Chapter 1: Business Across Borders

Keith HeadSauder School of Business

Objectives of this chapter

• Define “international.”• Introduce the key international

business (IB) transactions and entities.

• Analyze the factors that make International Business more costly than domestic business and—potentially—more rewarding: The Six Forms of Separation.

What kind of transaction is it?

• German-resident honeymooners pay to stay in Sun Peaks Lodge (a hotel owned by Germans residing in Canada)

• Volkswagen, a German multinational corporation, exports cars built at its Mexico subsidiary to Canada

• KH (US citizen residing in Canada), buys an Apple (California-based corporation) iPod assembled in China, including a Toshiba (Japan) disk drive.

What makes a transaction “international”?

Residence Test: are the permanent addresses (“centres of economic interest”) for buyer and seller in different countries?

Other criteria: nationality, “origin”

Transaction types• Trade: exports (+) & imports (-)

– Merchandise– Services– Goods for processing

• Income receipts (+) & payments – Investment income– Employee compensation

• Investment sales (+) & purchases– Portfolio Investment– Direct Investment– Acquisitions of intangibles (IP)

Canada’s 2006 IB transactionsTransaction + Money in

(Bn C$)- Money out (Bn C$)

Goods trade 456 (exports) 404 (imports)Service trade 67 (exports) 82 (imports)Inv. Income (receipts+)

62 (receipts) 73 (paymts)

Portfolio Inv. 32 (sales) 79 (purchases)Direct Inv. 78 (FDI->C) 51 (C->DIA)

I.B. Entities

• Uninational Enterprises• Multinational Enterprises

– MNCs– MNPs

• Multinational Contractual Networks– Supply & distribution networks – Alliances between competitors

Six Forms of Separation

• Political Separation• Physical Separation• Relational Separation• Environmental Separation• Developmental Separation• Cultural Separation

Political Separation

Physical Separation

Political Borders Impede

• Movement of Goods: Customs • Movement of People: Immigration• Movement of Money: Currency

exchange• Movement of Capital: Regulation,

Taxation• Movement of Ideas: Censorship,

Firewalls

Physical Separation

• Natural barriers to movement of goods, people, and information.– Oceans– Mountains– DISTANCE

• Costs of – transport (goods)– travel (people)– communication (information)

Physical Separation

Relational Separation

Relationships, Trust, & IB Transactions

• Transactions rely on trust– Between buyers and sellers– Of public officials– Of intermediaries

• International transactions undermine trust– Lack of information about reputations.– More unforeseen contingencies make contracts

incomplete.– Unfamiliar legal systems– Distant and possibly biased courts

Environmental Separation

Environmental Separation: Why?

• Foreign countries are far away (phys. sep.)

• Far away countries tend to be different (env. sep.)– Climate – Surface and sub-surface resources– Topography (population density)

Environmental Separation: So What?

• Differences create opportunities for gains from trade

• Differences change consumer demands and require market adaptations in product attributes

• Differences raise difficulties for expatriate managers (“hardship” areas)

Environmental Separation: the coffee belt (top 10 in yellow)

Environmental Separation: wine producers

Environmental Separation: Tropical diseases

Developmental Separation

Developmental Separation: How to Measure it?

Two things that matter: life expectancy and extreme poverty

• Canada: 80.3 years, 0% live on <$1/day

• China: 72.5 years, 9.9% live on <$1/day

• Indonesia: 69.7 years, 7.5% live on <$1/day

• Nigeria: 46.5 years, 70.8% live on <$1/day source: UN Human Development Report 2007/2008.

Developmental Separation: How to Measure it?

• Economists focus on Real Income per Person (y), or the closely related gross domestic product (GDP) per capita

• The idea is to measure the total amount of goods and services the average person could buy (the “material standard of living”).

Developmental Separation

But keep in mind: averages don’t tell the whole story

A Big Problem for Comparing Country’s Development Levels• Prices differ a great deal across countries• Low average income countries tend to

have lower price levels (the Penn Effect) See figure• $100 can usually buy more goods and

services in a poor country than a rich country

• To compare standards of living we need to use special exchange rates, called PPP rates to convert local currency GDP per capita into price-adjusted incomes.

The “Penn” Effect

Developmental Separation: Why?

• Differences in income per capita arise mainly from – different rates of economic participation – differences in “capital”* per worker.

y =Y/N = (Y/L)(L/N)

*broadly defined (narrowly defined capital per worker cannot explain development differences)

Capital takes many forms

– Physical capital (plant & equipment)– Natural capital (rivers, sunshine, oil

reserves)– Human capital (skills from education &

experience)– Intellectual capital (patents & brands)– Social capital (trust, associations &

institutions)

Developmental Separation: So What?

• Income differences affect how much consumers can purchase and also the attributes of goods that they demand.

• Incomes differences reflect differences in capital endowments that determine worker productivity. Poor countries are often not cheap countries due to corruption, lack of infrastructure, etc.

Further consequences (?) of developmental separation

Cultural Separation

Cultural Separation: Two Mechanisms

I. Legacy of a predominately common heritage– We teach our children what our parents

taught us, which they learned from their parents…

– Examples: surnames, religion, language, politics, family recipes, home remedies.

Cultural Separation: Two Mechanisms

II. Imitation of “peers” ( local interactions)– Conformism (direct desire to imitate)– Social learning– Conventions (coordination)

Deal-killing Faux Pas

• Business card rituals– Do study carefully upon receiving– Don’t use as tooth pick, bend, shove in

pocket w/o glance, scribble notes, toss• It’s ok to act like a foreigner—within

limits!– When to bow– When to speak English– How to drink

The Takeaway

• Residence test is the traditional way to define international transactions.

• Transactions include trade, income, and investments

• Differences between nations both motivate and impede international transactions

• Don’t believe the small (or flat) world hype. Due to the 6 forms of separation, we don’t live in a global village (and perhaps we never will).