Punjab College of Technical EducationCourse Module MBA –IB (3rd Semester)

Subject: International Trade and Economics Code : MBAIB 301 Tests: 04Case Study: 03Assignment: 02Total lectures: 38

Weightage of Internal Assessment:MSE – 15 MarksTests – 5 MarksPresentation – 10 MarksCase study – 5 MarksAssignment- 5 Marks

Course Instructor – Deepa Kapoor

Course Objectives: The objectives of this course are to help you gain tools that will enable you to systematically think about issues in international economics. The course will cover two main areas in international economics: international trade and international development.

International trade will cover: development of trade among nations; theories of trade; policies, factor endowments, trends, and barriers to trade. International Development will cover basic development topics such as: the role of free trade, foreign aid, and institutions for economic growth and development.

S.No. Topics To Be Covered Assignment Test CaseStudy

1 Introduction to class about the subject-Relevance, Topics to be covered, Requirements of the course.

2 Theories of Trade-Adam Smith’s The Law of Absolute Cost Advantage

- Trade occurs between two countries if one of them has an absolute advantage in producing one commodity & the other country having absolute advantage in producing some other commodity.

Ricardo’s Comparative Cost Advantage Theory- Trade takes place because different countries have

different advantages (efficiency) in the production of different specialization.

3 Opportunity - Cost Version of Comparative Advantage TheoryAssignment 1

4 Hecksher-Ohlin Theorem (Theory and Graphical Representation)

- Countries will export those goods that make intensive use of those factors tat are locally abundant, while importing goods that make intensive use of factors that are locally scarce.

5,6 Factor- Price Equalization Theorem (Graphical Model)- In terms of Physical Criterion

7 Factor- Price Equalization Theorem (Graphical Model)- In terms of Price Criterion

Leontief Paradox8 National Competitive Advantage: Porter’s Diamond Model

for TradeFour attributes of a nation shape the environment in which local firms compete, & these attributes promote or impede the creation of competitive advantage

- Factor Endowment- Demand Conditions- Related and Supporting Industries- Firm strategy, Structure and Rivalry

9 Case Study- Rise of Indian Software Industry 110 Test 111 Terms of Trade - the rate at which one country’s goods

exchange against those of another.- Gross Barter Terms of Trade- Net Barter Terms of Trade- Income Terms of Trade-

12 - Single factoral Terms of Trade- Double Factoral Terms of Trade- Real Cost Terms of Trade- Utility Terms of Trade

13 Mill’s Doctrine of Reciprocal DemandMarshall- Edgeworth Offer Curves

14 Factors Affecting terms of trade- Shifts in the Demand for country’s exports/ imports- Economic growth and Terms of trade

15 Factors Affecting terms of trade- Effect of Tariffs- Effect of Devaluation

16 Factors Affecting terms of trade- Change in supply on TOT- Change in tastes of people

17 Tariff Barriers Effect of Tariffs

- Price Effect- The Protective Effect- Revenue Effect- Consumption effect

18 Effect of Tariffs- Terms of Trade Effect- Balance of Payment Effect

19 Effect of Tariffs- Income Effect

Retaliation20 Non-Tariff Barriers

Assignment 221,22 WTO

- Role of WTO- Uruguay Round and the WTO- Doha Round and the WTO- India and WTO

23 Test 224 Trade Blocs

Levels of Economic Integration- Free Trade Area- Customs Union- Common Market- Economic Union- Political Union

25 Trade Blocs- NAFTA- SAARC

26 Trade Blocs- European Union- ASEAN

27 Case Study 228 India’s Trade

- Trading Partners- India’s Exports and Imports: Commodity wise and

Country Wise- Balance of Trade

29 Balance of Payments- Components of BOP- India’s BOP position

30 BOP- Measures to remove Disequilibrium in Balance of

payment31 International Factor Movements

- ImmigrationEntry Modes

- Exporting- Turnkey Projects- Licensing- Franchising

32 Foreign Direct Investment33 Test 334 Exchange Rates

- Bretton Woods- Fixed and Flexible Exchange rate- Exchange rate determination theories

35 Case Study 336,37 International Monetary Fund

- Evolution of IMF- Role of IMF

38 Test 4

Suggested Readings:International Economics By Dominick SalvatoreInternational Economics By D.M. MithaniInternational Economics By Francis Cherunilam

Case studies (Weightage in Internals: 5 Marks)

Following case studies are attached with the course module

S.No. Case Study Title Description1 The Rise of the Indian

Software IndustryWill help to know how different trade theories explain the performance of Indian software industry.

2 Martin’s Textiles Understand the impact of regional grouping (NAFTA) on Textile company

3 Caterpillar Inc. Impact of country’s currency price rise on company’s competitive position in world market.

Assignment (Weightage in Internals: 5 Marks) Select any two countries and identify Products and Industries in which these countries

have a comparative advantage as well as those in which they have comparative disadvantage.

Identify Tariffs and Non- Tariff Barriers in the Indian economy and its effect on India’s trade.

Presentation (Weightage in Internals: 10 Marks)Presentation will be taken in group of 4 students. Following are the topics to be covered in the presentation:

- Foreign Direct Investment In India- TRIPS and TRIMS- Anti-Dumping Practices (with special reference to cases in India) - Impact of Global recession on India’s Trade- Euro Dollar Market- India’s export- IMF and its role - Balance of Payments - FDI- Comparison of India and China- WTO and Agriculture

- WTO and Environment Policies- Impact of NAFTA on Trade- Impact of ASEAN on Trade

Case Study- I

The Rise of the Indian Software Industry

As a relatively poor country, India is not normally thought of as a nation that is capable of building a major presence in a high-technology industry, such as computer software. In a little over a decade, however, the Indian software industry has astounded its skeptics and emerged from obscurity into an important force in the global software industry. Between 1991-92 and 1996-97, sales of Indian software companies grew at a compound rate of 53 percent annually. In 1991-92, the industry had sales totaling $388 million. By 1996-97 sales were around$1.8 billion. By 1997, there were over 760 software companies in India employing 160,000 software engineers, the third-largest concentration of such talent in the world. Much of this growth was powered by exports. In 1985, Indian software exports were worth less than $10 million. Exports hit $1.1 billion in 1996-97 and are projected to reach $4 billion by 2000-01. As a testament to this growth, many foreign software companies are now investing heavily in Indian software development operations, including Microsoft, IBM, Oracle, and Computer Associates, the four largest US-based software houses.

Most of the growth of the Indian software industry has been based on contract or project-based work for foreign clients. Many Indian companies, for example, maintain applications for their clients, convert code, or migrate software from one platform to another. Increasingly, Indian companies are also involved in important development projects for foreign clients. For example, TCS, India's largest software company, has an alliance with Ernst & Young under which TCS will develop and maintain customized software for Ernst & Young's global clients. TCS also has a development alliance with Microsoft under which the company developed a paperless National Share Depositary system for the Indian stock market based on Microsoft's Windows NT operating system and SQL Server database technology. The Indian software industry has emerged despite a poor information technology infrastructure. The installed base of personal computers in India stood at just 1.8 million in 1997, and this in a nation of 1 bil lion people. Moreover, with just 1.5 telephone lines per 100 people, India has one of the lowest penetration rates for fixed telephone lines in Asia, if not the world. Internet connections numbered just 45,000 in 1997, compared to 30 million in the United States. Sales of personal computers are starting to take off; over 500,000 were expected to be sold in 1998. The rapid growth of mobile

telephones in India's main cities is to some extent compensating for the lack of fixed telephone lines. In explaining the success of their industry, India's software entrepreneurs point to a number of factors. Although the general level of education i~ India is low, India's important middle class is highly educated and its top educational institutions are world class. Also, there has always been an emphasis on engineering in India. Another great plus from an international perspective is that English is the working language throughout much of middle-class India-a remnant from the days of the British raja.

Then there is the wage rate. In America, software engineers are increasingly scarce, and the basic salary has been driven up to one of the highest for any occupational group in the country, with entry-level programmers earning $70,000 per year. An entry-level programmer in India, in contrast, starts at around $5,000 per year, which IS very low by international standards but high by Indian standards. Still, salaries for programmers are rising rapidly in India, but so is productivity. In 1992, productivity was around $21,000 per software engineer. By 1996, the figure had risen to $45,000. Many Indian firms now feel that they have approached the 'critical mass required to realize scale economies in software development and to achieve legitimacy in the eyes of important global partners and clients.

Another factor playing to India's hand is that satellite communications have removed-distance as an obstacle to doing business for foreign clients. Since software is nothing more than a stream of zeros and ones, it can be transported at the speed of light and negligible cost to any point in the world. In a world of instant communications, India's geographical position has given it a time zone advantage. Indian companies have exploited the rapidly expanding international market for outsourced software services including the expanding market for remote maintenance. Indian engineers can fix software bugs, upgrade systems, or process data overnight while their users in Western companies are asleep.

To maintain their competitive position, Indian software companies are now investing heavily in training and leading-edge programming skills. They have also been enthusiastic adopters of international quality standards, particularly ISO 9000 certification. Indian companies are also starting to make forays into the application and shrink-wrapped software business, primarily with applications aimed at the domestic market. It may only be a matter of time, however, before Indian companies start to compete head-to-head with companies such as Microsoft, Oracle, PeopleSoft, and SAP in the applications business.

Case Discussion Questions1. To what extent does the theory of comparative advantage explain the rise of the Indian software industry?

2. To what extent does the Heckscher-Ohlin theory explain the rise of the Indian software industry? ,3. Use Michael Porter's diamond to analyze the rise of the Indian software industry. Does this analysis help explain the rise of this industry?4. Which of the above theories-comparative advantage, Heckscher-Ohlin, or Porter's-gives the

best explanation of the rise of the Indian software industry? Why?

Case Study –II

Martin's Textiles

August 12, 1992, was a really bad day for John Martin. That was the day Canada, Mexico, and the United States announced an agreement in principle to form the North American Free Trade Agreement. Under the plan, all tariffs between the three countries would be eliminated within the next 10, to 15 years, with most being cut in 5 years. What disturbed John most was the plan's provision that all tariffs on trade of textiles among the three countries were to be removed within 10 years. Under the proposed agreement, Mexico and Canada would also be allowed to ship a specific amount of clothing and textiles from foreign materials to the United States each year, and this quota would rise slightly over the first five years of the agreement. "My' God!" thought John. "Now I'm going to have to decide about moving my plants to Mexico."

John is the CEO of a New York-based textile company, Martin’s Textiles. The company has been in the Martin family for four generations, having been founded by his great-grandfather in 1910. Today, the company employs 1,500 people in three New York plants that produce cotton-based clothes, primarily underwear. All production employees are union members, and the company has a long history of good labor relations. The company has never had a labor dispute, and John, like his father, grandfather, and great-grandfather before him, regards the work force as part of the "Martin family." John prides himself not only on knowing many of the employees by name, but also on knowing a great deal about the family circumstances of many of the longtime employees.

Over the past 20 years, the company has experienced increasingly tough competition, both from overseas and at home. The mid-1980s were particularly difficult. The strength of the dollar on the foreign exchange market during that period enabled Asian producers to enter the US market with very low prices. Since then, although the dollar has weakened against many major currencies, the Asian producers have not raised their prices in response to the falling dollar. In a low-skilled, labor-intensive business such as clothing manufacture, costs are

driven by wage rates and labor productivity. Not surprisingly, most of John’s competitors in the northeastern United States responded to the intense cost competition by moving production south, first to states such as South Carolina and Mississippi, where nonunion labor could be hired for significantly less than in the unionized Northeast, and then to Mexico, where labor costs for textile workers were less than $2 per hour. In contrast, wage rates are $12.50 per hour at John's New York plant and $8 to $10 per hour at nonunion textile plants in the south eastern United States.

The last three years have been particularly tough at Martin's Textiles. The company has registered a small loss each year, and John knows the company cannot go on like this. His major customers, while praising the quality of Martin's products, have warned him that his prices are getting too high and they may not be able to continue to do business with him. His longtime banker has told him that he must get his labor costs down. John agrees, but he knows of only one surefire way to do that, to move production south..,-way south, to Mexico. He has always been reluctant to do that, but now he seems to have little choice. He fears that in five years the US market will be flooded with cheap imports from Asian, US, and Mexican companies, all producing in Mexico. It looks like the only way for Martin's Textiles to survive is to close the New York plants and move production to Mexico. All that would be left in the United States would be the sales force

John's mind was spinning. How could something that throws good honest people out of work be good for the country? The politicians said it would be good for trade, good for economic growth, and good for the three countries. John-could not see it that way. What about Mary Morgan, who has worked for Martin's for 30 years? She is now 54 years old. How will she and others like her find another job? What about his moral obligation to his workers? What about the loyalty his workers have shown his family over the years? Is this a good way to repay it? How would he break the news to his employees, many of whom have worked for the company 10 to 20 years? And what about the Mexican workers, could they be as loyal and productive as his present employees? From other US textile companies that had set up production in Mexico he had heard stories of low productivity, poor workmanship, high turnover, and high absenteeism. If this was true, how could he ever cope with that? John has 'always felt that the success of Martin's Textiles is partly due to the family atmosphere, which encourages worker loyalty, productivity, and attention to quality, an atmosphere that has been built up over four generations. How could he, replicate that in Mexico with a bunch of foreign workers who speak a language that he doesn't even understand?

Case Discussion Questions

1. What are the economic costs and benefits to Martin's Textiles of shifting production to Mexico?

2. What are the social costs and benefits to Martin's Textiles of shifting production to Mexico? 3. Are the economic and social costs and benefits or moving production to Mexico independent each other? 4. What seems to be the most ethical action? 5. What would you do if you were John- Martin?

Case Study- III

Caterpillar Inc.

Caterpillar Inc. (Cat) is the world's largest manufacturer of heavy earthmoving equipment. Earthmoving equipment typically represents about 70 percent of the annual dollar sales of construction equipment worldwide. In 1980, Cat held 53.3 percent of the global market for earthmoving equipment. Its closest competitor was Komatsu of Japan, with 60 percent of the Japanese market but only 15.2 percent worldwide.

In 1980, Caterpillar was widely considered one of the premier manufacturing and exporting companies in the United States. The company had enjoyed 50 consecutive years of profits and returns on shareholders equity as high as 27 percent. In 1981, 57 percent of its sales were outside the United States, and roughly two-thirds of these orders were filled by exports. Cat was the third largest US exporter. Reflecting this underlying strength, Cat recorded record pretax profits of $579 million in 1981. However, the next three years were disastrous. Caterpillar lost a total of $1 billion and saw its market share slip to as low as 40 percent in 1985,

while Komatsu increased its share to 25 percent. Three factors, explain this startling turn of events: the higher productivity of Komatsu, the rise in the value of the dollar, and the Third World debt crisis

In retrospect, Komatsu had been creeping up on Cat for a long time. In the 1960s, the company had a minuscule presence outside of Japan. By 1974, it had increased its global market share of heavy earthmoving equipment to 9 percent, and by 1980 it was over 15 percent. Part of Komatsu's growth was due to its superior labor productivity; throughout the 1970s, it had been able to price its machines 10 to 15 percent below Caterpillar's. However, Komatsu lacked an extensive dealer network outside of Japan, and Cat's worldwide dealer network and superior after-sale service and support functions were seen as justifying a price premium for Cat machines. For these reasons, many industry observers believed Komatsu would not increase its share much beyond its 1980 level.

An unprecedented rise in the value of the dollar against most major world currencies changed the picture. Between 1980 and 1987, the dollar rose an average of 87 percent against the currencies of 10 other industrialized countries. The dollar was driven up by strong economic growth in the United States, which attracted heavy inflows of capital from foreign investors seeking high returns on capital assets. High real interest rates attracted foreign investors seeking high returns on financial assets. At the same time, political turmoil in other parts of the world and relatively slow economic growth in Europe helped create the view that the United States was a good place. in which to invest. These inflows of capital increased the demand for dollars in the foreign exchange market, which pushed the value of the dollar upward against other currencies

The strong dollar substantially increased the dollar price of Cat's machines. At the same time, the dollar price of Komatsu products imported into the United States fell. Because of the shift in the relative values of the dollar and the yen, Komatsu priced its machines as much as 40 percent below Caterpillar's prices by 1985. In light of this enormous price difference, many consumers chose to forgo Caterpillar's superior after-sale service and support and bought Komatsu machines. The third factor, the Third World debt crisis, became apparent in 1982 during the early 1970s; the nations of OPEC quadrupled the price of oil, which resulted in a massive flow of funds into these nations. Commercial banks borrowed this money from the OPEC countries and lent it to the governments of many Third World nations to finance massive construction projects which led to a global boom in demand for heavy earthmoving equip-ment. Caterpillar benefited from this development. By 1982, however, it became apparent that the commercial banks had lent too much money to risky and unproductive investments, and the governments of several countries (including Mexico, Brazil, and Argentina) threatened to suspend debt payments.

As a result of these factors, Caterpillar was in deep trouble by late 1982. The company responded quickly and between 1982 and 1985 cut costs by more than 20 percent. This was achieved by a 40 percent reduction in work force, the closure of nine plants, and a $1.8 billion investment in flexible manufacturing technologies designed to boost quality and lower cost. The company also pressed the government to lower the value of the dollar on foreign exchange markets. By 1984, Cat was a leading voice among US exporters trying to get the Rea-gan administration to intervene in the foreign exchange market

Things began to go Caterpillar's way in early 1985~ Prompted by Cat and other exporters, representatives of the US government met with representatives of Japan, Germany, France, and Great Britain at the Plaza Hotel in New York. In the resulting communiqué-known as the Plaza Accord-the five governments acknowledged that the dollar was overvalued and pledged to take actions that would drive down its price on the foreign exchange market. The central bank of each country intervened in the foreign exchange market, selling dollars and buying other currencies (including its own). The dollar had already begun to fall in early 1985 in response to a string of record US trade deficits. The Plaza Accord accelerated this 'trend, and over the next three years the dollar fell back to its 1980 level.

The effect for Caterpillar was almost immediate. Like any major exporter, Caterpillar had its own foreign exchange unit. Suspecting that an adjustment in the dollar would come soon, Cat had increased its holdings of foreign currencies in early 1985, using the strong dollar to purchase them. As the dollar fell, the company was able to convert these currencies back into dollars' for a healthy profit. In 1985, Cat had pretax profits of $32 million without foreign exchange gains of $89 million, it would have lost money. In 1986, foreign exchange gains of $100 million accounted for nearly two-thirds of its pretax profits of $159 million. More significant for Cat's long-term position, the fall in the dollar against the yen and Caterpillar's cost-cutting efforts by 1988 had helped to eradicate the 40 percent cost advantage that Komatsu had enjoyed over Caterpillar four years earlier. After trying to hold its prices down, Komatsu had to raise its prices that year by 18 percent, while Cat was able to hold its price increase to 3 percent. With the terms of trade no longer handicapping Caterpillar, the company regained some of its lost market share. By 1989, it reportedly held 47 percent of the world market for heavy earthmoving equipment, up from a low of 40 percent three years earlier, while Komatsu's share had slipped to below 20 percent.

Case Discussion Questions

1. To what extent is the competitive position of Caterpillar against Komatsu dependent on the dollar/yen exchange rate? Between mid-1996 and early 1998, the dollar appreciated by over 40 percent against the yen. How do you think this would have affected the relatively competitive position of Caterpillar and Komatsu?

2. If you were the CEO of Caterpillar, what actions would you take now to make sure there is no repeat of the early 1980s experience?

3. What potential impact can the actions of the IMF and World Bank have on Caterpillar’s business? Is there anything Cat can do to influence the actions of the IMF and World Bank?

4. As the CEO of Caterpillar, would you prefer a fixed exchange rate regime or a continuation of the current managed-float regime? Why?