<<

. 3
( 3)



The challenge is how to continue to grow in a highly competitive
business while acceding to the newer ideas on sustainable LDC
development. Like Ford, Nestl´ faces widely differing consumer
e
demands and regulatory requirements across the world, and any
change to packaging, product contents, or marketing strategy
requires considerable expenditure of resources.
» The company™s sales of breast milk substitutes in LDCs is said
to have declined, although the precise details are not known.
In a 1988 interview, a company spokesman was reported as
saying ˜˜infant formula in developing countries is now less than
1 percent of our consolidated sales. It would be very easy simply
to drop this matter, be rid of the controversy. Why don™t we do
it? Because we believe we ful¬ll a need.™™
05.02.08
Key Concepts and
Thinkers
A more detailed look at some essential concepts that are not widely
understood: the nature of the antagonism between protectionism and
free trade; Keynes™ contribution to managing the world™s economy and
more recent approaches; Alan Greenspan™s role in the US economy;
how productivity growth seems to be declining in the developed
world “ but it is hard to measure and involves many trade-offs; growth
in the future “ Paul Romer™s view.
» Glossary
» Protectionism versus free trade
» John Maynard Keynes (1883“1946)
» Monetarism and Milton Friedman
» Supply-side economics
» Alan Greenspan
» The productivity problem and growth
» Paul Romer: new growth theory.
78 GLOBAL FINANCE


˜˜An ˜acceptable™ level of unemployment means that the govern-
ment economist to whom it is acceptable still has a job.™™
Anonymous

GLOSSARY
Aggregate demand “ The total demand for goods and services in an
economy.
Aggregate income “ The total income of all production factors in a
given period. It is exactly equal to aggregate output.
Aggregate output “ The total amount of goods and services produced
or supplied in a given period.
Balance of trade “ The difference between a country™s exports and
imports.
Balance of payments “ The accounting record of a country™s trans-
actions with the rest of the world in goods, assets, and services;
also, the accounting record of its supply and demand for foreign
currencies.
Capital ¬‚ight “ The escape of ¬nancial and human capital from coun-
tries offering low rates of return.
Command economy “ An economy where central government sets
prices, wages, and production targets.
Comparative advantage “ There is much misunderstanding of this
key concept. It is the idea that everyone bene¬ts if each country
specializes in producing the goods that it can generate most ef¬-
ciently, relative to other countries, and imports those goods that
other countries produce most ef¬ciently. The USA produces some
food crops more ef¬ciently than China, while China produces
clothing more ef¬ciently. By selling these goods to one another,
they both gain. See Chapter 2.
Depression “ A severe and long-lasting recession (see ˜˜recession™™).
There is no consensus on precisely when a recession becomes a
depression.
Federal Reserve System (the Fed) “ The central bank in the US that
monitors and in¬‚uences the US money supply and interest rates.
GATT “ An international agreement on trade ¬rst signed in 1947.
Great Depression “ A period of severe unemployment and economic
contraction during the 1930s.
KEY CONCEPTS AND THINKERS 79


Gross Domestic Product (GDP) “ The total market value in a country
of all ¬nal goods and services produced by units located there.
Nominal GDP is the ¬gure in today™s money, while real GDP is the
in¬‚ation-adjusted ¬gure.
Gross National Product (GNP) “ The total market value in a country
of all ¬nal goods and services produced anywhere by units owned
by that county™s nationals.
In¬‚ation “ A general increase in prices.
International Monetary Fund (IMF) “ An agency that tries to stabi-
lize international currency exchange rates and lend to countries
having dif¬culty in ¬nancing their international transactions.
M1, M2 “ Measures of the money supply. M1 is the money that can be
used directly for transactions money, while M2 (also called ˜˜broad
money™™) is M1 plus savings accounts and other ˜˜near monies.™™
Real business cycle “ The idea that business cycles ¬‚uctuate according
to rational expectations and enjoy complete price and wage ¬‚exi-
bility.
Recession “ The conventional de¬nition is a drop in aggregate output
for two successive quarters or more.
Stag¬‚ation “ When in¬‚ation and high unemployment occur together
during a recession.
Tragedy of commons “ The idea that things that are owned collec-
tively by a group are not ef¬ciently used or maintained because
individuals do not bear the full cost of their actions. The name
comes from a problem in England in the 1700s, when some land
was held in common for the community. Individual farmers had an
incentive to overgraze common land to bene¬t their own animals,
but overall the community suffered because of the damage to the
land; no one had an incentive to care for the land.

PROTECTIONISM VERSUS FREE TRADE
The argument for free trade is essentially that each country should
specialize in producing the goods and service in which it has a compar-
ative advantage. If a trade barrier is imposed on imports, demand
may drop as consumers have to pay a higher price, and the country™s
production is less ef¬cient. Trade has potential bene¬ts for all nations.
Goods are not usually imported unless their net price is below that of
80 GLOBAL FINANCE


their domestic alternative. Two countries that sell to each other in this
way will bene¬t people in both nations, enabling them to consume
more goods while spending less.
The bene¬t of free trade is one of the few matters that most
economists agree upon. In practice, however, companies, industries,
and whole sections of society, together with the politicians who
represent them, often demand that their special interests should be
protected from foreign competition. A major drawback of protectionist
measures is the danger of retaliation “ for instance, in 1980 when the
UK imposed controls on imports of clothing from Indonesia (worth
about £10mn), Indonesia canceled a defense order worth £40mn and
reconsidered other UK import deals worth £350mn.
Another objection is that economic ef¬ciency, meaning producing




Y
things that people want at the lowest possible cost, is often ignored in
protectionist arguments.
FL
Nevertheless, there are sometimes grounds for selective protectionist
measures.
AM

» Protecting jobs “ foreign competition may cost local people their
jobs. Although these workers may be ultimately employed in other
industries that are expanding, there is a cost. People may have to
move to another part of the country to get work, and spend time and
money acquiring new skills. Those who are in the weakest position
TE



and ¬nd it dif¬cult to change may suffer hardship for many years.
» Unfair trade practices from foreign competitors “ while anti-trust
laws in the US prevent companies from monopolizing an industry
and engaging in ˜˜predatory™™ pricing, other countries, notably Japan,
have no such restrictions. In such cases, free trade clearly does
not mean the same thing to all trading partners. Many American
economists regard this as a legitimate argument for protection,
especially in the face of a powerful industry in a foreign country
behaving ˜˜strategically™™ in international trade. ˜˜Dumping™™ goods in
other countries at a price that is lower than the real production cost
is often seen as unfair, for instance by the US and the European
Community in relation to certain Japanese exports.
» Cheap foreign labor is unfair “ developed nations tend to have a
higher cost of living and pay higher wages than developing countries.
Manufacturers in high wage countries, for instance, may claim that
KEY CONCEPTS AND THINKERS 81


it is unfair that their competitors in, say, China, are able to produce
goods at a fraction of their own costs because of low wages.
» National defense and avoiding dependence on other nations “ in
the event of war, it may not be possible to import some products
and services from other nations. For instance, steel is regarded
as essential for national defense in the US. Any industry seeking
protection, however, tends to use the national defense argument,
so a question remains over which industries are truly essential to
national defense.
Weaker countries often argue that becoming over-reliant on a
larger trading partner for essential goods leads to the loss of polit-
ical independence; some protectionists claim that the superpowers
consciously create dependence in their small trading partners.
» Safeguarding new industries “ an industry that is just beginning in
a country may have the potential to develop a major competitive
advantage as it matures. Protection may legitimately be needed from
larger foreign industries to keep it alive in the early stages. However,
protecting a young industry that can never become ef¬cient is a
waste of resources (labor, capital, and raw materials) that could be
better used (see Chapter 6, Peruvian car manufacturing).

JOHN MAYNARD KEYNES (1883 “ 1946)
Much of macroeconomics is based on the work of the British economist
John Maynard Keynes, whose 1936 book, The General Theory of
Employment, Interest and Money, attempted to explain the problems
of the interwar slump in Britain and the Great Depression. Hitherto,
prices and wages were thought to be the key determinants of employ-
ment levels, but Keynes argued that aggregate demand for goods and
services and aggregate expenditure were actually the most impor-
tant factors and that governments should stimulate aggregate demand
during recessions (see Chapter 3). According to Keynes, the govern-
ment™s duty is to act as employer of last resort during recessions by,
for example, spending on large public projects, even if this causes a
government de¬cit. Keynes was also the ¬rst person to emphasize the
links between the money markets and goods markets.
The Roosevelt New Deal of the thirties was the ¬rst attempt to apply
Keynesian ideas to the problems of recession. Following WW2, many
82 GLOBAL FINANCE


countries took up the idea of government intervention with enthu-
siasm, and ˜˜Keynesian™™ economics came to mean active government
participation in the economy at all times. Keynes, in fact, was against
the high taxation levels required by a permanently large public sector,
but during post-war reconstruction the political arguments for state
involvement in production, such as the nationalization of industries,
became popular, particularly in Europe. The US, too, adopted aspects
of Keynesianism, believing that the state could successfully ˜˜¬ne tune™™
the economy to stabilize production output and employment levels.
The recession of the 1970s and 80s revealed problems with this
approach and there is now a general feeling that the neo-Keynesian
methods were not precise enough instruments to control an economy,
particularly during prosperous periods. Keynes himself, a polymath
intellectual with a penchant for currency speculation, might well have
been horri¬ed to see the way his ideas were applied after his death,
although he would no doubt have applauded the general increase in
living standards that has been achieved in developed countries since
the Second World War.

MONETARISM AND MILTON FRIEDMAN
Monetarism emerged as a response to the perceived ineffectiveness
of state intervention during the 1970s and 80s. To understand its
proposals, we need to examine the concept of the velocity of money.
Suppose A purchases goods from B for $100 in January. B may hold
the money until April before spending it with C, who holds it until
July when she spends it with D, who doesn™t spend the $100 until
December. The $100 has changed hands four times during the year, so
its ˜˜velocity™™ is 4.
In the real world, GDP is used (imperfectly) as a substitute for the
total value of transactions in an economy. The velocity of money is
calculated as the ratio of nominal GDP to the money supply. If the total
value of ¬nished goods and services produced in one year is $9trn and
the money supply is $1trn, the velocity of money is 9/1 = 9.
The quantity theory of money assumes that the velocity of money
remains virtually constant over time. If this is true, then changes in the
supply (stock) of money will be equal to changes in nominal GDP and
the demand for money does not depend on interest rates.
KEY CONCEPTS AND THINKERS 83


Monetarism is not a monolithic ideology, and there is little general
agreement amongst monetarists on de¬nitions, let alone on how its prin-
ciples should be applied. Almost everyone, including non-monetarists,
agrees that prolonged in¬‚ation is a purely monetary phenomenon.
In other words, in¬‚ation cannot go on inde¬nitely unless there is an
increase in the money supply, which is controlled or at least strongly
in¬‚uenced by a nation™s central bank.
Monetarist guru Milton Friedman (see Chapter 9) believes that
central banks should restrict themselves to keeping the money supply
growing in line with real output growth.


SUPPLY-SIDE ECONOMICS
The stag¬‚ation of the 1970s gave rise to the idea that the real problem
was that too much taxation and regulation was reducing incentives to
work, invest and save. The solution was therefore to stimulate supply
rather than demand, which had been the main focus of orthodox
approaches. Tax cuts would encourage both individuals and companies
to spend and invest, while lower regulations would help businesses
to grow. This would lead to an increase in the supply of labor, since
more people would want to work, or work harder, and there would be
more capital available for investment. Both in¬‚ation and unemployment
would fall.
The Laffer Curve (see Fig. 8.1) illustrates the argument for reducing
taxation.
According to Laffer, if the tax rate is 0%, then people will want to
work, but the government will receive no tax revenues. If the tax rate
is 100%, no one will want to work because all their income will go
to the government, so the government will still receive no revenues.
Since the curve is symmetrical, there are pairs of points (one on the
upper part of the curve and one on the lower, for instance A and B in
Figure 8.1) where tax revenues to the government will be equal, but
the lower part of the curve will relate to a higher supply of labor than
the upper part because the tax rate will be lower.
The ˜˜Reaganomics™™ of the 1980s brought in substantial tax cuts
in 1981 in an attempt to set rates on the lower part of the curve.
The US economy promptly came out of recession, in¬‚ation fell, and,
84 GLOBAL FINANCE

100
A
Tax Rate (%)




B

0
Tax Revenues

Fig. 8.1 The Laffer Curve “ a depiction of the idea that the size of the total
tax revenues varies with both the level of taxation and the consequent level of
willingness to work.

except for one year, tax revenues rose throughout the 1980s. Was this
a vindication of supply-side economics?
Some people think not. The reduction in in¬‚ation may have been
a delayed effect of the recession of 1980 and 1981. Tax cuts may
encourage people to feel that their ¬nancial needs are being met more
easily, so they can afford to work less rather than more “ in fact, some
studies in the 1980s found that the increase in labor supply was quite
small in the US.
Reaganomics claimed that the government could increase expen-
diture despite the tax cuts and still balance the budget. This did not
occur; the US government de¬cit increased by almost $2trn between
1983 and 1992.
The recovery that began in 1982 might be accounted for by the
effect that supply-side measures had on demand, and also because the
Fed increased the money supply by 20% between 1981 and 1983 and
interest rates dropped dramatically.

ALAN GREENSPAN
Alan Greenspan is the chairman of the Federal Reserve Board (the Fed),
the central bank of the USA. Most famous for his 1996 remark about the
KEY CONCEPTS AND THINKERS 85


possibility of ˜˜irrational exuberance™™ forcing stock market valuations
to unsustainably high levels, this soft-spoken Republican occasionally
attracts criticism for his cautious approach to managing US monetary
policy.
Greenspan ¬rst held public of¬ce under Nixon as director of policy
research in the late 1960s, and became chairman of the Fed in 1987,
a post he will hold until 2004. The fact that he has presided over
the Fed during four presidencies is a testament to his political as well
as economic shrewdness. His power to in¬‚uence the US economy
through short-term interest rates has made him the focus of attention
worldwide, leading him to choose his words carefully when making
public statements. His measured, calming approach has been applauded
by business people and politicians of all hues, although some object
to his view that ¬nancial markets should, as far as possible, be left to
respond to economic developments freely.
Greenspan believes (see Chapter 4) that the severe corporate down-
sizing of the 1980s and early 1990s have helped to dampen demands
for wage increases, thus keeping in¬‚ation low. The Fed, therefore,
has been able to afford to ease up on monetary restraints since
then. A strong advocate of de¬cit reduction, Greenspan has presided
over a period when the US de¬cit dropped, almost reaching zero in
1997.
Alan Greenspan is a ¬rm believer in the most conservative of all
virtues, saving. Throughout the stock market boom of the late 1990s,
he frequently aired his concerns that people were spending their stock
market gains because they regarded them as permanent increases to
their wealth. ˜˜We save too little,™™ he complains, arguing that domestic
investment still largely depends on domestic saving. The recent stock
market collapse lends credence to his views.

THE PRODUCTIVITY PROBLEM AND GROWTH
The New Economy argument (see Chapter 4) has largely been based on
the view that new high-tech businesses have found a way to increase
productivity in the US. To put this into context, we need to recall
the great productivity debate of the late 1970s and early 1980s. US
productivity has gradually declined since the 1960s, as it has done in
other developed countries.
86 GLOBAL FINANCE


Explanations for this vary, including the low rate of US saving,
less investment in R&D, investment diversion to energy saving, and
increased regulation. Much discussion revolved around the apparent
success of Japan compared with the US. By the 1990s, however,
Japan™s growth had dramatically slowed and attention shifted else-
where. Various long-term growth policies were attempted in the US
from the 1960s onwards that attempted to increase savings, stimulate
investment generally, encourage R&D, reduce regulations, and improve
education.


MEASURING PRODUCTIVITY
As we saw in Chapter 4, of¬cial productivity ¬gures are not thought
to be accurate. This is because it is very dif¬cult to measure the
effects of many products. For instance, it is easy enough to measure
the number of new PCs made, but it is much harder to accurately
measure the increased bene¬ts each new model, with its increased
memory and other features, gives to their users “ a lawyer might
save weeks of preparation by using a PC to research cases on
the Internet, and book production times have been drastically cut
through IT, yet this kind of saving of time is not measured by the
of¬cial data. Many economists argue that this problem has been
true since the late nineteenth century, and applies equally, if not
more so, to indirect productivity advances brought about by trains,
cars, airplanes, telephones, and so on.


There is little agreement over why the overall trend seems to be one of
declining productivity growth in most developed nations but it is clear
that there are political dif¬culties in adopting a sustained long-term
growth policy in a democracy. Such policies are likely to take many
years before they produce impressive results and may be expensive in
the mean time, making them vulnerable to criticism. Without general
support, politicians are likely to drop such policies in favor of measures
that engender short-term popularity.
There is not even a consensus that growth itself is a good thing.
Supporters of growth say that growth produces all kinds of desirable
bene¬ts including better health, longer life expectancy, more choice
KEY CONCEPTS AND THINKERS 87


in many areas of life, more and better goods “ in short, a better quality
of life for all. Anti-growth arguments focus on four main points.

1 Growth may actually reduce quality of life “ many lifestyles, such as
that of small farmers, become uneconomic as a country grows, and
some people regret their passing. Environmental damage, stress-¬lled
urban lives, pollution, and hazardous waste are just a few examples
of the undesirable effects of industrial growth. Many things that have
an effect on the quality of life cannot be traded and may disappear
because of growth “ simple pleasures may be lost to generations
devoted to an economic rat race.
2 Growth encourages inequity “ the rich save more than the poor, and
these savings are available for investment, a source of growth. Critics
of growth say that the have-nots in society are locked out of many
of the bene¬ts afforded by growth, yet must endure the worst of the
undesirable effects.
3 Growth will use up the world™s resources “ in the 1970s there was
much debate about this, stimulated by a group called the Club of
Rome that predicted dire consequences from continued growth.
Since the 1970s, governments and corporations have become more
sensitive to this issue; new resources have been found, more ef¬cient
technologies developed and conservation measures have been taken.
Most if not all major corporations now try to take an ˜˜eco-friendly™™
public relations position. As well as the predictors of doom, there
are also moderates who point to the rapid growth in the developing
world as a problem. In this view, the developing world may run
out of resources by the time they mature enough to need them for
internal consumption.
4 Growth creates arti¬cial dependency “ traditionally, consumers are
seen as ˜˜sovereign™™ in their desires, and markets merely supply what
is wanted. Some growth critics argue that sophisticated marketing
and consumer credit manipulate consumers into becoming perpetu-
ally indebted purchasers of useless items.
Sustained economic growth clearly implies trade-offs with what
might be called ˜˜well-being™™ and different nations ¬nd different
compromises between the two. Not many people in developed
countries would want growth at any price, but they may have the
luxury of choices that most people in LDCs do not enjoy. In poorer
88 GLOBAL FINANCE


countries, needs are often so basic and urgent that such a debate can
seem irrelevant.

PAUL ROMER: NEW GROWTH THEORY
Paul M. Romer, a Professor of Economics at Stanford University, is a
leading developer of ˜˜new growth theory,™™ which attempts to explain
the dynamics of wealth creation better. He argues that while classical
economic theory is good at explaining how extracting natural resources
works, it does not properly explain the ˜˜information economy.™™
Extracting natural resources such as oil from the earth is subject
to diminishing returns: as more oil is produced, there is less of it
left and extraction becomes more expensive. In the case of computer
software or biotechnology, however, there are large initial develop-
ment costs, but the costs of subsequent production are very small. For
example, once you have designed a bacterium to produce a desired
product “ say, insulin “ there is almost no limit to the amount you can
produce.
Classical economics sees labor and capital as the two inputs that
increase productivity (output) “ to increase production, you either
employ more workers or invest in better machinery. Romer argues
that technology and knowledge are also ˜˜inputs™™ “ new designs and
techniques can also increase productivity. In high-tech industries,
productivity has massively increased for decades while prices have
declined, the opposite of what happens with ¬nite resource extraction.
The more we invent and discover, the better we get at the process of
discovery, so our ability to create growth and value builds on itself,
says Romer.
Romer thinks that having an economy conducive to having and
applying ideas may be more important than having resources or capital.
Japan lacked resources and capital, for instance, but has achieved
astounding growth over the last 50 years. Romer comments:

˜˜The lesson from the Japanese experience is clear: mundane forms
of applied research, such as design work or product and process
engineering, can have large cumulative bene¬ts for the ¬rm that
undertakes them and even larger bene¬ts for society as a whole.
Moreover, the gains from applied research are largest not when it
KEY CONCEPTS AND THINKERS 89


is dictated by government agency priorities or academic interests,
but instead when it is closely integrated into the operations of a
¬rm and motivated by the problems and opportunities that the
¬rm faces.™™

On this view, the hope for LDCs lies in investing in education and
providing incentives to its people to acquire ideas from other parts
of the world, create their own, and apply those ideas commercially.
Effective patent and copyright protection, for instance, are powerful
incentives to the creation and transmission of ideas. Many LDCs have
suffered a ˜˜brain drain™™ as local talent has emigrated to the developed
world where there is more opportunity for ful¬lling ˜˜knowledge work.™™
Romer delights and offends both ardent free marketeers and protec-
tionists with his fresh approach. For example his views on what he calls
˜˜meta-ideas,™™ ideas about how to encourage the creation and distribu-
tion of useful ideas, suggest that developed nations should ¬nd new
institutions to support ˜˜a high level of applied, commercially-relevant
research in the private sector. These institutions must not impose high
ef¬ciency costs and, most important, must not be vulnerable to capture
by narrow interests.™™ This implies a combination of state intervention
with private enterprise.
Although still young (he is in his early 40s), Romer is widely tipped
for a Nobel Prize in economics, although skeptics say that more work
is needed on how to apply his theories. Intellectually rigorous and
cautious, Romer is nevertheless willing to make a ¬rm prediction “ that
the leading country in the twenty-¬rst century will be the one that ¬nds
a new and more effective way (a ˜˜meta-idea™™) of supporting private
sector production of commercially applicable ideas. Romer is certain
that such ways will be found.
05.02.09
Resources

Y
A look at some important books relating to the development of today™s
business environment. Useful Websites and further reading.
FL
» Big business in the economy
» Monetarism
AM

» International trade
» Technology and growth
» Internet resources
» Further reading.
TE
92 GLOBAL FINANCE


˜˜All models are wrong but some are useful.™™
George Box

This chapter contains a basic guide to some of the key Websites
and books to consult when beginning to get to grips with the global
economy.
Macroeconomic issues are easier to understand in hindsight; the
problem with topical coverage is that it tends to address unanswerable
questions about the future. For this reason, most of the books discussed
in detail here were written some time ago. Nevertheless, most of them
are classics and provide a valuable perspective on current debates.
With issues that are complex and dif¬cult to understand, novelty is not
always a virtue “ appreciating how we got here is an important part of
judging where we are likely to go next.

BIG BUSINESS IN THE ECONOMY
The Visible Hand: The Managerial Revolution in
American Business
This Pulitzer Prize winning book by Alfred D. Chandler Jr. analyzes
how large corporations developed to their current importance. He
argues that recognizably modern businesses developed when admin-
istrative co-ordination began to be more effective than market mech-
anisms in enhancing productivity and lowering costs, giving rise to
a management hierarchy. Management hierarchies came to be self-
perpetuating, expansionist, and increasingly professionalized. As a
separation between management and ownership developed, manage-
ment professionals tended to focus on long-term stability and growth
rather than short-term gains, and corporations grew larger, reaching
their position of whole branches of today™s economy. Written in 1977,
this book provides a good background to today™s issues regarding the
globalization of business.
» Chandler, A.D. Jr. (1977) The Visible Hand: The Managerial Revo-
lution in American Business. Harvard Belknap, Cambridge, MA.

The Myth of the Global Corporation
This 1999 book argues against the common view that multinationals
are more in¬‚uential in the global economy than governments, and that
RESOURCES 93


they are so ˜˜transnational™™ as to owe no allegiance to any nation.
The authors describe US, German, and Japanese ¬rms in particular,
showing that MNCs from these countries tend to pursue national objec-
tives and operate very different systems. For instance, MNCs from
different countries vary widely in the importance they give share-
holders, in their closeness to banks, in management accountability,
and in their exposure to international capital markets. A potential
strain between national ideas about corporate governance and global
pressures for standardization is discussed. Power is not shifting from
governments to supranational corporations, say the authors, but the
tendency for states to pursue nationalist policies in trade, technology,
and ¬nance could well bring about the eventual disintegration of the
global economy.

» Doremus, P.N., Keller, W.W., Pauly, L.W., Reich, S. (1999) The Myth
of the Global Corporation. Princeton University Press, Princeton.

MONETARISM
A Monetary History of the United States, 1867“1960
Arch-monetarist Milton Friedman and co-author Anna Jacobson Sch-
wartz™s 1963 book had a major impact on economic thinking in the US,
and is still one of the most frequently quoted texts in economics. Prior
to its publication, it was generally thought that having a government
monetary policy was ineffective and that the state should restrict itself
to keeping interest rates low enough to keep unemployment at an
acceptable level. Friedman established that the quantity of money is
controllable and strongly in¬‚uences the economy.
The book covers the Great Depression in much detail, arguing that
a better monetary policy could have greatly reduced the problems it
caused, notably at a crucial point in 1930/31 when a banking crisis
developed.
The book is accessible and highly readable, without equations in
the main text “ it is probably the best foundation for an understanding
of the genuine theoretical advances that monetarism has produced.
Money does not explain everything, nor does Friedman claim so; the
point is that the ¬‚ow and quantity of money has important, and to
some degree manageable, effects on the economy.
94 GLOBAL FINANCE


» Friedman, M. & Schwartz, A.J. (1963) A Monetary History of
the United States, 1867“1960. Princeton University Press (for the
National Bureau of Economic Research), Princeton.
INTERNATIONAL TRADE
Mercantilism
Controversial when it was ¬rst published in 1931 because of fears of
fascism, this book proposes that the success of the West over the last
500 years has been in large part due to mercantilism, a way of organizing
labor, business, and government to work for national prosperity by
promoting overseas trade. Pure laissez-faire is impossible, it suggests.
Overseas trade was the most effective way of generating taxable
revenues, increasing the strength of the state and thereby bene¬ting
the whole country, and from the 1500s to the 1700s, mercantilist
policies helped to build wealthy nation states out of chaotic feudalism.
In the nineteenth century, powerful European nations continued to
follow mercantilist policies, dominating the rest of the world both
economically and politically.
The twentieth century rise of competing ideologies that give greater
weight to labor (socialism, communism) or business (capitalism) than
to government made this book seem irrelevant, although much of
its historical analysis was generally accepted by critics. Today™s glob-
alization process has brought a changing and uncertain relationship
between the three economic elements (labor, business, and govern-
ment) and has revived interest in the book as people look for new ways
of organizing countries to create prosperity.
» Heckscher, E.F. (1931) Mercantilism. George Allen and Unwin,
London. Revised, second edition, edited by Ernst F. S¨ derlund,
o
1955, 2 volumes. (Originally published as Merkantilisment: Ett led
i den ekonomiska politikens historia. P.A. Norstedt and S¨ ner, o
Stockholm.)
TECHNOLOGY AND GROWTH
The Unbound Prometheus: Technological Change and
Industrial Development in Western Europe from
1750 to the Present
This classic work sheds much light on the newness or otherwise of
the New Economy debate. The author, David Landes, believes that the
RESOURCES 95


principal engine for development in Western Europe during the last
250 years has been technological advance, although he also examines
the important role of natural resources. In the latter part of the book
he focuses on wider macroeconomic issues after WW1, but continues
his argument that knowledge is portable and public, and that business
willingness to take the risks to acquire new knowledge was a key factor
in growth. He examines a multitude of industries in great detail to see
whether this idea applies. Much food for thought on the reasons why
the ef¬ciency gains of today™s information industries take so long to
show up in overall productivity rates.
» Landes, D.S. (1969) The Unbound Prometheus: Technological
Change and Industrial Development in Western Europe from
1750 to the Present. Cambridge University Press, Cambridge MA.

INTERNET RESOURCES
US Federal government
» http://www.census.gov/ Census Data: Population statistics “ US
Census Bureau.
» http://www.bls.gov/¬‚s/ International Labor Statistics: Bureau of
Labor Statistics™ site.
» http://www.cbo.gov/ The Congressional Budget Of¬ce: Source for
information on the ¬nances and programs of the US federal govern-
ment.
» http://www.cbpp.org/ Center on Budget and Policy Priorities: US
Federal government budget ¬gures.

Economists
» http://www.wws.princeton.edu/pkrugman/ Paul Krugman: A page
established and maintained by economist Paul Krugman to give
interested parties easy access to some of his more recent writings.
» http://www.stanford.edu/promer/ Paul Romer: Romer was the lead
developer of ˜˜new growth theory.™™

Statistical data
» http://www.economagic.com/ Economic Time Series Page: Econo-
magic has a database of over 100,000 economic time series. This is a
useful site for basic information on trends.
96 GLOBAL FINANCE


» http://www.geohive.com/index.html GeoHive: Statistics on the
human population.
» http://www.amstat.org/publications/jbes/index.html Journal of
Business & Economic Statistics: The Journal of Business and Eco-
nomic Statistics (JBES) publishes articles dealing with a broad range
of applied problems in business and economic statistics.

News magazines
» http://www.economist.com/ The Economist (of London): One of
the world™s best news magazines. News articles on global issues.
On-line articles on a variety of topics affecting economies across the
world.
» http://www.¬ndarticles.com/ FindArticles.com: FindArticles.com is
a large archive of published articles that you can search for free. It
contains articles dating back to 1998 from more than 300 magazines
and journals.

General economics
» http://www.nber.org/ National Bureau of Economic Research:
Nearly 500 NBER Working Papers are published each year, and
many subsequently appear in scholarly journals. Papers are available
in PDF format and the list is updated weekly.
» http://www.aeaweb.org/jep/ Journal of Economic Perspectives:
The Journal of Economic Perspectives (JEP) attempts to ¬ll a
gap between the general interest press and most other academic
economics journals.
» http://www.awlonline.com/parkin/econ100/ Michael Parkin: At
this Website, you™ll ¬nd a rich array of ˜˜learning tools™™ to boost
your understanding of economics.
» http://www.eh.net/ Economic History Resources: Created in 1993,
they provide several free electronic discussion lists to provide
resources and promote communication among scholars and students
in business history, economic history, the history of economics, and
related ¬elds.
» http://¬c.wharton.upenn.edu/¬c/w¬c/papers.html Wharton School
of Finance: The Wharton Financial Institutions Center provides
access to its many opinions and ˜˜meaningful insights™™ through the
site.
RESOURCES 97


Internet
» http://www.icannwatch.org/ ICANN Watch: ICANN Watch reports
on decisions and events at ICANN (The Internet Corporation for
Assigned Names and Numbers). The policies and decisions of this
organization affect how the Internet is governed. The site offers
commentary and criticism from a wide variety of sources, guided
only by the belief in the power of ideas and informed discussion and
debate to shape events and institutions.
» http://www.law.miami.edu/ Michael Froomkin™s Home Page: Mic-
hael Froomkin is a frequent contributor to ICANN Watch. Here you
will ¬nd additional articles and information on the Internet, the
economy and law topics.

Market-oriented
» http://www.msdw.com/gef/ Stephen Roach at Morgan Stanley:
Market-oriented articles on recent economic news.
Non-government organizations (NGOs)
» http://www.worldbank.org/research/growth World Bank Economic
Growth: The research branch of the World Bank tries to pull together
the relevant information about economic growth. This area lists
recent research and project reports.
» http://www-wds.worldbank.org/ World Development Sources:
World Development Sources (WDS) is a Web-based text search
and retrieval system which contains a collection of World Bank
reports most of which are scanned. Also included is the ASCII text
of the report generated from the image by OCR.
» http://www.imf.org/ International Monetary Fund: IMF maintains
an extensive list of reports for countries and regions on-line. Many of
the older papers are available for download in PDF format. Current
papers require payment.
» http://www.oecd.org/ OECD: Organization for Economic Co-opera-
tion and Development Publications and its statistics. Covers economic
and social issues from macroeconomics, to trade, education, devel-
opment, and science and innovation.
» http://www.un.org/ United Nations: The United Nations sponsors
many programs for social, political, and economic development. The
reports of these and other activities are available at this site.
98 GLOBAL FINANCE


» http://www.wto.org/ World Trade Organization/: The WTO Web-
site contains material for a range of users, from the general public to
students, academics, and trade specialists. It includes introductions
to WTO activities and a large database of of¬cial documents.
» http://www.wtowatch.org/ WTO Watch/: WTO Watch places copies
of news and WTO publications on their site. Sponsored by the
Institute for Agriculture and Trade Policy.

Regional trade and economic centers
» http://www.mac.doc.gov/nafta/ North American Free Trade Agree-
ment: One of the primary objectives of the Of¬ce of NAFTA
and Inter-American Affairs (ONIA) is to increase access to foreign
markets for US exports, through the elimination of tariff and non-
tariff barriers to trade. This site provides access to documents and
reports.
» http://www.aseansec.org/ Association of South East Asian Nations:
The site provides many links to historical and cultural information
and directories of businesses in the region.
» http://www.apecsec.org.sg/ Asia Paci¬c Economic Cooperation: A
group of 21 nations of the Paci¬c Rim. The site includes all of the
of¬cial statements from APEC ministers, economic reports on each
nation, tariffs, intellectual rights, and maintains a virtual library of all
APEC meetings.
» http://europa.eu.int/ European Union: Of¬cial site of the European
Union.

FURTHER READING
Agmon, T., Hawkins, R.G. & Levich, R.M. (eds) (1984) The Future of
the International Monetary System. Lexington Books, Lexington,
MA.
Aliber, R. (1987) The International Money Game, 5th edn. Basic
Books, New York.
Amihud, Y. & Levich, R. (eds) (1994) Exchange Rates and Corporate
Performance. Irwin, Burr Ridge, Ill.
Bergsten, C.F. & Graham, E.M. (1995) The Globalization of Industry
and National Governments. Institute for International Economics,
Washington.
RESOURCES 99


Brewer, T. (1985) Political Risks in International Business. Praeger,
New York.
Buckley, A. (1992) Multinational Finance, 2nd edn. Prentice Hall,
New York.
Chacoliades, M. (1970) ˜˜Increasing returns and the theory of compara-
tive advantage.™™ Southern Economic Journal.
Coffey, P. (1987) The European Monetary System, Past, Present and
Future, 2nd edn. Kluwer Academic Publishers, Dordrecht, Nether-
lands.
Dennett, D. (1995) Darwin™s Dangerous Idea: Evolution and the
Meanings of Life. Simon and Schuster, New York.
Dunning, J.H. (1993) The Globalization of Business. Routledge,
London.
Elfstrom, G. (1991) Moral Issues and Multinational Corporations. St.
Martin™s Press, New York.
Fallows, J. (1995) Looking at the Sun. Pantheon, New York.
Fleming, J.M. (1955) ˜˜External Economies and the Doctrine of Balanced
Growth.™™ Economic Journal, June.
Fujita, M., Krugman, P. & Venables, A. (1999) The spatial economy.
MIT Press, Cambridge.
Fukao, M. (1995) Financial Integration, Corporate Governance
and Performance of Multinational Companies. Brookings, Wash-
ington.
Greider, W. (1996) One World, Ready or Not. Simon and Schuster,
New York.
Grossman, G.M. & Rogoff, K. (eds) (1995“ ) Handbook of Interna-
tional Economics , Vol.3. Elsevier Science, Amsterdam.
Helpman, E. & Krugman, P. (1985) Market Structure and Foreign
Trade. MIT Press, Cambridge.
Hirschman, A. (1958) The Strategy of Economic Development. Yale
University Press, New Haven, Conn.
Krugman, P. (1991) ˜˜Increasing returns and economic geography.™™
Journal of Political Economy.
Krugman, P., (1994) ˜˜Does Third World growth hurt First World
prosperity?™™ Harvard Business Review, July.
Krugman, P. (1995) Development, Geography, and Economic Theory.
MIT Press, Cambridge.
100 GLOBAL FINANCE


Krugman, P. (1996) ˜˜How to be a crazy economist.™™ In: S. Medema and
W. Samuels (eds) Foundations of Research in Economics: How do
Economists do Economics? Edward Elgar, Brook¬eld, Vermont.
Krugman, P. & Obstfeld, M. (1994) International Economics: Theory
and Policy, 3rd edn. HarperCollins, New York.
Lall, S. et al. (1983) The New Multinationals. Wiley, New York.
Leibenstein, H. (1957) Economic Backwardness and Economic
Growth. Wiley, New York.
Lewis, W.A. (1954) Economic Development with Unlimited Supplies
of Labor. The Manchester School, 22.
Lewis, W.A. (1955) The Theory of Economic Growth. Allen and Unwin,
London.
Little, I., Scitovsky, T. & Scott, M. (1970) Industry and Trade in Some
Developing Countries. Oxford University Press, Oxford.
Milner, H. (1988) Resisting Protectionism. Princeton University Press,
Princeton.
Myrdal, G. (1957) Economic Theory and Under-developed Regions.
Duckworth, London.
Nelson, R. (1956) ˜˜A Theory of the Low Level Equilibrium Trap in
Underdeveloped Economies.™™ American Economic Review, May.
Ohlin, B. (1933) Interregional and International Trade. Harvard
University Press, Cambridge.
Oxelheim, L. (1993) The Global Race for Foreign Direct Investment:
Prospects for the Future. Springer-Verlag, Berlin.
Penrose, R. (1989) The Emperor™s New Mind. Oxford, New York.
Porter, M. (1990) The Competitive Advantage of Nations. Free Press,
New York.
Romer, P, (1991) ˜˜Increasing Returns and New Development in the
Theory of Growth.™™ In: W. Barnett et al. (eds) Equilibrium Theory
and Applications: Proceedings of the 6th International Symposium
in Economic Theory and Econometrics.
Rosenberg, N. (1982) Inside the Black Box: Technology and Eco-
nomics. Cambridge University Press, Cambridge.
Scitovsky, T. (1954) ˜˜Two Concepts of External Economies.™™ Journal
of Political Economy, 144“51.
Smith, R.C. & Ingo, W. (1990) Global Financial Services. Harper and
Row, New York.
RESOURCES 101


Utriu, R. (1996) Troubled Industries. Cornell University Press, Ithaca.
Wells, L. (1983) Third World Multinationals. MIT Press, Cambridge.
Yof¬e, D. (ed.) (1995) Beyond Free Trade. Harvard Business School
Press, Boston.
Yoshino, M. & Rangan, U.S. (1995) Strategic Alliances. Harvard Business
School Press, Boston.




Y
FL
AM
TE
05.02.10
Ten Steps to Making
Global Finance Work
This chapter presents some of the key opportunities, techniques, and
survival strategy in the global economy, including:

» new markets in the developing world
» Europe
» accessing capital markets
» managing forex risk versus speculation
» Foreign Direct Investment (FDI) and the alternatives.
104 GLOBAL FINANCE


˜˜Achieving free trade is like getting to heaven. Everyone wants to
get there, but not too soon.™™
Anonymous

1. NEW MARKETS IN THE DEVELOPING WORLD
As we have seen, the recipe for future prosperity in the developing
world is complex and controversial. Nevertheless, the globalization
process has opened up certain countries, promising a substantial long-
term boost to world growth and creating opportunities for companies
to expand out of their own maturing markets.


OPPORTUNITY IN CHINA
Until 1979 China was a closed economy. Since then, it has modern-
ized rapidly, largely because of its massively improved trade and
investment relations with the rest of the world.
By 2020, China could displace Japan to become the largest
trading nation in the world after the US, potentially generating
substantial growth both for itself and its trading partners. Progress
depends on factors such as joining the WTO (with a conse-
quent further reduction in trade barriers) and sustaining foreign
investment by major reforms in its ¬nancial system. In the face
of problems, foreign investment can disappear as quickly as it
arrives, so China™s rulers face a major challenge in macroeconomic
management in the medium term.
The World Bank estimates that by 2020, China™s market share of
the world export market for clothing will reduce as it moves up
the value chain into light manufacturing and transport, machinery,
and equipment. Exports from North America, Europe, and Japan to
China are expected to rise by 6.5% annually until 2020, mainly in
knowledge- and capital-intensive goods and services, but also
in food, where North America has a comparative advantage.
China™s growth, therefore, is expected to bene¬t the developed
nations. While South-East Asian countries are fearful that China
will undercut them in many industries, they are likely to enjoy net
gains overall, according to the World Bank.
TEN STEPS TO MAKING GLOBAL FINANCE WORK 105


2. COPING WITH RECESSIONS
The conventional de¬nition of a recession is a period when aggre-
gate output declines for two consecutive quarters. They occur quite
frequently “ the US, for instance, experienced seven recessions in addi-
tion to the Great Depression during the twentieth century. They do
not necessarily occur in tandem around the world. It is reasonable
to assume that they will continue to occur periodically, so any busi-
ness must have a strategy for recession survival. Some economists
argue that recessions are good for the economy because they drive
inef¬cient ¬rms out of business and force all ¬rms to cut waste
and use their resources better. Acting quickly to cut costs is likely
to be effective once it is clear that that a recession is underway;
assuming that growth will be permanently uninterrupted is likely to be
fatal.


OIL PRICES AND THE GLOBAL ECONOMY
When OPEC raised oil prices in the 1970s it caused chaos in
many economies that led to stag¬‚ation and a considerable transfer
of wealth from oil-consuming to oil-producing nations. Could it
happen again?
In the late 1990s, there was concern that oil prices had roughly
tripled in less than two years, but it is unlikely that the global
economy will be affected as severely as it was in the 1970s. For
one thing, there was a sharp price drop in 1977 and most of
the subsequent price increases were simply a return to previous
levels. More importantly, the world learned from its mistakes;
the developed countries have shifted substantially towards less
energy-intensive technologies and use oil much more ef¬ciently.
Even large price hikes in oil are unlikely to affect their economies
seriously. Developing countries, however, are intense energy users
and are much more vulnerable.
Much depends on the strategy of the oil exporters, many of
whom have ¬scal and current account de¬cits and have been
postponing infrastructure projects. If they spend the money gained
from increased oil prices on these projects, it will be recycled back
106 GLOBAL FINANCE



to the rest of the world rather than being stored as foreign currency
reserves, as it was in the 1970s.


3. MANAGING PEOPLE IN THE KNOWLEDGE
ECONOMY
While no one knows whether knowledge-based industries will perma-
nently boost GDP growth in the rich countries, they are replacing
manufacturing as the most important businesses. Management guru
Peter Drucker believes that knowledge will soon become the key
resource in the developed world. With an aging but healthy popula-
tion, rich countries will expect people to work an extra ten years, into
their seventies, he says.
Not everyone will be a winner, even amongst knowledge workers
themselves. While some people may prosper as independent consul-
tants or on short-term contracts, others are likely to ¬nd the expected
move away from full-time, job-for-life employment dif¬cult. ˜˜Knowl-
edge technicians,™™ highly educated workers in areas such as IT, medical
laboratories, and engineering, may not be particularly well paid. They
are predicted to become the fastest growing group, replacing the
skilled manual workers of today in numbers and, possibly, negotiating
power.
This has important implications for human resource management.
How will companies keep their knowledge workers? Recently in the US
the trend has been to offer stock options and earnings-related bonuses.
Drucker claims that this ˜˜always fails™™ and suggests that a better way
will be:
» to allow greater autonomy in making decisions;
» to take an inclusive approach to company goals and strategy;
» to ensure that people are given appropriate tasks; and
» to provide continuous training

4. EUROPE
As the world™s largest trading bloc, with 40% of world trade, the Euro-
pean Union cannot be ignored. It represents a substantially different
TEN STEPS TO MAKING GLOBAL FINANCE WORK 107


form of capitalism to the US model and although stock market capi-
talism has helped to galvanize many EU ¬rms, a complete adoption of
the ˜˜Anglo-Saxon™™ business norm is unlikely.
The EU™s reason for existence is primarily strategic, to provide
security and prosperity both within its own borders and in the countries
to the east. Plans for enlargement have aroused little opposition in the
rest of the world, perhaps, some say, because the EU is unlikely to
become united enough to project political power as a single entity, but
is seen as a positive force for prosperity and growth.
Protectionist policies are common within the EU, between member
states (despite regulations to the contrary) as well as with the outside
world. EU ¬rms are trying to streamline themselves, but tough labor
protection laws are likely to hamper ef¬ciency. US-style peremptory
¬ring of staff is unacceptable.
The diversity of Europe™s members means that different countries
want different things out of the union. For example, some countries
like Britain and Denmark have so far stayed out of the single currency.
Enlargement will add to the pressures against tighter federalization.
One solution that may emerge is that the EU becomes a collection
of overlapping deals between member states, where some choose to
co-operate together closely on certain issues while opting out of others.
Markets may continue to become freer in Europe, but they are unlikely
ever to approach a pure state of laissez-faire, even internally.

5. GLOBALIZATION AND THE WTO
Globalization is not as far advanced as many people seem to think. The
world is only very partially integrated. The GATT/WTO process, aimed
at lowering trade barriers around the world in order to raise economic
growth, has achieved much but has taken more than half a century to
do so. The vocal anti-globalization backlash has got it wrong in so far as
it claims that globalization hurts the poor; it actually helps them, and
most developing nations want freer trade.
Businesses need to be aware of changing public attitudes, and today
most large companies emphasize their commitment to values such
as environmentalism, consumer protection, and energy conservation.
Faced with the tough disclosure rules for public companies, ˜˜green™™
legislation and consumers™ power to in¬‚uence politicians, companies
108 GLOBAL FINANCE


are paying more than lip service to these values “ many companies
publish detailed information on their efforts to reduce waste of raw
materials, for instance.
Globalization may be good for business generally, but is it good for
your business? Some ¬rms might prefer to enjoy a monopoly rather
than struggle with competitors in a fast changing world. New markets,
freer trade, and capital ¬‚ows only offer opportunities to companies that
are ef¬cient, ¬‚exible, and innovative.

6. ACCESSING CAPITAL MARKETS
Entrepreneurs dream of successfully ¬‚oating their companies on a
major stock market. Not only will it make them, the prior owners,
rich, but it also offers a very large supply of capital for growth. A
small private business may be dynamic and have many opportunities
to expand, but it cannot sell corporate bonds (a ¬xed rate loan) easily
or issue shares to the general public. It must seek ¬nance from banks,
venture capitalists, or private investors, which limits the amount it
can borrow and is more expensive. Even large ¬rms in countries with
˜˜segmented™™ capital markets suffer from this problem.
Going public on a major market is not easy. The ¬rm must usually
have a good track record, although recently the rules have been relaxed
for certain dynamic industries, such as IT and biotechnology, to allow
the ¬‚otation of start-ups.
To access the global capital markets, a company needs to:

» establish and maintain good relations with institutional investors and,
eventually, the public;
» conform to very exacting standards of information disclosure, which
is costly; and
» consider starting slowly by issuing corporate bonds to create and
encourage investor con¬dence.


7. MANAGING FOREX RISK
The world™s currency system is broadly one of ˜˜managed ¬‚oating™™
driven by market forces. Many countries™ currencies, however, are
traded in extremely thin and highly regulated markets, throwing doubt
TEN STEPS TO MAKING GLOBAL FINANCE WORK 109


on the of¬cial rate of exchange. It is sometimes very dif¬cult for a
company even to obtain a quotation for these currencies from forex
dealers.
If your company does business in a foreign country, it is exposed to
three main exchange rate risks.

» Transaction risk: the chance that the exchange rate changes after
you have bought or supplied goods and services at an agreed price.
This also applies to lending and borrowing abroad.
» Operating risk: your business in a foreign country may be going well,
but if there is a crisis (such as the Asian currency crisis of 1997), it
will negatively affect your expected future cash ¬‚ows there. One way
to mitigate this is to borrow money in that currency and use your
sales income to service the debt “ this is called ˜˜natural hedging.™™
There are many variations on this approach, such as ˜˜back to back™™
loans, where two companies in different countries lend each other
equal amounts in their own currency to be repaid at the same time.
» Accounting risk: US listed companies, for instance, must restate
their foreign subsidiaries™ accounts in US dollars when preparing
their group ¬nancial statements. There is a risk that a change in the
exchange rate could affect the parent™s published ¬gures. A ˜˜balance
sheet™™ hedge avoids this by balancing foreign currency assets and
liabilities. You can almost never have a balance sheet hedge and a
hedge against transaction risk at the same time; faced with a choice,
managers tend to prefer to hedge against transaction risk (real cash
losses).

Managing forex exposure is a specialized ¬eld. A long run of gains in
forex dealing can tempt companies to think of their forex managers as
a pro¬t center. Continuous selective hedging is essentially increasing
risk through speculation rather than trying to reduce it. Firms rarely
admit this.

8. FOREIGN DIRECT INVESTMENT (FDI)
If your ¬rm wants to invest abroad, it must have a competitive advantage
in its home market, such as management expertise, economies of scale,
¬nancial strength, differentiated products, or better technology. The
110 GLOBAL FINANCE


advantage must be speci¬c to your ¬rm and it should be transferable to
the foreign market.
Before embarking on an FDI, de¬ned as creating a wholly- or partly-
owned foreign subsidiary, consider the other options, which may be
less risky.

» Exporting: Selling to foreign agents and distributors. The least risky,
but least pro¬table, method.
» A strategic alliance: Many EU ¬rms are swapping shares and entering
into joint ventures with other European companies as a way of
pooling resources and protecting themselves against competitors.
» Licensing and management contracts: Licensing technology or
˜˜lending™™ managers to a foreign ¬rm.

FDI is a much more risky and expensive option. It should only be under-
taken where the potential rewards outweigh the risks “ for example, if
your company will dominate the foreign market.


9. VALUING FOREIGN ACQUISITIONS
Buying a foreign company is often a better way of entering a foreign
market than starting from scratch. It is quicker, eliminates some local
competition (they™re working for you now), and companies are some-
times available at bargain prices.
As with all acquisitions, the great danger is in paying too much.
Buying a foreign ¬rm in a developing country is likely to be costly in
terms of due diligence, and the likely actions of the host government
need to be fully understood. The acquiring company also needs to be
sensitive to how it is perceived by local people. Don™t assume that
US-style market capitalism works the same way in developing nations.


10. MNC INTERNATIONAL PORTFOLIOS
Investment theory tells us that you can reduce risk by diversifying
across several investments in different sectors. This idea can be applied
to MNCs too, because the returns on operations in different countries
vary and do not normally ¬‚uctuate in tandem. In other words, when
some countries are doing poorly, other countries may be doing well,
TEN STEPS TO MAKING GLOBAL FINANCE WORK 111


although there appears to be a trend towards closer correlation of
returns.
Calculating the optimal weighting of the ˜˜portfolio™™ of an MNC™s
businesses is abstruse and based on assumptions that may not prove to
be accurate. It can, however, be a useful way of looking at an MNC™s
overall strategy to answer questions like: ˜˜Suppose risks suddenly
increase in China “ should we reduce our investments there and
increase them in Brazil? How might that affect our overall returns?™™


KEY LEARNING POINTS
1 Countries are opening up their markets around the world. China
and India, with their vast populations, are predicted to become
major trading nations by 2020. Look for ways to take advantage
of these new opportunities.
2 In the 1990s excitement about the booming tech stocks led
some companies to behave as if recessions were a thing of the
past. Don™t make that mistake “ make sure you have a plan of
action in place to respond effectively to downturns.
3 ˜˜Knowledge workers™™ are different from the skilled manufac-
turing workers of the past. They are more mobile and require
more autonomy, training, and participation in strategy. Is your
company winning the loyalty of its knowledge workers?
4 If your ¬rm is in Europe, it may have trouble seeing the wood
for the trees. Freer trade and the prospect of enlargement are
creating great uncertainty. Take the trouble to research the
issues and try to gain an overall perspective on trends.
5 The anti-globalization movement is a sign of the power of
consumers. Are your company™s policies in line with the atti-
tudes of people in your markets? Are you publicizing and
explaining your policies in a way that people can understand?
6 Is your ¬rm taking full advantage of the global capital markets?
Investors in different countries perceive risks differently “ you
may need to look abroad for the cheapest capital in the amount
you require.
7 Foreign trade implies forex risk. Is your company claiming to
reduce the risks by hedging while actually increasing them?
112 GLOBAL FINANCE



8 FDI is the most costly and riskiest method of foreign trade, but
offers the most rewards in some cases. FDI only works if you
have a transferable competitive advantage. Most ¬rms start out
by exporting before making heavier commitments.
9 Buying a foreign ¬rm can be the cheapest and most cost-effective
way of direct investment into a foreign market (FDI). Make sure
you don™t pay too much and that you fully understand how the
host government will behave. How will you get local customers
on your side?
10 MNCs are judged by their consolidated returns, which may
¬‚uctuate if they are overly reliant on particular markets. Inter-
national portfolio theory is a way of looking at all the MNC™s
businesses to see if their relative weighting can be adjusted



Y
to reduce the ¬‚uctuation in the overall return. This might be
FL
done, for instance, by postponing further expansion in certain
countries in favor of projects in others.
AM
TE
Frequently Asked
Questions (FAQs)
Q1: What are GATT and the WTO?
A: See Chapter 3, The General Agreement on Tariffs and Trade (GATT)
and the World Trade Organization (WTO).

Q2: Why is the theory of comparative advantage cen-
tral to free trade?
A: See Chapter 2, The theory of comparative advantage.

Q3: Is growth always good?
A: See Chapter 8, The productivity problem and growth.

Q4: When could protecting an industry be justi¬ed?
A: See Chapter 8, Protectionism versus free trade.

Q5: What™s new about the New Economy?
A: See Chapter 4, Is there really a New Economy?
114 GLOBAL FINANCE


Q6: Is it true that the biggest multinationals have
larger sales than most countries™ GDPs?
A: See Chapter 5.

Q7: Why should multinationals care what consumer
pressure groups think?
A: See Chapter 7, Nestl´ “ global corporate responsibility.
e

Q8: What™s really happening in the EU?
A: See Chapter 7, The European Union: restructuring business.

Q9: What was ˜˜Reaganomics™™ all about? Did it work?
A: See Chapter 8, Supply-side economics.

Q10: How can my business take advantage of global-
ization?
A: See Chapter 10.

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