. 1
( 3)



Leo Gough


I Fast track route to mastering global finance and macreconomics

I Covers the key areas of global finance, from the theory of

comparative advantage and the aims of the WTO/GATT to
multinational business and managing forex risk

I Examples and lessons from some of the world™s most successful
businesses, including Ford, NTT DoCoMo and Nestl©, and ideas
from the smartest thinkers, including Paul Romer, Milton
Friedman, J M Keynes, Paul Krugman and Alan Greenspan

I Includes a glossary of key concepts and a comprehensive
resources guide
Leo Gough

I Fast track route to mastering global finance and

I Covers the key areas of global finance, from the theory of
comparative advantage and the aims of the WTO/GATT to
multinational business and managing forex risk

I Examples and lessons from some of the world™s most
successful businesses, including Ford, NTT DoCoMo and
Nestl©, and ideas from the smartest thinkers, including Paul
Romer, Milton Friedman, J M Keynes, Paul Krugman and Alan

I Includes a glossary of key concepts and a comprehensive
resources guide
Copyright ™ Capstone Publishing 2002

The right of Leo Gough to be identi¬ed as the author of this work has been
asserted in accordance with the Copyright, Designs and Patents Act 1988

First published 2002 by
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This title is also available in print as ISBN 1-84112-203-3

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Introduction to
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Introduction to ExpressExec

05.02.01 Introduction 1
05.02.02 What is Global Finance? 5
05.02.03 Evolution of Global Finance 13
05.02.04 The E-Dimension 25
05.02.05 The Global Dimension 35
05.02.06 The State of the Art 45
05.02.07 In Practice: Global Success Stories 61
05.02.08 Key Concepts and Thinkers 77
05.02.09 Resources 91
05.02.10 Ten Steps to Making Global Finance Work 103

Frequently Asked Questions (FAQs)
Lower barriers to the ¬‚ow of goods, labor, and capital is bringing about
a globalization in ¬nance and business generally. This chapter considers
the causes of the process.

» The rationale for globalization.

˜˜Tariff: A scale of taxes on imports, designed to protect the
domestic producer against the greed of his consumer.™™
Ambrose Bierce1

In 1994 billionaire businessman the late Sir James Goldsmith published
a book called The Trap in which he argued that what is wrong with the
trend towards the greater internationalization of trade is that industries
in developing countries are paying lower wages than their competitors
in the West.2
People have been making this celebrated error, known as the
˜˜pauper labor™™ fallacy, for nearly two hundred years. What is curious
is that Goldsmith, a highly successful entrepreneur by any standards,
should be arguing against free trade in such terms.
As we will see throughout this book, the globalization process is
all about reducing barriers to the free movement of capital, goods,
and labor between all the countries of the world. Most governments
are, with some reservations, broadly in favor of the process, as are
most economists, because they believe that lowering these barriers will
boost world growth “ by co-operating, everyone will get richer. In this
view, richer countries need to be constantly moving into industries
where they have an advantage, such as high technology, allowing less
developed nations to develop and export. Low wages in a Third World
country, they say, are a function of low productivity in that country™s
industry. If that industry becomes highly productive, wage rates will
rise. Singapore and Japan, for example, today enjoy comparable wages
and living standards to the West because of their success in building
productive industries over the last 40 years.
Economic growth is not a zero-sum game. If Country A is rich, this
does not mean that Country B has to be poor. The more productive
the world is, the richer it gets as a whole “ and working to distribute
wealth to all people is part of the process of increasing productivity.
A way to make everyone richer? Why would any business person be
against the idea? Perhaps this is not as odd as it seems. Businesses are
primarily interested in their own pro¬ts. A company may be able to
make excellent pro¬ts in a country where everyone else is doing badly;
working for the general good is irrelevant to the central business goal.
Also, it takes decades, at least, for a country to become prosperous,

while businesses have to focus on making pro¬ts in a much shorter
This book is about how macroeconomic events are affecting busi-
nesses everywhere. Most of the time, companies must focus on
microeconomic issues “ events in their markets, their industries, their
supply chain, and so on. When the underlying structure of the world
economy changes, as it is today, companies have to take notice; the
opportunities are immense, but so are the dangers.
The availability of cheaper capital in the global markets, a reduction
in labor bargaining power, the rise of imports, the increase in cross-
border mergers and acquisitions, the opening up of huge markets such
as China and India, changes in public attitudes, demographic change,
and the e-revolution are just some of the factors in globalization. They
are not going to go away, and companies that ignore them or fail to
understand the underlying reasons why they are occurring, are being
acquired or going out of business.
In Europe, for instance, Siemens has reduced its operating divisions
from 15 to 5, as has Thyssen Krupp (from 23 to 8), Fiat™s Agnelli
family has sold 20% of the ¬rm to General Motors, Daimler-Chrysler has
purchased US company Chrysler and UK company Vodafone made the
¬rst hostile takeover ever to take place in Germany when it acquired
Everywhere you look in the world, globalization is having an effect.
It is probably having a ¬nancial impact on your company already. If
not, it soon will.

1 Bierce, A. (2000) The Unabridged Devil™s Dictionary. University of
Georgia Press.
2 Goldsmith, J. (1994) The Trap. Macmillan, London.
What is Global Finance?
This chapter introduces ¬ve basic concepts in global ¬nance and
examines the role of international business.
» Macroeconomics
» The theory of comparative advantage
» Growth
» Types of economic system
» Ways of classifying economies
» International business.

˜˜every individual . . . endeavors as much as he can . . . to direct
. . . industry so that its produce may be of the greatest value . . .
He intends only his own gain, and he is in this, as in many other
cases, led by an invisible hand to promote an end that was no part
of his intention . . . . By pursuing his own interest he frequently
promotes that of society more effectually than when he really
intends to promote it .™™
Adam Smith

In this chapter we will look at some commonly used ideas in macro-
economics and international business.

Macroeconomics is the study of whole economies, as opposed to
˜˜microeconomics,™™ which looks at how individual industries, house-
holds, and businesses function. While macroeconomics is a vital
concern of governments, it is also essential to businesses, espe-
cially those with operations overseas. Macroeconomic concerns, such
as currency exchange, in¬‚ation, unemployment levels, economic
development, and international trade, are a major element in success-
fully managing operations in a complex and ever-changing environ-

One of the most important ideas in economics is comparative advan-
tage, originally propounded by David Ricardo, a British economist and
politician of the early 1800s. The proposition is simply that nations,
societies, and members of those societies collectively bene¬t most by
specializing in what they do best, even if some parties are ˜˜absolutely™™
more ef¬cient producers than others.
To follow the argument, imagine two people, A and B, on a desert
island, who have only two jobs to do: collecting coconuts and ¬shing.
Assume that they agree that both items are of equal value “ 1 coconut
is worth 1 ¬sh. Person A is better than Person B at both tasks (see
Table 2.1).
The problem is to decide how A and B should spend their time.

Table 2.1 Productivity per day worked.

Coconuts Fish

Person A 20 20
Person B 10 16

A could tell B, ˜˜You are a bad worker, so stay out of my way and do
nothing.™™ The result of this would be a maximum production capacity
of either 20 coconuts or 20 ¬sh per day.
B may be a less productive worker, but he can still make a
contribution. To ¬nd the most productive way of dividing their
labor, they look at the ˜˜opportunity cost™™ of the alternatives (see

Table 2.2). FL
Table 2.2 Opportunity cost.

Produced Opportunity cost

When A collects coconuts 20 coconuts 20 ¬sh not caught
When B collects coconuts 10 coconuts 16 ¬sh not caught
When A catches ¬sh 20 ¬sh 20 coconuts not collected

When B catches ¬sh 16 ¬sh 10 coconuts not collected

A and B need both coconuts and ¬sh. If A catches ¬sh and B collects
coconuts, they will produce 20 ¬sh and 10 coconuts per day, but if A
collects coconuts and B catches ¬sh, they will produce 16 ¬sh and 20
Since they both agree that 1 coconut is worth 1 ¬sh, they will
collectively produce more units of value (36) if A collects coconuts and
B collects ¬sh than if they divide their labor the other way around (30
units of value).
In economic jargon, A has an ˜˜absolute™™ advantage in both coconut
and ¬sh production. B, however, has a ˜˜comparative™™ advantage in
producing ¬sh since he can produce 16 units of value per day for an
opportunity cost of only 10 units of value.

Every day we are exposed to the notion that growth is very important
and we could be forgiven for wondering why. While there may be
philosophical differences over the true value of growth (some people
may prefer to live simply, while others want everything they can get),
many misunderstandings arise because of confusion over the concept
of economic growth.
Economic growth is the increase in the total production output
of an economy. As long as output grows faster than the population,
the standard of living increases. Economic growth happens when an
economy either ¬nds new resources or when it ¬nds ways of producing
more using existing resources. Since the Industrial Revolution that
began around 250 years or so, much of the world has done both.
The population has increased dramatically (see Table 2.3), yet living
standards have, overall, gone up.

Table 2.3 Increasing agricultural production (corn and wheat) in the US:
1939“1995. (Source: US Department of Agriculture Statistics, 1992; Statistical
Abstract of the United States, 1996.)

Year Corn Wheat
Yield per Labor hours Yield per Labor hours
Acre (BU) per 100 BU Acre (BU) per 100 BU

1939 26.1 108 13.2 67
1949 36.1 53 16.9 34
1959 48.7 20 22.3 17
1969 78.5 7 27.5 11
1979 95.3 4 31.3 9
1985 107.2 3 36.9 7
1990 112.8 NA 38.0 NA
1995 120.6 NA 38.1 NA

In developed countries, agricultural productivity has greatly impro-
ved. For example, in the US, the productivity in corn and wheat have
grown massively since the 1930s, while the work needed to produce it
has dropped by over 90% (Fig. 2.1).



Billions of people

Modern Ages
Middle Ages
Bronze Age
Old Stone Age

Neolithic Age

Iron Age


Bubonic Plague



2-5 million 8000 7000 6000 5000 4000 3000 2000 1000 1 1000 2020
years B.C. B.C. B.C. B.C. B.C. B.C. B.C. B.C. A.D. A.D. A.D.

Fig. 2.1 World Population Growth.

This extraordinary improvement has been achieved by advances
in scienti¬c knowledge, farming equipment, and farming techniques,
none of which could have developed without the investment of money
and labor through successive generations.
Today, poorer countries face dif¬culties in achieving growth. Growth
comes in many ways, but the two most important drivers are techno-
logical advance and accumulating capital (in the sense of useful assets
such as roads, factories, and machinery). Both of these drivers require
investment, and poor countries have trouble in diverting resources
from producing essentials, such as food and clothing, into projects that
will create long-term growth.

In practice, most countries have a ˜˜mixed™™ economic system, where
there is both government involvement and a degree of freedom in the

markets. In their pure form, there are two extreme possibilities: the
command economy and the laissez-faire economy.
The command economy is controlled by a central government
that owns state enterprises, and sets production targets, prices, and
incomes. In recent years, command economies have not done well “ the
economies of the former USSR and Eastern Europe have collapsed
and undertaken a painful transition to a market economy with varying
degrees of success. While countries such as Poland have been recording
real growth since 1992, others, such as Albania and Romania, have not
enjoyed much foreign investment and remain in dire straits. China
has undertaken a series of reforms that have freed its markets dramat-
ically “ some cities in China, such as Shanghai, are capitalist boom
towns “ while retaining a large degree of government involvement.
The ˜˜pure™™ laissez-faire economy is where the government has no
participation at all. Individuals and companies buy, produce, and sell
as they wish, and the outcomes are a result of countless individual
decisions. Supporters of free market systems argue that they encourage
ef¬ciency, because an inef¬cient producer will be driven out by better
competitors, and that the consumers have great power because busi-
nesses will respond to their demands. Prices will adjust themselves
automatically as supply and demand ¬‚uctuates.
Laissez-faire has problems too, however. It can be demonstrated that
inef¬ciencies can and do exist. Without government involvement there
can be many injustices, and it is a feature of laissez-faire that there are
recurrent episodes of unemployment and in¬‚ation.
Although most economists agree that some government intervention
is desirable, there is a perennial debate about how, and how far, it
should go (see Chapter 8).

There are nearly 200 sovereign states in the world, each with its own
economy. The International Monetary Fund (IMF), the United Nations
(UN), and the World Bank all have different ways of classifying the
world™s economies, re¬‚ecting these organizations™ own agendas.
The most widely used system in business is the IMF™s, which classi¬es
nations into three groups:

» industrial economies: the 23 most industrialized countries, including
the US, Canada, Japan, Western Europe, Australia, and New Zealand;
» developing countries: some 130 nations in Latin America, Asia,
the Middle East, and Africa. Some countries in this group have
enjoyed substantial growth in recent years, so there is now a subcat-
egory of ˜˜newly industrializing countries™™ (NICs) including such
powerhouses as Hong Kong, Singapore, South Korea, and Taiwan;
» transitional economies: 28 countries of the former Soviet bloc that
are now trying to develop market economies.

International trade had always been important, but during the last
20 years countries have become markedly more interdependent. A
widespread restructuring of economies to adapt to freer trade and
capital movements, and in response to the collapse of the USSR, is
occurring. While this presents many new opportunities for business,
it is by no means certain that the process is irreversible. As we will
see throughout this book, there are many forces and issues that are
directly or indirectly resistant to globalization. Although some believe
that multinational companies (MNCs) are a major factor in driving
further globalization, others argue that MNCs are actually much more
closely tied to their countries of origin than is generally appreciated,
and that they tend to pursue national, rather than global, objectives
(see Chapter 9, The Myth of the Global Corporation). There are also
worries that globalization could increase the wealth gap between rich
and poor nations.

» While microeconomics looks at the ˜˜trees™™ of units such as
individual businesses and households, macroeconomics looks at
the ˜˜forest™™ of a whole economy.
» The theory of comparative advantage is the essential argument
for free trade “ it states that free trade bene¬ts all partners, even
those who are ˜˜absolutely™™ more ef¬cient.

» Economic growth is de¬ned as the increase in the total produc-
tion output of an economy.
» ˜˜Command™™ economies are run by the government, which sets
prices, production levels, and wages. In laissez-faire economies,
the government does not interfere in market processes. In
the real world, all countries have some degree of government
participation in their economies.
» The IMF groups countries into three economic categories:
1 industrialized (includes the US, Western Europe, and Japan);
2 developing (the rest of the world);
3 transitional (the ex-Soviet Bloc countries).
» International business has greatly increased over the last 20
years. ˜˜Globalization™™ is the great business issue of the day “ but
no-one knows how far it will go or how long it will last.
The Evolution of Global
How did we get here? From Adam Smith and David Ricardo to twentieth
century attempts to manage increasing economic complexity. How
multinationals evolved.
» The evolution of macroeconomics
» The evolution of multinationals
» The General Agreement on Tariffs and Trade (GATT) and the World
Trade Organization (WTO)
» GATT “ the Uruguay round
» The International Monetary System (IMS)
» Timeline: Key events in the development of global trade and ¬nance.

˜˜Without stable political foundations, markets collapse.™™
Doremus et al.1

The most important and long-lived controversy in macroeconomics is
the debate over free trade (see Chapter 8) “ how much, or little, should
governments interfere in business? In 1776 Adam Smith made the
then revolutionary claim that the market system, in which everybody
competes for sel¬sh gain, actually results in more bene¬ts for all people
than a directed system. His famous assertion, quoted at the beginning
of Chapter 2, that an individual working for their own gain is ˜˜led by
an invisible hand to promote an end that was no part of his intention,™™
has become one of chief tenets of market-based economies.
In the early 1800s, British landowners controlled Parliament; import
and export of grain had been controlled by the Corn Laws, a collection
of tariffs, subsidies, and restrictions intended to reduce imports, boost
exports, and keep the price of grain high. Newly wealthy factory
owners emerged wanting cheap food so that they could keep the
wages they paid low. The debate lasted for years, resulting in the
eventual repeal of the Corn Laws in 1848.
The British economist David Ricardo supported repeal and devel-
oped the argument for free trade that still remains the central point
today: that specialization and free trade will bene¬t all trading parties,
even when some are ˜˜absolutely™™ more ef¬cient producers than others.

Although the term ˜˜macroeconomics™™ was not coined until after the
Second World War, the Depression of the 1930s marks its birth as a prac-
tically applicable body of ideas. During the 1930s, international trade
slumped and there were rounds of ˜˜competitive™™ currency devalua-
tions as countries tried to make their export goods cheaper. Traditional
theorists believed that wages would drop to a level where there was
little unemployment, but for a decade unemployment across the world
remained high. John Maynard Keynes, a British academic, developed
a solution, arguing that what was needed was for governments to
intervene and stimulate overall demand.
Following the end of the Second World War, Keynes™ ideas gained
wide acceptance and governments increasingly used taxation, public

spending, and intervention in interest rate levels and the money supply
to try to manage their economies.
By the 1960s, con¬dence in governments™ ability to keep economies
stable was at its height; many people believed that it was possible to
˜˜¬ne tune™™ the economy to control variations in production output
and employment levels.
In the 1970s, following the oil crisis of 1973 when the OPEC oil-
producing nations dramatically increased prices, the developed nations
experienced wild ¬‚uctuations in in¬‚ation, unemployment, and produc-
tion output. The new phenomenon of ˜˜stag¬‚ation™™ appeared, where
a rapid price in¬‚ation combined with high unemployment “ prior to
the 1970s, in¬‚ation had only occurred during periods of prosperity and
low or declining unemployment.
By the 1980s, it was clear that ˜˜Keynesian™™ economics as generally
understood was not working effectively. Criticisms ranged from the
simple argument that government bureaucracies were not ef¬cient
enough to act quickly to more complex theoretical views that cast
doubt over whether monetary and ¬scal policies could actually affect
the overall economy at all.
Monetarism (see Chapter 8) generally favors a slow, steady increase
to the money supply in line with growth in output and is against
governments actively trying to in¬‚uence the economy by expanding the
money supply during bad times and slowing the growth in the money
supply during good times. In the 1970s, the debate between monetarist
and Keynesian approaches was a huge controversy as governments
struggled to cope with in¬‚ation and unemployment.
Two other macroeconomic approaches developed out of the chaos
of the 1970s, ˜˜new classical™™ economics and ˜˜supply-side™™ economics.
New classical economics suggests that people and businesses have
rational expectations about the economy and that government inter-
vention can have little effect on overall output “ it advocates very
little government intervention. Supply-side economics focuses on the
idea that heavy regulation and high taxation reduces incentives to be
productive (work, save, and invest). Deregulate and reduce tax, they
say, and the economy will expand. During Ronald Reagan™s presidency
in the 1980s, the US experimented with supply-side ideas. Did they
work? The jury is still out, with supply-siders pointing to the facts that

after tax cuts in 1981 the US recession ended, federal receipts rose
throughout the 1980s despite the tax cuts, and in¬‚ation fell during the
period. Opponents counter that the national debt increased by $2trn
between 1983 and 1992 and argue that higher tax rates would not have
dampened economic growth.
Today, there is still much disagreement over the competing macro-
economic theories. They are dif¬cult to test conclusively because there
is not enough data “ the half century since WWII is simply too short a
period of time. The different theories are also dif¬cult to standardize
in ways that allow them to be tested against one another. In short,
macroeconomics is still a young science and there is much left to learn.

Although multinationals appeared in the early 1800s it was not until the
1870s that MNCs developed in a form that we would recognize today.
Technological developments and organizational innovations allowed
the creation of vast global enterprises, most of which were based in
Europe. Some of these, such as British American Tobacco, Nestl´ and
Michelin, are still major corporations today. In the late nineteenth
century, these MNCs were principally focused on gaining control of
commodities in the colonies with which to supply products at home
and for export. They were not yet a major force on the business scene,
however, with much international business being dominated by cartels.
MNCs came into their own after WWII. US ¬rms entered foreign
markets in force, but concentrated mainly on developed countries,
rather than on the raw material producers of the prewar era. US MNCs
employed large numbers of skilled workers, advertised massively, and
had intensive R&D programs.
By the 1970s, MNCs began to change as Japanese and European
companies began to ¬‚ex their muscles. Japanese ¬rms began to
use newly industrialized countries (NICs) as ˜˜export platforms™™ for
their products while European companies entered the US market and
increased their ownership of US ¬rms. As a result of the rapid growth
of newly industrialized countries since 1980, a new generation of
multinational ¬rms have appeared in Asia (in particular, from Taiwan,
Singapore, Hong Kong, and South Korea) and to a lesser extent in Latin

Today, MNCs are major players in world business, with their foreign
af¬liates accounting for about a third of total world gross domestic
product (GDP).

GATT was originally signed in 1947 by 23 industrialized nations
including the US, the UK, France, and Canada. In 1995 it was succeeded
by the WTO. GATT has had eight rounds of international trade nego-
tiations, all aimed at reducing trade barriers. In the grim post-war
atmosphere of 1947, the average import tariff in industrialized coun-

tries was around 40%. Today it is around 5%. In the 1960s, the
˜˜Kennedy™™ round of GATT achieved an average cut of around 30%,
reducing manufacturers™ costs by about 10% by 1972. In the late 1970s,
the ˜˜Tokyo™™ round also achieved tariff cuts of approximately a third,
with greater cuts for trade between the most developed countries and

smaller cuts for trade between developed and newly industrialized
As well as addressing tariffs, GATT also tries to reduce trade
discrimination by insisting that any trade advantage given to one

member country must be given to all other members. Exceptions are
allowed for free trade areas and customs unions such as the European

The most recent completed round of multinational trade negotiations
began in Uruguay in 1986 and was ¬nally concluded in Geneva in 1993,
although the US did not approve it until 1994. It is the biggest and most
comprehensive trade agreement ever made, and its supporters claim
that it will increase the volume of international trade of merchandise
by 9“24% over what could otherwise be achieved.
The three most signi¬cant features of the Uruguay round are:

1 Tariffs and protections for agriculture are reduced. Historically,
agriculture has often been the most protected of industries. Uruguay

calls for an average reduction of agricultural tariffs on imports of
2 Uruguay bans restrictions on the import of services such as banking,
insurance, computer consulting, legal services, and accounting.
3 Increased protections for intellectual property. Local laws usually
protect domestic intellectual property, such as copyrights, patents,
and artistic works, but internationally ˜˜piracy™™ is common. Uruguay
requires its signatories to protect foreign owners of intellectual
property to the same degree as they protect their own.

A major criticism of GATT is that it lacks teeth; compliance is voluntary.
Developed countries have generally complied with GATT agreements,
but there have been numerous cases where some have not. A disagree-
ment between the EU and the US in the early 1990s over oilseed
subsidies resulted in the EU refusing to comply with some GATT
recommendations for several years and only capitulating when the US
threatened to impose tariffs in retaliation.
The WTO is intended to solve this problem by a streamlined disputes
system with binding arbitration; more than half of the disputes brought
so far have been between the US and the EU.

Gold had been used as a store of value for millennia, but by the
late nineteenth century world trade had increased so much that
there was a need for a more sophisticated system of a more formal-
ized system of settling international trade accounts. Countries began
to set their currency at a certain value relative to gold and the
˜˜gold standard™™ became the accepted international monetary system
within Western Europe in the 1870s, with the US adopting it in
It was a period of low in¬‚ation, and the ˜˜rules of the game™™
were clear. Every country set the rate at which its currency could be
converted to gold. For example, sterling was pegged at £4.2474 per
ounce of gold while the US dollar was pegged at $20.67 per ounce.
The pound/dollar exchange rate was therefore calculated as shown in

the equation below:

20.67/4.2474 = 4.8665
£1 = $4.8865

Each country promised to give anyone gold in return for its currency
on demand, so maintaining adequate reserves of gold was vital. A major
effect was to limit the rate of growth in the money supply to the rate
at which a country could acquire additional gold.

With the outbreak of the First World War, everything changed. The gold
standard was abandoned and currencies were allowed to ¬‚uctuate over
wide ranges. Speculation against weak currencies and in favor of strong
ones helped to cause exchanges rates to become far more volatile
than was justi¬ed by the ˜˜real™™ values of currencies; and companies
were unable to offset these changes in the forward exchange market
because it was then relatively thinly traded. In the inter-war years this
had the effect of preventing world trade from growing proportionately
with the growth of world gross national product (GNP). In the Great
Depression of the 1930s, world trade declined to very low levels.
By the mid-thirties, cash was no longer convertible to gold except
by central banks. With the outbreak of the Second World War, many
of the main trading currencies could not be exchanged for other
currencies and by the end of the war only the US dollar remained as an
easily-exchanged currency.

Bretton Woods 1944
The Allies of the Second World War met at Bretton Woods in New
Hampshire in 1944 to discuss how to create exchange rate stability
once the war had ended. Since the United States had become by far
the most powerful country in the world, it was agreed that the new
international monetary system would be based on the US dollar, with
every currency being given a ¬xed exchange rate to the dollar. The
system itself was tied to the US dollar at $33 to an ounce of gold.
The World Bank and the International Monetary Fund (IMF) were
created; the World Bank assisted reconstruction after the war and

subsequently provided aid for economic development, and the IMF
serves as a lender of last resort for central banks in countries that are
experiencing dif¬culties with exchange and balance of payments; its
principal purpose is to help keep the system relatively stable. During the
1990s, the IMF has played a signi¬cant role in assisting countries such as
Russia, Brazil, Mexico, Thailand, and South Korea during ¬nancial crises.

For nearly two decades, the dollar-based system worked well, as
countries worldwide struggled to rebuild their economies and world
trade grew rapidly.
If a country wished to change its exchange rate, it had to make a
formal announcement that it was revaluing, or devaluing, its currency.
In 1949, 28 countries devalued their currencies.
Bretton Woods set the stage for the rise of socialism. Countries
were able to pay for the huge cost of creating welfare states by issuing
bonds, which in turn encouraged in¬‚ation. As world trade mushroomed
and the economic balance between countries began to change, vast
funds grew up which were highly mobile and could be switched from
one country to another without the permission of governments. The
demand for gold was high, and the of¬cial price of $33 to an ounce
was undermined by the creation of secondary markets, where gold was
traded at much higher prices.
Large dollar funds developed outside the US, which created a lack
of con¬dence in the dollar/gold value. In 1971, the US gold reserves
were reduced by a third in the ¬rst seven months and President
Nixon suspended of¬cial gold transactions. This was, in effect, a
unilateral decision to abandon the Bretton Woods system and the
world™s currencies were allowed to ˜˜¬‚oat™™ in relation to the dollar.
By the end of the year, most of the major trading currencies had
appreciated against the dollar. A second dollar devaluation of the dollar
occurred in 1973 when it fell to $42.22 per ounce, a drop of 10%. By
June 1973 it had fallen by another 10%.

In a ¬‚oating exchange rate system, no currency is formally linked to any
other, or to gold. The rate at which you can exchange one currency

for another is simply the best rate that someone will give you, so
exchange rates are highly volatile. During the oil crises of 1973 and
1979, when OPEC dramatically increased the price of oil, the ¬‚oating
system helped to minimize the chaos as the strain was taken by an
adjustment in exchange rates (the OPEC countries™ currencies suddenly
became much more valuable), rather than by stopping real economic
Today, there are diverse ways of controlling exchange rates “ some
countries allow their currencies to ¬‚oat freely with the market, while
others ˜˜peg™™ their currency to ¬‚uctuate within a ¬xed range against
the dollar. Overall, the current system is best described as ˜˜managed
¬‚oating,™™ with nations™ central banks intervening in currency markets
occasionally to try to in¬‚uence their exchange rates.

» 1848: The protectionist Corn Laws repealed in Britain, a landmark
victory for free trade.
» 1870s: Multinational companies, such as Nestl´ and Michelin, deve-
lop to exploit new technical processes.
» 1914: The First World War forces countries to abandon the gold
standard. Exchange rates ¬‚uctuate wildly, to the detriment of world
» 1930s: The Great Depression “ mass unemployment and a dramatic
slowdown in international trade casts doubt on the idea that free
markets are fully self-adjusting. J.M. Keynes argues that governments
can stimulate economies by spending.
» 1944: The Allied powers meet at Bretton Woods to devise a system
for stabilizing exchange rates and promoting growth and trade. All
currencies are tied to the US dollar, and the IMF and World Bank are
» 1947: The GATT trade agreement, intended to reduce international
trade barriers, is signed by 23 nations.
» 1950s: American MNCs grow rapidly in developed foreign markets,
investing heavily in R&D and using sophisticated marketing methods.
» 1971: The US abandons the Bretton Woods system, and currencies
are allowed to ¬‚oat against one another.

» 1973: The OPEC oil cartel hikes the price of crude oil, throwing the
developed world into recession.
» 1970s: Stag¬‚ation (high in¬‚ation and unemployment) appears. Euro-
pean and Japanese ¬rms grow to become MNCs. Keynesian ideas are
challenged by monetarism.
» 1980s: New classical economics and supply-side economics increase
in in¬‚uence. Growth, especially in Asia, encourages a new generation
of MNCs to emerge from the newly industrialized countries (NICs).
» 1993: The Uruguay round of GATT is concluded.
» 1990s: Globalization and free markets are in the ascendancy, with
countries all around the world privatizing state-owned ¬rms and
reducing barriers to free capital ¬‚ows.
» 1995: GATT is succeeded by the World Trade Organization (WTO).
» 2000: A preliminary meeting of the WTO to discuss a new trade
round in Seattle collapses amid recriminations between devel-
oping countries, the US and the EC, while outside there are
violent protests. An anti-globalization movement gathers strength
(see Chapter 6).

The Industrial Revolution brought massive opportunities for
growth, and a ¬erce debate over the relative bene¬ts of free
trade versus protectionism developed that is still raging today.
The inability of governments to deal with the problems of the
Great Depression of the 1930s gave rise to Keynesianism, which
encourages state intervention to stimulate demand.
The end of WWII ushered in a new era of prosperity and
stability based on Keynesian principles and a new international
monetary system linked to the US dollar. GATT was established
to work towards lowering trade barriers around the world and to
encourage trade.
Since the 1950s, multinational companies have increased in
importance. Multinational companies ¬rst arose in America, then
in Europe and Japan, and ¬nally in the NICs such as South Korea.
Today, MNCs are major players in world business, with their

foreign af¬liates accounting for about a third of total world gross
domestic product (GDP).
Oil shocks, stag¬‚ation, and public sector inef¬ciencies in the
1970s gave rise to new approaches to managing the economy, in
particular monetarism, new classical economics, and supply-side
economics. Today, controversies still remain over which, if any,
of these approaches provide accurate models of how the world
really works.

1 Doremus, P.N., Keller, W.W., Pauly, L.W. & Reich, S. (1999) The Myth
of the Global Corporation. Princeton University Press, Princeton N.J.
The E-Dimension
Looking at the Internet as part of a continuum of IT advances. Ideas
about the effects of technological advance on growth. What™s new
about the New Economy?

» Is there really a New Economy?
» Best practice? Changes in the forex business.

˜˜. . . suppose that, for whatever reason, the market goes up month
after month; your MBA-honed intellect may say ˜Gosh, those P/Es
look pretty unreasonable™, but your prehistoric programming is
shrieking ˜˜Me want mammoth meat!™™ “ and those instincts are
hard to deny.™™
Paul Krugman, economist

IBM chief Lou Gerstner said in 1999 that the booming dot-com compa-
nies were just ˜˜¬re¬‚ies before the storm.™™ A real boom is coming, he
thinks, when ˜˜the thousands and thousands of institutions that exist
today seize the power of this global computing and communications
infrastructure and use it to transform themselves.™™
The Internet can be seen as part of a continuum of IT advances
that are leading to a networked world where the physical cost of
communications is virtually zero. This is likely to transform the supply
chains of big businesses, saving billions of dollars by slashing processing
costs, procurement cycles, and the prices of purchases. Major car
companies such as Ford and Chrysler are already claiming huge savings
through e-business. Ford™s parts division Visteon (now spun off as a
separate company) serves small dealers via the Internet, producing
large ef¬ciency gains. Ford is also developing business-to-consumer
e-applications that promise the public more personalized cars.
On the level of individual companies and industries, e-business
clearly offers opportunities to beat the competition through more
ef¬cient communications. But what will this mean overall during the
next two or three decades? One possibility is that it will accelerate
outsourcing so much that large companies will split up into loose
alliances of smaller units and independent knowledge workers.
A change in the way corporations are organized looks likely. What is
less clear is whether the elimination of the cost of communications will
really have a substantial effect on the growth rates of the developed
world “ as envisioned by the ˜˜New Economy™™ pundits.

Stanford economics professor Paul Romer (see Chapter 8) has an
amusing way of looking at the limits to growth: the total amount of
matter and energy in the universe remains the same, and what human

beings do when they produce things is rearrange some of that matter.
The better we get at ¬nding ˜˜recipes™™ for rearranging matter, the more
productive we are “ for example, by making previously worthless
silicon into silicon chips for computers.
Romer is optimistic about the potential for new discoveries to sustain
or increase growth rates in the future. He points to the recent discovery
of superconductive materials that may ultimately have economically
dramatic applications, and argues that just to evaluate all possible
unknown combinations of the known elements in the periodic table in
search of new ˜˜recipes™™ would take an unimaginably long time with
existing techniques. The scope for future discovery, therefore, is vast,
says Romer.
Paul Romer is a respected economist who is one of the authors of
˜˜New Growth Theory™™ which emphasizes the importance of knowl-
edge and discovery in the economy (see Chapter 8). Romer believes
that the per capita GDP is highest in the US now because the US
invested more than other countries in knowledge and discovery during
the twentieth century. In other words, the US is reaping the rewards
in growth terms for its investment in innovation.
So far, so good. The idea that technological innovation is economi-
cally very important is not new. In 1957, for instance, the economist
Robert Solow calculated that about 90% of the increase in per capita
GDP in the US in the ¬rst half of the twentieth century was due to
technological advances.
In the 1990s, however, enthusiasts began to claim that the extraor-
dinary success in the US of the knowledge industries (including
information technology, the Internet, biotechnology, and telecom-
munications) combined with international ¬nancial liberalization and
trade growth, were creating a ˜˜New Economic Paradigm.™™ In the
˜˜New Economy,™™ they said, US workers have become much more
productive, doubling the country™s potential growth rate and lowering
unemployment without a corresponding increase in in¬‚ation. Produc-
tivity growth has accelerated and the of¬cial statistics that do not
support this are failing to measure the New Economy accurately. Most
traditional economists think that measures of productivity have in any
case understated the improvement in living standards for more than a

In 1997, the US economy looked particularly good, with 4% GDP
growth (against an average of 2.4% annually over the previous two
decades), in¬‚ation under 2%, and unemployment at a 25-year low of
4.6%. Between 1995 and mid-1998, American households increased
their net worth from stock market gains of some $6trn. Since then,
the collapse of the dot-com stocks, a down-turn in the overall stock
market and a looming recession has called much of the New Economy
optimism into doubt. The rules of the ˜˜Old Economy™™ may not have
been repealed after all.
There can be little doubt that high-tech advances have brought
about productivity gains on a microeconomic level (see below), but
the New Economy rhetoric is making macro, not micro, claims. What
is remarkable about it is how rapidly the idea of a New Economy

has been taken up in business. Serious businesspeople have been
taking the New Economy seriously; why? On a micro level, it is not
hard to understand “ your business may or may not be able to gain
advantages by entering e-commerce, say, and at the very least you
need to understand what all the fuss is about. Most business is done

at the microeconomic level, so why should the New Economy™s macro
claims matter? The answer could be simply that it is good for business
con¬dence. The hope of increased growth is an attractive one; we all
like to feel that everything is getting better in a general way, and if our

customers, suppliers and investors think so too, so much the better.
In Chapter 4 of Finance Express (also in the ExpressExec series), the
potential microeconomic effects of the New Economy are discussed
in detail. Here we are examining the New Economy™s two principal
macroeconomic claims:

» that in the late 1990s the US economy, despite the low of¬cial ¬gures,
was actually experiencing high productivity growth;
» that expanding demand will not lead to in¬‚ation, even if unemploy-
ment is very low. Global competition will prevent US ¬rms from
raising their prices.

The ¬rst claim, of high productivity growth, looks a little shakier in late
2001 than it did during the late 1990s. The OECD latest provisional GDP
forecasts predict US growth of 1.1% for 2001 and 1.3% for 2002, with

similarly low ¬gures for other leading countries and actual shrinkage in
Japan: -0.7% for 2001 and ’0.8% for 2002.1
How unusually good was 1997? Not that unusual “ in 1983, for
instance, growth was almost 7% without a change in in¬‚ation, but
growth dropped to a lower rate over the next 10 years (an average
of 2.4%). The economy ¬‚uctuates, and there are sometimes short-
term increases in output, particularly following a period of underuse
of capacity. In 1982, the US economy was in recession, with high
unemployment, and 1983™s growth surge could be accounted for by
the process of taking up the slack in the labor force.
Economist Arthur Okun proposed the ˜˜law™™ that unemployment
decreases by 1% for every 3% increase in GDP. Although subsequent
research has shown that this relationship is less stable than he supposed,
as a rule of thumb it seems to demonstrate that the higher-than-average
growth in both 1983 and 1997 could be explained by the drops in
unemployment in those years (2.2% in 1983, 0.6% in 1997).
But why has in¬‚ation remained low? Until recently it was gener-
ally thought that if US unemployment fell below about 6% in¬‚ation
would rise as workers, knowing that they were in a seller™s market,
demanded higher wages. The answer could be that other factors
have helped to keep in¬‚ation low: the Asian ¬nancial crisis of 1997
reduced costs of imports to the US, for instance. It is possible that
the ˜˜sustainable™™ unemployment rate at a steady in¬‚ation rate has
dropped a little, perhaps due in part to a more ¬‚exible labor market
and a fear of downsizing. If the low in¬‚ation rate can be explained
by slow growth in wages and employee bene¬ts, it is not evidence
for the new invisible boom in productivity claimed by New Economy
While recognizing that such low in¬‚ation during a period of business
expansion was puzzling, Alan Greenspan, Chairman of the Federal
Reserve, had to this say about this issue in late 1998:

˜˜Some of those who advocate a ˜new economy™ attribute it
generally to technological innovations and breakthroughs in global-
ization that raise productivity and proffer new capacity on demand
and that have, accordingly, removed pricing power from the
world™s producers on a more lasting basis.

˜˜There is, clearly, an element of truth in this proposition. In
the United States, for example, a technologically driven decline is
evident in the average lead times on the purchase of new capital
equipment that has kept capacity utilization at moderate levels and
virtually eliminated most of the goods shortages and bottlenecks
that were prevalent in earlier periods of sustained strong economic
˜˜But . . . as the ¬rst cut at the question ˜˜Is there a new
economy?™™ the answer in a more profound sense is no. As in the
past, our advanced economy is primarily driven by how human
psychology molds the value system that drives a competitive
market economy.™™
Alan Greenspan2

Greenspan went on to argue that developed economies are always
changing and evolving, in general towards a more ef¬cient system “ we
have been upgrading and modernizing constantly since the start of the
Industrial Revolution. He agrees with the New Economists and others
that most of the growth in output has been created by the application
of new ideas, and suggests that our tendency to make things smaller
(transistors, microprocessors) may be linked to the increased costs of
processing more and more physical resources.
Like all scientists, economists tend to talk about probabilities,
not certainties. Greenspan and others think that it is probable that
there is no ˜˜New Economy™™ in any lasting sense. An excellent
period of growth does not necessarily mean that ¬‚uctuations in con¬-
dence, in¬‚ation, employment, investment, and so on have permanently

The world™s biggest ¬nancial market is foreign exchange, where an
estimated $1.5trn changes hands every day. The wholesale end of the
market, dominated by banks, has always been cut-throat. Currency
brokers and traders operate on tiny margins to execute customer
orders for foreign currency “ as little as 0.002% of the value of the

Banks have been using bespoke electronic networks for many years
for forex trading between themselves, which made them slower to
adopt the Internet than other ¬nancial markets, such as stocks and
bonds. Having their own network kept up their margins; corporate
customers would typically telephone their bank to ask for an exchange
rate quotation and there were limits to how far companies could
compare rates between different banks. Retail customers are even
further removed from the market, paying as much as 5% to purchase
small amounts of foreign currencies from banks and money changers,
with hotels often charging even higher rates.
Now the foreign exchange market is moving to the Internet. Major
US and European banks have formed consortiums to offer e-forex
services to companies. Chase, Citibank and Deutsche Bank (who
together control 28% of the global forex market) have partnered with
Reuters, the information services provider, to form Atriax. Another 70
second-tier banks have joined them. Atriax competes with FXalliance,
a consortium of 13 other major international banks that controls about
31% of the market, including Credit Suisse First Boston, Goldman, Sachs
Group, HSBC Holdings, JP Morgan, Morgan Stanley Dean Witter, and
UBS Warburg.
Philip Weisberg, of FXall, says that ˜˜the liquidity and market lead-
ership that will be provided by FXall™s member banks provide clients
with greater price transparency, tighter pricing, and quicker order
execution than is currently available of¬‚ine.™™
The new trading platforms bring this antiquated market into the
modern era. Atriax™s boss Dan Morehead said: ˜˜The [forex] industry is
fairly antiquated. People still make phone calls, scurrying from one bank
to another to get prices. The industry does not even have a centralized
marketplace, let alone an electronic one.™™ Celent, a banking consulting
¬rm, predicts that by 2004 at least 50% of all forex trading will be over
the Internet.
Widespread job losses have already occurred as telephone-based
˜˜barrow boy™™ forex traders ¬nd that their limited skills are no longer
required. Much online trading is automated, meaning the demise of the
majority of the back-of¬ce accounting staff as well.
Margins are likely to continue shrink as the disintermediation
process accelerates. Independently owned multi-bank sites, such as

Currenex.com, are offering new forex services to companies, such as
the ability to trade on their own. There are even schemes to offer retail
customers forex trading, such as OANDA.com.
Banks are under threat from these new competitors. The challenge
for them is to ¬nd innovative ways to keep the business for themselves.
One promising strategy is the cross-bank R&D alliances that are forming
to develop cutting-edge technology for e-banking services. By sharing
a ˜˜killer app™™ across the whole industry, banks might be able to fend
off outsiders in the long term.

» The Internet ˜˜disintermediates™™ (cuts out middle men) and
drives down prices because of ˜˜price transparency™™ (you can
compare prices more easily) and ef¬ciency gains.
» The physical cost of communications is dropping massively.
Large companies are enjoying major savings by putting their
supply chains online. Ultimately this could lead to a devolution of
companies into loose networks of small, independently owned
» ˜˜Knowledge,™™ in the sense of technological advances, is gener-
ally recognized to have been the main engine for growth in
developed countries during the twentieth century. The US,
Japan, and Europe are all roughly at the same level of techno-
logical development “ the US may be ahead in microprocessors,
for instance, but Europe is ahead in mobile telephony.
» A period of strong US growth in the 1990s fuelled by knowledge-
based industries gave rise to claims that there was a ˜˜New
Economy™™ or a ˜˜New Economic Paradigm™™ of accelerating
productivity growth without more in¬‚ation. Some argued that
the productivity of the new businesses were being underes-
timated in of¬cial growth ¬gures and that this was evidence
that the limit to US growth without unacceptable in¬‚ation had
changed. This argument is questioned by traditionalists who say
that standard productivity measures have always underestimated
productivity because no one has found a way to measure the
total effects of innovations (the car, antibiotics, etc.) “ we do

not know whether or how the unmeasured part of productivity
growth has changed.
» The idea that the US economy will grow faster in the future
than it has in the past is an attractive one to almost everyone
in business everywhere. Faster US growth suggests more sales,
more investment, more entrepreneurial opportunities, more
stock market ¬‚otations, and so on worldwide. The idea of the
New Economy spread rapidly, perhaps because it supplies a
rationale for business con¬dence about the future.
» The claim that productivity growth would continue to accelerate
inde¬nitely is challenged by a worldwide economic downturn
beginning in 2000/01. There seems to be little evidence that the
familiar phenomenon of economic booms and recessions has
ended. To judge whether knowledge industries really boosted
productivity growth starting in the 1990s, we will have to wait
several decades to see the overall trend.

1 Financial Times, October 19, 2001.
2 Alan Greenspan, speaking at the Haas Annual Business Faculty
Research Dialogue, University of California, Berkeley, California,
September 4, 1998.
The Global Dimension
The power of multinationals (MNCs) and the advantages of becoming
one, particularly in ¬nance. Governments™ attitudes towards MNCs.

» Variety in NIC companies “ the Ultraman battle
» Why become an MNC?
» MNCs vs governments
» Technology alliances
» The ¬nancing of MNCs
» Best practice: Novo.

˜˜If states are understood . . . as institutional structures or polities,
then the basic institutional structure of transnationals will be
in¬‚uenced or even determined by the institutional characteristics
of states.™™
Stephen Krasner1

The United Nations estimated in 1998 that there were 53,607 multi-
national corporations (MNCs) with some 448,917 af¬liated companies.
The total sales of foreign MNC af¬liates actually far exceed the world™s
exports and amount to around a third of total world GDP.
It is often said that the largest multinationals have GDPs bigger than
small countries; it™s true. In fact, half of the largest economic units in
the world are multinationals, not countries, measured by turnover or
GDP. Only 14 nations have larger GDPs than the largest MNCs (see
Table 5.1).

Table 5.1 The top 10 multinationals by foreign assets. (Source: UNCTAD,

Ranking by Country Currency Industry
Foreign Assets

1 General Electric US Electronics
2 Shell, Royal Dutch UK/Neth Petroleum
3 Ford Motor Company US Automotive
4 Exxon Corp US Petroleum
5 General Motors US Automotive
6 IBM US Computers
7 Toyota Japan Automotive
8 Volkswagen Group Germany Automotive
9 Mitsubishi Corp Japan Diversi¬ed
10 Mobile Corp US Petroleum

As we saw in Chapter 3, until the 1980s, most MNC activity occurred
in the developed countries, with around 50% of production occurring
in the US, UK, Canada, Germany, and Holland, but the dynamism of
the newly industrialized countries (NICs) has created a host of young

home-grown multinationals, particularly in Asia. Until the 1990s, the
world™s trade was dominated by North America and Europe, but East
Asia is now a powerful third force; together, the three trading areas
account for the vast majority of MNC activity, about 1/3 of world
exports and around 60% of manufacturing output.

Many Westerners tend to think of Asian business as almost wholly
based on heavy manufacturing and information technology, driven
by state-run central planning; but less earthy businesses are increas-
ingly common. As an illustration, here is an example of a recent
court battle between a Japanese and a Thai company over the
intellectual property rights for a cartoon character.
Ultraman, a popular cartoon character from Asia, originally
appeared in comics in the 1940s. A 1960s television series
featuring the superhero was sold widely across the world. In
2001, Tsuburaya Productions of Japan sued Chaiyo Production in
Thailand alleging unauthorized reproduction of Ultraman images
and claiming 100 million baht (£1.6mn) in damages. Chaiyo™s boss,
Sompote Sangduenchai, argued that he had originally proposed
the Ultraman character to Tsuburaya™s late founder, Eiji Tsuburaya,
and that it was inspired by images of traditional Thai buddhas. He
also claimed that Tsuburaya granted Chaiyo the rights to produce
Ultraman movies worldwide outside Japan in return for ¬nan-
cial assistance given in the early 1970s. The character has evolved
substantially over the years, and the case, Thailand™s highest pro¬le
intellectual property dispute of the year, revolves around the de¬-
nition of Ultraman “ Tsuburaya claims the present character was
not designed until 1966.

Although the largest MNCs are concentrated in the oil, automotive,
and electronics industries, MNCs overall are in a very wide variety
of businesses. Most economists think that the principal motive for

extending a company™s reach beyond its home ground is the search
for higher and/or more stable pro¬ts over the long term, either by
increasing sales or reducing costs.
Cost-focused MNCs tend to grow internationally by buying suppliers
(˜˜vertical integration™™) in the hope of cheaper raw materials or a more
secure supply. The classic example is the major oil companies who set
up long-term extraction arrangements around the world after the end
of the First World War to ensure their supply of crude oil. In the 1980s
and 1990s many manufacturers in the developed world set up assembly
plants in areas such as South-East Asia and China, often exporting
parts for assembly and then reimporting them into their own countries
for sale. The developing world offers an abundance of high quality
labor in countries that do not demand substantial additional payments
beyond wages paid for work done, unlike the developed world, where
non-wage elements (such as social security contributions) range from
50%“80% of the total in many countries.
Market-focused MNCs tend to spread ˜˜horizontally,™™ seeking new
markets in other regions. While long range forecasts are notoriously
inaccurate, many, including the World Bank, believe that by 2020
markets such as China and India will be larger than those of most
developed countries today (see Fig. 5.1), and many MNCs are seeking
to establish their presence in these promising areas.

The staggering scale of MNC operations causes unease amongst govern-
ments, particularly those of poorer nations, for a number of reasons.
One is the effect on the balance of payments. A foreign MNC may
bring capital into the country, in which case there is an initial gain,
or it may borrow or raise equity locally. Ultimately, however, the
MNC hopes to repatriate far more pro¬ts than the amount it invests,
negatively affecting the balance of payments.
Another dif¬culty is the so-called ˜˜Trojan Horse™™ effect. Western
European countries with high unemployment have tried to create jobs
by encouraging foreign multinationals to set up business. Ef¬cient MNCs
that have done so have been criticized because they have outcompeted
less ef¬cient domestic rivals, thus causing job losses. A variation on this
theme is some EU member states™ fears that non-EU MNCs invited into

Global Economic Growth:
1992-2020 (US=100%)
United States


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