considering the more
difficult processes of creating a customs union or common market.
her countries have consulted and met repeatedly over the years. Other
area nations have expressed interest in seeing ASEAN expand, but it has
still to realize its original objective of becoming a fully operational FTA.
Mission
While the mission of the World Bank is to lend monies to Third World
countries for economic development purposes, and although the World
Bank is dependent on high-income countries for its capitalization, the
fact remains that the allocation of these funds to specific projects means
business with a guaranteed payment structure to companies selected as
corporate vendors and contractors. This reality does not escape the eyes
of business.
Indeed, as pait of the World Bank effort to stimulate growth by
encouraging the development of small business enterprises (cottage in-
252 International Business and Trade: Theory, Practice, and Policy
for more funds that are obtained by selling bonds through bond markets.
The buyers of these bonds can be private sector investors and/or various
national government agencies that may wish to hold IBRD paper to
attractively fringe a “politically correct” portfolio.
The IBRD has a governance presided over by a president, who is
selected by the bank’s major contributors. The president, to date, has
always been a resident of the United States. The major role of the IBRD
is to manage the finances of the World Bank group, to develop and
establish overall policy and direction, to coordinate political and eco¬
nomic relations with member countries, to coordinate the policies and
programs of other World Bank affiliates charged with more specific
missions, and to make direct loans on approved industry development
projects.
are made at the market rate of interest. Debt maturities conform with
project requirements, which range from 5 to 15 years. Loans can be
denominated in a client’s currency of choice. In most cases, however,
loans are denominated in hard (convertible) currencies like the dollar,
yen, or deutsche mark.
The IFC is presently beginning to move away from direct loans in
favor of equity investments. It is placing more emphasis on quasi-equicy
investments such as subordinated loans, convertible debentures, and
preferred stock. It is also expanding into the arena of small business
development programs by encouraging smaller scale equity investments
in rural communities.
The IDA was created in I960. Countiy members of the IDA are also
members of the World Bank. The IDA is often called the World Bank’s
“soft loan window” because of its long-term loans made at very low or
nominal rates of interest to the poorest of developing countries. These
loans have highly flexible repayment arrangements and are provided for
the purpose of stimulating investment and economic development and
encouraging foreign trade.
The IDA does not have its own staff, officers, or buildings. The staff
and officials of the IDA are the staff and officials of the IBRD. The IDA
is simply a “window” of the bank. It is essentially “legal fiction,” a
separate account and set of books within the IBRD and not a different
institution. The elaborate emphasis on the separate nature of the IDA is
said to be necessary to assure the capital markets from which the IBRD
borrows that their funds would not be endangered by the soft loans
made by the IDA.
Much of the IDA’s activity is concentrated on infrastructure develop¬
ment (e.g., road construction and transport facilities; health and educa¬
tional facilities; energy, power, and light generation; telecommunications;
etc.).
Although the IBRD and the IDA finance the same type of projects and
select countries according to the same standards, there are some differ¬
ences between the two. The IBRD and IDA transfer resources to different
groups of countries (some are called “blend” countries because they
receive a blend of IBRD loans and IDA credits).
The IBRD would more likely concentrate its resources in a country
International Systems and Organizations 255
Some Observations
Of all the national and international organizations involved in giving
motive and direction to international trade and investments, the World
Bank group appears to be the best organized and has the best and most
comprehensive programs. It also seems to be in the best position to live
up to its potential as the premier institution qualified to mobilize and
allocate financial, human, technical, and material resources to bring about
economic growth and development in Third World areas. This involve¬
ment means an ever-expanding number of trade and investment oppor¬
tunities for big and small business.
Governance
There are approximately 172 members. Each member contributes to the
IMF’s general resources according to its quota, which is generally based
on its relative economic and financial importance in the world economy.
The highest authority of the IMF is exercised by the Board of Gov¬
ernors. Each member countiy is represented on the board by a governor
and an alternate governor. Normally, the Board of Governors meets once
a year, but the governors may vote by mail or other means between
annual meetings. The Board of Governors has delegated many of its
powers to the executive directors. However, the conditions governing the
admission of new members, adjustment of quotas, election of executive
directors, as well as certain other important powers remain the sole
responsibility of the Board of Governors. The voting power of each
member of the Board of Governors is related to its quota in the IMF.
The 24-member Board of Executive Directors, which is responsible for
the day-to-day operations of the fund, is in continuous session in Wash¬
ington, D.C. under the chairmanship of the fund’s managing director
(currently Michael Camdessus). Similar to the Board of Governors, the
voting power of each member is related to its quota in the fund, but in
practice the executive directors normally operate by consensus.
International Systems and Organizations 261
would not be able to sustain and manage large deficits, and a serious
liquidity crisis could result. SDRs were therefore created as an additional
reserve asset to complement existing reserves of U.S. dollars and gold
and to expand the international community’s liquidity.
SDRs are the unit of accounting for all transactions between the IMF
and its members, as well as an international reserve asset. Also, SDRs are
used to settle international transactions between the central banks of
member countries of the IMF.
SDRs were allocated to member countries on the same quota basis as
membership. Holding SDRs gives the bearer the option and the flexibility
to acquire foreign exchange from other members of the IMF.
The value of the SDR was originally fixed in terms of gold, with one
fine ounce of gold equivalent to 35 SDRs (or US$1 = 1 SDR). In 1974,
this valuation was replaced by a system that utilized a weighted average
of 16 international currencies, commonly referred to as a “basket.” This
“basket” was made up of the currencies of the 16 IMF members whose
share of world exports of goods and seivices exceeded 1% between 1967
and 1972. Changes were made in this “basket” to reflect the changing
proportions of world trade. This arrangement, which lasted until 1980,
calculated the SDR on a daily basis.
Despite daily recalculation, this valuation system suffered from many
problems. In particular, many of the currencies in the “basket” were not
traded actively in the international market, which made actual weighting
extremely difficult. In an attempt to remedy this situation, a new “basket”
was introduced in 1980. The new “basket” consisted of the currencies of
the five countries (U.S. dollars, German marks, Japanese yen, French
francs, and British pounds) with the largest share of world exports of
goods and seivices. Today, the value of the SDR is determined by the
prevailing market value of the currencies adjusted according to their
basket weights. Since the 1980 valuation, the basket weights of the
deutsche mark and the yen have increased, while the weight of the U.S.
dollar has decreased.
The basic objective of creating SDRs was for Third World countries
and other impoverished nations to benefit the most from their distribu¬
tion. They were to be used as a mechanism to finance aid to meet the
needs of developing countries. However, many of these nations contend
that SDRs should be linked not to quotas but rather to the actual needs
of the IMF member countries.
The majority of the industrialized nations, including the United States,
feel that the SDR’s primary function is to create international reserves and
International Systems and Organizations 263
International Monetary Fund (IMF). Its charter was laid down at the
Bretton Woods Conference in July of 1944. The fund itself was estab¬
lished in December 1945 to promote international monetary cooperation,
to facilitate the expansion and balanced growth of international trade,
and to promote stability in foreign exchange.
World Bank. The mission of the World Bank is to lend funds to Third
World countries for economic development purposes. Although the World
Bank is dependent on high-income countries for its capitalization, the
fact remains that the allocation of these funds to specific projects means
business with a guaranteed payment structure to companies selected as
corporate vendors and contractors.
QUESTIONS
23.1 Describe and explain the operation of the World Bank. Discuss
how it can be used by multinational companies seeking overseas
business opportunities.
International Systems and Organizations 265
23.3 Define and then discuss the differences between a free trade zone,
a free trade association, a customs union, and a common market.
23.4 Discuss the objectives of the European Union. Will they be met? If
so, by when?
23.6 Some regional associations have failed, while others are still in
existence. Discuss the reasons why.
'
.
Glossary
267
268 International Business and Trade: Theory, Practice, and Policy
Charter party. The party that owns a particular cargo while it is on board an
ocean vessel in transit between the exporter and importer.
Clean collection. Shipping documents that include only a bill of lading, draft,
and/or invoice sent by an exporter directly to a foreign buyer, bypassing the
international banking collection system.
Clean, on board ocean bill of lading. A common carrier’s specific receipt for
an exporter’s invoiced goods placed on board an outbound vessel. These
receipts cover no other goods, as might be the case with consolidation
shipments.
Export letter of credit. The flip side of an importer’s letter of credit. When
a letter of credit is opened by an importer in favor of an exporter and
received by the beneficiary exporter, it becomes an export letter of credit.
Fixed rate tariff. An import tax on the weight, measure, or volume of product
imported (e.g., $1.00 per pound on bulk items, $0.50 per foot on lumber, or
$10.00 per gallon of alcohol).
Foreign direct investment (FDI). A U.S. investment into other countries, with
the objective of owning partially or entirely an economic enterprise for the
purpose of establishing market share and generating revenue and profits that
can ultimately be transformed into stockholders’ dividends. Summarily, they
are made to grow a business.
Foreign exchange rate. Also called the foreign currency price and the cross-
border exchange rate, it is the price of one currency stated in terms of
another.
Foreign Sales Corporation Act (FSCA). A federal law that allows U.S. export¬
ers to exempt part of their export earnings from income taxes if their sales
are made by an FSCA-approved subsidiary located in an offshore possession
of the United States.
Forward foreign exchange rate. The price of a foreign currency quoted for
delivery at a future date.
Free trade zone (FTZ). A geographic area within the customs jurisdiction of
a country in which goods may be imported, warehoused, and processed.
Import taxes are levied on the final nature and description of the goods as
they leave the zone.
General Agreement on Tariffs and Trade (GATT). See World Trade Organization.
General average claim. A claim by a common carrier (ocean) against all
charter parties (shippers) on a specific voyage resulting from damage to the
vessel or from its loss.
Import letter of credit. A bank’s written promise to pay a fixed sum of money
on behalf of a company (foreign importer) to a beneficiaiy (an exporter) by
a certain date, subject to specific performance (show proof of shipment) by
the beneficiary. The importer’s bank (collecting bank) sends the letter of
credit to its correspondent bank (the exporter’s remitting bank), which then
forwards it to the exporter. Any letter of credit opened by an issuing bank
on behalf of an import buyer can be considered an import letter of credit.
Intangible assets. All the intellectual assets that protect a company’s goodwill
as reflected in the image and personality the firm conveys to the trade,
competitors, and customers. See also Goodwill; Intellectual assets.
Intellectual assets. The patents, trademarks, trade names, and copyrights that
identify goods and services as originating with a specific producer. This
means that no one else in a given jurisdiction may copy those intellectual
assets without the express permission of the owner. While infringements
272 International Business and Trade: Theory, Practice, and Policy
occur routinely in the United States, they are often more flagrant in many
other countries.
Joint venture. A highly structured and formal strategic alliance involving two
or more partners. Joint ventures vaiy in their flexibility and participation by
the stockholding partners. There can be two principal partners, each owning
50% of the voting common stock, or there can be several partners. The
protocol joint venture agreement can require an equal sharing of the enterprise’s
capitalization, or the partners may agree to another formula (e.g., one party
Glossary 273
provides technology and scarce resources, and the other(s) supplies labor,
management, land, and other assets).
Product liability. Liability incurred by a manufacturer and its agents when its
product causes damage to people and property when in use in the United
States or any other country.
Purchasing power parity theory. Based on Say’s law of “one price,” it sug¬
gests that differences in inflation rates among nations will impact currency
exchange rates. Summarily, between two trading partners, the one with the
higher relative rate of inflation will see its currency drop in value in the short
term against that of its trading partner.
Sight draft. In a sight draft shipment, shipping documents are released to the
buyer (drawee) upon payment of the draft. This term of payment is often
called D/P (documents against payment) or CAD (cash against documents).
It means that the importer’s bank will not release the shipping documents to
the importer until payment has been rendered.
Special drawing rights (SDRs). Created in 1969 and first circulated in 1970 by
the International Monetary Fund, they were intended to increase the liquidity
of trading nations. Inability of IMF member countries to agree on the alloca¬
tion system has prevented expansion in the use of SDRs.
Spot foreign exchange rate. The price of one currency stated in terms of
another quoted for immediate delivery.
Time draft. In a time draft shipment, shipping documents are released to the
buyer (drawee) upon the importer’s promise to pay the draft on a designated
future date. That date is stated on the face of the draft. This means that the
importer’s bank will release the shipping documents to the importer once the
draft has been accepted.
Trade bloc. A generic term for a free trade association or a customs union
through which member countries agree to establish a common tariff wall or
other restrictions against imports originating outside the trade bloc area.
MERCOSUR and the European Union are examples of successful emerging
trade blocs.
Trans-shipments. A practice by international carriers that involves off-loading
and reloading goods from a ship or airplane before it reaches its final
destination.
enue Service. The IRS’s current position seems to be that if the main reason
an individual or company establishes residency overseas is to take advantage
of a tax haven environment, its income generated through that jurisdiction
will be taxed as regular U.S. income under the worldwide income rule.
Value-added tax (VAT). An excise tax on the selling price of goods and
services. All sales taxes are by definition VATs. European Union countries
have among the highest VATs in the world. Import taxes based on a percent¬
age of an item’s invoiced value are sometimes also called VATs.
Warranty. A promise by the issuer that certain actions will result in other
predictable events (e.g., that a sewing machine will sew cloth, etc.). A product
warranty is a promise by a manufacturer that its product will perform as stated
in published literature. A warranty can be explicit or implicit (implied).
World Bank. Also known as the International Bank for Reconstruction and
Development, the World Bank is an international bank owned by its members
(about 180 nations), whose mission is to make long-term loans to developing
countries for economic development purposes.
Worldwide income rule. Under U.S. law, a resident of the United States must
pay U.S. federal income taxes on income earned in the United States as well
as on income earned anywhere else in the world, unless exceptions are
allowed by law or by international treaty.
'
Abbreviations and Acronyms
279
280 International Business and Trade: Theory, Practice, and Policy
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287
288 International Business and Trade: Theory, Practice, and Policy
Central banks, 43, 44, 45, 49, 53, 56, 57, Currency, 42, 49, 52, 53, 262
70 changes, 212
coordination with IMF, 48 convertibility, 138
monetary stability and, 46—47 defined, 67-73
Certificate of insurance, 128, 135 devaluation, 63
Certificate of origin, 128, 135 price changes, 46
Changes, 3 reserves, 72, 76
Check, 130, 142 stability, 259
CIF, 115, 121, 194 Currency futures, 72, 76
Clean collection, 129, 130, 135, 142 Currency of ultimate redemption, 48
Coca-Cola Company, 32, 106, 108, 157, Current account, 59-60, 259
164 Customs, 126, 212
“Coins of the realm," 43 Customs broker, 86-87, 88, 89
Colgate-Palmolive, 21, 31, 157 Customs union, 247, 263
Collecting bank, 128, 129, 130, 142, 144,
147, 149 Data verification, 140-141
Collection, 128-131 Dealer, 30, 31, 38, 101
types of, 142 Debt, 56
Collection process, 140, 144 Deficit, 57, 62-63
Commercial invoice, 126, 135 Delivered at frontier, 116
Commodity price changes, 46 Delivered duty paid, 117
Common carrier, 87-88, 89, 120, 127 Democracy, building, 239, 240
Common market, 246, 247, 264 Demographics, 3, 6-8
Communications, 11, 13 Design patent, 108, 164
Communism, 16, 25 Developed country, 13
Community, obligation to, 9-10 Developing country, 8, 10, 11, 12, 13
Compensation, 9 Direct exporting, 29-30, 38
Compensatory transaction, 57, 64, 65 Direct financing, 229
Consistency, 34 Direct loans, 226
Contract-filling operation, 32, 157 DISC, see Domestic international sales
Contract Loan Program, 236 corporation
Contract manufacturing, 20, 31-32, 38, Disclaimer, warranty, 99-101
157-160, 161 Disney, 108, 175
Contractual safeguards, 176 Distribution, 35
Copyright, 105, 106, 107, 110, 111, 163, Distributor, 20, 31-31, 38
164-165, 170 import, 96, 97
Corporate challenges, 12-13 warranty and, 101
Corporate responsibility, 9-10 Distributorship
Corporations agreement, 175
international business operations, see international, 93-94
International business operations Dividends, 37, 39, 181, 202, 221
organization and philosophy, 17-24 Documentary collection, 129, 130, 135, 142
Correspondent bank, 128, 129, 147, 149 Documentary draft, 132
Correspondent relationship, 87 Documentation, 125-128, 130, 135, 140,
Counterfeiting, 170 152, 148
Crate & Barrel, 184 Documents against acceptance, 132, 144
Credit, 11, 50, 138 Documents against payment, 132, 141, 144
Credit risk, 231 Dollar, U.S., see U.S. dollar
Cross-border currency prices, 67, 68 Domestic international sales corporation,
Cross rates, 76 217-218, 222
Index 289
Key Features
• Complete chapter-by-chapter summary at the
beginning of the book previews the topics covered
• Focus is on the practical aspects of conducting
global business
• Each chapter contains Summary and Conclusions,
Key Terms and Concepts, and Question and Answer
sections that complement and reinforce the concepts
discussed in the text
• Glossary of commonly used terms and expressions
helps readers with unfamiliar jargon
• Table of abbreviations and acronyms provides
quick reference
SLISSfi
ISBN 1-57444-155~fl
9781574441550
2016 02 0913:17
- -
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