CHAPTER E4. INTERNATIONAL COMMERCE

Topics covered in this chapter:

1. the distinction between international and domestic business operations

2. differences between international and interregional commerce

3. possible bases for interregional trade

4. the changeability of regional advantages

5. the impact of nationalism on international commerce

6. the effects of using different currencies

7. the significance of cultural differences

8. means of acquaintance with target markets

CHAPTER E4. INTERNATIONAL COMMERCE

We open this chapter with a half-serious apology for including a chapter which focuses upon the international dimension of business. The reason for the apology is that in much of the rest of the world outside of the United States of America, there is little significant distinction between international and domestic business operations. If one is in business at all, he or she automatically engages in international business operations. Managers of such firms hardly give second thoughts to the requisites for sourcing supplies, selling products, or locating production in countries other than that within which the firm's home office is located.

The apology is only half serious because many people in various countries, and notably the United States of America, are somewhat intimidated by the international dimension. It is a mixed blessing to the United States that it has a rich endowment of natural resources and a huge internal economy. Domestic firms have been able to rely upon the internal economy for both sources of supply and markets for their domestically-produced products. Because they have been able to look inward for over two centuries, managers of American firms have tended to regard the outside world as marginal or peripheral to their activities. Many view the international sector as possessing some mystique which requires special capabilities to penetrate. This perception is enhanced by the fact that Americans are for the most part monolingual. Although English is the only language spoken and understood by the majority of Americans, Spanish may yet overtake English as the American lingua franca.

If much of American business has seemed intimidated by international involvements, post-war American consumers have carried on a love affair with foreign-made goods and services. During much of the post World War II era, U.S. balance of payments deficits have been the rule rather than the exception. Concerns about on-going trade deficits and mounting international debt to foreigners have led various U.S. governmental agencies to devise programs to promote exports and discourage imports. American experience with protecting domestic industries from foreign commercial incursions spans more than two centuries.

On-going trade and payments deficits and official concern about them have aroused the interest of the American academic community in international commercial relations. Some graduate programs have specialized in international commerce; examples include the American Graduate School of International Management (the "Thunderbird School") in Phoenix, Arizona, and the Masters of International Business Studies (MIBS) offered by the Business School of the University of South Carolina. Beginning in the 1970s, a deliberate effort was mounted by business studies programs to internationalize their curricula.

By the early 1980s the principal business studies accrediting organization, the American Assembly of Collegiate Schools of Business (AACSB), had established a standard requiring any program seeking accreditation or reaccreditation to achieve a satisfactory internationalization of its curriculum. The most commonly used models for such internationalization have been to employ foreign faculty and recruit foreign students, to introduce new courses focusing upon international business problems and procedures (e.g., international marketing, international finance, international management), and to infuse international concepts into existing courses as appropriate. The latter two models have spawned a flock of new textbook titles as well as revisions of existing texts to incorporate references to the international arena.

In a sense, the recent obsession of American commerce and academia with anything international is only a transitional phase. With the passage of time, international commercial activity will become more commonplace; eventually business studies curricula will become sufficiently internationalized that special commentary about the international sector will no longer be warranted. Three phenomena militate in favor of this transition. (1) Technological advances in communications and transportation shorten the time and costs of distance, thereby diminishing market imperfections and facilitating international exchange. (2) English, the language spoken by the majority of Americans, seems to have emerged as the global language of commerce as well. (3) Efforts underway in various regions of the world to achieve both economic and political integration (the European Union, a "single market" by 1993, currency union by 1999, and a "United States of Europe" by some point in the twenty-first century) tend to render concepts of the international ever less significant. But until such transformation is completed (if ever), we shall be compelled to include chapters such as this in our texts.

Bases for Interregional Commerce

John Donne has said that "No man is an island, entire of itself..." (Devotions upon Emergent Occasions, Meditation 17). It is surely true that no nation can be an island completely unto itself either. Some have tried. After both its Revolutionary War and World War I, the United States seemed to withdraw into isolationism in order to avoid further international entanglements, both political and commercial. After its establishment in 1918, the Union of Soviet Socialist Republics (U.S.S.R.) pursued a de facto strategy of autarky, i.e., internal self-sufficiency. Of all of the nations in the world, these two might have come closest to functional autarky because of the immense richness of their natural resource endowments. But neither of these nor any other nation in the world has been able to achieve absolute autarky. There are several fundamental reasons why they have found it either necessary or beneficial to engage in international commercial relations. There is a very significant difference between international and interregional commerce, but we shall defer consideration of it until a later section. For the moment we shall focus attention upon bases for interregional commerce.

It is a fact of physical nature that resources are unequally distributed across the earth's geographic space. Some resources approach ubiquity (found everywhere); others are concentrated by regions. Resources which are found in only one or two places on earth may be referred to as geographic uniquities. Examples include rare elements or precious gems or metals, agricultural commodities which grow only under very special conditions, and natural tourist attractions. Populations of regions possessing such uniquities are fortunate in having access to such resources which they are able to exploit; populations elsewhere are correspondingly unfortunate. Populations of regions devoiof such uniquities may acquire them (or things produced using them) by engaging in interregional trade or military aggression to capture them.

There are few perfect ubiquities or uniquities among productive resources. Most resources are found in many places across the globe, although in greater or lesser geographic concentrations. Goods and services requiring those resources as inputs may be produced more cheaply in regions where they are found in abundance than in other regions where they are scarce.

The Principle of Comparative Advantage

Economists have enunciated the so-called principle of comparative advantage to explain regional specialization in the production of goods and services. According to this principle, people in each region should specialize in producing those goods and services which can be produced most efficiently in their region compared to other regions. "Most efficiently" means at least opportunity cost (in terms of other goods and services foregone) compared to the other regions. Since the production of goods becomes geographically specialized, people in different regions must trade their specialties for the specialities of people in other regions.

Generalization in consumption is enabled everywhere through trade even though there is regional specialization in production. It can be shown with theoretical exercises as well as empirical information that those who specialize their production according to the principle of comparative advantage and trade with one another enjoy higher welfare than they would under conditions of autarky.

It is sometimes suggested that there are regions of the world which are essentially devoid of productive advantages, whereas other regions seem to possess all of the advantages (veritable "Gardens of Eden"). We can resolve this problem by further refining the definition of comparative advantage. A region's absolute advantages include all of those things which it can produce at lower opportunity costs than can be achieved in other regions. A region's absolute disadvantage is anything which can be produced elsewhere at lower costs in terms of other goods and services which must be foregone.

It may well be that opportunity costs of most things are lower in one region relative to all others, but this does not mean that the region should generalize in production. Its comparative advantages lie in those things for which it has greatest absolute advantage(s), while the comparative advantages of other regions lie in the things for which they have least absolute disadvantages. They should still specialize in production, but the one in its greatest absolute advantage and all the rest in their least absolute disadvantages. It follows logically from this definition of comparative advantage that it is not possible for a region to have no comparative advantage(s). Furthermore, it can be shown that all of the regions of the world, the sparsely-endowed as well as the abundantly endowed, will enjoy higher welfare with specialization according to the principle of comparative advantage and trade with one another unencumbered by politically imposed constraints.

Modern elaborations of the theory of comparative advantage recognize at least five bases for regional comparative advantages: resource endowments, cultural preferences, known technologies, scale economies, and company-specific knowledge. The first three are endogenous to locale; the last two technically are independent of geography, but may become location specific at the discretion of production decision makers. For purpose of illustration, it is usual in trade theory to hypothesize a two-resource, two-commodity, two-region world. Suppose one of the regions, A, is abundantly endowed with capital resources but has only enough labor to operate its capital stock, and that the other region, B, is abundantly endowed with labor but has a small amount of capital which serves as minimal tools for the labor. The two regions produce two commodities, X which under technologies known in both regions requires a great deal of labor but not much capital, and Y which uses substantial amounts of capital but only a little labor. If the two regions employ identical technologies for producing the two goods and further have identical preference functions, region A should specialize in producing good Y, whereas region B should produce more of good X. Each should trade some of its specialty to the other in exchange for some of the other's specialty.

Suppose that the two regions have identical resource endowments and know the same productive technologies. While people in both regions consume both goods, suppose that people in region A have a stronger preference for X, the labor intensive good, while people in region B like Y, the capital intensive good. In this case, it would be appropriate for region A to specialize in producing X and region B in producing Y. Each should trade some of its output to the other in order to achieve consumption generalization in both regions. In this case, the basis for comparative advantage is differential preferences rather than resource endowments.

As a third possibility, suppose that the two regions possess identical resource endowments and share a common preference system, but that scientists and engineers in region A have advanced technology with respect to the production of X so as to economize on labor, whereas common technology continues to be used in the production of Y, the capital intensive good, in both countries. Again, intuition suggests that region A should specialize in the production of X leaving region B to specialize in production of Y. They should trade some of their respective specialties to each other. The basis of comparative advantage here is differential technologies rather than resource endowments or preferences. Scale economies and company-specific knowledge may also serve as bases for regional comparative advantage.

It would be highly unlikely in any of these cases that perfect specialization (i.e., only X is produced in A and only Y is produced in B) would result. Both goods would continue to be produced in both regions, but in each region more of the comparative advantage good would be produced, and less of the comparative disadvantaged good(s). Also, the real world is composed of many regions, some of which are similar to others in respect to resource endowments, preferences, or technologies, and different from the other regions in various respects. The basis for comparative advantage of each may lie in one of these areas or a combination of them. Empirical evidence suggests that a larger volume of the world's trade is conducted among regions which are similar in income levels and preferences, than among regions which are widely divergent in any of these areas.

Qualifications to the Principle of Comparative Advantage

As noted in previous chapters, managerial opportunities and threats are to be found in almost any circumstances, including those of interregional trade. Certain qualifications to the argument presented to this point should be noted. One is that comparative advantages, whether attributable to resource endowments, preferences, or technologies, are not "struck in stone," i.e., they are changeable. Circumstances of resource depletion can terminate a former comparative advantage based on the richness of a resource endowment. The discovery of a new deposit or pool of a natural resource can confer a comparative advantage. Population growth or immigration may confer a comparative advantage in producing labor intensive goods where one formerly did not exist. By the same token, emigration may result in depletion of a former comparative advantage based on labor abundance. Natural disasters such as a volcanic eruption, a hurricane, or a freeze which destroys a crop stock may bring to an end some historic comparative advantage. Changing preferences away from "old" goods and toward newly developed ones may shift comparative advantage from regions specializing in the "old" and toward regions specializing in the "new."

The forms of comparative advantage transition noted above follow from natural or market phenomena which are not under the control of the firm. One of the most significant forms of change in comparative advantages comes about through technological advances which develop new items or new processes which economize on scarce resources. Another significant phenomenon which may change comparative advantage is capital investment. Regions which formerly were capital scarce may become capital abundant, as for example the newly industrialized countries ("NICs") of South Asia. The reason that these two forms of comparative advantage transition are significant to managerial decision making is that they are implemented at the discretion of managers of firms. It is by mounting an effort at research and development (R&D) or by capital investment that managerial decision makers may seize entrepreneurial opportunities and deliberately change the competitiveness of their firms and the comparative advantages of their regions.

The International Dimension

To this point we have been discussing interregional trade; in the so-called "pure theory of trade" there is no distinction between interregional and international trade. The emergence of national identity and the nation state over the past four centuries have enabled two additional factors which provide for regional differentiation: nationalism and the operations of government.

The interests of governments in international commerce have necessitated another qualification to the comparative advantage theory. The government may attempt to protect an old domestic industry in order to preserve a comparative advantage which is fleeing to foreign regions. An example is the cotton textile industry as it moves from the South of the United States to East and South Asia. Such protection may take the forms of subsidies to the domestic industry or quotas or tariffs imposed on imported merchandise. Or the government may promote the development of what is believed to be a latent comparative advantage of the region by subsidizing a so-called "infant industry." A recent example of this may be the developing electronics industries in India and Singapore.

Government may attempt to neutralize another region's comparative advantage by imposing an import tariff which is intended to eliminate a foreign cost advantage ("leveling the playing field"). The government may impose an import quota as a means of limiting the damage resulting from importation of an item which can be produced at lower cost elsewhere. Or the government may take "compensatory" action in any of these areas to offset some policy being implemented by the government of another region. In any of these cases of protection, the effect will be to diminish any potential for gain by comparative advantage specialization.

National identity leads to nationalism, a sort of emotional cement which binds together people of the same cultural background. They may share a common history and heritage; they may be more-or-less homogeneous with respect to race and ethnicity; typically they subscribe to the same religion or various sects or denominations of a common religion; the vast majority of them speak the same language; and, most importantly, they share a common vision about what it means to be a citizen of the nation. The term is often used to describe a "nation of people" or simply "a people" in the biblical sense (the "Children of Israel" in the Bible are an example of a nation in this sense). The emotional cement of nationalism may reveal itself in the form of patriotism, i.e., love of homeland, its cultural and political heritage, its flag.

Other terms such as provincialism or regionalism may attain almost the same sense of nationalism, but with respect to the attitudes of people in more restricted geographic locales. Belgians typically are much more nationalistic with respect to being Flemish or Walonian than they are about being Belgian. It is more important to some in the United States to be Texans or Southerners than it is to be American. The European Union is attempting to establish a sort of super-national regionalism so that citizens of the fifteen member states will begin to feel a sense of European nationalism which eventually may displace nation-state nationalism. Although there is no good term to describe it, a similar emotional cement often exists among the students and alumni of an American state university, especially when in athletic competition with a rival state university.

Nation states are political entities defined by boundaries encompassing areas which may coincide closely with that populated by a "nation of people" in the biblical sense. Sometimes a nation state encompasses two or more nations of peoples. American Indian tribes have often been referred to as "nations;" there were many nationalities in the former Soviet Union; modern India encompasses numerous tribal peoples. In the early 1990s, the various nationalities contained by both the Soviet Union and Yugoslavia began to pull apart.

Occasionally political boundaries separating nation states divide peoples of the same nationality. The post-war political division of Europe left the German people separated by "walls" as well as borders. In South Asia, the Bengali tribal people are split by the India-Bangla Desh border. The Pakistan-Afganistan border divides the Baluchi people, while the Pakistan-India border separates Punjabi tribal people. Separatist movements in these and other areas may have as their goal the reunification of peoples of the same nationality which have been separated by political boundaries.

Nation states also may not coincide with economic regions which are characterized by the possession of natural resources. Both the United States of America and the Russian Republic include numerous uniquely definable economic regions. Sometimes national boundaries split a common resource endowment region. Europeans have often redrawn national boundaries across the rich coal and iron deposits of the Alsace-Lorraine region.

The essential characteristic of the nation state is its possession and exercise of national sovereignty by the government of the nation state. "National sovereignty" means that the government of the state has the authority and the power to do anything it wishes with respect to the peoples and resources contained within its political boundaries. This power includes the ability to determine the form of economic organization of the economy of the state (until recently, the government of the former U.S.S.R. mandated socialism), and to impose protectionist measures with respect to the industries within the economy (the government of the U.S.A. has a long history of protectionism). It includes the right to insist upon the use of a national currency within the realm and to exclude the of currencies preferred by others. Sometimes this authority and power leads to human rights abuses to which people and authorities in other nation states raise objections. Such exercise of discretion by the state is constrained only by the tolerance of its citizens and by attitudes and military prowess of other nation states.

Currency Diversity

One of the most critical factors which sets international trade apart from interregional trade is a consequence of the exercise of national sovereignty: the use of different currencies in different nation states. Because the dollar in used in the U.S. economy while the pound sterling is accepted exclusively in the United Kingdom, the balance of payments between the U.S. and the U.K. is important to economic and political considerations in both countries. The dollar-sterling exchange rate is critical to the volume of goods and services entering into international commerce between the two countries at any point in time.

Where the same currency is used throughout a region, these matters become irrelevant. In the United States, who is concerned about the balance of payments between South Carolina and New York? And what about the exchange rate between the currency used in South Carolina and that accepted in New York (both use the U.S. dollar)? In the European Union the British still insist upon the pound sterling while the French use francs and the Germans use marks. The U.K.-French and U.K.-German balances of payments continue as hot issues, as do the pound-franc and pound-mark exchange rates. This is true especially since governments in some of these countries (Germany, in particular) insist upon stabilizing the exchange rates while governments of others (notably the U.K.) are inclined to use currency devaluation or exchange rate fluctuation as means of correcting balance of payments disequilibria. The Maastricht Treaty of 1992 provides for the establishment of a common currency in Europe by 1999 once certain entry conditions are met, but it appears that nationalism within Europe may prevent the attainment of currency union.

Currency matters spill over upon the commercial sectors of the international trading partners. We venture a guess that these issues will become irrelevant in Europe only when Europeans can adopt and accept a common currency such as the Euro or one of the constituent currencies. But there will still be problems in the balance of payments between the U.S. and Europe and with the dollar-Euro exchange rate until such time that Americans and Europeans can agree to use a common currency.

The Cultural Dimension

The analysis of nationalism would be much simpler if every nation state were associated exclusively with a certain nation of people. But as we have already noted, this is not the case. Whether we are speaking of the nation state or a particular nation of people who share a common heritage, the principal implication of nationalism is that there are significant differences among populations which yield important consequences for trade and the location of economic activity. These differences may spring from natural phenomena such as heritage, customs, language, etc., or they may be artificially imposed by the behavior of the governments of the nation states.

Even if political relationships are not involved, differences of national heritages and languages lead to suspicions about the customs and intentions of "foreigners," and in extreme cases to xenophobia, i.e., fear and hatred of foreigners. An extreme economic consequence of xenophobia is the attempt to achieve autarky. The important point is that nationalism, whether emanating from cultural differences or state sovereignty, tends to diminish the potential for gains from interregional and international specialization and trade. In the extreme, nationalism can completely eliminate such potential gains if sovereign national governments pursue strategies of extreme political isolation and economic autarky.

Because of nationalism, it is necessary to recognize that comparative advantage may be based upon preferences which differ by regions which are defined by national boundaries as well as by cultual heritage. It is also necessary to note that natural comparative advantages may be enhanced or neutralized by the discretionary actions of government officials.

The managerial implications of nationalism, whether based in cultural differences or the exercise of state sovereignty, is that business decision makers wishing to buy, sell, or produce in other countries must come to an understanding of the cultural characteristics and governmental practices of the other countries. It is these differences which make foreign dealings appear to be mysterious, difficult, and risky. The antidotes are acquaintance and familiarity with the foreign environments within which the firm expects to operate. Acquaintance and familiarity can be achieved through study, travel, and interaction with nationals from the target markets. The study should include examination of cross-cultural differences which lead to appreciation of customs and practices different from one's own.

One of the best ways to achieve such appreciation is to learn the languages of the peoples who live in the regions where the firm wishes to operate. Competence in the languages of the target markets may also be crucial to successful business dealings. Peoples in most countries of the world are multilingual; in some few countries (notably the United States) the norm seems to be monolinguality. A business negotiator who is knowledgeable of the trading partner's language as well as his or her own will likely have the upper hand over a negotiator who speaks only one language. Also, if one is not familiar with the trading partner's language, the partner will be able to lapse into his or her own language when speaking with associates. Finally, we may note that most people in other lands have greater appreciation of their trading partners if they can at least attempt to speak the local language.

What's Ahead

In this chapter we have explored the possibilities of engaging in international commerce, i.e., exporting to or importing from other regions of the world. But it is also feasible and potentially profitable to engage in direct foreign investment, i.e., to locate production in other regions of the world than the home country, and to engage in direct foreign investment to establish the foreign domociled production facilities. Chapter E5 is devoted to the multinationalization of enterprise.

CHAPTER E4 SUMMARY

1. In much of the world outside of the United States, little signficant distinction is made between international and domestic business operations; Americans often seem intimidated by the international dimension.

2. On-going trade and payments deficits and official concern about them have heightened the interest of the American academic community in international commercial relations.

3. With the passage of time, interntional commercial activity will become more commonplace so that special commentary in the academic curriculum will no longer be warranted.

4. Some nations have pursued strategies of autarky, but none has been able to achieve such a state.

5. In the end there is very little difference between interregional and international commerce.

6. The fundamental explanation of interregional commerce is that resources are unequally distributed across the earth's geographic space, but other explanations lie in different preferences and technologies.

7. According to the theory of comparative advantage, people in each region should specialize in producing those goods and services which can be produced most efficiently in their region in comparison to other regions.

8. Interregional trade enables consumption generalization even though there is regional production specialization; such specialization and trade enables the achievement of higher welfare.

9. Because comparative advantage consists in a region's greatest absolute advantage or least absolute disadvantage, it is logically impossible for a region to have no comparative advantage.

10. Regions with identical resource endowments but different tastes or technologies may have comparative advantages based in these differences.

11. Comparative advantages are subject to change over time and may be changed by techonological change and capital investment.

12. The government of a region may act to change or subvert the natural comparative advantages of its region or others.

13. Nationalism and national differences may contitute a basis for exchange where none otherwise exist in resource endowments, preferences, or technologies; nationalism may also serve to nullify natural comparative advantages.

14. The use of different currencies in different nations distinguishes international commerce and may constitute an impediment to trade unless currencies may be freely converted into one another.

15. Nationalism tends to diminish the potential for gains from interregional and international specialization and trade.

16. Business decision makers wishing to buy, sell, or produce in other countries must come to an understanding of the cultural differences and governmental practices of the other countries.

17. Acquaintance and familiarity may be achieved through study, travel, and interaction with nationals from the target market; one of the best means is to learn the languages of the peoples who live in the regions where the firm wishes to do business.

CHAPTER E4 SIGNIFICANT TERMS

international business
resource endowments
trade deficits, international debt
internationalization of the curriculum
international market imperfections
isolationism
autarky
interregional commerce
unequal resource distribution
ubiquities, uniquities
comparative advantage
opportunity cost
generalization in consumption
specialization in production
trade
absolute advantages, disadvantages
non-endowment explanations
opportunities, threats
immigration, emigration
comparative advantage transition
protection
nationalism
peoples
borders, walls
economic regions
national sovereignty
national currencies
exchange rates
devaluation
payments
cultural heritage
xenophobia
gains from trade
languages

CHAPTER E4 QUESTIONS FOR DISCUSSION

1. Explain why in most of the world there is little distinction made between international and domestic business. ...why in the United States there is a signficant distinction made between...

2. Why might the American emphasis on international business diminish with the passage of time?

3. Why do nations like the United States and the Soviet Union sometimes retreat into isolationism and autarky? What are the economic implications?

4. Identify possible bases for interregional specialization and trade.

5. Distinguish comparative from absolute advantage and discuss the relationship between the two.

6. Explain how generalization in consumption can be achieved even though regions specialize in production.

7. Explain why it is logically impossible for a region to have no comparative advantage.

8. Beyond generalization in consumption, explain why the people of a region should go to the trouble to specialize in production.

9. Identify the economic criterion for specialization in production; what are the implication of specialization on some other (noneconomic) ground?

10. Explain how preference diversity between regions can serve as a basis for trade.

11. Explain how the use of different technologies in different regions can serve as the basis for specializing their production in different goods.

12. Why to trading partners rarely achieve perfect specialization in producing different commodities?

13. Explain how regional comparative advantages may change or be changed over time.

14. Discuss the consequences for the industries and the workers of a region when one of its historic comparative advantages moves elsewhere.

15. Why do governments often try to protect a domestic industry from which the comparative advantage has shifted to other regions? What are the economic implications of such protection?

16. How can government promote the development of what is believed to be a latent comparative advantage of its region?

17. Explain how nationalism in different coutries may serve to enhance their potentials for trade with one another.

18. Explain how nationalism in different countries may become an impediment to capturing the potential gains from specialization and trade.

19. How do the behaviors and relationships among alumni of the same college or university resemble nationalism? What are the economic implications?

20. Discuss the economic consequences of a division of a nation of people by artifical boundaries or walls.

21. Discuss the economic implications of the exercise of national sovereignty by the government of potential trading partners.

22. Why might the use of different national currencies in different countries constitute a problem for international trade? How can this problem be averted?

23. Identify possible ways in which international cultural diversity might pose problems for international trade. What are the managerial implications?

24. Why does nationalism, whether based in cultural diversity or the exercise of state sovereignty, diminish the potential for gains from interregional and internatioal trade?

25. Identify means by which business decision makers wishing to buy, sell, or produce in other countries can become acquainted with the cultures of their target markets?

26. Discuss the implications of a lack of understanding of a prospective trading partner's language.